Last checked at 
* Flood of ECB money boosts volatility
* Sales and trading revenue likely to benefit
* ECB bond buying offers immediate uplift
* Potential liquidity crunch remains a concern
By Anjuli Davies and John Geddie
LONDON, March 29(Reuters) - Investment banks feeling thepinch from increased regulation since the financial crisis couldreap an earnings reward from a boost in trading activity underthe European Central Bank's (ECB) trillion-euro quantitativeeasing (QE) programme.
The flood of money into markets from the ECB's bond-buyinghas brought an increase in the volatility that traders crave asinvestors stake bets on the impact the scheme will have oninflation and long-term interest rates.
"QE is likely to underpin a sustained period of strength ineuro capital markets," Citigroup said in a research noteon Friday. "There has been a sharp spike in rates and foreignexchange volatility, which also points to a strong quarter forwholesale banks' macro revenues."
Revenue from fixed income, currencies and commoditiestrading, the so-called FICC universe, have historically been arich source of profit for banks, but new capital rules and movestowards electronic trading have squeezed the sector in recentyears.
The 10 biggest investment banks' revenue from FICC fell 7percent in 2014, industry analytics firm Coalition calculates.
What's more, the investment bank balance sheets that supporttrading markets have declined by 20 percent since 2010 and by 40percent in risk-weighted asset terms, Morgan Stanley analysts estimate. The analysts said that a further 10-15percent reduction is likely over the next two years.
The trading environment in Europe, however, could be aboutto take a turn for the better.
"ECB moving to QE could provide a real fillip to earnings,"Morgan Stanley analyst Huw van Steenis said. "Fixed incometrading may buck the trend of five years of shrinkage."
Anshu Jain, the co-chief executive of Deutsche Bank, one of continent's largest trading banks, said inJanuary that the ECB's bond-buying programme would be of"profound importance" for Europe and its banks.
"You may see a progression which hurts net interest marginsbut benefits sales and trading revenue," Jain said on anearnings call with analysts.
Citigroup said that the best-placed banks would be thosewith significant euro-denominated franchises, including BNPParibas, Deutsche Bank, HSBC and SocieteGenerale. JPMorgan is the biggest bank byrevenue in the FICC space.
DIRECT IMPACT
While it's too early to tell the exact impact of the QEprogramme, which is expected to last until at least September2016, the fees earned from the central bank's buying alone couldbe significant.
Economists at the U.S. Federal Reserve estimate that WallStreet firms could have made as much as $653 million in feesselling bonds to the Fed during its monetary stimulus programme.
When the ECB launched its LTRO (longer-term refinancingoperations) scheme in late 2011, revenues in the rates businessof global investment banks improved the following year,increasing to $29 billion in 2012 from $27.4 billion theprevious year, data from Coalition shows.
But traders and analysts question how much is really down tothe first-order effects of ECB action or second-order effectssuch as volatility.
Price fluctuation has certainly picked up this year aftermonths in the doldrums.
Banks benefit because such volatility allows them to chargehigher margins on trades because of the greater risk aroundexecution. It also helps them sell hedging instruments toinvestors.
But QE also presents risks. One of the biggest fears fortraders is that ECB buying and the reluctance of some investorsto sell because of regulation or client obligations could reducethe amount of debt actively traded in the longer term.
Signs of that squeeze are already showing in the soaringcost of borrowing in secured lending markets.
"Volatility and volumes are good for traders. Volatility butno volumes ... are awful for traders," one euro zone governmentbond trader said on condition of anonymity.
A survey of dealers this month showed concern that theJapanese government bond was not functioning well underlingering concerns that its QE programme, launched in 2013, isreducing bond market liquidity.
However, data shows there has been no dramatic change intrading volumes over that period.
Even if ultra-low yields in government bonds put off someinvestors, bankers say they will be able to capitalise on thosethat rush to put their cash into assets with better returns.
"You trade flows," one investment banker said. "The trend isonly just starting."
Data shows that cash is already flowing out of governmentbonds and money markets towards junk bonds and emerging markets.
But the real rewards will come if the ECB's stimulus servesto hoist inflation and bond yields with it.
"If QE is successful, long-term rates will go up andgenerally higher rates will lead to more activity and hedgingopportunities. Banks will benefit as much as asset managers,"another investment banker said. (Editing by David Goodman)
