Tuesday, April 23, 2013 12:41:47 PM

New models beckon as reforms drive broker revenues down

New rules on OTC derivatives will accelerate the shift of investment banks' fixed income, currencies and commodities (FICC) business to electronic trading over the next three years, a new report has found.

Deutsche Bank yesterday released a report on the impacts of new swaps regulation on future investment banking income in Europe, which suggested pressure on margins would herald further consolidation.

It found that changes introduced under the European market infrastructure regulation (EMIR) and proposed revisions to the Markets in Financial Instruments Directive in Europe (MiFID) reinforced the migration of FICC business to commoditised electronic trading already underpinned by capital and liquidity requirements of Basel III.

Both the Dodd-Frank and EMIR have introduced reporting and central clearing rules for derivatives. Under MiFID II standardised OTC derivatives will be traded on exchanges or electronic trading platforms, such as organised trading facilities or multilateral trading facilities.

The report said the push to move derivatives on to exchanges or alternative venues will see banks lose the ability to warehouse. The loss of revenue in G-10 rates trading would be felt most sorely because it is "the most lucrative part of the investment banking FICC complex".

"We expect the general trend of FICC trading moving to electronic venues to accelerate over the next two to three years. MiFID2 in 2015 may end up being the capstone to these changes, rather than the starting point," the report said.

 "This will leave investment banks charging for market access, and less able to extract rent," the report said.

As a result, investment banks could face a loss of US$17 billion in sales and trading revenues by 2016.

European banks were more at risk than US banks because of dependence on swaps revenues and the Financial Transaction Tax being considered by 11 euro-zone states, the report said.

Even though electronic trading tended to be more transparent and cheaper, the overall costs of trading may rise as a result of collateral requirements, said Deutsche Bank. As well as reducing margins and increasing costs in the long term, the migration of OTC derivatives would be particularly painful in the short term.

"We expect dual running of systems to put upward pressure on costs, making downward pressure on compensation more important than ever. We think the long-run results of these changes will be a wave of industry exists from FICC sales and trading by second tier players."

The report described banks with less than a 6% market share as "at risk" of exit from full-service FICC sales and trading.

The closure of smaller institutions could lead to further concentration, with the top five FICC houses controlling 55% of the market in the next three years, up from 46% in 2012 and 36% in 2007, the report said.

Paloma Migone +44 (0) 20 7397 3815