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The state of investment banking today: Morgan Stanley’s definitive guide

Morgan Stanley

Morgan Stanley and Oliver Wyman have produced a new copy of their annualized report on the state of the global investment banking industry. Depending upon where you work, the prognosis is not bad. The main takeaway is that you will be best off if you work in a large US investment bank.

Have read through the 92 page report, we have distilled the key points. This is what you need to know.

1. Collateral financing is the hot new thing

The Financial Times identified collateral and so-called ‘collateral transformation’ (turning risky assets into what appear to be safer ones) as the new thing last month. Collateral transformation is, ‘is emerging as a rare bright spot in the banking industry,’ it said.

Morgan Stanley and Oliver Wyman agree. They say the shift to central clearing houses for over-the-counter (OTC) derivatives, is leading to collateral becoming trapped in clearing houses: “The chronic shortage in collateral, agitated by market fragmentation, will drive new opportunities around collateral demand and financing.”

How big is the collateral revenue opportunity? Morgan Stanley and Oliver Wyman put it $5-$8bn, but predict that the large global custody houses will take 80% of this.

2. Fixed income sales and trading businesses are now in good shape for the future

People working at UBS, which still has many thousands of fixed income redundancies left to go, may disagree, but Morgan Stanley and Oliver Wyman say banks have mostly finished putting their fixed income houses in order. Across the industry, risk weighted assets in fixed income have been reduced by around 25%. Fixed income businesses are therefore positioned to deliver strong returns.

Equally promisingly, Morgan Stanley and Oliver Wyman think the threat to fixed income revenues from centralized clearing over OTC derivatives has been overdone. Investors are expecting a 10-20% reduction; a 3-5% reduction is more likely.

3. Cost cutting is still needed in equities and investment banking (IDB)

While fixed income sales and traded businesses may have been future-proofed, the same can’t be said for equities sales and trading or investment banking.

Equities businesses are suffering from persistently low client volumes, from the shift to electronic trading, and from high fixed platform costs, say the analysts. Many equities businesses are unprofitable as a result. Part of the problem, as the chart below shows, is that equity derivative and prime brokerage businesses are no longer able offset losses in cash equities businesses.

Far more significant equities cost cutting is unfortunately needed. As we noted the other day, banks are still making significant redundancies in their equities businesses.  Morgan Stanley and Oliver Wyman suggest costs might be stripped out as follows: cutting sales staff and stopping duplication between cash salespeople and delta one sales people, re-examining the research model, or getting rid of ‘redundant operational and IT infrastructure.’

In IDB, there are profitability issues in Europe and Asia. “Many banks are simply not generating sufficient income to cover their platform costs,” say Morgan Stanley and Oliver Wyman.

Oliver Wyman state of the equities business

4. If you work in fixed income sales and trading, avoid rates and securitisation. Go for FX and commodities 

Fixed income may now be in good shape for the future, but this doesn’t mean it’s a growth business. Morgan Stanley and Oliver Wyman are predicting that revenues from fixed income currencies and commodities (FICC) will grow by only 1% in 2013, by 1% in 2014 and another 1% in 2015. They say the shift to clearing OTC derivatives will drag on growth.

Some FICC business lines are expected to be far more affected by central clearing than others. Rates and credit/securitisation revenues are expected to fall by 10% this year compared to 2012. However, FX and commodities revenues are expected to increase by 5-10%.

5. If you work in equities, try derivatives or prime broking 

Revenues from cash equities sales and trading are moribund say Morgan Stanley’s analysts. Revenues from equity derivatives sales and trading and prime broking could rise by up to 5% this year, they predict.

6. Jobs can still be taken out of the back and middle office 

Bad news if you work in a support role in an investment bank: cost cutting is still needed.

Morgan Stanley and Oliver Wyman suggest banks might eradicate operational costs in all sorts of ways. These include: ‘radically simplifying the operational landscape and processing environment;’  ‘rationalising unnecessary technology assets;’ ‘driving synergies between FICC and equities back to front, around clearing and electronic infrastructure;’ and the ominous-sounding ‘ systematic role ‘purification’ across overlapping activities in Operations, Finance and Risk.’

7. America has become the all-important driver of investment banking profits. Asia and Europe are far less profitable

America is the key market for investment banks. In 2011-2012, Morgan Stanley and Oliver Wyman estimate that the Americas’ share of revenues increased from  44% to 47% while its share of profits increased from 55% to 60%.

Both Asian and European markets are unprofitable for investment banks by comparison. “Europe and Asia suffer from fragmented markets that drive duplicative cost structures, particularly in the client sales and coverage functions, but also in the supporting operational stack which is often splintered across multiple hubs / markets,” says the report. “The US is significantly more profitable than Europe or Asia, and crucially offers scalability.”

As a result, banks are starting to think more critically about their activities beyond their home markets in Europe and are starting to re-evaluate Asia as a ‘growth’ region. More needs to be done.

8. European banks are struggling. US banks are struggling far less 

Banks in Europe are faced with serious challenges. These include the financial transaction tax and the bonus cap, which threatens to drive up fixed costs. At the same time, the analysts point out that many European banks are managing two major European centres – their home markets and London. This dual focus is driving up their costs and regulatory burdens.

In the circumstances, European banks might like to increase their presence in the profitable American market. However, Morgan Stanley and Oliver Wyman point out that European banks are about to be significantly disadvantaged in the US by the new FBO (Foreign Banking Organisations) proposals, which will significantly increase the amount of funding they need to allocate to their US operations.

The US businesses of Deutsche, Credit Suisse and Barclays will be most impacted by the new rules, says the report.

Conclusion: it may be time to work for a US bank.

9. If you work in either fixed income or equities sales and trading, you really need to work for a market leader

Morgan Stanley’s analysts have long been proponents of the ‘flow monster’ theory of sales and trading – namely that the biggest banks with the biggest market shares will come to dominate sales and trading markets even more in future, while smaller players will be obliged to withdraw.

They reiterate this in the new report, saying that: “Given higher fixed cost bases, achieving relevant scale is more important to reach adequate returns through greater efficiency on platforms, or else players need to downsize or exit.”

The following charts, taken from the document, indicate market shares in fixed income and equities sales and trading. If you work in either asset class, you may want to avoid banks on the left hand side.

Oliver Wyman getting out of FICC

Oliver Wyman getting out of equities

10. There are big opportunities for debt capital markets (DCM) bankers in Europe

We’ve said before that DCM jobs look safe in Europe. Morgan Stanley and Oliver Wyman analysts effectively concur. There are twice as many mid-sized corporates which could raise debt through capital markets in Europe as there are in the US, but the percentage of corporates using the markets to raise debt is 1.5 to 2 times higher in the US than it is in Europe.

“We see a structural opportunity for $100-200bn of additional DCM issuance in Europe, revenue opportunity of $0.5-1.0bn including issuer and investor multipliers,” Morgan Stanley and Oliver Wyman predict as a result. “Globals and locals will battle for the opportunity.” In other words: top European DCM bankers will be sought after for some time to come.

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