The low flow blow

Dealers in the European flow rates market are finding out what happens when the structure of a market moves more rapidly than the structure of a bank.

Bid-offer spreads in many rates products have more than halved over the past couple of years, Risk.net analysis has found – one euro swap tenor recorded an 89% fall in its 30-day average spread, with European government bond spreads dropping by anywhere up to 75%. Spreads are now as low as they have been for a decade.

Traders blame a combination of increased electronic trading – which has fuelled fierce competition – and new best execution requirements, which encourage clients to select a dealer on the basis of price alone, rather than relationship considerations.

Couple this with Europe’s low, stable rates, and the result has been a sustained slide in profitability.

So the mood among traders is pretty gloomy. That’s a natural reaction to the growing strain on their business; but it’s not just about sliding revenues and smaller bonuses – there’s something else going on here. It’s a sense of hopelessness. Many rates traders don’t see a way out. There are no buttons to press, no levers to pull, there’s nothing they can do to untap a geyser of extra revenue.

Innovation in data and analytics is being talked up by some banks, who say it could help them price more accurately, hedge more effectively, and provide clients with more insight.

Yes – but not to the extent that a 6% return on equity becomes a 12% ROE.

The answer isn’t the top line – it’s the bottom line. Which means the fate of the traders now rests with technology and ops specialists who believe they can radically change the structure of the market and of individual banks.

As a whole (they say), the industry can save billions of dollars by eliminating the web of back-and-forth reconciliations between counterparties, or between functions within a bank. Further savings could come from a new-tech approach to settlement, with trades settling instantly against some kind of digital currency – removing risk and reducing capital.

Some dealers are also now starting on long-overdue projects to break up centralised tech and ops support teams and bring those resources into the business – scrapping often-inaccurate cost allocations and giving the business the ability to think about, and control, costs from one end of a trade to the other.

Slowly, the outline of a meaner, more efficient trading business is being sketched out. The question is how long it takes to get there. If more proprietary traders gain access to bond and swap markets in the meantime, then dealers could find they have no franchise left worth saving.