March 2016

Background on the Australian FICC Market

The FICC market in Australia, as it is globally, continues to function under the challenges of pressure from regulators, internal cost structures and the ongoing impact of changing technology.

With the demise of proprietary trading due to the deliberate introduction of direct restrictions and punitive costs designed to break the business model, there has been a major change to the way banks interact with their FICC customers. No longer can banks use the balance sheet as the facilitator of client business. In many ways they are having to revert back to the broking model that preceded this. This is already impacting on liquidity. It seems that the regulators are well aware of this and the impact that this is having in the current climate let alone when an event type move is on. However they are focused on reducing the amount of risk taken on by banks and happy to ignore some of the potential consequences.

As a result of this global phenomenon in combination with historically low rates albeit having seen the first rate rise by Fed in many years, FICC teams globally are being downsized as banks realign their focus both from a big picture perspective as well as more targeted areas that provide greater growth and returns.

These big picture decisions have resulted in RBS and more recently Barclays withdrawing from the Australian market as well as head count reductions across all the global bulge bracket banks in Australia.

The domestic banks also continue to shed head count as they continue react to pressures to reduce costs as well as increasing productivity. This has seen the CBA cut its markets headcount by 10% late last year and Westpac looking for reductions across its institutional business. The risk is that the other domestics will also head down the same path.

One of the quickest ways to increase productivity is to drive sub institutional clients onto the banks execution platform and this has worked the most successfully in FX which is had a head start on the technology and a product that is well suited to electronic execution.

The domestic banks have also adopted the trend to juniorize its teams. Replacing an MD with an AD may give a fast sugar hit to the bottom line in reducing the cost structure but is a risk that longer term damage could be inflicted on the organization as a result of weakening relationships between the bank and its clients.

On a more positive note, the domestics have been prepared to hire people that can provide them with new skills and experience that may not have been available to them in the past. These opportunistic hires however have to overcome the zero tolerance for an increase in total headcount. As such room has to be made if the hire is going to go ahead.

Current situation in the Australian FICC Market

There appears to be a consensus around concerns over the ongoing cost impost of adhering to the new regulatory environment. This not only has resulted in an increased cost of capital to the FICC business but in terms of ongoing costs associated with compliance issues with the increased and more detailed monitoring of all forms of communication.

As touched on before the costs associated with warehousing large amounts of stock on the banks’ balance sheet has resulted in banks having to manage any inventory that they carry very carefully. As a result they will have to be selective in which product they quote on and which they may act as an agency on. As a result some banks may specialize in particular bonds or names and will also have to develop a deeper knowledge of the market through more sophisticated data mining and analysis of price action and customer activity.

On-boarding customers is also now more time consuming as well as costly  given the increased compliance requirements that are in place to protect customers.

Banks are also concerned about the decline in liquidity and the risks that brings not only to the broader market in the face of an event driven move but also in their ability to trade out of positions.

Domestic banks are also concerned about their ability to compete with their global counterparts when it comes to developing technology. Development and implementation costs are high and domestic banks do not have the economies of scale that the international banks do. This is of vital importance given the push to transact more and more business across the FICC space via portals. It also ties in closely with the push to improve end to end efficiencies.

Coverage Models

Historically banks have tended to adopt a coverage model based on product. In order to achieve this they had to have sales specialists covering a number of clients for each product. This required larger teams and was sustainable in more profitable times. This structure was cleaner cut at the larger banks which had the head count to do this with the lines becoming a little blurred with the medium to smaller banks not having the scale to do this resulting in some cross over between products.

However in recent times, given the drivers of reducing costs and increasing productivity, sales teams have been squeezed from a headcount perspective to be as lean as possible. As a consequence, there has been a natural gravitation towards a more macro focused coverage model where a salesperson is responsible for a range of products on offer to a particular customer. This is further enhanced with the ongoing push to drive customers to utilizing portals and as such allowing a salesperson to expand their coverage capacity as well as by pruning clients to leave only those that are deemed to be profitable across key product areas.

Global banks in Australia also appear to becoming more selective in the customers they cover evaluating which ones provide the greatest returns and focusing on these rather than covering a range of customers who do not pay their way. This has the potential to further tighten a banks coverage and product offering as a result of the increased cost of capital. Banks could be forced into becoming product specialists in certain areas concentrating its price making and sales capabilities to a confined range of bonds for example.