Bloomberg/ Los Angeles
Almost 20 years ago, when Susan Estes was running Deutsche Bank AG’s fixed-income desk in New York, she’d field calls from clients looking to put on $4bn spread trades in the US Treasury market.
Plenty has advanced from those days. Trades don’t require a phone call anymore and are executed faster than ever, and the Treasury market itself is four times as big as it was. But one key element has regressed: Banks’ willingness to take on risks of that size. To get the same rate as Estes would’ve charged on that $4bn trade, clients today could only pull off $250mn, she said.
“You can only do one-sixteenth of the size, that’s what’s remarkable,” said Estes, a trading executive at Morgan Stanley and Deutsche Bank who is now chief executive officer of Treasuries trading system OpenDoor Securities.
And of course with smaller size comes less revenue. The $1.25mn generated on the $4bn trade would be just over $78,000 on the $250mn deal.
Her example depicts the new reality on Wall Street – one of lower risk, smaller paydays and fewer humans. Banks’ trading desks bounced back more quickly from the financial crisis than almost any other part of the economy, but since then it’s been a steady bleed as new rules left traders with less money to deploy, regulators looking over their shoulders and managers focused on avoiding a blowup. It’s all left the big risk takers at risk themselves.
More than a decade after the crisis, markets that are finally moving into the modern technological age and more stringent capital rules are creating a secular slump in Wall Street’s biggest business. And 2019 is poised to set a new low with the sixth decline in the last seven years.
Trading income at 12 of the largest global investment banks plunged $39bn from 2010 to last year, according to data from analytics firm Coalition. Adding this year’s slide, it’s roughly the equivalent of both Goldman Sachs Group Inc and JPMorgan Chase & Co vanishing.
The list of reasons is as numerous as the quarters when global banks preached patience to frustrated investors. And all signs are pointing to new threats as traditional competitors and new ones see the weakness as a chance to strike. Plenty of rivals are taking aim at the bond market – already the biggest driver of Wall Street’s revenue slump – and trying to make it more closely resemble the fast-moving, electronic, low-margin world of stocks. Some marketplaces are trying to cut banks out altogether.
In the early years of the slump, the debate was whether it was fleeting or permanent. That has morphed into just how low it will drop before it finally bottoms out. Last year’s $110bn revenue haul at the 12 firms was down from $149bn in 2010, and the biggest firms are down more than 5% through the first nine months of 2019.
Morgan Stanley investment bank chief Ted Pick said earlier this year that the firm’s decision a few years ago to cut a quarter of its fixed-income trading staff was due to “the secular challenge of a declining wallet.” JPMorgan CEO Jamie Dimon said in September that volume will continue to go up, but that doesn’t mean revenue will.
“The battle is more in the technology world at this point than in just having brilliant traders,” Dimon said. “Over time, it will grow, but some of the margin will come down. And how that offsets each other, I just don’t know.” About one-third of the $39bn drop has gone to smaller firms, said Roger Rudisuli, a senior partner at McKinsey who heads its capital markets practice. The other two-thirds “has just disappeared” as expanded electronic trading and new competition has reduced the margin banks earn by trading with clients, he said.
For a business as wide-ranging as one that deals in stocks, options, government notes, corporate debt, currencies, commodities, options, credit derivatives, leveraged loans and municipal bonds, the factors for the decline are plenty. Some of the most lucrative pre-crisis products, like synthetic collateralised debt obligations, have disappeared, as have proprietary trading desks that brought in almost $5bn a year for the biggest US banks.
Hedge funds, typically banks’ most active clients, have suffered outflows while struggling to outperform lower-cost funds. In August, assets in passive US index-based equity mutual funds and ETFs topped those in active stock funds for the first time.
Add to these the new financial regulations including restraints on bank capital, quantitative easing, a near-zero interest rate environment, political uncertainty and whether there is too much or not enough volatility in the market and the recipe for banks losing revenue becomes clear. Job cuts have naturally followed.
Citigroup Inc slashed hundreds of trading positions, Deutsche Bank exited equities sales and trading while laying off thousands and HSBC Holdings Plc and Societe Generale SA are also eliminating hundreds of workers.
“There’s a lot of things going on in the world,” Marty Chavez explained in a Bloomberg Television interview shortly after announcing he was stepping down from his role as co-head of Goldman Sachs’s trading business.
“I would say regulatory change is a part of it; interest rates; quantitative easing for very long periods of time; the cleanup, the aftermath of the financial crisis; the rise of technology – one of the most deflationary things that exists; the availability of data, broadly disseminated, to everybody; and derived data or analytics on the data. All of these things have combined.”
Larry Tabb, founder of research firm Tabb Group, described Wall Street’s business model as consisting of moving and storage. Moving is the trading side, storage is holding securities as inventory for customers over the short term. Both are threatened.
On the moving side, market makers and quantitative trading firms such as Citadel Securities, Jump Trading LLC, and Virtu Financial have elbowed their way into equity markets with new technology and less regulation and have started to turn their sights toward fixed income.
Capital rules have limited banks’ ability on the storage front and pushed some of those functions to the buy side.
Risk constraints on bank traders are so tight now that in many cases small-scale deals are off the table, he said. Goldman Sachs’s value-at-risk – a measure of how much a bank’s traders could lose on most days – was $55mn in the first nine months of this year. While the calculation has gone through plenty of tweaks, it was more than quadruple that a decade ago.
“They’re not even looking for singles, they’re looking for bunts,” Tabb said of the banks.
Other factors have heightened the pain. Extended low rates – or even negative rates in many parts of the world – have damped appetite in bond trading, said Blu Putnam, chief economist for CME Group Inc, the world’s largest futures exchange. Mayra Rodriguez Valladares, managing principal at New York-based MRV Associates, which trains bank examiners and finance executives, points to the uncertainty caused by trade wars. Mark Williams, a finance lecturer at Boston University’s Questrom School of Business, chalks some of it up to Fed policies that have effectively capped volatility.
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