Customized trades may generate half the equity-derivatives revenue at Citigroup Inc. within two years as investment banks seek to offset lower profit from stock broking and clients demand services beyond traditional dealing.
Equity solutions, such as structured products that allow clients to bet on a particular theme, will increase from the current low-double-digit share of the revenue generated by the bank’s derivatives and Delta One desk, Mike Pringle, Citigroup’s global head of equity trading, said in an interview.
The equity business “is undergoing the most rapid reinvention of the client base and what the stock market actually means,” London-based Pringle said in an interview. “That is only going to continue at an extremely rapid pace.” Exact figures are difficult to pinpoint as the offerings straddle business units, he said.
Citigroup, which ranks 10th by equity-trading revenue, generates almost two-fifths of its $3 billion in annual sales from derivatives. Investment banks are tempering the effect of lower stock-trading volumes and tighter commissions with higher-margin bespoke contracts that track underlying securities, often coupled with additional benefits such as hedges and leverage.
The products have also grown in sophistication amid a shift in client demand. Banks sell contracts based on industry-group strategies, volatility and dividends, transactions that span asset classes and the firms’ own teams. Thematic strategies can include creating a product that tracks a tailored basket of shares, as well as deconstructing an index by removing specific stocks to suit a client’s need.
Revenue from stock trading at New York-based Citigroup, a unit run by Derek Bandeen in London, gained 22 percent last year, Citigroup reported in January. Sales were unchanged in 2012 and fell 35 percent in 2011.
The 10 biggest derivatives clients in the world last year were fund managers and investors who traditionally bought and held stocks, Pringle said. Bandeen said he wants to gain a greater share of commissions among the biggest clients and sees further concentration of business among the top firms.
The bank ranks tenth by equities revenue, lagging behind No. 1 Goldman Sachs Group Inc., Morgan Stanley and Deutsche Bank AG, according to reported data on Bloomberg.
Citigroup’s performance in equities “has been more volatile than its peers,” said Richard Staite, an analyst at Atlantic Equities LLP. “The bank doesn’t have the benefit of a significant wealth-management or retail brokerage business.”
“Given the strong performance of markets in the past few years, equities has been a focus for all banks,” said Staite, who has a neutral rating on Citigroup. “With spreads on cash trading having been under a lot of pressure, profitability on derivatives has remained higher.”
About 38 percent of Citigroup’s equity revenue comes from derivatives, and the rest from cash equities, according to Coalition Ltd., a London-based research firm. For the broader industry, derivatives make up about 50 percent of equity trading and sales revenue, Coalition data show.
“If you approach the equity business in the traditional way, only selling research and trading cash equities, it would be a real profit challenge,” Bandeen said in the same interview. He added the bank is adapting to changes in strategy by large clients such as pension funds, which increasingly want alternatives to the traditional stock-versus-bonds allocation.
The third-largest U.S. bank is also making a push into Delta One products. They offer investors the possibility to bet on directional moves or hedge their holdings with the use of swaps, funds or other securities without implying any risk for the bank. They also help clients trade baskets of securities that are expected to move in tandem with others.
In a recent customized solution, Citigroup offered investors a swap to cash in the portion of Vodafone Group Plc shares that were accounted for by the U.K. company’s stake in Verizon Communications Inc., months before they would receive a special dividend of cash and Verizon shares in hand. When Vodafone handed in the payment in February, following completion of a Verizon Wireless sale, Citigroup offered investors another product to hedge the implicit currency and index-tracking risks of receiving stock in a U.S. company.
“What is helping us is the rapid growth in derivatives and Delta One in making them sit pari passu with traditional cash equities,” Bandeen said.
Regulators are implementing new rules and capital requirements for derivatives to make trading in the instruments less risky in the aftermath of the financial crisis in 2008.
Some firms may exit trading to focus on research and advisory to lower their costs, said Bandeen, who joined Citigroup in 2008 after 22 years at Morgan Stanley. While derivatives and Delta One will grow, emerging markets will also remain a key driver of activity in the longer term, he added.
Citigroup and JPMorgan Chase & Co. have prepared investors for a fourth straight drop in first-quarter trading, a period of the year when the largest investment banks typically earn the most from that business.
Citigroup finance chief John Gerspach said March 3 his firm expects trading revenue to drop by a “high mid-teens” percentage, less than a week after JPMorgan Chief Executive Officer Jamie Dimon said revenue from equities and fixed income was down about 15 percent. If trading at the nine largest firms slumps that much, it would extend the slide from 2010’s first quarter to 36 percent.