Capital markets in the doldrums

  • By Elizabeth Fry
calm water

A rating agency says an unusual calm has descended on global capital markets and squeezed investment banks' income.

This lull in market volatility - which has stifled client activity and inhibited deal flow -  has prompted S&P Global to cut capital market revenue forecasts for the world's top investment bankers by 5 per cent.

This is quite a reversal of the 5 per cent rise in revenue forecast by the ratings agency as as recently as April 2017.

"If realized, this would make 2017 the fifth consecutive year in which industry revenues fall, demonstrating structural and cyclical pressures on the sector,” noted S&P credit analyst, Richard Barnes.

"Looking ahead to 2018, although difficult to predict at this stage, we would expect capital market revenues to remain roughly flat versus 2017 if volatility remains low.

"That said, given the growing likelihood of global central banks tapering the current monetary stimulus, volatility could well pick up by then.”

Some large US investment banks have estimated third-quarter sales and trading revenues to be 15 per cent to 20 per cent lower than the same period last year when the surprise Brexit referendum result, and imminent US presidential election, created a more favourable climate

However, quarter-by-quarter performance is not the rating agency’s main focus and the relatively small change in expected revenues does not materially change its view of the sector.

Also, Barnes was quick to point out that low volatility and lack of client engagement have slightly improved some banks' capital ratios, due to lower value-at-risk and trading inventory.

“That said, we qualitatively consider a return to a more normal operating environment when forecasting our risk-adjusted capital ratios for banks with large trading portfolios.

“We view the current benign environment as a temporary--albeit protracted--situation rather than the new normal.”

Accordingly, the lower revenue forecast does not affect ratings although S&P said the prolonged revenue pressures might lead some banks to further restructure, which could potentially weaken their business stability or capital generation.

“Although we expect central banks to taper their interest rate and liquidity stimulus gradually, it would be unrealistic to expect markets to reprice entirely smoothly."

In this scenario, he added, investment banks should benefit as renewed volatility causes market participants to reposition portfolios and hedge rediscovered risks.

“However, many asset classes appear fully valued and banks could suffer from sudden market corrections, despite their smaller and more liquid trading inventories.”

Looking ahead to possible headwinds, Barnes said the January 2018 implementation of the revised European Union Markets in Financial Instruments Directive (MiFID II) could affect trading revenues in European markets.

According to the credit analyst, the agency’s rating outlooks on the major investment banks are currently a mixture of stables and negatives.

“However, our negative outlook on Deutsche Bank is a case where the outlook primarily reflects an institution-specific issue, namely its ability to restructure its operations, rebuild its franchise and make progress toward its financial targets.

“Similarly, while our outlook on Credit Suisse is stable, its ability to achieve its 2018 restructuring objectives is an important factor in our analysis.”