• Financial Post

Financial Post | December 7, 2015

Canada’s Bank Bond Traders Masters of a Dwindling Universe

Ari Altstedter, Bloomberg News

Canada’s “Masters of the Universe” are finding their kingdom a little smaller as global regulations that have cost U.S. and European colleagues their jobs start to bite at home.

Bond traders at Canada’s Big Six banks — whose U.S. peers Tom Wolfe termed “Masters of the Universe” in his 1987 novel “The Bonfire of the Vanities” — saw collective revenue creep up 2.6 per cent in the fiscal year ended Oct. 31, according to data compiled by Bloomberg. That’s not enough to offset a 15 per cent drop from last year, and means combined revenue from fixed- income trading at the six banks for 2015 is down 10 per cent from levels three years ago.

The Canadian traders’ results last week came just as news broke that U.S.-based Morgan Stanley is cutting as much as a quarter of its fixed-income staff after years of revenue declines and insufficient returns. The culprits fingered on both sides of the border are new global regulations making it more expensive for banks to trade bonds, and growing pressure from electronic trading systems that are making them less valuable as the market’s middlemen.

The rest of the world is starting to see a decline in their fixed-income staff numbers — layoffs, layoffs, layoffs. Canada’s one of the last holdouts

“The business is less profitable,” said Ian Russell, head of the Investment Industry Association of Canada, which represents bond dealers in the country. “They’re adjusting personnel and either shifting operations or downsizing them. And you’re seeing some of that in the attrition numbers in the fixed-income capital markets groups across our dealers, just on a much smaller scale than in the U.S., and a bit quieter.”

Though Canada’s six largest banks emerged from the 2008 credit crisis in better shape than global peers — in part because their trading desks were less exposed to the toxic mortgage bonds that set off the panic — the nation’s lenders have still been subject to the new regulations instituted globally to keep it from happening again.

Part of those rules increase the capital banks must hold to keep securities such as bonds on their balance sheets. That’s meant the returns those businesses now offer as a percentage of the capital they require tend to be lower.

“The rest of the world is starting to see a decline in their fixed-income staff numbers — layoffs, layoffs, layoffs,” said Peter Kane, a principle at consulting firm Greenwich Associates in Toronto, who works with Canada’s bank-owned bond dealers. “Canada’s one of the last holdouts.”

Electronic Trading

For bond investors, the banks’ pullback has raised concerns fixed-income securities will become harder to trade. Unlike stocks, which are often bought and sold on public exchanges, bonds have traditionally traded in private transactions conducted over the phone and by e-mail. Bank bond desks acted as the market’s main middle men, buying bonds from sellers and warehousing them on their balance sheets until new buyers emerged.

The big mark-ups they could charge for doing that in such an opaque market, and the huge bonuses they could earn for doing it successfully, earned them their grand title in Wolfe’s book. The latest regulations make that same activity more expensive.

In the U.S., that’s led to an increase in the number of electronic bond-trading platforms that allow investors to trade directly with each other, according to a report from Greenwich. Similar platforms have started to emerge in Canada, too, but it may take them awhile to pick up the slack left by the banks’ retreat, according to Robert Young, head of Liquidnet Canada, one of the new platforms.

“It takes longer for us to plug people in than it takes for banks to take capital off their desks,” he said by phone from Toronto.

‘Further Downsizing’

Bank bond traders in Canada have also been migrating to hedge funds to take advantage of their former employers’ retreat. Acting like a complement to dealers’ remaining balance sheet, they can trade like they once did, unencumbered by the new regulation.

“We definitely look to partner with the Street on providing that balance sheet,” said Brian D’Costa, who was global head of fixed income and rates trading at Canadian Imperial Bank of Commerce, before leaving in 2013 to start his hedge fund, Algonquin Capital. “That’s absolutely part of our funds’ strategy.”

The sense that bank bond traders’ heyday is behind them comes amid the latest cries that the three-decade bond rally may finally be ending as well. Bond values have climbed ever higher in recent years as yields were dragged ever lower by central banks piling on monetary stimulus. Global bond yields touched their record low in February, according to Bank of America Merrill Lynch data. Canada’s 10-year government bond yield fell one basis point, or 0.01 percentage point, to 1.58 per cent as of 9:02 a.m. in Toronto.

Now, with the U.S. Federal Reserve set to raise rates for the first time in almost a decade as early as next week, the long rally may turn into a long rout. Where before just warehousing bonds on a bank’s balance sheet meant a small profit, now it could mean a small loss.

“You’ve probably had the highest prices in bonds your ever going to get,” said IIAC’s Russell. “You’ll probably see further downsizing in fixed-income operations.”

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