Consulting | Treasury, FX, FI and MM
Written by Roland Probst
Nov 8, 2021
The fixed income and commodity and currency (FICC) desks of banks have been relative laggards in terms of performance over the last decade. A combination of a torrent of new regulatory requirements, increased competition and a low interest rate environment has squeezed a once-reliable profit generation centre. But income or no income, the FICC desk remains a vital part of an integrated bank offering – and a critical driver of a bank’s corporate treasury product distribution function.
Inefficient operations are ripe for transformation. This is a trend that hasn’t changed in the 20 years between when I worked in FX and Rates for a major European bank, then launched and built-up LPA Group, to where we are now. The same problems that beset banking systems and processes decades ago persist.
The opportunity for forward-thinking institutions is to radically re-imagine their operations for today and tomorrow’s market environment. This represents the ability to shake off years of stifled innovation, unnecessarily high costs and questionable customer service in favour of a more mutually beneficial relationship.
Many of the banks with the worst ratios of capital expenditure to returns in their FICC desks are Tier 2 to 4 banks. Here institutions have maintained full-stack infrastructure despite not having the volumes and therefore being truly sub-scale compared to bulge bracket institutions.
Most banks are fundamentally conservative institutions. With billions on the line, it is nearly impossible to stick one’s head above the parapet. High profile failures end careers, while success can easily be claimed by someone else. This goes some way to explaining while even though the financial services industry has spent more than two decades of discussions breaking up value chains, precious little has happened.
Even though there have been panel after panel discussions on the value of moving some parts of the trade out of the bank, very few institutions have actually taken action. Others are acting, but in a way that is more retreat than bold move forward. In order to avoid the highest regulatory requirements in the customer business, some (mid-sized) banks have decided to serve only ‘professional’ customers. The advisory effort is incomparably lower compared to smaller ‘retail’ customers, but this customer group is more cost-sensitive, which in turn becomes apparent in the margins.
Other banks refused to change course because of the equity and reputation placed on existing projects. Part of this has to do with the ‘sunk cost fallacy’ – in many cases expensive systems have been purchased and installed, at the cost of millions of dollars. But there is a reason that’s it is called the sunk cost fallacy – it’s not necessarily true. Expensive internal systems grow ever more extortionate as regulations continue to evolve. Every new reporting action, every new change to the trade surveillance process adds costs and contributes to the overall unprofitability of the desk. As the old saying says, the best time to take action was five years ago – the second-best time is right now.
Some institutions are finally taking action and moving towards a more sustainable infrastructure. The model for a sustained FICC desk runs through the corporate treasury function. There are six parts to the creating systems built to last.
● Implement ‘mark to market’ thinking throughout the organization – There should be maximum transparency on revenues and costs and deep-seeded understanding of where the company is at any particular time
● Standardise and reduce wherever possible – Unless a product absolutely requires differentiation and meets a necessary level of profitability, transfer to a standard solution or operator. In every asset class only 5-8 different products are required, not 50!
● Externalize services and processes – Focus in on parts of the value chain that do not allow customer differentiation. Don’t forget to consider reducing the size of your trading desks.
● Move towards variable costs – Upfront projects can cost millions and divert resources that may not be ready. And a change in circumstance could require a whole new process just after completion. Don’t get locked in and instead move towards solutions can be up or down levelled based on the need of the organization
● Digitize regulatory processes – Regulatory compliance is necessary, but it is also a cost. Move all of this work away from analogue processes to more quickly implement future developments
● Don’t make everything in-house – Favour the purchase and packaging of products rather than taking on the risk and investment of creating products that already exist and can be licensed. This could be a good way to adopt new technologies quickly, like AI and machine learning, which can be essential in optimal timing and process for some treasury functions.
Fully achieving this model requires a dedicated third-party partner. The list above can serve as a checklist for evaluating whether a particular partner has the capability to fully unlock value present inside organisations. The right partner should have a track record and dedicated resource to deploying solutions that use cutting edge technology to lower the total cost of desks. For example, LPA’s Hedge Pilot provides artificial intelligence-driven calculations that advise when and how much to hedge. The firm’s Captano product provides access to market liquidity for a range of FI, FX and MM prices, while providing market insights and risk calculations that help sales people do their job better. Or the Capmatix product family helps to reduce cost for regulatory compliance in this space
There is a knotty, inconvenient truth at the heart of the banking industry. Even many of the largest, most successful institutions in the world are losing money across large portions of their business. If these companies, with scale and peerless reputations can’t consistently turn a profit, what hope do the smaller regional institutions have? The answer is to change the game that is being played. With smart outsourcing and the development of a strong relationship with a specialty provider, investment banks of all sizes can set up a sustainable model for the FICC as they exist today.
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