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As laid-off employees were photographed trudging out of offices with their termination papers, the media correctly focused on years of unchecked ambition and mismanagement at Germany's largest bank. But that obscures a truth about the $68 trillion stock market: For nearly everyone outside of a few giant U.S. players, equities trading is a money-losing affair.
Institutional stock trading has become a winner-take-all arena in which a few big players are carving out larger slices of a shrinking pie. On the one hand, Morgan Stanley, Goldman Sachs and J.P. Morgan Chase have been gaining share by helping clients buy and sell stocks and related instruments. These firms made $11.4 billion in equities revenue this year, down 14% from 2018. On the other, tiny nonbank computerized firms like Virtu that barely existed a decade ago have driven down trading commissions.
That leaves a string of European firms stuck in the middle – forced to invest in technology and people to keep up, but without the size and scale to make the math work.
"If we continue down the path we've been on for the last few years for another one, two, three years, anyone that's trying for that middle way is going to just get crushed," said the global head of equities trading at a large Wall Street bank who declined to be identified speaking candidly. "There's no room there."
The major forces shaping equity markets — regulation and technology — are to blame. In the past decade, trillions of dollars moved from active to passive strategies such as index funds, while quants and high-speed firms have taken over more volumes in daily trading.
That's hurt most old-school hedge funds and asset managers not named Vanguard or BlackRock and given rise to sophisticated electronic trading platforms, where commissions are a fraction of human-brokered trading.
Central banks, meanwhile, have spent most of the post-financial crisis era cutting rates or keeping them near zero, effectively sucking volatility out of markets and making it more likely that big clients remain on the sidelines. And last year, the European regulation known as MiFID II unbundled stock trading and research, stepping up pricing pressure on both.
"Clients are suffering, and there are too many banks," said a senior equities executive at another large investment bank who would only speak on the condition of anonymity.
It costs roughly $4 billion a year to run a full-service global equities business, with traders, salespeople and research analysts in financial districts around the world, this person said.
"It's a very hard business model," the executive said. "On day one, you're down $4 billion. How do you make that work? America is where the game is, and for the rest, at some point, they have to figure out whether they want to be in this business."
Below Morgan Stanley, Goldman and J.P. Morgan in the equities revenue hierarchy is UBS, Bank of America and Citigroup, according to industry research firm Coalition. Further down are Barclays, Credit Suisse, Societe Generale, HSBC and BNP Paribas. Deutsche Bank, in Coalition's bottom ranking, reportedly lost $750 million in its equities division last year.
Banks outside of the top five typically don't earn enough revenue to make a return on equity of at least 10%, the minimum threshold expected by investors, according to an industry insider.
That hasn't stopped European banks from maintaining big trading desks for years. By staying in the game, they can profit if the trading environment normalizes or outlast rivals. That's what happened recently when Barclays poached hedge fund clients with $20 billion in balances from Deutsche Bank.
But Barclays itself is under pressure to prove that it should remain in the trading game. An activist investor with 5.5% of the bank's shares has been agitating for the bank to scale back its investment bank, saying that Barclay's strategy ignores "the fundamental realities of the global corporate investment bank marketplace."
Banks also fear that if they exit less profitable parts of the equities business, they will lose clients to brokers that maintain the full spectrum of services across products and geographies.
In late 2015, when Morgan Stanley decided to fix its ailing bond-trading business, it had considered a range of cuts, or even exiting fixed income completely. But that came with its own risks, including that clients would depart, according to a person with knowledge of the situation. It ultimately announced a 25% cut to the division.
So far this year, the trading environment has only gotten tougher. Banks posted the worst first half of trading results in the last decade. There has yet to be an event like the explosion of volatility in February 2018 that helped Goldman Sachs make $200 million in profit on a single day.
One innovation is making competition even fiercer: Hedge funds and asset managers are increasingly using so-called algo wheels to automatically route trades to the broker with the best performance.
That's because under MiFID II, the firms have to prove they are getting the best execution on a trade, rather than sending orders to a favored broker or a salesperson who bought a client dinner.
More than ever, big investors are concerned about losing basis points — hundredths of a percent — of price slippage in a trade. And quarterly meetings between banks and their clients have given way to monthly sessions to discuss algorithm performance and other tools.
"If you're waiting for a quarterly review to find out why you're 'down share' with somebody, well you've already lost a ton of information and revenue in the interim," said the global equities trading head.("Down share" means losing trading volume to a rival bank.)
To stay in the game, banks have to engage in an expensive technological arms race, spending millions of dollars on infrastructure, from smart routers and algorithms to high-speed connections to exchanges.
Goldman Sachs, which embarked on a plan to improve its equities trading technology in 2015, plans to plow more than $100 million in the business in coming years, according to Raj Mahajan, a Goldman partner and co-head of the bank's securities engineering division.
"If you're not making the appropriate investments in scale, then you're going to be on the outside looking in," Mahajan said. "We want to be clients' first call and we want to be their first click. If that is what you set your sights on, it's going to cost a lot to be in this business."
What's coming next will be even harder for smaller banks to manage. The largest investment banks already have the most trading data. As they get better at applying artificial intelligence and other techniques to those data sets, they will increasingly have an edge, according to insiders.
Stock traders and salespeople have already been squeezed out of the industry or replaced with younger, cheaper employees with more technical skills. Employment levels at the world's biggest investment banks have fallen every year since at least 2012, according to Coalition.
Those that remain need to be happier making less money than they used to, according to New York-based recruiter David McCormack.
"I tell people this every single day: If you don't want to work for $500K, I get it. Leave the industry," he said. "If you think you're going to make a million bucks again, it's never going to happen."