The biq squeeze
Asset managers are about to find life more expensive. After years of mounting regulatory costs and low interest rates, investment banks are attempting to charge clients more. The trend looks likely to accelerate over the coming 12 months.
Only three of the world’s 10 biggest investment banks are expected to make a return on equity in excess of 10 percent next year, Eikon SmartEstimates show. A steady stream of fines has wiped out the efficiency gains from cutting operating expenses. Banks will struggle to make their cost of capital, estimated by McKinsey to be around 11 percent to 12 percent.
That leaves pricing as the next source of added return. The areas where profitability has been hit hardest are fixed income trading and prime broking, the business of servicing hedge funds – this is where new regulation on liquidity and leverage really bites.
Rules forcing banks to hold enough high-quality assets to get through a 30-day market crisis restrict lending. These constraints are already widening bid-offer spreads on longer-dated derivatives, and raising rates on loans. Leverage requirements for banks make it costlier to provide finance to equity hedge funds seeking to gear up their portfolios. The same dynamic is at work for fixed income repurchase agreements, or repo, a type of collateralised lending that enables hedge funds to bet on falling bond prices.
Banks may offer some of these services as loss leaders. Barclays, for example, is taking a holistic three-year view of client relationships in some cases, says one person familiar with its working. This approach will work only where clients are big enough to offer multiple revenue opportunities. Many banks are aiming for fewer overall relationships with more relevant clients. That may spur consolidation, particularly among hedge funds.
The simpler alternative is to raise prices where products are becoming uneconomic. Credit Suisse is talking to clients about raising prime broking charges, says a person familiar with its activities. JPMorgan Chief Executive Jamie Dimon has said that revolving loans and repos need re-pricing. The persistence of low returns will spur others to follow.
This view is a Breakingviews prediction for 2015. Click here to see more predictions.