A boom in bond issuance and secondary trading volume, coupled with wider spreads last year, prompted many financial service firms to step up their commitments to the European fixed income business. Unfortunately, these investments were made on the eve of a meaningful slowdown in market activity.
The results of Greenwich Associates’ 2010 European Fixed Income Investors Study show that institutional trading volume in European fixed income – including cash bonds and derivatives – increased by about 25% during the 12-month period covered in the research, which ran from 2Q09 to 2Q10. However, that overall average increase spanned two distinct periods: the relatively strong markets of late 2009 and the abrupt slowdown in trading volume in 2010.
The eruption of a government finance crisis in Greece and other European countries slammed the brakes on European credit markets in early 2010. The unexpectedly slow pace of trading activity in both equity and fixed income markets through much of this year had a big impact on the 3Q10 earnings of major banks and investment banks.
These disappointing results have intensified the competition for marketshare in institutional fixed income trading, giving a new urgency to the question of whether Europe’s biggest dealers will be able to retain gains achieved during the crisis or whether other competitors will be able to capture or recapture market share. They also raise the question of whether sell-side firms that made major investments in their fixed income businesses during the 2009 boom, perhaps with return expectations that will be hard to realise, will be forced to rethink their decisions and scale back.
European Bond Dealers Face New Challenges
Competitive pressures have been gradually remaking the dealer landscape of European fixed income since the creation of the euro and the integration of European debt markets. That process was thrown into overdrive during the global credit crisis, when institutions fearful of fast-mounting risk levels fled to the assumed quality of a handful of fixed income dealers perceived as having strong balance sheets just as more troubled sell-side firms were being forced to pare back their own market commitments. The primary beneficiaries of this flight were Barclays Capital, Deutsche Bank and JP Morgan, which now rank as Greenwich share leaders in European fixed income overall, with 2010 market shares of 14.6%, 13.0% and 10.2%, respectively.
Volatility in the overall market environment is posing a tough challenge to banks competing against these top dealers. These competitors can be broken into two general groups: aspirants to pan-European or even global status, and national champions. The former group – the aspirants – includes between five and 10 large banks, some with significant fixed income platforms spanning multiple European countries. Several of these banks were seen as top-tier or near top-tier players with broad franchises prior to the crisis but were forced by balance sheet issues to scale back their fixed income businesses. Other aspirant banks had a smaller European profile before the crisis but had staked out robust niche businesses due to their strong capabilities in structured and other exotic, higher-margin products.
The collapse of those businesses forced some of these banks to retrench and to fall back on more liquid rates and credit products. Some found themselves in a weaker position in these markets due to either the lack of scale required to thrive in rates products or the origination capability that provides such a strong competitive advantage in credit products. “Several of these dealers built out teams and businesses based on wider than normal bid/ask spreads that soon thereafter narrowed quickly and dramatically,” said Greenwich Associates consultant Andrew Awad. “Now, with revenues far below projections, it is unclear if these dealers will be able to support their expanded cost bases.”
For the most part, these aspiring competitors trail Europe’s top three dealers in terms of the breadth of their capabilities, the size of their balance sheets, or both. As a result, a number of these will face challenges competing with the likes of Barclays Capital, Deutsche Bank and JP Morgan on an across-the-board basis. “Competing against the market leaders on a pan-European or global basis requires not only balance sheet and fixed income talent, but also costly infrastructure to facilitate e-trading and research,” said Greenwich Associates consultant Woody Canaday. “In all likelihood, many of the banks competing against Europe’s top dealers will be forced to choose their spots and to focus their resources on specific products, geographies and/or client bases.”
Mixed Prospects for National Champions
Prospects are more mixed for banks in the second group – Europe’s national champions. The integration of Europe’s fixed income markets has eroded the traditional barriers to entry that protected the home-market advantages of national champions. Meanwhile, the significant costs associated with building and operating a pan-European platform prevent many national banks from considering significant cross-border expansion. At the same time, several national banks emerged from the global market crisis in a strong position relative to some pan-European and global players, and launched growth strategies spanning not only Europe, but also Asia and the Americas.
“Although certain national players have visions of pan-European or even global expansion, most national fixed income dealers will look inward for growth,” said Greenwich Associates consultant Peter D’Amario. “National dealers’ deep ties and familiarity with middle-market investors give them a sustainable advantage over foreign competitors, and most national banks have sufficient capabilities to meet the requirements of companies of this size.”
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