Banks Seek Solution to Declining Fixed Income Profitability

Many sellside institutions are increasing the amount of e-trading technology they use to deal corporate bonds and interest rates swaps (IRS), reports GreySpark Partners.

According to the London-based capital markets consulting firm, the uptake of e-trading technology in the sellside fixed income space comes amid a period of low fixed income liquidity, especially in the corporate bonds market.

GreySpark’s report, entitled
‘Trends in Fixed Income Trading 2014’
, highlights that e-trading technology can provide new ways for banks to maximise the efficiency of their dealing activities as part of a broader effort across the industry to move from a principal model of trading to an agency, broking-centric trading model. The report explores the different ways in which banks are increasingly adopting new, innovative business models for fixed income dealing in 2014.

As the costs associated with compliance with post-financial crisis regulations rose for Tier I and Tier II investment banks, the size of corporate bonds balance sheets at these banks has declined. GreySpark estimates that in 2007, the top 20 largest investment banks warehoused approximately US$250bn in corporate bonds on their balance sheets. In 2014, 96% to 99% of that US$250bn of sellside corporate bond liquidity held by banks is now owned by buyside firms.

Banks are also struggling with the costs associated with developing new fixed income e-trading and e-commerce business models, which are an essential part of the sellside’s overall adaptation to the new regulatory pressures.

GreySpark forecasts that sellside efforts to develop e-trading business models for trading bonds will evolve to match a new set of industry practices that emphasise balance sheet efficiency. In many banks, the business model imperatives governing balance sheet efficiency are seen as the costs associated with new investments in technology solutions that allow for more sophisticated fixed income dealing analytics on a trade-by-trade basis, especially in corporate bonds trading. For IRS, the firm’s research shows that the majority of over-the-counter (OTC) derivatives volumes will become e-traded by 2016 to match current levels of e-trading overcapacity for all but the most exotic swaps instruments.

“While more electronic dealing venues will emerge in the future to connect buyers with corporate bond liquidity, the sellside must still reorganise itself around corporate bond liquidity pools that allow investors to find inventory wherever possible,” said Frederic Ponzo, GreySpark managing partner and lead author of the report. “Ultimately, a better connected marketplace is one wherein consolidated, aggregated liquidity is paired with data mining technology that allows the sellside to better communicate to the buyside where that liquidity can be found from a specific seller.”

Russell Dinnage, GreySpark senior consultant and report co-author, added: “GreySpark believes that there are four, distinct sellside business models emerging in response to the increasing fragmentation of fixed income liquidity, specifically for corporate bonds and swaps flow. The ability of Tier I or Tier II broker-dealers to realise new fixed income dealing models is a reflection of the change-the-bank costs associated with implementing a transformation of the bank’s sales force and trading desks into a vertically-integrated, cross-asset sales-trading organisation.”

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