The global financial crisis has led to the development of a new class of intermediary in the European fixed income market, according to a white paper published by Pershing, a provider of outsourced clearing and execution services.
The withdrawal of investment banks’ balance sheets from both capital raising and execution, as a result of tighter regulation and greater risk aversion, has paved the way for new entrants to a rapidly growing fixed income marketplace, dubbed ‘new merchant banks’ in ‘European fixed income: ready for lift-off’, a report commissioned by Pershing, a subsidiary of US financial services group BNY Mellon, and written by business and technology consulting firm Investance.
A surge in fixed income issuance, notably in the corporate sector, has created opportunities for new players as large banks reduced their balance sheet commitment to capital raising, the white paper suggests. “There were fewer IPOs in the market, which pushed a lot more people towards issuing paper as debt, which had become a cheaper way of raising money in the interest rate environment,” Scott Coey, director and head of institutional relationship management and business development at Pershing, told theTRADEnews.com.
Fixed income issuance was also boosted by governments’ attempts to kick-start flagging economies during the crisis. “In addition to the increase in corporate debt issuance, sovereign debt issuance also grew, giving greater liquidity to high rated paper,” said Coey. New entrants have also been active in fixed income instruments that devalued sharply during the crisis. According to Coey, “These new firms saw the potential for price recovery in mortgage-backed securities and distressed debt and the opportunity to act in an advisory and an execution capacity for these instruments.”
The increase in issuance and trading opportunities coincided with large investment banks cutting staff, resulting in a pool of talent looking for a new challenge. The burgeoning fixed income market was an obvious choice. “A lot of ex-heads of European business at investment banks saw new opportunities in the market to act as an intermediary between the buyers and sellers of this debt,” said Coey.
The financial crisis – and particularly the collapse of US investment bank Lehman Brothers – brought about a heightened awareness of counterparty risk that allowed the new firms, whose founders already had good relationships with their prospective client base through their previous roles, to lure business away from the big hitters. “Instead of putting everything with one large house for prime services, investors have separated their businesses out by asset class to take advantage of the niche services provided by these ‘new merchant banks’,” said Coey.
Pershing estimates that anything between 50-100 firms have entered the European fixed income markets, but the paper says some are simply seeking to capitalise temporarily on the wide bid-offer spreads that have been seen over the past year. It estimates that only 20-30 of the newcomers have a longer-term plan.
Unlike the large banks they hope to supplant, however, the entrants do not have large balance sheets to support client execution, and so are using outsourcing solutions, and effectively borrowing the capital bases of their service providers. “In this way, the lending of balance sheet in the settlement and clearing space has enabled the new merchant banks to focus on building their service offerings and on marketing their core expertise,” the paper read.