By Jamie McGeever
LONDON (Reuters) - The boom years of financial market trading, when banks made unprecedented profits from bonds, currencies and commodities, may be over for good as financial firms realise there will be no cyclical upswing on their dealing desks.
Even though it's taken Western economies several years to regain pre-crisis national output levels, many doubt banks will ever revisit the pre-crisis high watermark of their trading activities.
Revenues from fixed income, currencies and commodities - the so-called 'FICC' universe - continued to tumble for most major U.S. and European banks during the first quarter of 2014, increasing the pressure on them to rethink business models.
Thanks to a more stringent regulatory environment and a potential turning point in the 20-year cycle of falling global interest rates, the twin peaks of just before and after the 2008 global financial crisis look unlikely to be revisited.
Revenue from FICC and equity trading, which critics sometimes dub "casino banking" and distinguish from traditional investment banking services like underwriting share issues or arranging mergers and acquisitions, still accounts for over 70 percent of banks' overall income from investment banking, according to research by Freeman Consulting.
FICC and equity trading income at Goldman Sachs last year was 72 percent of the bank's overall revenue from investment banking, compared with 82 percent in 2010. Morgan Stanley's FICC and equity trading revenue was 70 percent of its total investment banking revenue, well down from 82 percent in 2003.
The FICC share of these trading revenues is shrinking. In 2007 around 70 percent of Goldman's $22.89 billion (13.5 billion pounds) overall trading revenue came from FICC. Last year, barely half its $15.72 billion of such revenue was from FICC, according to Freeman.
In 2006 FICC income accounted for just over 60 percent of Morgan Stanley's $15.9 billion overall trading revenue, compared to just 35 percent of the $10.1 billion pie last year, the consultancy said.
As new regulation bites and extraordinary monetary and economic policies smother extreme market swings, the trading volumes and price volatility that middlemen banking traders thrive off has ebbed.
And it looks like a structural shift rather than a cyclical or temporary lull.
"The revenues have gone. The world has changed from 2007, 2008," said Grant Peterkin, head of absolute bond returns at Lombard Odier in Geneva.
"The regulatory aspect is the biggest aspect."
Regulation after the 2007-08 crisis such as 'Dodd-Frank' and 'Volcker Rule' legislation in the United States and Basel III banking reforms globally, effectively restrict banks' ability to hold, trade and speculate on fixed income and derivatives.
This reduces liquidity, but other traditional liquidity providers like hedge funds have been unable to fill the gap because their businesses are also under pressure.
IN A FICC
The pressure on banks' FICC operations was brought into sharp focus by the broad-based slump in first-quarter earnings.
British bank Barclays grabbed the headlines, posting a 41 percent plunge in trading revenue compared with the same period in 2013, then announcing 7,000 of its 26,000 investment banking jobs will be cut.
"Some of the pressures we saw on the business towards the end of last year are clearly structural as well as cyclical," Barclays Chief Executive Antony Jenkins told CNBC on Thursday.
Other bank chief executives are likely to follow Jenkins in terms of direction if not magnitude, and reduce the size of their FICC trading desk operations, analysts say.
They are expected to continue cutting costs, trimming headcount, and in some cases, exit particular markets.
UBS is withdrawing from parts of fixed income trading while Barclays has consolidated its G10 currency, emerging market foreign exchange and precious metals trading operations.
Elsewhere, JP Morgan Chase is selling its physical commodities business and Deutsche Bank is closing its oil, grains and industrial metals business.
Although Barclays' results may be an outlier and contrast with other extremes, such as the 35 percent increase in trading revenues at the likes of Morgan Stanley, the average decline in FICC revenue from 10 major U.S. and European banks in the first quarter was 14 percent.
That ongoing funk was all the more alarming as the first quarter is traditionally the most profitable for FICC trading, as pension and insurance funds open fresh investment positions for the year and companies and governments sell new bonds in an annual refunding splurge.
The 10 banks showed FICC revenues totalled $24.18 billion in the first quarter, down from just over $28 billion a year earlier and almost $30 billion for the same period in 2012.
The 10 are: Barclays, U.S. banks JP Morgan, Morgan Stanley, Goldman Sachs, Bank of America, Citi, and European firms UBS, Deutsch, BNP Paribas and Credit Suisse.
The collapse in market volatility has also contributed to the decline. This may be a relief for risk-averse investors but it also makes them less likely to use market hedging instruments sold by the banks.
It also reduces the arbitrage opportunities that nimble banks and brokers feed off for in-house trading profits.
Implied volatility, which measures the potential for asset price swings over a specific period, is at or close to record lows in deeply liquid and highly-traded assets like U.S. Treasuries, euro/dollar and dollar/yen.
Analysts also say the whiff of scandal resulting from global investigations into alleged rigging of benchmark foreign exchange rates and Libor interest rates is clouding the FICC environment, and forcing banks to set aside billions of dollars for potential litigation costs.
The final nail in the FICC coffin, analysts say, is that the world on the cusp of rising interest rate cycle, led by the U.S. Federal Reserve's reduction - or "tapering" - of its extraordinary post-crisis stimulus.
It's completely uncharted territory for banks and traders, and not conducive to making easy money.
"We've had the most enormous change," said Chris Wheeler, banking analyst at Mediobanca in London. "And there's more to come as the full impact of tapering is felt."
(Corrects paragraphs 5 and 6 and adds paragraphs 7 and 8 to specify that revenues referred to include equity trading and are percentages of total revenues from investment banking alone, and to detail FICC share of overall trading revenue)
(Editing by Sophie Hares)