How to fix FICC

Rupak Ghose is a board adviser to fintech companies, the former head of corporate strategy at ICAP/NEX and a former financials research analyst at Credit Suisse.

It’s now conventional wisdom that banks need to diversify away from trading to develop more recurring revenue streams. Equity research analysts, shareholders, consultants, investment bankers and media jump to highlight how fixed-income, currency and commodity (FICC) trading is a structurally low-PE-multiple business, given its volatility and capital requirements.

But the FICC trading machine churns on and on, not only surviving but carrying investment-bank cost bases on its shoulders. In 2022, FICC generated around a fifth of group revenues of the largest five US investment banks, and it has probably provided a similar level for major European players.

Last year was the Year of the Macro Trader, especially in US rates and commodities markets. The below data from Bank of America’s and Citi’s earnings illustrates how much macro volatility supported FICC revenues in 2022.

2022 was also the Year of Volatility. For banks’ trading desks, this was an especially good kind of volatility, not only boosting revenues from companies doing more hedging, but juicing performance for important hedge-fund clients as well.

While the hedge fund industry overall saw negative returns in 2022, macro and multi-strategy funds had stellar returns. This trend naturally benefited banks where hedge funds make up a greater share of clients.

No firm has benefited from this more than Goldman Sachs. Their FICC revenues more than doubled over the past five years and were more than 25% higher than the elevated levels of 2020. In contrast, the traditional market leaders JPM and Citi delivered FICC revenues 10 to 15 per cent below their 2020 records. This is unsurprising, given their strong forex franchises and lower exposure to commodities than Goldman.

Even so, Goldman came out of earnings season as the ugly duckling. Be more like Morgan Stanley, we all heckled. The “Pepsi trick”, as the FT wrote, of diversifying into more recurring, high-return wealth management businesses is a sensible one for all banks to consider. If Barclays hadn’t sold BGI, for example, it would look more like Morgan Stanley.

There’s a problem, though: good acquisitions are difficult to find, and new businesses’ buildouts rarely move the dial.

M&A scenarios look good in theory, but sellers of leading franchises are rare. For every UBS there is a Credit Suisse wealth management. For every Capital Group there is an Abrdn. For every Lloyds there is a Metro bank. Non-FICC businesses aren’t inherently high-growth, stable or profitable.

So, what about organic growth? The law of large numbers kicks in here. Nowhere is this more important than at Goldman Sachs. When you generate almost $15bn of annual FICC revenues, any organic diversification strategy is going to be a rounding error. And as we saw with Goldman, moving away from your core competencies comes with risks.

Banks are stuck with FICC. Where diversification is achieved it is often by accident rather than design. For instance, the trading implosion at Credit Suisse. In fact, in Credit Suisse’s case, the ostensibly higher-quality wealth management business imploded soon after as well.

So how should they make the best of the situation? There are several hygiene factors I would focus on.

The first is diversification. And I mean diversification within FICC. Unlike equities, this is a fairly heterogenous business, spanning multiple asset classes, client bases, geographies, and products.

To demonstrate what that means, I’ll give an example:

In the bank’s latest earning call, Goldman Sachs CEO David Solomon proudly highlighted how his team had delivered on his goal of expanding wallet share with the bank’s largest trading clients. Goldman is now in the top three for 77 of its largest 100 trading clients, versus 44 only 3 years ago.

This is a great achievement, of course. At a time when clients are consolidating their spend, being top 3 with them drives material profitability. Liquidity drives liquidity, creating network effects in trading, and there is the benefit of scale on cost structures.

But it raises a question: how diversified are those revenues?

JPMorgan and Citigroup’s FICC businesses are more diversified than Goldman Sachs. They also benefit from the moat provided by consistent captive flows from their broader banking relationships. These factors ensure that their FICC businesses are less volatile than Goldman Sachs. This should be more valuable to shareholders over the long run in terms of valuation multiples.

There will always be differences in mix; Goldman Sachs will never be a top-3 FX franchise, given the lack of a leading transaction banking network. But demonstrating more diversification and stability for FICC revenues can’t be underestimated. This is a reason why going big in transaction banking is much more relevant for a firm like Goldman than chasing sexy credit-card deals with Apple.

Banks must also demonstrate they are winning in structural high growth markets.

Banks invented credit derivatives, but their ETF businesses have lost out to players like Jane Street. This is also true in markets where underlying structures have changed. Banks struggled to compete with high-frequency trading firms as the US Treasury market moved electronic on cash and futures CLOBs. As market consensus builds on a “broken” Treasury market will they be the solution? A path to that could be through regulatory changes allowing them to hold more inventory, or looking for ways to prosper as clearing sponsors.

Finally, banks should take a leaf out of the playbook of the exchanges and electronic trading platforms which have come to dominate the FICC market data space through a combination of organic and acquisitive growth. Perhaps Goldman Sachs could turn its Marquee platform into the next Aladdin.

In any event, banks are stuck with FICC, so they need to make the best of it. Diversification. Lower volatility. New markets. All of these options make sense to do — at least, within FICC. Chasing revenues alone is a loser’s game. Instead banks should show investors that not all FICC businesses should be valued on the same multiple.