Citigroup has scrambled hard to snatch a bigger slice of that collapsing pastry in recent years. Greenwich Associates suggests that its market share in secondary European fixed income grew from 6.2% in 2012 to 7.7% in 2013. But Gerspach says, ominously for the firm’s traders, that Citigroup continues to cut expenses and reduce capacity.
JPMorgan reported a 21% decline in revenue from fixed-income markets for the first quarter of 2014 compared with a year earlier, blaming lower levels of client activity. At Bank of America, first-quarter FICC revenue declined 15% from a year ago after adjustments.
So the question of whether fixed-income trading revenues can revive if volatility returns to the rates markets as the Federal Reserve normalizes and the European Central Bank flirts with quantitative easing is a big one for bank shareholders.
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In the run-up to these poor first-quarter numbers, analysts at Citigroup noted that wholesale bank valuations are largely being driven by their FICC dependence and that markets remain deeply sceptical of the FICC business model – revenue outlook, profitability, market positioning, as well as litigation risks. Investors won’t be encouraged, then, to read of new plans to bring trade-execution algorithms to the cash market in US treasury bonds, operating across the order books of some of the biggest dealers. Even following recent declines, those big FICC revenues for the banks suggest that there is much more fat yet to cut in margins on fixed income.
Those revenues constitute a substantial transfer of wealth from investors who pay to cross the spread when buying and selling bonds to the dealers. In a low-rate, low-volatility world, real-money fund managers and hedge funds are focusing on how to increase efficiency in bond-market trading and reduce the friction costs and slippage that consume a high proportion of the moderate alpha that portfolio managers can generate.
Transaction cost analysis is still rudimentary in the opaque and over-the-counter fixed-income market, but the growing proportion of trading done electronically – Greenwich Associates suggest it passed 25% last year – will change this.
The game isn’t up for the banks in fixed income but it is set to change fast. In the credit bond markets, the IMF is sounding the alarm on secondary bond-market illiquidity.
If banks no longer have the cheap capital and funding to take principal risk onto their balance sheets, then they must do a much better job of broking the bond markets and connecting buy-side clients with potentially offsetting axes.
Firms such as Algomi and CodeStreet are pioneering new systems to capture and mine the data often lost inside big banks’ fixed-income sales and trading floors that might enable this.
And if the big FICC houses think they can find some revenue respite in the foreign exchange markets, they can think again.
Even aside from the current furore over investigations into potential malpractice in FX: for the time being at least, what was seen as one of the key markets to be in post the financial crisis is under pressure. Volumes are way below their highs of from Q4 2012 to Q1 2013. Traders put this down to a lack of volatility, but they see little sign of it returning for now.
The move to electronic trading is accelerating; margins are getting tighter (no sign of oligopolistic pricing here), as competition and transparency grows, and the costs of maintaining a leading tech platform, once built, never go away.
Layer in the increased legal and compliance costs that all foreign exchange banks now have to endure, not to mention the fines that they fear they’ll inevitably have to pay, and making a profit in what is already the lowest margin market in the industry is getting harder and harder.
To mangle the old saying: FICC ain’t what it used to be.