The Decline of Trading Revenues: Challenges in the Financial Markets
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Just as London’s docks––once the world’s busiest-emptied when the tides of trade lapped new shores, the dealing rooms of the world’s biggest international financial market are being hollowed out. The buying and selling of bonds (“fixed income” in the argot), currencies and commodities have been the main source of profits for investment banks in recent years. In 2009, the world’s big investment banks earned nearly $142 billion from FICC––63% of their total revenue, according to Coalition, a data firm. By last year that had halved to nearly $74 billion, accounting for slightly less than half of the revenue.
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The latest drops are all the more surprising since the first quarter of the year tends to be particularly profitable for banks. Moreover, the quarter ought to have been especially lucrative this year given the brisk pace of corporate-bond issuance as creditworthy companies tried to lock in low borrowing rates. The disappointing numbers are rekindling an argument within the industry over whether FICC’s decline is merely cyclical or the start of a long-term in the profitability of banks’ trading businesses.
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The trend towards falling trading revenues is a global one, afflicting New York and Hong Kong too. But it is being felt most acutely in London, which is home to the bulk of European investment banks. Analysts expect Europe’s big banks to report even sharper drops in trading income than their American rivals. Huw van Steenis, an analyst at Morgan Stanley, reckons Europe’s leading investment banks, gave up about five percentage point of market share in FICC to the three leading American banks last year. They may lose another three points this year. Central banks’ strenuous efforts to keep long-term interest rates low are depressing bond trading. There is little reason to buy or sell bonds if the interest rates that determine their price are low and stable. Trading volumes may pick up again as central banks slow and eventually half their bond-buying, particularly if the retreat from “quantitative easing“ leading to jumps in interest rates.
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Yet deeper trends also appear to be at work. The most important is the growing weight of regulation. Banks everywhere are now required to hold more capital to underpin their trading. The Swiss rules are especially demanding, to the detriment of the two biggest Swiss banks, Credit Suisse and UBS. There is also a global push to shift derivative-trading to central clearing houses. Estimates vary as to how much of the sting these regulations is yet to be felt. Analysts at Citigroup, for instance, reckon that about two-thirds of the impact has already been absorbed, leaving revenues to decline by another 6-7%. Others predict that they still have twice as far to fall. It is probably safe to side with the pessimists. This is partly because bankers and analysts tend to underestimate the harm that regulation will inflict on revenues. But it is also because regulators are likely to push the trading of more instruments onto exchanges, where margins are narrower, as a result of market-rigging scandals affecting currency trading and interest rates.
