Global institutions are gaining in size while more modest firms
are running to keep up
By Telis Demos
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (May 8, 2018).
It's a good time to be a megabank.
In many businesses, the largest global banks such as JPMorgan
Chase & Co. and Bank of America Corp. are getting bigger, while
others are struggling to keep pace. The latest example: the
volatility-induced surge in first-quarter stock-trading revenue
that smaller U.S. investment banks almost universally missed out
on.
Stifel Financial Corp., Raymond James Financial Inc., Evercore
Inc., and Piper Jaffray Cos. all reported drops of 10% or more in
stock-trading revenue for the first three months of 2018 compared
with a year ago, according to company filings, resulting in the
lowest market share in years for midtier trading firms.
By contrast, trading arms of the biggest U.S. banks -- at
JPMorgan and Bank of America, as well as at Citigroup Inc., Goldman
Sachs Group Inc. and Morgan Stanley -- posted gains in equities
sales and trading revenue ranging from 26% to 38% for the quarter
versus a year ago.
That suggests one widely held prediction coming out of the
financial crisis -- that regulation would crimp giant Wall Street
trading desks and open opportunities for nimbler, less-regulated
trading shops -- isn't holding up.
Instead, the broad shift toward complex electronic trading and a
decline in the number of hedge funds and active asset managers,
especially smaller ones, have put pressure on the trading desks of
small and midtier firms.
Of course, smaller firms have notched some wins, and some are
reporting record revenue, due in part to strong showings in
businesses like wealth management and merger advice.
In equities trading, the overall revenue pie has shrunk from
about $90 billion in 2007 to about $40 billion last year, according
to research provider Coalition. Pricing pressure has been
relentless due to factors including lightning-fast algorithmic
traders.
The rise of passive index funds and exchange-traded portfolios,
plus a new trend of investing directly in volatility, has put
active fund managers, who are the core clients of smaller
securities firms, on the defensive. The first-quarter equity
revenue surge at big banks was driven primarily by derivatives
activity around volatility, not traditional "cash" stock
trades.
"We would have expected to attract more activity given the bouts
of volatility we experienced in the quarter," Deb Schoneman, Piper
Jaffray's president, told analysts in April. "However, active asset
managers -- our client base -- did not participate as much."
At the end of 2013, six publicly-reporting midtier investment
banks including Jefferies Group and Cowen Inc. generated about 8%
of U.S. banks' reported equities-trading revenue, according to
company reports compiled by analysts at Nomura Instinet. At the
beginning of this year, that share dropped to around 4%.
"In the first quarter, the volume that was occurring was from
passive strategies, and those ... tend to be more low-touch trading
that the big banks have always dominated," said Ronald Kruszewski,
Stifel's chief executive, in an interview.
New regulations are playing a role. European authorities this
year began a ban on the practice of using trading commissions to
pay for stock research, part of a set of rules known as Mifid
II.
Now, funds investing money for European clients, even if they
are trading in the U.S., may need to pay for research directly.
The upshot of the change is that some fund managers are now more
attuned to the cost and value of research and are paring back
relationships. Greenwich Associates, an industry research firm,
estimated that budgets for research have dropped by $300
million.
"The model for research is challenged across the industry right
now, and has been for about a decade," said Paul Reilly, chief
executive of Raymond James, on a call with analysts in April. He
estimated that the new rules have reduced some of his firm's
commission revenue.
While Raymond James had "no plans" to exit trading, Mr. Reilly
said, the firm's focus has been to grow its M&A and
private-markets businesses. Raymond James's net revenue reached a
record level, $1.8 billion, for the first three months of the
year.
Meanwhile, JPMorgan's chief financial officer, Marianne Lake,
told analysts in April that the new European rules and other
changes in the markets may be helping the country's largest bank by
assets. "We're gaining some share and we're benefiting from some of
that concentration, " she noted.
Some smaller brokerage firms like Stifel say they're less
concerned about their own financial health -- the company reported
its best first quarter ever this year -- than they are about their
clients, many of them small public companies that depend on midsize
firms for research and promoting the ease of trading in their
shares.
Current regulations "are advantaging highly liquid stocks," says
Stifel's Mr. Kruszewski. "Smaller companies can be harmed."
Write to Telis Demos at telis.demos@wsj.com
(END) Dow Jones Newswires
May 08, 2018 02:47 ET (06:47 GMT)
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