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Fixed Incomes activities – A model under pressure

Corporate and Investment Banks (“CIBs”) have seen their return on equities adversely impacted by regulatory constraints, such constraints have forced the Investment Banking industry to drastically shrink its balance sheets.

Moreover, the current market conditions, including vast changes in structure, are pushing banks to change their business strategy into the Fixed Income world.

In order to preserve their Fixed Income businesses, banks are reacting by radically reducing costs and developing new revenue streams. In the long term, Corporate and Investments Banks are looking at ways to transform their business model (e.g., the Agency Model) using technology to enhance performance. 

Why do the Banking Regulations increase costs for the Banks?

Three waves of regulations have recently impacted the Fixed Income industry: Basel III capital and liquidity requirements, proprietary trading rules and prudential standards.

Basel III liquidity ratios reduce the return on banks’ assets and increase the costs of their liabilities. Specifically, long term funding costs may rise as many banks may attempt to take similar actions simultaneously in order to improve or maintain their liquidity positions.

Basel III capital requirements also lower banks’ available capital and consequently drive-up the cost of capital. This notably impacts risk-heavy businesses (such as credit, rates and proprietary trading).

Proprietary trading laws such as The Volcker Rule, Liikanen, and Vickers pursue a common goal: to shield deposits and retail banking activities from the risks associated with investment banking activities which are linked to volatility in the financial markets. These regulations lead to a rise of costs for CIBs: Implementation costs (differentiating between prohibited trading and permitted trading is challenging; compliance & reporting requirements are significant), market migration and liquidity costs. All these costs directly affect CIBs’ ROEs.

The Enhanced Prudential Standards for Foreign Banking Organizations, a set of rules included in the Dodd Frank Act, have a serious impact on the investment banking industry in the US. This is forcing big foreign banks operating in the US to establish local holding companies for all of their American subsidiaries. These holding companies will be subject to capital and liquidity ratios whereas previous arrangements allowed foreign banks to operate through capitalized branches or subsidiaries backed by guarantees from a parent company. These rules impose additional substantial costs (re-organization, new reporting, additional capital requirements, etc.…).


Restructuring the model

In addition to the new regulatory landscape, several constraints have led the FICC (Fixed Income, Currency and Commodity business lines) revenue bases to collapse since 2009 (- 60% of 2009 highs) notably because of:

  • Competition: Competition is stronger between banks of different sizes. Bigger banks have a scale advantage allowing them to offer a full range of services and therefore maintaining business relationships with large clients. Simultaneously, smaller banking entities must develop niche strategies leveraging value added for clients (specialization in Fixed Income orders origination and execution, franchise oriented model with a more regional footprint and deep customer focus, experience of emerging markets, etc.).
  • Collapsing margins in flow rates: The combination of the OTC reform (Dodd-Frank, MiFID II, etc.) that increases the cost of trading (New margin requirements; new capital charges for exposures); Compliance costs (mainly related to additional reporting requirements) and the exposure of the Rates business lines to downsides from central bank withdrawal of quantitative easing consequently impact FICC revenues.


Various approaches have been carried out by banks in order to cope with a deteriorated Fixed Income environment.

  1. Reduction of Costs

Banks have notably reduced their Front Office staff costs. Recently, a significant number of press articles have been highlighting the layoffs happening in Bond trading across several major banks.

Reorganization of Operations and IT is an over lever: Banks are developing electronic businesses and are outsourcing their IT operations. For instance, a global Swiss bank has outsourced its Fixed Income trading platform. The multiple trading platforms are replaced by standardized solutions that allow the bank to strip out millions of dollars in costs over a number of years.

  1. New sources of revenues

New sources of revenue, such as Clearing, are being developed by banks in order to counter the structural changes. New regulations are forcing more over-the-counter transactions, such as swaps, to be processed through clearing houses, which force more institutional investors and corporations to clear their trades for the first time. A global French bank has recently restructured its over-the-counter client clearing and foreign exchange prime brokerage operations along with its listed derivatives clearing business. At the same time, this bank has created a standalone derivatives clearing business, aiming to grab market share, boost earnings, and spur a new phase of growth for the fixed income business.

  1. The Agency model

In order to shore up balance sheets and lower associated risks, banks may decide to act as brokers on the products they distribute. By matching up buyers and sellers, banks could continue to earn revenue from the fixed income business while diminishing their exposure to Basel III capital requirements.

This model, the “Agency Model” may answer some of the current key issues in Fixed Income including the lack of liquidity (due to regulatory changes and risk appetite of market intermediaries), and the regulatory costs (funding and capital costs).

  1. Technology is an important developmental edge. It can provide a simplification of middle and back offices processes, allows the replacement of expensive mid-level manual layers and can also improve client service and trading.Technology transformation

It is a cost killer: $2-3 billion of industry costs per annum can be saved due to technology investments (Morgan Stanley, 2014). In particular, smart sourcing can be an important source of cost-cutting: In-house platforms are highly duplicative and provide no competitive advantage. Economies of sccale through external supply chain can be implemented in order to enhance flexibility and allows more potential innovation.

Moreover, thanks to electronification, market efficiency and dealer economics can be improved. Electronic data can be used to more efficiently match potential buyers and sellers. This allows banks to reduce the inventory they keep on their balance sheet and the associated costs. In addition, technology can make the client-dealer relationship easier by automating elements of price distribution, speed up the evolution of the existing relationship towards electronic platforms and finally allow automation of elements of price distribution, construction and risk management.

Electronification could also facilitate the Agency Model functioning by handling bigger volume of trades, supporting complexified workflows and Straight Through Processing (“STP”). STP is crucial to the success of interoperability of electronic platforms and buyers/sellers, in order to allow real-time pricing and trade execution. Streamlined processes can also create opportunities to offer additional services to clients, such as real-time and same-day transaction reporting.

Finally it is a differentiating factor. Banks should shift away from reactive regulatory and remediation costs, and move towards a more strategic infrastructure change program.


Since the financial crisis, profitability in the Fixed Income industry has sharply declined and banks are under both self-risk reduction and regulatory pressure: new liquidity and capital ratios and limitations on proprietary trading have lowered banks‘ abilities to participate in Fixed Income markets as they did prior to the financial crisis.

The buy side therefore is obliged to find alternative providers. As a consequence, the industry is moving toward more innovative models, such as all-to-all models, to match orders efficiently, and to allow buy side firms to deal with each other.

This era of increased regulatory pressure and scrutiny does not appear to be subsiding in the near future.. The SEC is actively discussing enhanced pre and post trade transparency (lack of transparency is impacting retail investors that are highly involved in the municipal and corporate bond market, and that are currently not able to assess the fairness of the execution prices), and wants to address the lack of liquidity issue in the secondary Fixed Income markets, notably by facilitating electronic trading through product standardization).

Whether they like it or not, Investment Banks have to accept the idea of a new era, adapt their business model and find relief and new opportunities in the form of technology innovation.


Sia Partners



  1. Sia Partners, based on public data coming from registration documents
  2. Morgan Stanley, 2014
  3. Morgan Stanley, 2015
  4. Financial Times, 2014
  5. BIS, 2015
  6. SEC
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