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(Corrects paragraphs 5 and 6 and adds paragraphs 7 and 8 tospecify that revenues referred to include equity trading and arepercentages of total revenues from investment banking alone, andto detail FICC share of overall trading revenue)
By Jamie McGeever
LONDON, May 11 (Reuters) - The boom years of financialmarket trading, when banks made unprecedented profits frombonds, currencies and commodities, may be over for good asfinancial firms realise there will be no cyclical upswing ontheir dealing desks.
Even though it's taken Western economies several years toregain pre-crisis national output levels, many doubt banks willever revisit the pre-crisis high watermark of their tradingactivities.
Revenues from fixed income, currencies and commodities - theso-called 'FICC' universe - continued to tumble for most majorU.S. and European banks during the first quarter of 2014,increasing the pressure on them to rethink business models.
Thanks to a more stringent regulatory environment and apotential turning point in the 20-year cycle of falling globalinterest rates, the twin peaks of just before and after the 2008global financial crisis look unlikely to be revisited.
Revenue from FICC amd equity trading, which criticssometimes dub "casino banking" and distinguish from traditionalinvestment banking services like underwriting share issues orarranging mergers and acquisitions, still accounts for over 70percent of banks' overall income from investment banking,according to research by Freeman Consulting.
FICC and equity trading income at Goldman Sachs lastyear was 72 percent of the bank's overall revenue frominvestment banking, compared with 82 percent in 2010. MorganStanley's FICC and equity trading revenue was 70 percentof its total investment banking revenue, well down from 82percent in 2003.
The FICC share of these trading revenues is shrinking. In2007 around 70 percent of Goldman's $22.89 billion overalltrading revenue came from FICC. Last year, barely half its$15.72 billion of such revenue was from FICC, according toFreeman.
In 2006 FICC income accounted for just over 60 percent ofMorgan Stanley's $15.9 billion overall trading revenue, comparedto just 35 percent of the $10.1 billion pie last year, theconsultancy said.
As new regulation bites and extraordinary monetary andeconomic policies smother extreme market swings, the tradingvolumes and price volatility that middlemen banking tradersthrive off has ebbed.
And it looks like a structural shift rather than a cyclicalor temporary lull.
"The revenues have gone. The world has changed from 2007,2008," said Grant Peterkin, head of absolute bond returns atLombard Odier in Geneva.
"The regulatory aspect is the biggest aspect."
Regulation after the 2007-08 crisis such as 'Dodd-Frank' and'Volcker Rule' legislation in the United States and Basel IIIbanking reforms globally, effectively restrict banks' ability tohold, trade and speculate on fixed income and derivatives.
This reduces liquidity, but other traditional liquidityproviders like hedge funds have been unable to fill the gapbecause their businesses are also under pressure.
IN A FICC
The pressure on banks' FICC operations was brought intosharp focus by the broad-based slump in first-quarter earnings.
British bank Barclays grabbed the headlines,posting a 41 percent plunge in trading revenue compared with thesame period in 2013, then announcing 7,000 of its 26,000investment banking jobs will be cut.
"Some of the pressures we saw on the business towards theend of last year are clearly structural as well as cyclical,"Barclays Chief Executive Antony Jenkins told CNBC on Thursday.
Other bank chief executives are likely to follow Jenkins interms of direction if not magnitude, and reduce the size oftheir FICC trading desk operations, analysts say.
They are expected to continue cutting costs, trimmingheadcount, and in some cases, exit particular markets.
UBS is withdrawing from parts of fixed incometrading while Barclays has consolidated its G10 currency,emerging market foreign exchange and precious metals tradingoperations.
Elsewhere, JP Morgan Chase is selling its physicalcommodities business and Deutsche Bank is closing itsoil, grains and industrial metals business.
Although Barclays' results may be an outlier and contrastwith other extremes, such as the 35 percent increase in tradingrevenues at the likes of Morgan Stanley, the averagedecline in FICC revenue from 10 major U.S. and European banks inthe first quarter was 14 percent.
That ongoing funk was all the more alarming as the firstquarter is traditionally the most profitable for FICC trading,as pension and insurance funds open fresh investment positionsfor the year and companies and governments sell new bonds in anannual refunding splurge.
The 10 banks showed FICC revenues totaled $24.18 billion inthe first quarter, down from just over $28 billion a yearearlier and almost $30 billion for the same period in 2012.
The 10 are: Barclays, U.S. banks JP Morgan, Morgan Stanley,Goldman Sachs, Bank of America, Citi, and Europeanfirms UBS, Deutsch, BNP Paribas and Credit Suisse.
The collapse in market volatility has also contributed tothe decline. This may be a relief for risk-averse investors butit also makes them less likely to use market hedging instrumentssold by the banks.
It also reduces the arbitrage opportunities that nimblebanks and brokers feed off for in-house trading profits.
Implied volatility, which measures the potential for assetprice swings over a specific period, is at or close to recordlows in deeply liquid and highly-traded assets like U.S.Treasuries, euro/dollar and dollar/yen.
Analysts also say the whiff of scandal resulting from globalinvestigations into alleged rigging of benchmark foreignexchange rates and Libor interest rates is clouding the FICCenvironment, and forcing banks to set aside billions of dollarsfor potential litigation costs.
The final nail in the FICC coffin, analysts say, is that theworld on the cusp of rising interest rate cycle, led by the U.S.Federal Reserve's reduction - or "tapering" - of itsextraordinary post-crisis stimulus.
It's completely uncharted territory for banks and traders,and not conducive to making easy money.
"We've had the most enormous change," said Chris Wheeler,banking analyst at Mediobanca in London. "And there's more tocome as the full impact of tapering is felt." (Editing by Sophie Hares)
