Like armoured knights on a muddy field – the future of FICC June 27, 2012 at 7:41 am
A man wearing fourteenth century armour walking across a muddy field won’t travel particularly quickly. Put him in a crowd with longbows firing at him, and he is likely to have a very bad day. The Hundred Years war, from Crécy to Agincourt, showed that that expensive creation the armoured knight was no longer the cutting edge of warfare. The longbow was the crucial piece of technology that rendered him obsolete.
This all comes to mind reading a great piece of Citibank research on the profitability of the big investment banks. Basel 2.5 was the beginning of the end – FICC’s Crécy – and Basel 3 was the definitive engagement – FICC’s Agincourt. As Citi says:
- Assuming a full capital allocation on Basel 3, we estimate fixed income trading ROEs in 2011 were in the mid-single digits
- …Which would correspond to 13-14% ROE in a “normal” macro environment and no impact from regulatory headwinds…
- …But falls to 10-12% when we factor in our estimated impact to revenue pool from regulatory reform, although there will be a wide disparity.
In my view, FICC with an ROE close to the banks' cost of capital makes little sense. (Citi disagrees, quoting synergies with other higher return businesses such as investment banking.) Much of this activity is already moving to hedge funds, and this trend will continue unless ROEs improve - which they won't, thanks to Basel 3. It will take a long time for the edifice of large bank-based trading operations to be deconstructed, just as it took over a hundred years for the mounted knight to be replaced by lighter, faster moving troops. There will be be a few survivors: Citi suggests JPM, DB and BARC will be among them, and I don't disagree. The trend is clear though: in the long term, large and profitable FICC operations will become about as rare as the cuirass in global banks.