If you want to keep your job in an investment bank over the next nine months, you might want to take defensive action. 2019 has not started well, and according to a new report on the banking industry by Morgan Stanley and Oliver Wyman, it will not end well either.
The two firms are expecting a $40bn decline in wholesale banking revenues between 2018 and 2021, with the biggest declines coming this year. Surviving the cataclysm will require careful positionining. The report has some guidance on what this should entail.
Beware second tier flow trading businesses
In the past three years, Morgan Stanley and Oliver Wyman estimate that falling margins and rising capital commitments have cut 15% in revenues from sales and trading globally. Profits have fallen even further as regulatory and technological costs have risen. In total, the implied market value of the global sales and trading industry has fallen by an estimated 25% to 35% since 2015 alone.
The worst place to be in this scenario is a bank with a small flow trading business that's struggling to retain market share and can't afford to invest in new technology. The report notes that these banks are already struggling to cover their cost of capital and that things will only get worse. If you work in flow trading today, you want to be at a large player with a large client franchise, a big internal liquidity pool, and all the money in the world to fund continuous technology investments...
Beware flow trading in European banks
Working for a second tier flow trading business is pretty much synonymous with working in flow trading for a European bank. The report notes that MiFID II alone has eroded 20% to 30% of revenues from European cash equities businesses and that European banks in particular are struggling to generate returns above their cost of equity.
This threatens to become more of a problem, not less. Returns on equity at European banks are already, on average, half those of U.S. rivals and European markets are shrinking. Yet, European banks need to invest heavily in flow trading platforms if they're to remain competitive.
It won't happen. Oliver Wyman and Morgan Stanley predict that the Europeans will instead embark on a round of even harsher cost cutting. Existing cost reduction programmes will reduce costs by 6-8% relative to 2018 levels, but most European banks will still have an average return on equity of only 8% by 2021. Far more serious action, with steeper cost reductions and capital reductions must follow.
'Rates, credit and equities businesses offer the most attractive opportunities for wide scale exits, particularly outside of home regions,' says the report.
Beware rates trading
This brings us to rates trading in particular. If you must work in fixed income trading, do not let it be here.
The report claims that, 'every $100mn of rates revenues earned by the sell-side on average destroys $10mn of shareholder value, for an industry-wide RoE of 8%.'
This is clearly not a sustainable situation. Although structured and corproate rates businesses generate good returns, government bonds and institutional swaps do not. Banks that want to be present in these markets will need to seriously question why they think it's a good idea.
Beware compliance, but especially beware support functions
Compliance and regulatory costs have become a huge headache for banks. Once upon a time, banks were able to flex their costs in line with changing revenues in the market. Nowadays, though, Oliver Wyman and Morgan Stanley think only 30% of costs allocated to busineses are flexible.
As banks try to seriously cut costs in the years to come, this is going to be problematic. Compliance and control costs can be cut, but it takes time and requires the closure of entire business units. In the short term, therefore, the obvious way to extract costs is to go for central functions like the corporate centre. This is therefore where the cuts will come - hard.
Beware institutional clients
If you're determined to keep your job, you should also shift away from covering institutional clients like hedge funds and asset managers. The report suggests that institutional client revenues are growing at approximately one quarter of corporate client revenues and that this is an increasingly problematic area for smaller banks. It doesn't help that ~85% of sell-side revenues earned from trading with institutional clients currently come from working with hedge funds and active asset managers. Banks have almost no way of extracting revenues from the large passive asset management industry.
And if you want to keep your job? Move to Asia. There, revenues are expected to grow at an annual rate of 3%, or an annual rate of 7% in China. Global banks with the, 'right licenses and ownership structures' are in the Chinese sweetspot, although it won't be easy - the market is highly competitive and global banks need to be in this for the long term.
Choose corporate clients
As noted above, corporate clients are expected to grow at 4x the pace of institutional clients between now and 2021. You especially want to work in transaction banking, where revenues are expected to grow at 4% per year (see below).
Choose data analytics jobs
Forget traditional sales and trading jobs and move into data analytics. Real time analytics, automated prices and client APIs are the future. Data will be used to generate trade ideas. Machines will be used to make trades. Humans goodbye.
Choose 'digitisation' jobs
If you're working in a support function today, you need to be one of the people automating it tomorrow. The report notes that client facing processes, such as onboarding and lending approval, have seen efficiency gains of >40% as they've been automated in the past. Risk and control functions are coming next.
Choose non-bank liquidity providers
Forget working for a struggling European bank that's already fallen behind the technology curve in flow trading and go for something outside of banking instead. The report notes that a new partnership model is evolving as banks seek to retain client contacts and to engage in market-making without significant investment in hardware, technology or coding talent.
These partnerships exist with market makers across rates, FX, credit and equities. The firms being partnered-with include non-bank liquidity providers which banks use to make trades whilst retaining their own client connections. There are also fintech firms that provide technology solutions to help banks allocate resources in real time, or white label market making firms that also offer trade analytics.
Choose transaction banking and choose cash management
As noted above, transaction banking is the place to be. It's growing by 4% a year and growth is likely to continue for the foreseeable future.
Within transaction banking, the very sweetest spot to be is cash management, Here, the report says new and cheaper platforms are causing big disruption and that 10% of revenues ($9-10bn) will be up for grabs. This helps explain why Goldman Sachs has suddenly decided to build its own cash management platform, to be launched sometime in 2020.
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