Posted by Charlie Morrow on Tue, Apr 29 2014

All Posts by Charlie Morrow

Experiencing diFICCulties? [sic]

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During banks’ 2012 earnings, capital issues seemed to be causing all the problems. However during the recent Q1 2014 earnings seasons for banks the focus has been on fixed income performance. Throughout April, we saw first the US banks, then the European banks, all largely reporting that their profits have been severely hit by poorly performing fixed income, currency and commodity (FICC) trading performance.

FICC has normally been considered the main profit hub for banks, however regulations, bringing in higher capital requirements (as seen with Basel III) and more stringent regulatory oversight (as seen with the US Volker Rule) have effectively limited the amount of risk that banks can take when entering into a trade, and they cannot use their balance sheets to warehouse debt like the used to. Banks are subsequently looking to create efficiencies (as we’ve sadly seen with the reduction of FICC professionals that they hire) or look to evolve and change the way they do business and run their order book.

While the commodities aspect of FICC businesses largely raised overall performance – the severe winter in the US lifting things in Q1 somewhat – it was the fixed income businesses that were more exposed to macroeconomic headwinds and regulatory adjustment, which have pulled things down, particularly in rates and currencies trading. This is of course a little bit of a generalisation as not all banks struggled, but you’ve certainly seen several US banks and several European banks all being impacted. And despite some good performance in commodities, we also recently saw J.P.Morgan sell off its commodities business, perhaps a sign of no faith in this line of work.

As regulations bite and these businesses become less profitable, one also needs to bear in mind that the slice of the pie was also fairly small. With many of the leading investment banks being in this space, it was a crowded one, and when volumes contracted post-2008, things got more fraught. Some have already started to pull-out – UBS being a prime example – while some banks recently stood by fixed income products, anticipating a surge in volume as interest rates in the US and Europe improve.

FICC is clearly not going to go away as a business for banks, and while things may not pick up for some time, those banks that remain in this space can probably expect to benefit from the market when it does. However from reading the analysis in the media, and from listening to some of clients too, the onus seems to be on the banks to take their businesses forward in a different way – one thing is clear that taking a profit off the spread is a rarer opportunity than it used to be, and a new approach to fixed income, where the bank’s role is changed from how it traditionally made markets, could be the best step forward.

Banking, Basel III, Electronic Trading, Regulation, Volcker,
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