Regulation to diminish banks' fixed income gains – Bernstein
trading may have boosted US institutional broking revenues in Q1 2011, but new legislation impacting bond trading will cause banks to adapt
their business models to maintain returns.
The warning comes as part of the latest ‘US capital markets quarterly’ research from Bernstein
Research, an arm of US broker Sanford C. Bernstein.
“As concerns about the US economy gave way to
greater confidence that the economy could be gaining momentum, investors began
a typical sector rotation to credit-sensitive assets from low-yielding
governments. Corporate bonds, mortgage, and high yield rallied as spreads
tightened, and a number of identifiable trends provided opportunities for
trading desks to take advantage of increasing flow as clients repositioned,”
stated the research, noting domestic investment-grade debt volumes reached
their highest in Q1 2012 since Q1 2009.
While a rebound in the US
economy led to a rise in US equity markets, the report noted the trading
environment was challenging and banks are likely to post lacklustre
commissions. The decline in equity performance was offset by slightly increased
equity derivatives trading activity, which the research said was due to
But the report cites new rules
– namely the Volcker rule and Basel III – as potential impediments to future
fixed income growth given their impact on banks’ market making activities.
Basel III, which will be
introduced on a phased basis in the coming years, will require banks to hold
capital against fixed income assets held on their balance sheet based on a
risk-weighted calculation. The Volcker rule ban on proprietary trading
introduced in the Dodd-Frank Act does include exemptions for market making, but
a number of market observers, including US broking trading body the Securities Industry and Financial Markets Association,
have said the rule will limit the scope for the facilitation of customer
“Volcker will change the way
fixed income units operate within banks, raising the costs of liquidity and
trading to market participants,” read the Bernstein Research note. “It will
shift the competitive landscape and provide an opportunity for non-bank broker
dealers to take share from the banks.”
The research highlighted
efforts by Goldman Sachs to modify its business model in light of the regulatory
changes, including greater automation of market making activities, a
reduction of staff on the trading floor and a decrease in overheads in an attempt
to enhance business margins.
“Trading desk use of the
balance sheet is being tightly constrained. Balance sheet composition is being changed
to optimise returns on risk-adjusted and Basel III capital, and to prepare for
the challenges of Volcker,” said the report.