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New U.S. swaps trading seen hurting banks less than feared

A sign outside the headquarters of JP Morgan Chase & Co in New York, September 19, 2013. REUTERS/Mike Segar
A sign outside the headquarters of JP Morgan Chase & Co in New York, September 19, 2013. REUTERS/Mike Segar

By Peter Rudegeair

(Reuters) - When U.S. regulators pushed trading in a profitable derivative on to newly created exchanges last month, many analysts feared the worst for banks' first-quarter results.

They worried that moving some of these interest-rate swaps - one of the most widely traded fixed-income derivatives that banks offer - to platforms called swap execution facilities (SEFs) would dry up volume, reduce banks' fees and make what was already expected to be a tough quarter for fixed income trading even more dire.

When SEFs came fully online on February 15, the immediate results were discouraging. The volume of derivatives through these new platforms plummeted by one-third as traders waited to see how the new system would work, said Anshuman Jaswal, senior analyst at Celent, a research and consulting firm.

But as quickly as volumes slumped, they rebounded. In the weeks following the rule change, they increased by 54 percent, Jaswal said. He added that there was some early anecdotal evidence indicating that the margins that banks earn on individual trades started to come down, but it was too soon to say that definitively.

"We think it was a temporary blip," said Will Rhode, director of fixed income research at TABB Group. "I would be surprised if dealers demonstrated in their first-quarter results some major impact from earnings because of the introduction of SEFs."

Major banks will report first-quarter results next month.

Trading in bonds, currencies and derivatives is one of the biggest businesses at the largest U.S. banks, accounting for 10 percent to 25 percent of overall revenues at banks such as JPMorgan Chase & Co , Citigroup Inc and Goldman Sachs Group Inc .

It's not clear how much of that revenue comes from trading in swaps that were moved to the SEFs, but the rebound nevertheless offers much-needed relief to banks.

Mandatory trading on SEFs was introduced in the first quarter, historically the busiest for trading desks as investors position portfolios for the new year. The uncertainty exacerbated an already challenging environment fixed income businesses face due to economic uncertainty and regulations that have made it harder for banks to make money in the business.

LOWER TRADING REVENUES

Bank executives have sounded cautious about their trading revenues.

"While there is uncertainty on the direct impact on volumes as a result of the introduction of SEFs, it is clear that regulatory uncertainty has created a reticence from clients to trade as actively as they may have before," said the head of interest rate trading at one large bank.

Citigroup expects trading revenue to fall by a "high mid-teens percentage" from the first quarter of 2013 because of an "uncertain macro environment," as well as particularly strong results a year ago. JPMorgan executives said last month that overall trading revenues were running 15 percent lower since the start of the year than the same period in 2013.

That could have a meaningful effect on banks' bottom lines.

Over the past 30 days, analysts surveyed by Thomson Reuters I/B/E/S have revised down first-quarter earnings estimates, many citing the trading slump as the primary reason. Analysts cut estimates of Goldman's first-quarter profit by 4.5 percent, on average, and Bank of America Corp's by 4.4 percent.

The dour outlook is part of a longer-term slump. First-quarter trading results at the largest banks have fallen every year since 2009 as a result of new regulations, according to Steven Chubak, a bank analyst at Nomura Securities in New York.

Banks hope that over time the benefits of executing trades on SEFs, such as higher trading volumes because of more transparent pricing, will outweigh making less on individual transactions, limiting one of the many headwinds they face.

"If things go as planned, (the new rules) will increase demand and the number of products" clients can trade more easily, Jaswal said. "There will be more efficiencies for the market overall."

(Reporting by Peter Rudegeair; Additional reporting by Lauren Tara LaCapra; Editing by Paritosh Bansal and Nick Zieminski)

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