March 14, 2016

If there is no business like show business then the bond business must be the stuff that nightmares are made of as you get to wondering what is in store for the market with almost every single major bank cutting back on the fixed income business since last year.

The latest was last week at Bank of America Merrill Lynch where “a bunch of senior sales and trading staff” were let go.

JP Morgan was also said to cut credit traders amid emerging-market volatility, losing their global head of EM credit, senior traders along with sales heads.

Goldman Sachs will eliminate more than 5 percent of traders and salespeople in its fixed-income business, cutting those operations more deeply than the annual companywide sweep normally used to make way for new hires… When Morgan Stanley cut about 1,200 employees in the fourth quarter, it included about 25 percent of its fixed-income trading staff.

The headlines have been relentless as a Bloomberg article last month pointed out that “Banks are taking a hatchet to their bond-trading businesses and the biggest casualties are proving to be the people with the most experience.

About 70 percent of credit traders cut in London last year at the 12 largest investment banks had worked in the financial industry for more than 10 years, according to data compiled by headhunters Michelangelo Search, which specializes in sales, trading and research roles. That’s increasingly leaving trading desks manned by more junior colleagues…

Experienced, better-compensated staff are falling victim to banks’ efforts to reduce costs as they try to generate profit within constraints imposed by regulators and central banks since the global financial crisis.

The loss of experience on banks’ trading desks couldn’t come at a worse time for bond investors. Credit markets are grappling with a global selloff as commodity prices plunge and emerging markets slow, stoking investors’ concerns about the state of the global economy. Weak bank earnings sparked a rout in financial debt securities this month.

There is a rush for the exit stinking up the air as Deutsche Bank and ING exit some European primary dealership roles in December 2015 as Credit Suisse decided in October last year to exit all primary-dealing in government securities across Europe.

I asked my good friend who happens to be in a high-risk job right now, being a senior fixed income trader, where all this is leading us to? To which she smugly replied as a culmination of losses.

The Loss of Liquidity

The starting point is the loss of market liquidity and depth which has been acknowledged by the markets for the past year. Regulators can only watch helplessly given that much of the loss of liquidity originates from heightened regulation and cost of doing business that justifies downsizing.

Central banks toying with fire with negative interest rates have frozen markets, increasing banks’ risks exposure, prompting prudent strategies to reduce and minimise trading under such disadvantageous terms.

Loss of Expertise

It is a loss for market expertise with the “juniorisation” effect taking hold of bond desks and there are good examples to be found in Singapore where the general impression that international investors have been given is that the local market is “unique” and credit markets here behave differently from developed markets which is a set-back for the MAS, who would wish to see triple A Singapore get a little more global recognition.

A dear friend, who would not be quoted, pointed out a little irony in the Singapore scene where credit traders buy and sell based on cash price and do not generally trade the credit-spreads, that typical credit traders elsewhere do.

Buying a bond at 100 and holding it to sell at 101 (+1% gain) makes them look good unless management realises the opportunity loss incurred because the government bonds have gained 3% in the same period. That is a credit loss which is largely ignored for only the Singapore trader because it is a “unique” market.

Losses For The Investor

An investor recounted to me his experience just last week in buying a SGD corporate bond. Calling around his bankers to buy a bond at a particular price, he was taken aback when one of the banks claimed the price was 2% higher, thinking that he was unaware of the market level, and that there was no stock of the bond at the price level that he wanted.

The rest of the banks he approached were able to fill his order. He was able to check on the bond price through friends who were traders and knew that the banks took a cut of 25cts from him.

Imagine an end investor without such resources?

Easy prey? Sitting Duck? Blind Monkey?

The Bond Market Business

Guerilla warfare thrives in a bond market deprived of liquidity and manned by inexperienced pilots.

Intermediaries with little vested interest or positions are able to profit from arbitraging between banks desperate for client business.

There is a story circulating about individual clients who buy SGD new corporate issues, demand for a cut of the private bank rebate (which is only awarded to private bank sales) and selling the bond for a quick profit at the issue price later when the bond starts trading, a case of happy client and happy sales desk, grateful for the flows.

The lack of market sophistication has left many a seasoned investor quite disillusioned, coupled with the lack of liquidity which has resulted increased restrictions on their investment mandates, imposed by a skeptical management.

The Future

The golden age of the bank trading business is coming to an end and it is difficult to imagine how much banking has changed unless you have been around for several decades and there are none left to tell the tale these days.

The Big Short and all those wall street movies depict times and lifestyles that will be limited to less and less people as fintech powers ahead at breakneck speeds to build those electronic platforms that will do the work for the executions desk in the future even as DBS Singapore has hired IBM’s robo-advisor, Watson, to help in their wealth management business.

And as my friend and I laugh at the “gangsta” bond markets and all the horror stories we hear from investors and insiders; companies that should not be allowed to issue bonds end up selling out their issuance, only for prices to collapse nearly immediately and; the random, baseless prices quoted by the traders left out there, mark-ups that will shock characters in Liars Poker, it does seem like the colourful bond business can compare to show business as major bank withdrawal continues and the curtains come down.