Unstructured Finance

Wall Street’s trading businesses turn to survival of the least dead

May 4, 2013

Darwin theorized that peacocks’ colorful plumage was a sign of        their evolutionary strength.

Wall Street has always been known as a cutthroat kind of place, but lately it seems big investment banks are just mulling around, hoping their competitors die first.

A report on Friday by Goldman Sachs bank analysts said that the industry has entered what they called a state of “reverse Darwinism,” in which banks are betting their long-suffering trading operations can increase revenue not by stealing business from rivals on a competitive basis, but by waiting for rivals to call it quits – leaving their clients with no choice but to move business elsewhere.

The Goldman analysts met with senior executives from Citigroup, Bank of America, Morgan Stanley and Lazard to find out what’s going on in their apparently stagnant capital markets businesses. The executives’ tone was “universally lackluster,” according to the analysts, who predict that investment banking and trading revenues will once again drop about 20 percent this quarter, as they did in the year-ago period. More pain is expected ahead as new derivatives trading rules, higher capital requirements and the long-awaited Volcker rule are implemented.

With that bleak backdrop, everyone is trying to figure out where they can cut costs and what businesses even make sense to stay in anymore. The only way to make money in trading, it seems, is to have such huge market share that enormous volumes can make up for the cost of the operation.

Yet many banks – well, apart from UBS – have been hesitant to pull the trigger on big cost-cutting announcements because it might put them at a competitive disadvantage. No one wants to blink first, because they’re all hoping they can stay in the businesses and outlast rivals. Plus, if there’s one thing that’s certain about trading businesses it’s this: it’s a whole lot easier to tear one down than to build it back up again after realizing the tear-down was a mistake.

“Most banks remain hesitant to announce outsized cost cuts in client facing businesses before peers; their concern being that banks that cut expenses first will see outsized pressure on their revenue,” the Goldman analysts said. “Using history as a guide shows this fear is justified, as historically banks that have cut expenses more than peers have seen outsized pressure on their revenue. This is creating a type of ‘reverse Darwinism,’ where banks are waiting for their competitors to leave certain businesses first, hoping their exit allows for share gains and more expense leverage for the banks that remain committed to the business.”

Arguably it should be easy to see the moves that individual banks have to make just by looking at market share figures in their business lines. Those data are collected by consulting firms like Greenwich Associates and Boston Consulting Group.

Bottom-tier banks at the dregs of the market share chain will have to exit, and top-tier banks will remain and thrive. But what’s harder to tell is whether banks in the middle zone will be able to keep their trading businesses alive. After all, if their weaker rivals die off, it might give them enough business to remain evolutionary.

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