After the toughest trading year he has ever experienced, Citi's global head of equity trading expects higher-margin derivatives to help the Wall Street stalwart steer a path through a similarly rocky 2012. A slide in cash volumes as international investors and buy-side houses fled the European market has prompted a rash of layoffs across the industry, underpinning Mike Pringle's goal to reshape the unit away from a lower-margin, cash-centric model.
Pringle told Reuters the firm was gradually moving some staff from cash into derivatives and Delta 1 products such as exchange-traded funds (ETF) as it looked to increase sales of them to traditionally cash-oriented clients. Citi has announced plans to cut 4,500 jobs globally. Some of those cuts came in equities, where net revenues fell 14 percent year-over-year to $2.5 billion in the first nine months of 2011.
Pringle maintains the division's headline numbers do not tell the whole story. "Year-on-year we have grown our client-facing revenues. I believe that commission levels at most of our competitors are down over the same period." Ultimately, Pringle said, the push into derivatives could result in the current 50/50 revenue split between derivatives and Delta 1 trading on one side and cash-market trading on the other moving to 70/30 in favour of derivatives.
The higher margins on offer would likely underpin the move. Margins on electronic cash trading can be as thin as 3-5 basis points, while ETFs are typically around 10-15 basis points. Delta refers to the degree of correlation between a derivative and its underlying asset, with 1 the highest correlation and a level traders aim to maintain.
The strategy has a colourful history, however, with two of the most high-profile trading losses of recent times - Societe Generale's 4.9 billion euro loss through Jerome Kerviel, and UBS's $2.3 billion hit from Kweku Adoboli in September - both coming via the banks' Delta 1 desks. The attraction is clear because, across the industry, cash equities businesses make little profit after bonuses and other incentives are paid. Banks have been able to more than make for up the shortfall in futures and Delta 1 in recent years. Citi's equity business is focusing on providing a wider array of products and services to a core group of top clients, a model Pringle, who has 15 years in equities, suspects others will follow.
Three years out, Pringle said Citi would target emerging market strength, look to have an "amazing electronic offering" and still maintain its presence in core activities such as its M&A business. "What everyone on the Street does now is everything for everyone. That's a dangerous proposition, as you don't get paid for that." Traditional long-only institutions were becoming much savvier with derivatives, Pringle said, driving an estimated increase in derivatives volume of 5 to 10 percent in 2011. With the market lacking direction, funds sell call options to maximise yield. Sovereign wealth funds, meanwhile, also invest "in a bullish way", by selling puts to buy stocks.