By Matt Scuffham
(Reuters) - After another lacklustre quarter for bond trading, most Wall Street banks are moving faster to adopt new technology to improve results, but analysts say the winners of the race must grow market share to combat shrinking margins.
Most posted revenue declines in that business during the third quarter from a year earlier, with only Citigroup Inc
Historically low interest rates and tougher regulations made some products more costly to trade and restricted proprietary trading and other activities. Experts said banks can improve bond trading results by automating more functions, speeding up and improving trade execution and making more products available for electronic trading.
Last Friday, JPMorgan Chief Executive Jamie Dimon told analysts that results could improve as the bond market doubles in size over the next two decades. Yet in recent years, the market for fixed income, currency and commodities products has swelled in size, but each trade has become less profitable
Revenue from bond trading across Wall Street has fallen 40 percent since 2010, according to data provided by Oppenheimer analyst Chris Kotowski. Banks now generate $61 billion per year from the business, compared with $101 billion in 2010.
If banks get more aggressive about improving bond trading technology, revenue could start growing again, analysts and executives said, noting that equities trading went through the same trend decades ago after regulations and client preferences forced business models to change. "The question is to what extent are some of the banks able to transform their business model to disrupt themselves before they get further disrupted," said Guy Moszkowski, a bank analyst with Autonomous Research. "I think there's a case to be made that a firm like Goldman Sachs has embraced that model."
Goldman Chief Financial Officer Marty Chavez, a computer scientist who becomes co-head of the trading business next month, has advocated "electronifying" bond trading since before it was conventional wisdom. The bank has been working through that process for years, and it could take longer to complete.
"Leave to machines things that the machines do best," Chavez told analysts during a conference call on Tuesday.
Goldman's main rival Morgan Stanley
Some trading executives once said that compared to equities, bond trading was too hard to automate. For instance, corporations have thousands of bonds lasting various durations. These are not traded on exchanges and there is much less liquidity than stocks have, so human traders are needed to match buyers and sellers.
But now, Goldman's corporate bond trading system uses algorithms to automate trades worth up to $2 million. Chavez said these will likely handle bigger transactions in the future.
The downside of automated trading is that profit margins will be squeezed until they become razor-thin. Eventually, only the banks with biggest market share can make the business profitable.
In equities trading, Morgan Stanley invested heavily in technology for equities trading as it exited the crisis. This year, it is likely to be No. 1 for that business by market share but its institutional securities unit, which includes trading, generated a return on equity of just 10 percent during the third quarter.
The metric, which measures how well a bank uses shareholder money to generate profits, was more than double that level in wealth management, where Morgan Stanley has expanded aggressively since the crisis.
Analysts say a bank must be among the top few in a trading business these days to make it worth pursuing.
According to Oppenheimer's Kotowski: "Things that are easily traded electronically trade near a zero margin."
(Reporting by Matt Scuffham; Editing by David Gregorio and Lauren Tara LaCapra)