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European fixed-income market hit by reeling dealers, fewer hedge funds and limited liquidity

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Three consequences of the current financial turmoil will shape Europe’s fixed-income markets for years to come, according to the latest European Fixed-Income Investors Study from Greenwich

Three consequences of the current financial turmoil will shape Europe’s fixed-income markets for years to come, according to the latest European Fixed-Income Investors Study from Greenwich Associates.

When markets eventually revert back to some basic level of functionality, higher costs of capital and more stringent capital requirements will force many dealers to significantly limit their prior roles as suppliers of broad-based liquidity to individual OTC product markets, the report says.

Attrition among hedge funds will reduce fixed-income trading volume, revenue and prime brokerage business generated by this important segment of investors, thereby diminishing hedge funds’ clout in European fixed-income markets.

In addition, the loss of revenues from structured products will leave a hole in dealers’ strategic plans that will have to be filled with more vanilla, client-driven, agency-based business.

According to the study, for which Greenwich Associates interviewed 981 institutional fixed-income investors across Europe, client-driven trading revenues earned by dealers of European fixed-income products declined by some 16 per cent to USD4.8bn in the 12 months to the end of July this year.

Some lost revenues will not be coming back any time soon, the researchers say. In particular, the structured credit businesses that represented a big component of revenue and profit projections in dealers’ three-year strategic plans have been devastated.

Those losses, combined with the drop-off in trading revenues from other fixed-income products and diminished prime brokerage business, will leave dealers in search of sources of revenues.

‘The new sources will actually be old sources,’ says Greenwich Associates consultant Frank Feenstra. ‘With structured product revenues gone, dealers will be forced to concentrate on more client-driven, agency-based businesses, which could provide a silver lining for long-only asset managers, pension funds and other parts of the traditional fixed-income trading base.

‘We will also find a return to a greater differentiation between ‘price takers’ and ‘price makers’ in the dealer community. Those dealers whose trading strategies depended on comfortable carry trades will find those no longer available or profitable. They will have to decide whether to go back to old-fashioned trading, with the attendant risks and profit opportunities, or become price-takers rather than market-makers.’

In the midst of these changes, Barclays Capital has became Europe’s biggest fixed-income dealer, outpacing Deutsche Bank by increasing its European-wide institutional trading market share to 11.7 per cent, with JPMorgan as a strong third in trading share.

Royal Bank of Scotland, which benefited from the addition of ABN Amro’s trading business during the research period, added market share from 2007. Other recent shifts in the competitive landscape, including the acquisition of Dresdner Kleinwort by Commerzbank, Bank of America’s acquisition of Merrill Lynch and the collapse or near-collapse of firms such as Lehman Brothers and Fortis, are likely to have an effect not only in the top ranks of European dealers but in the middle of the market.

Institutions named JPMorgan in Europe the best fixed-income dealer for 2008 in terms of its overall level of quality and franchise strength. JPMorgan received by far the highest scores on the Greenwich Quality Index this year, followed by Barclays Capital and Deutsche Bank. Barclays scored highest on the index for rates products, while JPMorgan received the highest score for credit products.

Based on the results of the survey interviews, Greenwich Associates named JPMorgan and Deutsche Bank as the European market’s quality leaders for trading liquidity and JPMorgan for fixed-income research, while JPMorgan, Barclays Capital and Deutsche Bank shared the title of quality leader in fixed-income sales.

Greenwich Associates also asked European institutions about the levels of support provided by dealers during the crisis, their own willingness or unwillingness to share sensitive information with individual dealers, and dealers’ understanding of institutions’ fixed-income business.

Based on institutions’ assessments, the research firm calculated an overall performance score dubbed ‘relationship capital’ for each dealer. Deutsche Bank and Royal Bank of Scotland had the highest relationship capital scores of any major dealers competing in Europe, followed by Barclays Capital and JPMorgan tied for third place, while institutions cited Deutsche Bank and JPMorgan as most supportive during the market crisis.

Greenwich Associates is an international research-based consulting firm in institutional financial services, specialising in providing benchmark information on best practices and market intelligence on overall trends. Based in Stamford, Connecticut, with offices in London, Toronto, Tokyo and Singapore, the firm offers more than 100 research-based consulting programmes to more than 250 global financial services clients.

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