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Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks |
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The sales and trading stumbles were embarrassing for senior managers and could feed into a broader reassessment of the post-crisis conclusion that flow is king and an emphasis on structuring a thing of the past.
Structuring provided a bright spot for some firms in the third quarter, and it is increasingly apparent that the opportunity for embedded proprietary risk-taking in client business lines will be key to future investment banking outperformance.
An indication of how this is likely to play out can be seen in the steps taken by market leader Goldman Sachs to cope with the new regulatory environment, including Dodd-Frank limitations on proprietary trading.
Goldman made a big play of the closure of its well-known Principal Strategies group. The bank sent public best wishes to nine US traders led by Bob Howard, who moved to KKR. The likely success of Pierre-Henri Flamand, former London-based co-head of Principal Strategies, in raising capital for his new fund and of Morgan Sze, the other co-head, in launching an Asian fund, also received widespread coverage.
But while its biggest in-house stock-based trading unit may have been unwound, Goldman has not been forthcoming on how it intends to deploy or redeploy the members of its Special Situations group.
This team specializes in structured positioning, often in distressed debt markets, an area that works best when combined with a client business that can be used to source opportunities and the accompanying complex hedges that are needed to make deals pay off.
Goldman announced a 37% decline from the third quarter of 2009 in the fixed-income, currency and commodities unit that is the engine of its profitability, citing “significantly lower net revenues in interest rate products and credit products”.
Goldman was toppled from its longstanding position as the clear leader in FICC revenues during the third quarter and was simply one of a pack of top dealers. It recorded a $3.77 billion total that was only just above the $3.5 billion from each of Bank of America and Citi and was not far above the equivalent of Deutsche Bank’s €2.2 billion.
That will almost certainly make Goldman reluctant to cut back further on embedded position-taking within its fixed-income franchise.
Credit products were among the weak spots for Goldman, compared with the third quarter of 2009, but a number of other dealers found that structured credit helped to offset the broad softening in trading volume this summer.
Deutsche Bank noted that client solutions activity in credit increased, although revenues in flow credit were lower.
UBS, which suffered a serious third-quarter setback to its overall mission of re-emerging as one of the biggest sales and trading franchises, at least turned in decent credit results. Its credit revenues rose over the second quarter to SFr587 million ($593 million), driven by strong performance in client solutions – the post-crisis phrase adopted by most dealers for structured credit.
The challenges of the third quarter, when customer volumes were lower than expected and revenues were compared with exceptionally strong results in the same period in 2009, will not cause big players to withdraw from a commitment to win flow market share. The foreign exchange and interest rate markets remain key sales and trading revenue sources, even if most houses struggled to match the numbers racked up last year. And investment banks will remain keen to portray themselves to investors and supervisors as firms with a focus on meeting fundamental client needs.
But the reminder that these markets ebb as well as flow has come at an awkward time for many banks.
The firms that have hired an assortment of new managers to build or rebuild market share are likely to have a particularly fractious end to the year. That could be followed by a contentious bonus season, at least for managers who do not have compensation guarantees.
Bringing together disparate senior investment bankers is not easy at the best of times and relations could become particularly strained now that the third-quarter results have provided a reminder of the challenges ahead.
Morgan Stanley chief executive James Gorman, who is not an investment banker by background, made little attempt to hide his disappointment with the firm’s fall in overall sales and trading revenues to $1.4 billion. “I am not satisfied with our overall performance… we still have considerable work to do across the firm,” he said in the bank’s quarterly earnings announcement.
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His counterpart at UBS, Oswald Grübel, a veteran of many investment bank business cycles, was more upbeat in his comparable public statement and expressed confidence in meeting the firm’s medium-term goals. But with the UBS investment bank recording an unexpected quarterly loss, the bankers hired to revive the franchise will be under no illusions that the clock is ticking on their experiment. This urgency and the broader peer group realization that building an efficient flow engine will not guarantee decent future sales and trading returns is likely to fuel an increased interest in structuring in 2011.
That in turn is likely to prompt many banks to edge back towards increasing the proprietary exposure that they embed in client-facing sales and trading businesses.
Early indications from implementation of the Dodd-Frank legislation are that US regulators will be satisfied with token gestures to unloading standalone proprietary dealing units by banks, without much interference in the details of core business lines.
European supervisors have shown even less interest in disrupting the sales and trading status quo.
That is likely to lead to a steady increase in embedded risk assumption next year, as banks try to revive their stalled sales and trading engines.
