Bond Trading Loses Some Swagger Amid Upheaval
Bond traders have long defined Wall Street’s swagger and, in good years, generated a large share of its profits. Now, though, an upheaval is taking place in the bond business that is wiping out billions in profits and thousands of jobs.
Wall Street banks like JPMorgan Chase, Goldman Sachs and Credit Suisse managed to keep their grip on the bond market in recent years, amassing huge inventories of bonds for clients and trading them mostly in private over-the-phone transactions.
But tighter regulations being enacted this year and new electronic trading technology being rushed to market are threatening to permanently constrain this bastion of big bonuses and risk-taking.
“It was a rock-solid kind of career not too long ago,” said Lou Ricci, a co-founder of the Hagan-Ricci Group, a headhunting firm. “You give me a really good bond trader right now, I probably can’t find them a job.”
In the second-quarter financial results that the nation’s largest banks have announced over the last two weeks, revenue has dropped across several business lines, pressured by the continuing economic malaise. But the pain in the fixed-income operations — called that because of the fixed interest rate that most bonds pay — has been particularly acute.
Morgan Stanley’s second-quarter fixed-income sales and trading revenue declined 60 percent from the previous year, more than other parts of its operations. Companywide, the bank said that it would be cutting about 7 percent of its work force this year. No banks report the specific staffing levels of their bond operations.
Fixed-income desks help companies and government agencies raise money by selling bonds to the public. They have made even more money trading existing bonds for their own account and on behalf of clients such as pensions and mutual funds, and managing the portfolios of these clients. The same divisions at banks have also bought and sold derivatives, financial contracts whose prices are based on bond values.
But those derivatives are being forced onto open exchanges or other platforms under the Dodd-Frank financial regulation law. Other new rules, requiring strong capital buffers, have made it more expensive for banks to hold the large inventories of bonds that allow them to serve as the middleman for buyers and sellers. Money managers and banks are creating open electronic marketplaces for trading government and corporate bonds. Still more new rules will limit banks from using their own money to make financial bets on bonds.
The series of changes will make it easier for regulators to monitor these complex markets and could drive down the large cut that banks take from most bond trades and make it cheaper for investors to buy and sell bonds. But some industry experts have said that more transparency in the trading of bonds could make it harder to buy and sell some less popular bonds because investors will not want to have their enormous trades exposed. This could drive up the cost of borrowing for companies and governments.
Revenue from fixed-income trading among the top dozen global banks has already dropped from its height of $190 billion in 2009 to $105 billion last year, according to Keith Horowitz, who researches large banks for Citigroup.
Mr. Horowitz estimated in a recent research report that the changes overtaking the industry were likely to keep revenue down about 15 to 20 percent in the long run. The big banks have only made about a third of the layoffs they will need to make in this area, according to a report from Kian Abouhossein, an analyst at JPMorgan Cazenove. “It’s a huge shift,” Mr. Horowitz said.
To understand the breadth of the transformation under way, step onto the sprawling trading floor at Credit Suisse in Manhattan.
The old style of trading is still visible on the corporate bond desks, where orders are yelled across the room and voices constantly come crackling through the “hoots,” a system that allows traders to broadcast questions to everyone on the floor. The trading here has resisted automation because companies that have only one stock have many different varieties of bonds, each of which carries its own price. Banks have found trading these bonds profitable because they have greater leeway over the pricing than if they traded in a market with transparent prices.
By contrast, the area where Treasury bonds are traded is hushed. These bonds are among the most standardized and have been easily automated. Credit Suisse released a program earlier this year, labeled Onyx, that lets its customers get a price for a specific Treasury and trade it without ever dealing with a human.
The traders here are mostly educated in math or physics, often outside the United States, and their desks are piled high with textbooks like the “R Graphs Cookbook,” for working with obscure computer programming languages.
“Our best traders spend a lot of their time pounding away writing code,” said Ryan Sheftel, head of the bank’s automated Treasury bond trading, pointing at one of his young employees. “He is doing thousands of trades, but doesn’t need to be manually involved anymore. The code he wrote is making the trading decisions.”
The increased use of automated platforms means that more programmers are needed, but fewer employees over all.
Corporate bonds may be next. While banks have long said corporate bond trading is too complex for automated trading, new companies are coming up with ways to price the many varieties of corporate bonds in real time. MarketAxess, a popular platform for trading corporate bonds, has introduced real-time pricing of some fixed-income products over the last two years, according to its chief executive, Rick McVey. On Tuesday, the company announced that it was introducing new technology that will allow institutional bond investors to connect directly without going through a trading desk.
“The model in fixed income has been pretty much the same for the last 20 or 30 years,” said Tim Grant, a managing director atBenchmark Solutions, one of the companies trying to make the corporate bond market more automated. “People will look back on this and will see that this is when everything changed.”
Banks are being pushed to move their trading onto automated platforms as a consequence of the international bank changes known as Basel III. These require banks to hold big cushions of capital to protect themselves in case trading positions lose value, with bonds requiring particularly large and expensive cushions.
This has resulted in banks shrinking the inventories of bonds they used to have on hand in case a customer wanted, say, a million dollars’ worth of 10-year General Motorsbonds. Now, those same customers have to look more broadly to find the same quantity, potentially bypassing Wall Street all together.
BlackRock, the large asset management firm that holds trillions of dollars in bonds on behalf of its clients, has introduced a platform known as the Aladdin Trading Network, which will allow customers to connect directly to buy and sell bonds. Banks like Goldman Sachs and Credit Suisse have battled for the same business by designing their own platforms to give clients access to a wider supply of bonds.
Another regulation forcing fixed-income desks to change quickly is a part of the Dodd-Frank financial legislation that is set to push derivatives like interest rate swaps onto exchangelike platforms later this year. Banks have lobbied vigorously against it, arguing that the electronic infrastructure is not ready for the complexities of the multitrillion-dollar market.
“Instead of evolving our way, we’re being pushed rather hard,” said the head of one fixed-income trading desk.
Analysts expect that the changes ahead will largely mirror what happened to stock trading a decade ago, when a combination of regulations and new technology transformed buying and selling stocks into a more automated business. That shift reduced staffing levels by 35 percent and compensation by 45 percent, according to recent research from Mr. Abouhossein.
The changes in stock trading also laid the foundation for the rise of high-speed trading firms that now account for a majority of stock trading. So far, the high-speed firms have largely been unable to penetrate the fixed-income world, but that is likely to change once they can link in to the bond market electronically.
Although banks have been building up their electronic platforms and laying off employees, Mr. Horowitz said they have not adapted fast enough.
“You can kind of fight it,” he said, “but you can’t fight that fight for too long.”
This article has been revised to reflect the following correction:
Correction: July 24, 2012
An earlier version of this article misidentified Mr. McVey’s company as Tradeweb.