By Helen Bartholomew
Published July 12, 2014 IFR
After a solid first quarter, equity derivatives desks have endured a difficult three months as volumes declined alongside a plunge in volatility, further denting hopes that the business will play a significant role in plugging the revenue gap left by the fixed income slump.
As banks prepare to deliver second-quarter results that will struggle to live up to solid first-quarter numbers buoyed by a widespread shift from rate-based to equity-based structured products, cracks in ambitious equity derivatives build-out plans have started to emerge, with a string of high profile departures across the Street.
“Overall, we’re looking at a reasonably solid first half, but while Q1 was good, Q2 came in below expectations. It’s not a disaster, but the low vol, low rate environment hasn’t been conducive to buoyant client activity,” said a European equity derivatives head at a European firm. “We’re looking at a difficult second half and we’re not planning for any marked improvement.”
Since the beginning of April, the VIX index of S&P 500 volatility has consistently traded below 17 and dipped to a new seven-year low of 10.28 at the start of July. US listed options volume for the quarter fell 11% year-on-year, according to the Options Industry Council, while the first half delivered an overall decline of 1.4%, mirroring a scenario witnessed across over-the-counter markets, according to traders. But there have been some bright spots.
“The growth story this year is US flow equity derivatives,” said Seb Walker, a partner at financial research firm Tricumen. “We’ve seen an increasingly buoyant hedge fund community and a shift in institutional accounts making greater use of equity derivatives,” he said.
Against a backdrop of persistent low volatility and rising regulatory constraints, concerns are mounting that growth targets across the industry will fail to be realised – something believed to be at least one driver behind recent departures.
“Equity is doing better than fixed income, but it’s not necessarily the case that all equity divisions are doing well,” said the equity derivatives head at another European house. “Some fixed income businesses have been subsidising smaller equities operations for many years and with the revenue falls facing fixed income that dynamic is changing. If you’re in a fixed-income focused bank, it’s probably quite tough in equities right now.”
All change
One of the most ambitious build-outs in equity derivatives is currently afoot at Citigroup. Those plans were delivered a blow last month when the firm lost global equity derivatives head Simon Yates to Two Sigma Securities, where he will run the broker-dealer arm of the US$20bn hedge fund.
Yates’ departure came hot on the heels of Mike Pringle, who left his role as global head of equities trading at the US house to join Moore Capital, a US$15bn hedge fund.
While the bank has had some success building a solid business, breaking into the top tier is proving difficult without a top cash equity ranking to match. Last year, the firm ranked 10th in equity sales and trading with revenues of US$2.5bn – flat to 2012 levels, while peers such as UBS, SG, Morgan Stanley and JP Morgan posted double-digit gains.
Last month saw two senior departures from Morgan Stanley as Alvise Munari, global head of equity derivatives distribution and financial engineering, and Pierre Mendelsohn, head of equity derivatives distribution in Asia, left to pursue other opportunities.
Under Munari’s leadership, MS successfully jumped up the revenue rankings in equity derivatives as it sought to mirror its top tier standing in cash equity markets. In 2013, the firm ranked second in equity sales and trading with revenues of US$6.6bn.
Munari, who is believed to have been appointed on a fixed-term contract when he was poached from Bank of America Merrill Lynch in 2010, will not be replaced and his responsibilities will be distributed across the team.
Goldman Sachs, the leading house in equity sales and trading, posted a 13% revenue decline across the business for 2013 and was one of just two houses surveyed by Tricumen that suffered a decline in equity derivatives revenues for the full year – RBS being the other.
According to Tricumen’s Walker, the shift reflects a narrow client base that is primarily focused on hedge funds and retail products, resulting in limited opportunities for efficient risk recycling.
“As the equity derivatives market matures, the most settled players seem to be the ones with the most balanced client mix. The downside of a less diverse client base is that your business tends to be one-directional, which either means you’re carrying too much risk or you have to hedge a lot,” he said.
The firm recently lost senior fund-linked trader Karim Bennani, though Goldman confirmed that the headcount in the business remained intact, its having hired traders Dimitri Nikolakopoulos and Piotr Zurawski from JP Morgan earlier in the year.
Officials at JP Morgan noted that the headcount in equity derivatives remained stable despite those departures and that the structuring commitment was unchanged despite the renewed focus on grabbing cash equity market share (see “Equities solid, but no new dawn”).
Regulation bites
Although largely sheltered from the scope of Dodd-Frank given the law’s focus on interest rate and credit derivatives, equities have not escaped the regulatory glare.
“What makes equity derivatives businesses different from other parts of investment banking is that you are indirectly dealing with the retail customer for a portion of the business, so it’s hugely regulatory sensitive and constrained by a whole raft of regulatory processes,” said the second European head.
In Europe, the regulatory bite is beginning to take hold as a range of over-the-counter equity derivatives instruments are currently being considered for mandatory clearing by the European Securities and Market Authority (see “ESMA warned on equity derivatives clearing approach”).
