Analysts at Bernstein Research have issued the first of what they say will be two notes on the state of the investment banking industry. Ominously, note number one is titled, "Is trading doomed to unprofitability under Basel?' Meanwhile, Coalition, the analytics and intelligence provider, has issued its third quarter review.
If you are currently working as a trader in an investment bank and you intend to remain a trader in an investment bank in 2017, this is what you need to know.
We've been here before (regularly): if you're not working for a flow-monster-market-leader in your chosen product area, life is going to be hard. You will probably lose your job.
"Only firms with the proper scale, technology and trading discipline have a realistic shot at earning a cost of capital in trading," say Bernstein analysts. They add: "And even those firms will not earn robust ROEs. As such, competitors are finally coming to terms with what counts as reasonable aspirations for the business, implying further industry shrinkage and consolidation over the next five years."
When your total compensation declines a bit this year and a bit next year and a bit more the year after that, it's no good stamping your foot and throwing a fit and demanding that you be properly remunerated or else: this is the new reality. Like it. Or lump it.
Compensation ratios (as a proportion of revenues) are going to decline from 50% to 40%, say Bernstein analysts. This pay reduction will be insufficient to make trading profitable again (this will also require reductions in risk weighted assets of 25%-33%), but banks can't cut compensation any more because traders remain a powerful cabal to be reckoned with.
Coalition's report contains the following graph showing revenues per 'producer.' Although revenues per head in fixed income have recovered slightly this year, they are still far off the levels of 2009, and the capital intensity of trading businesses has since increased significantly. On the whole, Bernstein's analysts say Basel III appears to represent a 40-50% increase in RWA over Basel I. Although Basel III doesn't start phasing in until 2015, most firms are trying to meet the requirements preemptively.
The days of trading expansionism are over. "If all the leading banks are cutting back, which banks are expanding?" ask Bernstein analysts. "The answer is none," they conclude.
Leading banks are locked in a war of attrition. Even the market leaders are not covering their cost of capital in trading businesses and they are therefore waiting for weaker competitors to fall away. This will be a slow process.
While it's all unraveling, the only hiring that takes place will be upgrading or the replacement of several expensive traders with a few expensive trader-programmers familiar with new electronic trading platforms. If you want a new job now you will need to be very, very good or very good and highly versed in C++.
Coalition underscores the recent disappearance in jobs with the following table. It thinks 7,000 jobs have disappeared since 2010. The good news is that there are only 1,800 fewer jobs now than in 2008.
"New technologies are being pursued to shift fixed income market making from the current risk-seeking, balance sheet intensive flow model toward "capital lite" client netting platforms supported by more limited pools of inventory," suggest Bernstein's analysts.
At the same time, they predict that trading profits will fall due to: increased risk weightings on riskier asset classes, regulatory constraints on proprietary trading and aged inventory, and rating agency constraints on firm-wide leverage.
Dodd Frank and the Volcker Rule will compound the problems by reduce liquidity in some segments of the fixed income market, reducing volumes in high margin areas such as high yield and emerging market credit.
Under central clearing, Bernstein thinks that 70% of equity and fixed income OTC derivatives will shift to central counterparty clearinghouses and electronic execution facilities. "Margins in derivatives are likely to decline from the 35% range toward the 20% range typical of other liquid OTC businesses, such as cash fixed income trading," they conclude.
The writing is on the wall for highly paid high-touch OTC derivatives traders. If this is you, you will probably need to accept a pay cut, or redundancy, or to try shifting very soon into a lower paid sales or client support role on the new electronic platforms.
Senior staff in trading businesses are most likely to be removed, say Bernstein's analysts. "Based on anecdotal conversations, we expect the mix of highly-paid managing directors in trading units to decline from 20% of staff to 10%," they suggest. Start saving, now.