First-quarter results from the big US banks show continued improvements in investment banking earnings after the strong second half of 2016.
Across the board, earnings from markets in the first three months of this year were 33% higher than in the first quarter of 2016, with revenues up 24% in FICC. Since the crisis, the banks have adjusted their models. And the markets have recently provided the right mix of volume and margin for FICC to become once more a bright spot.
The difficulty now is in equities.
Realized stock market volatility, depressed for over two years, remains close to historic lows. Volumes are constrained, margins are thin, technology costs and market data expenses are high. This now looks like a cyclical downturn turning into a structural issue that requires business model changes and even high-level consolidation.
That M&A wave is now beginning, though not among the big investment banks, where the top four – Morgan Stanley, Goldman Sachs, JPMorgan and Bank of America Merrill Lynch – already own a combined 50% share of global equity market sales and trading revenue.
Rather, M&A is underway among the very tech-enabled, low-headcount, high-speed traders that have driven efficiency and crushed margins in the equity markets.
In April, Virtu Financial agreed to acquire KCG in a $1.4 billion deal. This combines a leader in algorithmic trading powered by a global and scalable market infrastructure platform that automates market making and post-trade processing, in Virtu, with a longer-established customer franchise, in KCG, which is both a market maker and an agency execution provider to institutional investors and to retail equity platforms. The transaction sees a principal and market infrastructure business buying a customer franchise with higher revenues but lower profitability.
If the deal closes on schedule in the third quarter, Virtu will acquire a customer business that may well benefit if more institutional investors in the US embrace agency execution and transaction cost analysis in the way their peers in Europe have been forced to by Mifid II.
A new high-speed, algorithmic market-making bulge bracket is emerging with the enlarged Virtu, Citadel Securities, Susquehanna and others even as overall cash equity trading volume fell by around 8% in the first quarter of the year and margins continue to shrink.
The big banks will have been hoping that a painful slowdown for them might put some of the new high-speed market makers out of business and bring a chance to re-price liquidity at wider bid-offer spreads. But not all the new kids on the block are fading away. Some are scaling up. Competition could be even tougher.