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Curatia Analysis for Wed, Aug 14

Is the Era of Profitable Trading Over?

With markets increasingly passive, automated, and calm, financial firms across the spectrum are struggling to make money trading.

Once considered cyclical, the phenomenon has persisted long enough to convince banks, exchanges, and market makers to diversify into other lines of business, raising the possibility that the age of profitable trading is winding down.

Banks

The Death of Trading: Why More Big Banks Think the Business Is a Losing Bet,” a Monday Fortune headline intoned grimly. In keeping with that sentiment, banks are scaling back their trading operations or shuttering them altogether following steep declines in trading revenue in H1 2019.

In recent weeks, Deutsche Bank finally elected to unwind its global equities trading operation after losing $750M in its equities division in 2018. Citigroup announced its intention to cut hundreds of trading jobs after its equities trading revenues declined 17% YoY in H1.

In April, Société Générale opted to cut 1,200 jobs in the division that houses its trading activities. And Barclays laid off 3,000 employees in Q2 following a 19% slide in net profit.

Bank trading profits have declined as electronification has slashed commissions, regulation has constrained banks’ ability to use leverage, passive investing has eroded bank trading volumes, and an epoch of low rates has dampened volatility.

At the same time, rising infrastructure costs and connectivity fees have made profitability elusive for all but the most successful banks — namely JPMorgan, Morgan Stanley, and Goldman Sachs.

Those lenders are meanwhile accumulating profits they can plow back into the newest technologies. Goldman Sachs, for example, has said it will invest more than $100M in equities trading technology in the coming years.

They are also accruing huge trading data sets from which AI will increasingly derive new and valuable insights, creating a virtuous cycle for the biggest trading desks that could further marginalize banks merely hoping to maintain a presence in trading over time.

“‘Anyone that’s trying for that middle way is going to just get crushed,’” one global head of equities trading at a large Wall Street bank said.

But even the top three trading banks saw equities trading revenue slide 14% in H1 versus a year ago, raising the question of whether trading remains a viable business unit for any bank over the long term.

Once banks exit the trading business, prohibitive re-entry costs will likely keep them sidelined for years or, worse, permanently.

Exchanges

Exchanges facing dwindling trading revenues are likewise pivoting away from transaction-based revenue models in favor of selling data and marketing themselves as technology platforms.

They are also facing regulatory pressure in the US over market data fees and commissions. With strong industry backing, that pressure could erode stellar profit margins (typically in excess of 50% at present) and constrain revenue growth. Atlantic Equities has estimated that revenue growth at CME, ICE, and Nasdaq will retreat to the mid-single digits by 2020.

The demise of the floor trader has come to serve as a potent symbol of the struggles brought on by electronification. “NYSE floor traders are facing job extinction,” a New York Post headline trumpeted earlier this month. Readers have tracked the plight of floor traders closely; the article garnered a 100 popularity score, while a similar piece last month earned a 99.

That anxiety has spread across the pond and expanded to encompass traders more generally — or at least the human ones. “Debate: Are professional traders becoming obsolete?” a headline in London-based City A.M. dared to ask.

Trading Firms

Even trading firms, which became the poster child for the future of trading while enjoying a decade of robust growth at banks’ expense, have suddenly been sucked into the vortex of trading profitability concerns.

Virtu saw its stock plummet 18% last week after missing Q2 analyst estimates and “reporting results that raised questions about volatility and the profitability of trading.”

On Virtu’s earnings call, CEO Doug Cifu said that “‘market volume in this quarter presented one of the lowest market making opportunities in many years.’”

Fixed-income electronic trading platform Tradeweb saw its stock price slump by as much as 5% despite topping analyst estimates in Q2 after CEO Lee Olesky described “‘a challenging environment for trading in a market characterized by low volatility.’”

Hold the Phone

Collectively, those data points reveal mounting trepidation over trading profitability in the near- to medium-term — a sentiment bolstered by markets’ hypnotic trance in the face of rate cuts. With banks, exchanges, and trading firms all fretting over trading profits, there is certainly sufficient cause to sound the alarm.

That said, trading is a notoriously cyclical business. It remains to be seen whether the low volatility that’s handcuffed trading revenues so far in 2019 will persist, or more generally how much of trading’s diminished profitability is attributable to cyclical versus secular causes.

More broadly, US banks, trading firms, and especially exchanges all continue to log robust profits. As some firms exit trading businesses, survivors should benefit from a bigger share of the spoils. In addition, significant opportunities exist for expansion into markets beyond North America and Europe.

Those factors all paint a more optimistic picture of future trading profitability. The question is which firms will still be around to enjoy it.