In a previous BLOG item we started to review Denis Mahoney’s address to the ACORD Forum in London Oct 17. That item ended with Mahoney’s view that our industry is on the cusp of change through convergence with the capital markets and in the use of technology. Mahoney then went on to review and compare where this had happened in two other similar situations: UK ‘Big Bang’ 1986 and the SWIFT Clearing System.

The UK stock market pre ‘big bang’ was marked by: fixed brokerages; restrictive practices with brokers and jobbers; face-to-face trading on the ‘floor’; limited trading hours; little use of technology; no foreign ownership or market practitioners. It was essentially an ‘old boys’ club.

On the 27th October 1986 the world changed: Abolition of fixed commissions on share dealing heralded the average rate falling from 2% to 0.2%. The abolition of separate stock brokers and jobbers led to a complete re-structuring of the market, with the arrival of market makers. The removal of the ban on foreign ownership led to US and European banks acquiring virtually all British merchant banks, brokers and jobbers; the workforce became global and diverse.

The aftermath of ‘big bang’ saw the traditional ‘outcry’ trading replaced by electronic screen based trading – SETS in 1997 and central counterparty facility for clearing and settlement in 2001. 20 years later in 2007, we see that transactions are swifter and cheaper; share trading volumes up 15 times, foreign exchange turnover up 25 times. The City overtook New York to become the world’s ‘money capital’. UK exports of financial services rose from £2 billion in 1986 to £23 billion in 2005.

According to Mahoney the lessons from ‘big bang’ are that: protectionism does not pay; trade and the national economy thrive where barriers to competition are dismantled; ownership of capital does not matter; efficiency of market does. Perhaps the most important lesson for our industry is that believing (as the stock exchange did pre ‘big bang’) that ‘my industry is too complicated and therefore it will never happen to us’ is the opposite of Chicken Little believing the sky was going to fall on his head when it never was.

There are some pre requisites for electronic trading: standards for communication and transaction processing and simplification and standardization of the insurance products. There is no need, in Mahoney’s opinion, for the differences that the market practitioners claim gives them each a USP.

What happens when a market trades electronically? We see greater transparency from: price discovery; who is trading and how much is being traded. It is a more level playing field that will lead to new entrants and greater integrity of the market. There will be lower transaction costs leading to lower margins for participants but much higher volumes. Inefficient players are forced out of the market. Non value processes are identified and engineered out of the market in a Darwinian fashion and there is a clearer understanding of value added functions leading to alignment of value-add and reward.

The next case study to which Mahoney referred was SWIFT. This is the industry-owned co-operative supplying secure, standardised messaging services and connectivity to more than 7,650 financial institutions in over 200 countries. The guiding principles of SWIFT are a common platform of advanced technology and shared solutions through which each participant can build competitive edge. SWIFT started life in 1973. The first messages came in 1977 at a volume of 3.4 million in year 1. In 1987 it enters securities dealing. By 1996 volumes have increased to 3 million messages per day. In 2007 we see 15.9 million messages per day. In the battle for capital this is the kind of environment that insurance will compete against.

Mahoney concluded with the following key messages:
• Electronic processing has started and will grow fast
• The convergence with capital markets has started and will stay
• Electronic trading will be the next big thing and participants will have to adopt it to survive
• We need: more standard products; creation of insurance indices; communication standards between systems and platforms and transaction standards (accounting and settlement)
• ACORD has a role to play

Believe him or not, it is food for thought.