The calm before the storm

The spike in trading triggered by the COVID-19 pandemic has been a short-term boon for investment banks. Nonetheless, many large players must slash costs in anticipation of a deep global recession

The coronavirus pandemic has driven economies around the world to the brink of collapse, with lockdown measures triggering huge capital outflows, mangling supply chains and bringing economic activity to a near standstill. The IMF has predicted an unprecedented global recession, one that will set the world on a course for uncertainty well into 2021.

In some respects, this financial turmoil has been a boon to investment banks. Data from research firm Coalition shows banks’ revenues from fixed income, currencies and commodities witnessed their strongest first quarter since 2015 – rising 20 percent to $22.7bn – as the pandemic drove traders to rapidly buy and sell shares.

But this trading spike is only likely to bring short-term relief to investment banks. More broadly, banks look set for a period of belt-tightening as the COVID-19 crisis exerts serious pressure on earnings. One report co-authored by Oliver Wyman and Morgan Stanley predicts that, even in an optimistic scenario where the economy experiences a rebound in six months, investment banks could be on track for a 100 percent decline in profits this year. Many banks are freezing hiring as a result.

Adapting to the new normal According to S&P Global, European institutions are likely to be hit the hardest. Lenders such as Deutsche Bank – which was already struggling to stay profitable due to billion-dollar fines, increased market competition and significant restructuring – will have little protection to absorb a wave of defaults. Amid this pessimistic outlook, it’s US investment banks such as JPMorgan Chase and Goldman Sachs that find themselves in the best position.

US lenders outstrip their European counterparts in terms of profitability and revenue. What’s more, the Fed has taken aggressive steps during the pandemic to boost liquidity and keep financial markets operating, including buying at least $500bn of US Treasury securities and over $200bn of agency mortgage-backed securities. Many investment banks in the US will likely use the crisis to take further market share from smaller European lenders.

Like all companies, investment banks have had to take measures to limit the spread of the novel coronavirus. This has presented problems for lenders: for example, trading activities are critical » for market functioning, but they can’t be carried out remotely because of compliance regulations. Goldman Sachs has responded to this issue by assigning some employees a fixed location where they can trade while placing others on teams that alternate weekly between working from home and in one of its main offices.

Ensuring that operations can continue with as little disruption as possible – all while keeping staff safe – will be crucial to investment banks’ success in the coming months. So far, companies like JPMorgan have raised capital through virtual roadshows, while overseas business trips have been replaced by video calls. Video communications provider Pexip, for example, became the first company to use a fully virtual initial public offering to get listed on the Oslo Stock Exchange. Given the savings that banks can make by conducting roadshows virtually, this trend may become part of the new normal even after the crisis has ended.

Better together According to financial data company Refinitiv, mergers and acquisitions (M&A) professionals were optimistic for what 2020 held at the end of 2019, predicting a 7.4 percent rise in market growth. That optimism came crashing down after the outbreak of the novel coronavirus: Refinitiv found that M&A levels in the US fell by more than 50 percent in Q1 2020 compared to 2019, while global dealmaking dropped by 28 percent. Surprisingly, Europe saw the value of M&A deals rise by just over half to $232bn, although this can partly be explained by the Russian National Wealth Fund’s purchase of Sberbank for $39bn.

Some analysts are hopeful that dealmaking activity can bounce back more quickly than it did following the 2008 financial crash, but this all depends on the pace at which markets can recover. In the meantime, there are opportunities to be snapped up by strategic bankers: experts predict that we could see a wave of dealmaking activity within the healthcare sector as companies race to develop treatments for the disease. In the immediate aftermath of the crisis, there could also be significant movement as companies look to fix their supply chains and transform their operations.

Taking a virtual leap It has become increasingly clear over the years that cybersecurity should be a key priority for banks. Accenture estimates that cyber risks could cost the banking sector $347bn over the next five years, but with so many bank executives and traders now working from home, the risk of fraud and cyberattacks is especially high. Now is the time to run control tests and ensure cybersecurity measures are robust enough to withstand the attempts of opportunistic hackers.

The pandemic has also highlighted a key issue that many investment banks are yet to address: outdated infrastructure. The technology systems of many banks were put under pressure in March due to unusually high trading volumes. The more tech-savvy banks, meanwhile, have reaped the benefits of having new systems in place before the pandemic struck. In 2018, Morgan Stanley rolled out an artificial-intelligence-based platform for personalised engagement with clients called the Next Best Action system. In the first two months of the pandemic, this tool was used more than 11 million times.

According to a report by the Boston Consulting Group entitled Global Risk 2020: It’s Time for Banks to Self-Disrupt, banks must prioritise technological transformation to ensure they respond to the coronavirus crisis effectively: “By using artificial intelligence, machine learning and other advanced technologies and practices, they can improve bank steering, deliver predictive, real-time insights, and execute faster and more efficiently.” Technology, it seems, will prove a vital asset for investment banks as the crisis develops.