That will hardly come as a surprise, given the record revenues generated by banks’ FX businesses during a tumultuous third quarter in 2011 when the eurozone debt crisis threatened to spiral out of control and the Swiss National Bank shocked the market by imposing a floor in EURCHF. Fast forward a year and the market environment has changed markedly. Volatility in some currency pairs is down to levels not seen since the start of the financial crisis, while fears about the collapse of the eurozone have, if not disappeared, receded markedly. Deutsche Bank, the number-one bank in the currency market, according to the Euromoney FX survey, reported record FX volumes in the third quarter for the fourth consecutive quarter, but that did not translate into rising revenue. The bank said that while earnings across FICC were up 65% on the same quarter last year, currency revenues were “significantly lower than the prior year due to compressed margins”. Clearly, that is not a reflection of Deutsche’s FX business – it is one of the few units of the bank singled out for investment under the mid-term strategy plan of Anshu Jain and Juergen Fitschen, the bank’s new chief executives. Rather, it reflects the situation across the industry. Although banks do not break out revenue figures for individual businesses, Deutsche said rates and credit have been responsible for the rise in FICC earnings. That is a story that has been repeated across the street as this earnings season has developed, with Citi, Morgan Stanley and Credit Suisse among those reporting a jump in FICC earnings. Meanwhile, UBS, which this week announced a substantial reorganization that will see it shrink its investment bank and withdraw from a number of fixed-income businesses, said FICC revenues were up 20% on the third quarter of last year. UBS said FX revenues decreased in the third quarter, however, due to lower volume and reduced volatility. That was despite the Swiss bank seeing increased volumes and revenues from its electronic FX platform. Still, as it exits other businesses, UBS has maintained its commitment to FX, saying that its “leading foreign exchange business” will continue to be a “cornerstone” of the investment bank’s services. That the commitment comes amid falling FX revenues should not be a surprise. Indeed, falling industry FX revenues are a normal state of affairs, given the trend for higher FICC revenues. FX revenue generally has a counter cyclical trend against FICC revenue, surging when volatility picks up. That is what made FX such a large contributor to FICC revenues during the financial crisis. Now, as other markets come back amid at least tentative optimism about the global financial system, FX is likely to suffer, albeit from a high base. 2012 FX revenues “down 25%” One leading analyst that covers the industry believes FX revenues are going to be down 25% year on year for the full year 2012. He says the main reason for the decline will come from FX spot and short-dated options, while FX forwards, which generally align more closely to rate products, are going to do substantially better. “If you look at last year, we saw quite a big drop in fixed-income revenues, while FX was one of the few asset classes, along with commodities, that was up year on year,” says the analyst. “This year it is going to be the opposite. We see FICC revenue going up about 20%, while FX is going to be down about 25%.” He says there might be outliers that follow slightly different trends in FX, such as banks that have come from a low base and have invested in their electronic trading capabilities, or have certain captive client flows related to other parts of their business. “But I cannot see any big, major investment bank, which has a decent FX platform, doing better this year compared to what it did last year,” the analyst maintains. In truth, that should not be too alarming. FX revenues are simply normalizing after a stunning run triggered by the financial crisis that sparked unprecedented earning opportunities for banks. One leading FX bank, for example, made more money in FX derivatives in the third quarter of last year – a period when holiday-thinned markets traditionally used to make for limited opportunities – than it made in the third quarter of 2009 and 2010 combined. Indeed, the financial crisis changed the nature of the FX market, disrupting the natural rhythm that saw revenues accelerate in the first quarter, and then tail off in the second quarter and July and August, before rising again in September and the fourth quarter. As one senior FX banker puts it, the traditional shape of P&L in the FX industry was “thrown to the wind” by the financial crisis.
“That we had a massive crisis build up over the summer and third quarter of 2011 was a classic example of that,” he says. “But now we are back more to a normalized market, and we’ll see the traditional profitability play out through the year.”