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Financial sector leaders have more in common with global supply chain managers than they realise, asserts Fung Global Institute President Andrew Sheng. He explains why financial supply chains, just like those delivering consumer products, need to re-engineer as the global economic balance shifts towards emerging markets.
Most people think of supply chains as multiple firms assembling and processing inputs of raw materials and components for a global assembly line that delivers finished goods to consumers wherever and whenever they are wanted. Japans twin earthquake-tsunami and nuclear disasters, which halted production at a plant responsible for 60 per cent of components on which many global supply chains depend, have forced a re-assessment of the resilience of global supply chains. Such vulnerabilities are not confined to the real sector. The finance industry has also suffered its own near-meltdown. The failure of Lehman Brothers in 2008 not only roiled financial markets around the world but, more scarily, brought global trade to a near-standstill as wholesale banks refused to fund each other for fear of counter-party failure. What was once a simple banking system of collecting retail savings to fund the credit needs of borrowers has, with technology and financial innovation, evolved into a highly complex and global supply chain in its own right. Supply chains possess three key characteristics that are shared by both the finance and real sectors: their architecture, feedback mechanisms and processes, upon whose interactions their robustness and efficiency depend. In the architecture of finance, as with other supply chains, interdependent networks tend to concentrate in dominant hubs. For example, just two financial centres, London and New York, dominate international finance, and 90 per cent of all foreign exchange trading is conducted by only 22 players. Such concentration contributes to greater efficiency due to economies of scale. But it also contributes to greater systemic risks, because if the leading hubs fail, the whole system can fail. Secondly, open feedback mechanisms are critical to all supply chains since they ensure the systems ability to respond to changing environments. In the case of financial supply chains, feedback mechanisms have the additional power to amplify shocks until the whole system blows up, as we saw with the Lehman collapse in 2008, which threatened the cascading failure of investment banks, AIG and other financial institutions. Thirdly, the processes within supply chains, and the feedback interactions between them, can make the system larger or smaller than the sum of its parts. Since a complex network comprises linkages between many sub-networks, individual inefficiencies or weaknesses can impact the viability of the whole. Several factors for fundamental global change are converging in such a way that financial supply chains, like those delivering consumer products, are being re-engineered. Finance faces the same transformative challenges as the real sector as the global economic balance shifts towards emerging markets, billions of consumers enter the middle classes in the developing world, new social networks evolve through technology, and climate change becomes a factor in global commerce. Major financial and regulatory reforms currently underway will impose new and higher capital, liquidity and transaction costs on the financial sector. The financial sector is also under pressure to come up with new financial products that can help the real sector manage more complex risks whilst also enabling investment in areas of opportunity, such as green technology and much-needed infrastructure for developing economies. There are other promising drivers of change. It is now abundantly clear that global financial stability depends upon greater cooperation at the international level, with tighter enforcement of rules at the national level. It is also clear that emerging markets are searching for alternative growth models that are green and sustainable. Their financial sectors will have to operate very differently from the current model which is driven by consumption finance.

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In a world where both consumption and finance must slow to cope with restraints imposed by finite planetary resources and global warming, business strategist Umair Haque has posed five important questions that are worth transposing to the world of finance. First, Haques what is the role of marketing in a world where consumption must slow? becomes what role can finance play in reducing addictive consumption, funded by unsustainable leverage? Consumption by advanced countries must slow to re-balance their fiscal sustainability, whilst the growing share of emerging market consumption will drive global growth. But the emerging- market lifestyle cannot emulate the current model of wasteful consumption that is eroding the natural world. It must change to a way that is less wasteful on natural resources, and be both green and financially sustainable. The financial sector, therefore, must tailor its services and products accordingly. Second, what is the role of distribution in a world where consumption, savings, and investment will accelerate in volatility? These transformative times have radically altered risk profiles. The financial sector has a rare opportunity to help customers manage new risks and to promote services and products that deliver higher real returns from hard-earned savings. Such risks can only be successfully managed in a supply chain that distributes them to where they can be managed properly. Financial institutions will have to monitor and manage risk in a radically different manner, both for themselves and their customers. Third, Haque also questions the role of production in a world where consumption becomes savings. The current mode of financial production is top down. Instruments are designed in such a way that their sales generate more profits for financial engineers than for end users. However, technology, through the rise of interactive social networking, has made financial innovation more bottom-up. Millions of bank customers using mobile phones can provide immediate feedback on what products and services they like or dislike. In the future, client wealth and transaction management systems will get more input from customers more frequently so that product design is shaped interactively. Fourth, Haque challenges the role of strategy in a world where the game is no longer about winning more consumption than rivals are able to achieve. Current strategy in the financial sector drives excessive competition through the growing of market share at the expense of rivals, often breaking trust with customers and compromising tomorrow for today. The value chain of trust between the finance sector and their customers has been broken. Yet the financial sector has, in previous eras, proven it can operate as an important public good by providing trustworthy, efficient services. The winning financial network will therefore be the one which restores confidence that it shall offer the greatest public good of safe, stable and efficient financial services to the most clients. Finally, Haque talks about the role of innovation in a world where greater investment will flow into reinventing moribund industries. Innovation in the last century was about upgrading processes, products and services. With the current failure of trust, what the financial sector needs, now, is innovation of a more fundamental and altogether-higher order, involving business models, strategy and management that restore trust in finance. Just as Apple is transforming the computer industry through lifestyle products and trust in highly-reliable, user-friendly and cool services, financial institutions will have to introduce new value chains that restore trust and fit the growing needs of new markets. Given such profound changes, finance leaders should think about how to orchestrate the new financial supply chain that becomes the winning killer app for a new era.