Despite the pickup in equity commissions seen in 2013, Wall Street is now experiencing a sharp downturn in equity trading volume and volatility over the past few months – factors that could lead to a decline in equity commission revenue in the 2nd Quarter of 2014.
Volume and Volatility Plunge
Since April 1st, 2014 average daily trading volume in stocks that comprise the S&P 500 continues to slip and is now 17% below the level seen in the 1st Qtr of the year. As a result, equity trading volume in these bellwether stocks is now 29% below the average trading volume seen over the past five years.
Another factor which drives equity trading commissions is volatility in the stock market. Volatility, as measured by the CBOE Volatility Index (VIX) dropped to a six-year low in early June, leaving the VIX 40% below its 10-year average.
One factor which could be contributing to the decline in equity trading volume are the roll out of the Volcker Rule which has limited proprietary trading and risk taking at Wall Street banks. In addition, recent press and regulatory focus on high frequency trading could also be drying up volume from this group of market participants.
Consequently, we expect that equity commission revenue is likely to shrink during the second quarter of 2014. Fortunately, equity commissions are a small part of the revenue pie at many of the large Wall Street banks, excluding Goldman Sachs and Morgan Stanley that generate 20% and 21% respectively from equity sales and trading.
IPO Volumes Remain Robust
The good news for most Wall Street firms is the fact that investment banking revenues are likely to more than offset the weakness seen in equity commission revenue in the second quarter.
According to data collected by Renaissance Capital, IPO Volume so far this year has surged 40.9% to 25.8 bln when compared to the same time frame in 2013. In addition, IPO volume in the second quarter of the year is up 44.3% to $15.3 bln from $10.6 bln seen in the 1st Qtr 2014.
The improving domestic economy, rising confidence among CEOs, and continued record low interest rates have all combined to fuel very strong activity in the U.S. IPO market so far this year – a trend that is likely to continue for the remainder of the year.
Potential Impact on Research Biz
Falling equity commission revenue caused by weak trading volumes and a drop in volatility will result in smaller commission balances at buy-side firms which can be used to pay for sell-side and alternative research providers.
This is likely to have the most immediate negative impact on firms heavily reliant on trading commissions to be compensated for their research, like boutique firms with trading desks or those that have a large number of broker vote clients. Alternative research firms that have a significant portion of clients pay them in hard dollars won’t feel the pinch – at least not at first. On the other hand, larger sell-side firms that also have investment banking businesses will be shielded from the worst of the drop in equity commissions.
Hiring in the research business probably won’t see too much of an impact in the near term as most firms won’t respond to a one quarter drop in commission revenue. In fact, we would not be surprised to see some sell-side firms boost analyst hiring to be able to keep up with the strong gains in IPO volume.
Recent US equity volume and volatility data suggests that equity commissions are likely to dip in the second quarter of 2014, despite posting a double digit gain last year. These trends will have a negative impact on the revenue of some research providers – particularly boutique broker dealers who rely on trading desks and the broker vote to get paid.
However, the most important issue is whether this trend will continue into the second half of the year, as the longer that equity commissions slip, the more pronounced an impact will be felt in the research industry.