Deutsche Bank: The Bond Industry’s Reform Will Lead To Further Consolidation

by Trefis Team
Morgan Stanley
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German banking giant Deutsche Bank (NYSE:DB) recently released a report highlighting rather grim prospects for the global fixed-income, currency & commodities (FICC) trading business over the coming years. [1] In the report, which attempts to predict the impact of impending regulations on the fixed-income trading business, Deutsche Bank claims that global investment banks will have to contend with a $17-billion reduction in revenues from this business over coming years. This figure represents a little less than 10% of the total FICC trading revenues generated by all investment banks for 2012.

But this drop in revenues is not the industry’s biggest concern according to Deutsche Bank, which believes that market players with less than 6% share run the risk of being forced to close their FICC trading units. If Deutsche Bank is indeed foretelling the future accurately, then JPMorgan (NYSE:JPM), Barclays (NYSE:BCS), Citigroup (NYSE:C), Bank of America-Merrill Lynch (NYSE:BAC) and Goldman Sachs (NYSE:GS) are at risk the least thanks to their greater-than-6% share. On the other hand, HSBC (NYSE:HBC), RBS (NYSE:RBS), Morgan Stanley (NYSE:MS), Credit Suisse (NYSE:CS), BNP Paribas and Societe Generale who are on the wrong side of the cutoff figure are likely to give serious thought to shuttering or changing what was once an extremely lucrative business. Deutsche Bank excludes itself from the report, although its strong presence in the currency market in particular would put it on the first list.

See the full Trefis analysis for Deutsche BankBarclaysJPMorganBank of AmericaCitigroupGoldman Sachs

FICC trading is arguably the most potentially lucrative business for an investment bank with most of the big banks making a sizable chunk of their total revenues through FICC trading to this day. But the business has drawn considerable flak since the global economic downturn of 2008 due to its capital-intensive and volatile nature. And as regulators around the world try to find ways to make the bank’s take less risks with their cash, debt trading activities are expected to see a significant reduction over the coming months and years.

There are a multitude of factors that will bring about this decline. Firstly, the increased capital requirements for banks as mandated by the Basel III norms are already forcing banks to trim their FICC business in order to release some of the held-up capital. Secondly, tighter regulations aimed at reducing counter-party risks which are likely to be imposed in the near future will raise the margin and collateral requirements for clients – which would eventually result in lower client trading activity. Thirdly, banks are no longer free to use their own capital to indulge in trading as a part of the proprietary trading ban under the Volcker Rule. And finally, bond and derivatives trading would also be moved to exchanges soon resulting in a further reduction banks’ trading activity.

Deutsche Bank estimates the combined impact of all these factors on FICC trading revenues for investment banks to be nearly $17 billion. While this decline is not really drastic, the German bank claims that its impact on the market players will be exaggerated by the higher costs associated with the business once all the regulations are in place – so much so that FICC trading may no longer remain profitable for banks who do not have the advantage of huge volumes on their side.

This is what leads to a rather unsettling conclusion from Deutsche Bank – that all investment banks with a market share of less than 6% in the FICC trading industry run the risk of being forced to shut their trading shops. The bank quotes the example of Swiss banking giant UBS (NYSE:UBS) which is already in the process of exiting the business.

If Deutsche Bank turns out to be accurate with this forecast, the the irony of the situation is too big to be ignored – tighter regulations aimed at ensuring that super-sized investment banks don’t take untoward risks with their money will further reduce the number of dominant players in the industry. As a result some of the too-big-to-fail banks will only get bigger.

What remains to be seen is how the situation actually plays out in the near future.

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  1. New rules to wipe out $17 bln in bank trading revenue-report, Reuters, Apr 22 2013 []
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