COMMENT: FICC's not dead yet


By Keith Mullin

LONDON, Oct 21 (IFR) - I've always been a bit of acontrarian. I guess it's just in my nature. So I'm going againstthe flow by saying I'm getting a little tired of everyonewriting off the fixed income, commodities and currencies tradingbusinesses as if they're ready to be read their last rites.

I also continue to be bemused by the general over-reactionof shock and horror at the lower quarterly FICC numbers comingout of the banks. For reasons that are pretty clear, clienttrading volumes have been much lower in the current cycle andhave invariably been non-existent in the run-up to and amid allof the political nonsense in the US (which is far from over) andaround the will-they-won't-they quantitative easing saga, globalgrowth concerns, EM wobbles, peripheral eurozone woes, bankstability issues, war in Syria and other stories. There's anunbreakable link between news flow and the urge to trade.

People say volatility is the trader's friend, but thereality is that most people play event-risk from the sidelinessitting firmly on their hands. If volatility is the trader'sfriend, uncertainty is his sworn enemy. Price volatility hasinvariably been on the screens only and not underpinned by orderflow. I've heard countless times of late that if you try to dealon a screen price, it mysteriously vanishes. It's like walkinginto a shop to be told you can't buy anything.

Client and counterparty reluctance to trade around thefundamentals is exacerbated by very poor liquidity, whichcreates an eternal negative feedback loop. The days of freedealer liquidity are well and truly over as competition andmarket issues as well as capital and other regulatoryconstraints are brought to bear - the virtual disappearance ofprop trading in size among sell-side shops; lower tradingvelocity among hedge funds and real-money accounts; derivativesand market infrastructure reforms; capital cost of holdinginventory; margin compression; declining bank balance sheets andless leverage. And let's not forget the notion of trading arisk-free asset has gone out of the window, which has had asignificant impact.

Having said I'm not writing off FICC as a business, it'sclearly undergoing something of a makeover. Transformationalindustry issues bumping into multi-dimensional event-riskfactors will make for a poor trading environment all day long.But my point is that while the latter will always be present inone form or another, the former will at some point settle.Reported FICC numbers shouldn't be looked at microscopically ona quarter-to-quarter basis. They need to be looked atstrategically and on a cyclical basis.

It's worth pointing out that FICC has always been a highlyvolatile business from a net revenue perspective. I plottedGoldman Sachs's FICC number - as a proxy for the industry - forthe past 34 quarters, which is far back enough to have precededthe run-up to the global financial crisis. I added FICC revenuesfrom the institutional client services group to the debtsecurities and loans line in the investing and lending divisionto better match the combined number formerly reported as FICC inthe old trading and principal investments division.

This exercise certainly put the 44% FICC reversal in theQ313 numbers into perspective. The dispersion of the net revenueresults over my chosen period has been notable, but that's thenature of trading. In the pre-crisis period of 2005 throughQ107, Goldman's FICC number jumped wildly but averaged 35% ofthe firm's overall net revenue. The average taken over the pastnine quarters (when event-risk was rife and regulatory issuespressing) was 31%. The reversion line doesn't look thatdramatic. The average reported numbers for the two periods areonly 10% apart. JP Morgan's FICC to combined CIB/AssetManagement net revenue ratio is about the same.

Over time, we'll see FICC capacity freed up as dealers(slowly) tailor their offerings to highest perceived value-add,client fit, cost of capital and perhaps more realistic capitalallocation. Market-share gains will benefit the scale playersand the world will increasingly split into a small bulge-bracketand a cabal of specialists.

But as derivative trading morphs into the SEF world andvanilla cash volumes go increasingly electronic, and thebuy-side and sell-side reach an accommodation in the new world,increased transparency will drive better price discovery and asthe economic cycle improves and banks get through deleveraging,I think it's fair to suggest volumes will rise in lock-step.Don't write FICC off; it's simply entering a new chapter in itsvolatile life-cycle.

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