Investment bank fixed income revenues have fallen by less than expected in the second quarter of 2014, with a shift towards more liquid products helping to improve their profitability.
At the end of Q1 this year, most banks were predicting a dire outlook for their fixed income, currencies and commodities (FICC) businesses but, while revenues have largely continued to slide, they have performed far better than predicted.
Some have even managed to reverse the decline, with Bank of America Merrill Lynch reporting a year-on-year increase in FICC revenue of 5% to US$2.4 billion. Credit Suisse fared even better, seeing FICC revenue climb 14% year-on-year but is less confident of long-term prospects and has plans to cut the size of its interest rates trading business by 40% and exit the commodities market.
Other banks fared less well. Morgan Stanley and Citi both reported a 12% fall in FICC revenue while Goldman Sachs income dropped 10% and JP Morgan’s fixed income business was down 15%.
The impact of regulatory changes, particularly Basel III, which force banks to hold more capital for risky positions, has been blamed for the fall in FICC as banks are unable to hold as much product inventory or take on risk on behalf of clients as in the past. They are also facing increased competition from third party platforms offering trading in fixed income directly between market participants.
Stu Taylor, CEO of fixed income software specialist Algomi, said banks have been able to soften the impact of these regulatory changes by changing their approach to the fixed income market.
"What we're seeing is banks are concentrating risk in the more flexible and liquid securities, effectively playing in a safer part of the market due to regulation,” he explained.
Many have also trimmed operating expenses in FICC to limit the scale of losses.
The shift into more liquid fixed income products is set to distort the market for some time, according to Taylor.
"Oddly, already liquid securities are becoming more liquid, as everyone piles into them, while the tail-end of illiquid names is becoming less liquid."
However, he believes this trend will be short lived and investment banks will be forced to reform the way they do fixed income business in order to maintain profitability.
“Over the longer-term, margins at the highly liquid end will start to become compressed and banks will need to look at how they can operate profitably in less liquid securities, and we remain focused on helping them to scale their profitability so they can attack the tail-end of the market," he added.
Several banks also saw difficult equity trading conditions, with Goldman Sachs, Bank of America, JPM and Credit Suisse all reporting a fall in revenues for their equities businesses. Despite this, most saw positive earnings across their broader business, largely due to improved primary market conditions and corporate banking activities.