Before starting I need to thank the wit who, for some reason, wants to remain anonymous, who got in contact after Monday’s column and said the actual Pink Floyd song I was paraphrasing was Careful with that Axe Eugene, “which works equally well when discussing pricing in this conduct obsessed era”. That, in a nutshell, is why I appreciate the readership so much!
Moving on, this week has seen the start of the reporting season for US banks and at least as far as the FICC divisions are concerned, it hasn’t been good news.
What I found intriguing amongst all the usual corporate-speak was the admission by Citi’s CFO John Gerspach, that the bank’s lowest quarterly FICC results since 2011 were in some way driven by “a pull back from clients waiting for clearer market conditions that did not materialise”.
I find this interesting because of the inference that the firm is totally reliant upon its customers to make money (and of course it is by no means alone in that in the banking world). Obviously a strong client base is hugely important and it provides the bedrock for earnings at all institutions, but this focus on the client to the cost of every other business line – especially proprietary trading – was largely created over the last decade, a period of exceptionally low volatility with the background of a generally calm geo-political scene.
The world is very different now, and in many ways markets are behaving as they did in the last two decades of the last century – volatility is up and very random, driven by an uncertain economic outlook thanks mainly to political influences such as a Trump administration and Brexit. As noted by Gerspach, this environment has led many customers to simply pull the plug on their trading (thus further exacerbating liquidity conditions it should be noted).
The big difference between now and the end of the last century, however, is the bank’s risk-bearing capabilities and indeed their willingness to hold meaningful risk for a meaningful time. This environment has created the FICC version of a scene once described of the New York Timesnewsroom during a prolonged argument about redundancies at the paper. It was noted that the Times’ floor was “full of reporters sitting around waiting for the Titanic to sink again”. In the FICC version, we have a workforce targeted and dedicated to a client base that is no longer as active as it was, sitting around waiting for the next trade to come along?
As most banks do, Citi have performance thresholds for staff meaning, as the bank said this week, that staff costs will be lower to help offset some of the revenue deficit, but do banks need to rethink their approach to markets? In the past banks would have had proprietary trading teams of skilled professionals whose job it was to make money and who would have loved the very same volatility that is currently scaring off some of their clients. Yes, there would have been some bad days but there would have been good ones as well and overall it would be a better-balanced business.
These traders would also know they are there to make money (strictly within the rules) and therefore if they didn’t they wouldn’t be rewarded and probably wouldn’t have a job if it was a bad miss – that’s the way of the world, or rather it used to be.
This round of results represents to me a stark example of why we need risk takers in the banking industry again, because this is not only hurting market liquidity it is also apparently negatively impacting the banks’ own performance. Risk is a nasty word in regulatory circles of course and that makes such a move harder, but those same authorities are also starting to understand that there are liquidity problems in all markets – and at some stage the impact could be felt by the men and women on the street.
There needs to be dialogue between banking industry and regulators about this, but before that the banks themselves need to appreciate how their business model needs to change in the FICC space. The current model worked fine in low volatility markets where banks assumed the role of broker and nicked a few performance points here and there from fees and spreads, but in the current environment they look short of the required skill sets. Just look at how easy it has been for non-bank firms to assume a strong position in what have traditionally been bank-dominated markets.
Client protection needs to be paramount in the banking industry and a focus on the customer is not a bad thing at all. It’s just that I sense that banks are actually doing many of their customers a disservice by acting as brokers or advisors and not true counterparts in markets. The more (reasonable) risk held by banks the better liquidity conditions in markets would be – and that benefits all market participants, including those clients currently averse to dipping their toe into pretty shallow waters.
As a random thought this could be the signal for some banks to consider buying a non-bank firm to act as their market making unit, however the model would again have to be tweaked to ensure that larger risk can be held for longer and that proprietary risk sits on the book for more than just a few minutes or (micro) seconds.
Either way, the time would appear right for the banks to reinvestigate the benefits of a strong trading desk that proactively takes risk as well as assumes it from clients. That way they become slightly less reliant on what appears to be a fragile client base – and that can’t be a bad thing, especially as several of those clients are now suing them in both the US and UK!