Corporate hedging helps drive bank trading revenue

IFR 2511 - 25 Nov 2023 - 01 Dec 2023
7 min read
Christopher Whittall

The amount of trading revenue banks generate from their corporate clients has risen sharply in the past year, benefitting firms with a large presence in this space and prompting several to continue to plough more resources into corporate relationships.

Bank of America, Citigroup and Morgan Stanley are among the banks that have been intensifying their efforts with corporate clients, as treasurers and finance chiefs have scrambled to shield themselves against moves in interest rates, currencies and commodities over the past 18 months.

That activity has meant corporates now account for a greater share of banks’ fixed-income revenues, helping to offset a decline in trading from other clients like macro hedge funds. Industry experts estimate corporate clients represent more than 18% of the revenue pool for banks' fixed-income trading units this year, up from about 15% in 2021 before the US Federal Reserve began lifting interest rates.

“Diversification has certainly helped us, especially if you look at this year versus last year,” said Snigdha Singh, co-head of EMEA FICC trading and head of EMEA markets initiatives at BofA, which has registered the biggest market share gains in 2023 in fixed-income revenues among the top five US banks.

“There has been a lot of demand for risk transfers from corporates hedging to a higher rate environment and rehedging commodity exposures. Having the full suite of products as well as the geographical capability to move risk has helped strengthen the position of our franchise,” she said.

Money-making engine

It has been another strong year for banks’ bond trading divisions, which continue to reassert themselves as a crucial money-making engine after a lean period for much of the previous decade. The big five US banks generated US$51.5bn in fixed-income revenues in the first nine months of the year, a 3% decline from last year’s bumper haul but still about 40% above 2019.

Those industry-wide figures mask significant differences in performance among individual banks, however – a divergence that executives attribute to variations in banks’ client mix and geographical footprint. Banks’ ability to capture corporate hedging transactions has been instrumental this year in buoying large US firms – especially those like BofA, Citi and JP Morgan which are most focused on corporates and have also benefitted from abnormally high levels of activity in their home market.

That has come on the back of sharp swings in Treasuries and the regional banking crisis earlier in the year, as well as the once-in-a-lifetime initiative to replace US dollar Libor in trillions of US dollars of financial products. Many expect corporate clients to remain busy now that central banks have raised interest rates to their highest levels in well over a decade.

“Citi’s markets business is bigger with corporates than our competitors, and corporates have been doing a lot of risk management hedging and cashflow movements,” said Andrew Morton, head of markets at Citi, which does about a third of its markets business with corporates and reported its best third-quarter revenues in rates and currencies of the past decade.

Macro blowout

The outsized importance of the corporate business in 2023 represents a step change from recent years. In 2022, it was banks like Goldman Sachs and Morgan Stanley with close ties to hedge funds that outperformed peers in fixed income amid a blowout year for many of those investors.

Financial institutions remain comfortably the largest client segment for the trading arms of investment banks. But many have been looking to interact more with corporates, whose business they see as more reliable – and more profitable.

While macro hedge funds typically trade a lot, the margins banks make on these transactions tend to be far skinnier. Hedge fund activity can also slow during trickier periods when they lose money – as many did around the time of the US regional banking crisis in March.

Corporates, by contrast, have hedging needs regardless of the outlook for financial markets. That could be multinationals swapping their foreign earnings back to their home currency; private equity firms locking in the interest rate on the debt financing for an acquisition; or commodity producers ensuring they can sell their output at a reasonable price in the future.

“While you cannot predict what one corporate is going to do, if you cover 100 of them you can better understand the volume of business you will receive," said Jakob Horder, Morgan Stanley’s global co-head of fixed income. "Having that broad and well-diversified client base helps to provide an added stability to revenues, freeing up other areas of the trading business."

Building out

Morgan Stanley has historically focused more on trading with financial institutions like hedge funds. But Horder said the firm has made “meaningful gains” in the corporate macro business following a measured, targeted buildout. One example he gave is working more with private equity firms that the bank finances.

“We have been and continue to focus on the corporate business,” said Horder. “For us, it is all about the integrated investment bank. Our partnership with the capital markets business means we are well positioned to resource the corporate hedging trades that result from client financing.”

Those with strong links to the corporate world have also been looking to consolidate their position. Citi has hired more staff in commodities to help with large, "episodic" transactions. It has also overhauled its vast FX trading operations by merging its corporate and institutional businesses, and tapped global head of corporate sales and solutions in markets, Flavio Figueiredo, to lead the unit.

BofA, meanwhile, has roughly doubled the size of its currency and commodity salesforce catering to European corporate clients over the past two years as part of a broader push in global markets. "Opportunities have increased significantly in the corporate business over the last 24 months as higher volatility and surging inflation means greater demand for risk management solutions from clients across rates, FX and commodities," said Othman Kabbaj, BofA's head of EMEA FICC sales.