Rupak Ghose is a board adviser to fintech corporations, the previous head of company technique at ICAP/NEX and a former financials analysis analyst at Credit score Suisse.

It’s now standard knowledge that banks must diversify away from buying and selling to develop extra recurring income streams. Fairness analysis analysts, shareholders, consultants, funding bankers and media leap to spotlight how fixed-income, forex and commodity (FICC) buying and selling is a structurally low-PE-multiple enterprise, given its volatility and capital necessities.

However the FICC buying and selling machine churns on and on, not solely surviving however carrying investment-bank price bases on its shoulders. In 2022, FICC generated round a fifth of group revenues of the biggest 5 US funding banks, and it has most likely offered an analogous stage for main European gamers.

Final yr was the Yr of the Macro Dealer, particularly in US charges and commodities markets. The beneath knowledge from Financial institution of America’s and Citi’s earnings illustrates how a lot macro volatility supported FICC revenues in 2022.

2022 was additionally the Yr of Volatility. For banks’ buying and selling desks, this was an particularly good form of volatility, not solely boosting revenues from corporations doing extra hedging, however juicing efficiency for vital hedge-fund purchasers as effectively.

Whereas the hedge fund trade general noticed adverse returns in 2022, macro and multi-strategy funds had stellar returns. This pattern naturally benefited banks the place hedge funds make up a better share of purchasers.

No agency has benefited from this greater than Goldman Sachs. Their FICC revenues greater than doubled over the previous 5 years and had been greater than 25% greater than the elevated ranges of 2020. In distinction, the standard market leaders JPM and Citi delivered FICC revenues 10 to fifteen per cent beneath their 2020 information. That is unsurprising, given their robust foreign exchange franchises and decrease publicity to commodities than Goldman.

Even so, Goldman got here out of earnings season because the ugly duckling. Be extra like Morgan Stanley, all of us heckled. The “Pepsi trick”, because the FT wrote, of diversifying into extra recurring, high-return wealth administration companies is a wise one for all banks to think about. If Barclays hadn’t offered BGI, for instance, it will look extra like Morgan Stanley.

There’s an issue, although: good acquisitions are tough to seek out, and new companies’ buildouts hardly ever transfer the dial.

M&A situations look good in idea, however sellers of main franchises are uncommon. For each UBS there’s a Credit score Suisse wealth administration. For each Capital Group there may be an Abrdn. For each Lloyds there’s a Metro financial institution. Non-FICC companies aren’t inherently high-growth, secure or worthwhile.

So, what about natural development? The legislation of enormous numbers kicks in right here. Nowhere is that this extra vital than at Goldman Sachs. If you generate virtually $15bn of annual FICC revenues, any natural diversification technique goes to be a rounding error. And as we noticed with Goldman, transferring away out of your core competencies comes with dangers.

Banks are caught with FICC. The place diversification is achieved it’s typically accidentally somewhat than design. As an illustration, the buying and selling implosion at Credit score Suisse. Actually, in Credit score Suisse’s case, the ostensibly higher-quality wealth administration enterprise imploded quickly after as effectively.

So how ought to they make the perfect of the scenario? There are a number of hygiene components I’d deal with.

The primary is diversification. And I imply diversification inside FICC. Not like equities, it is a pretty heterogenous enterprise, spanning a number of asset courses, shopper bases, geographies, and merchandise.

To show what which means, I’ll give an instance:

Within the financial institution’s newest incomes name, Goldman Sachs CEO David Solomon proudly highlighted how his staff had delivered on his aim of increasing pockets share with the financial institution’s largest buying and selling purchasers. Goldman is now within the high three for 77 of its largest 100 buying and selling purchasers, versus 44 solely 3 years in the past.

This can be a nice achievement, after all. At a time when purchasers are consolidating their spend, being high 3 with them drives materials profitability. Liquidity drives liquidity, creating community results in buying and selling, and there may be the advantage of scale on price buildings.

Nevertheless it raises a query: how diversified are these revenues?

JPMorgan and Citigroup’s FICC companies are extra diversified than Goldman Sachs. Additionally they profit from the moat offered by constant captive flows from their broader banking relationships. These components be sure that their FICC companies are much less risky than Goldman Sachs. This must be extra priceless to shareholders over the long term when it comes to valuation multiples.

There’ll all the time be variations in combine; Goldman Sachs won’t ever be a top-3 FX franchise, given the shortage of a number one transaction banking community. However demonstrating extra diversification and stability for FICC revenues can’t be underestimated. This can be a motive why going large in transaction banking is rather more related for a agency like Goldman than chasing attractive credit-card offers with Apple.

Banks should additionally show they’re profitable in structural excessive development markets.

Banks invented credit score derivatives, however their ETF companies have misplaced out to gamers like Jane Avenue. That is additionally true in markets the place underlying buildings have modified. Banks struggled to compete with high-frequency buying and selling companies because the US Treasury market moved digital on money and futures CLOBs. As market consensus builds on a “damaged” Treasury market will they be the answer? A path to that could possibly be by regulatory modifications permitting them to carry extra stock, or in search of methods to prosper as clearing sponsors.

Lastly, banks ought to take a leaf out of the playbook of the exchanges and digital buying and selling platforms which have come to dominate the FICC market knowledge house by a mix of natural and acquisitive development. Maybe Goldman Sachs may flip its Marquee platform into the following Aladdin.

In any occasion, banks are caught with FICC, so they should make the perfect of it. Diversification. Decrease volatility. New markets. All of those choices make sense to do — at the very least, inside FICC. Chasing revenues alone is a loser’s sport. As a substitute banks ought to present buyers that not all FICC companies must be valued on the identical a number of.