September 2018 saw the tenth anniversary of the collapse of Lehman Brothers, the US corporate and investment bank that was symbolic of Wall Street. Its failure is still fresh in the mind, and marked a turning point for banking and financial regulation.
The disappearance of Lehman launched a cycle of “re-regulation” intended to increase the transparency and resilience of the economic and financial system. But September 2018 also saw a decline in equity markets after more than nine years of almost uninterrupted growth, an abrupt change in market conditions that severely affected the performance of the major banks’ trading departments. This under-performance has led some players to announce the cessation of some of their trading activities, or the launch of strategic reviews of their business portfolios.
However, performance in the sector has varied from one player to another. Apart from the cyclical impact of the abrupt change of momentum in equity markets, it appears that more structural factors may be shaping the competitive landscape for the corporate and investment banking sector, with a growing divide between European and American companies.
While it is difficult to judge this trend in the fourth quarter for fixed income activities alone (rates, foreign exchange, lending), where all the players have been hit by income reductions of between 15% and 34%, it is a more straightforward matter to assess equity activities, where US corporate and investment firms have maintained or increased their revenues, while European firms in the sector have seen a decline.
In a persistently low-rate international environment, all the fixed income players have been faced with a structural reduction in customer demand, whether for hedging or investment operations. Conversely, equity markets have seen no major adjustment since the end of the financial crisis. Increased prices and reduced volatility made it possible to maintain a high volume of customer activity.
However, these two markets have seen a decline in their margins along with the gradual introduction of the new regulations: Basel III, the law on the regulation and separation of banking activities (the separation of proprietary and market-making operations) and the Markets in Financial Instruments Directive (MiFID). By increasing capital and liquidity requirements, by accelerating automation and the standardisation of transactions and products, or by restricting market-making, regulatory developments have influenced the profitability of market transactions.
These factors have not had the same impact on corporate and investment banks in the US and in Europe. European firms have been unable to benefit from the same bullish domestic equity markets as American banks. Additionally, the decline of volumes has been greater on fixed income markets in Europe than in the US, because of the lack of implementation of the capital markets union plan and an approach to financing the economy still heavily based on banking intermediation.
Further, since 2017, US regulators have been undertaking a review of banking sector regulations. The initial aim is to simplify their implementation, resulting in less costly, burdensome and fragmented application. The most explicit of these projects is the Commodity Futures Trading Commission “KISS” project (“Keep It Simple, Stupid”). The various rules currently under discussion or already adopted have raised the thresholds associated with the concepts of a systemic player and of enhanced prudential requirements (raising the total balance sheet threshold from $50 billion to $250 billion); reduced the frequency of stress test reporting by lowering the number of scenarios to be tested and raising the testing threshold; and relaxed proprietary trading restrictions under certain conditions (the famous Volcker rule in its new incarnation as Volcker 2.0).
Hence, the downturn in the equity market at the end of 2018, although cyclical, is additional to a number of structural factors and has triggered strategic analyses based on the long-term capacity of European CIB firms to compete with their Wall Street equivalents.
A French version of this article was published in the Agefi Hebdo on 04/04/2019.