When Lehman Brothers collapsed almost exactly two years ago last week, the subsequent sell-side consolidation fell short of many expectations. Bear Stearns had already been acquired by J.P. Morgan in March, Dresdner Kleinwort was bought by fellow German outfit Commerzbank on 1 September and the takeover of broker-dealer Merrill Lynch by Bank of America was confirmed on the day that Lehman filed for bankruptcy.
Since then, the brokerage business has been surprisingly resilient. Many firms were, of course, propped up by government money while they restructured, but these funds have been largely paid back. Some banks avoided any handouts at all, such as the UK's Barclays, which was able to spend money on a reasonably priced set of US trading operations (one careless owner).
During this period, the brokers that were thriving or had the resources to make a grab for market share went hiring the staff that other firms had to let go. Successful teams could be and were picked up wholesale. A relatively stable ”bedding-in' period followed, but that calm is now threatened by the continuing fall in equity trading values and volumes from May's volatility-driven highs. If there is not enough business to go round, buy-side firms may need to cut broker lists back to their core counterparts.
Brokers say that the times are the toughest for many years, explaining that after a deep recession, it can take as long as four years for cash to flow back into equity funds from fixed income havens.
In this harsh environment, it is questionable how sustainable some sell-side businesses are.
Inter-dealer broker Icap withdrew from its Asian and European full-service cash equities ambitions, which included a research arm, in March 2010.
Anecdotes of depressed trading floors, with more arms folded than waving, suggest that some recently hired human capital is already losing its value.
There are two schools of thought as to which brokers will be hardest hit.
One says that the bulge bracket firms with operations across a range of asset classes should be able to support their equity operations over this quiet period, although for how long depends on the broker. The multitude of smaller agency brokers which operate largely on thin margins – and with fewer marquee clients and a relatively limited range of cross-subsidising opportunities – do not have that luxury. Faced with hard times, some brokers would likely be eaten up by others.
The other point of view is that the bulge-bracket brokers that maintain large trading floors, a wide range of technology-intensive trading services
and armies of research analysts won't be able to keep supporting a high cost base on such low volumes, while the small agency brokers are much more adept at making a living on much smaller margins.
To avoid taxes placed on bonuses earned by traders, such as the 50% levy on bonuses over £25,000 brought in by the UK government, many large brokers have switched from a largely bonus-based package to salary-based remuneration. On that account, they will certainly find it more expensive than previously to keep hold of non-performing staff.
It is also worth considering the ban on proprietary trading in by US deposit-taking banks effected by the Volcker rule, as part of the Dodd-Frank financial reform act. The impending closure of US brokers' proprietary trading desks could gather momentum in a low-volume environment and may be mirrored globally sooner than had been expected. Not only might that reduce overall trading volumes still further, it could deprive brokers of precious revenues – and talent – to support client-focused services.
During Q4 2010, can we expect a fresh round of redundancies and a shorter list of brokers to choose from – or all types of broker now lean enough to survive a bleak post-Lehman midwinter?
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