"Flow Monster" has become a mantra of trading managements.
Only Flow Monsters will survive in the world of Basel III. To become one banks must mercilessly cut staffing costs, replace a "smile and dial" sales force with electronic execution, optimize their balance sheets and invest in straight through trading and operations technology.
Managing Director Compensation levels on the trading floor must fall 20-25% while the percent of MDs on a trading floor must decline from 15-17% to 10-12%. These changes will
allow faster execution. They will drive pre-tax margins up from the 13-15% enjoyed in equity execution and 24-25% achieved in fixed income trading today, to ?23% in equity execution and ?32% in fixed income.
Better execution will capture more volume and tighter cost control will allow the Flow Monsters to profit despite lower leverage and higher regulatory capital charges. Subscale trading operations and those firms that do not invest will not be able to execute as quickly, cannot process as cheaply and will be unable to run businesses as lean as the new Flow Monsters.
The big trading houses will get bigger.
Volume will be captured, and assuming reasonable rules on risk taking from regulators these firms will be able to beat their cost of capital despite constrained balance sheets and the loss of proprietary trading.
The hindmost will be squeezed out of the market.
Brad Hintz is a senior analyst at Bernstein Research.