Trading desks of big Wall Street banks, grappling with higher capital requirements, may decide to boost their holdings of emerging market securities and sovereign debt, according to Brad Hintz at Sanford C. Bernstein & Co.
The so-called Basel III capital requirements imposed by the Basel Committee on Banking Supervision as well as limits to proprietary trading and changes to derivatives rules in the U.S.'s Dodd-Frank law make it harder for trading desks to earn a sufficient return on equity, Hintz wrote in a note to investors today. One solution will be changing the types of assets held on trading desks, Hintz said in the note.
"Our belief is that the 'new optimal' balance sheet of Wall Street will include larger emerging market positions in equity and debt" because they are fast growing and earn a higher return, Hintz wrote. Banks will also emphasize "a large government and sovereign book" because such holdings require little capital even if they earn low returns, he wrote.
Such a shift by Wall Street's biggest firms, which include JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley and Citigroup Inc., has potential risks if emerging market equities and bonds as well as sovereign debt lose value.
Two things: The irony of potentially pushing banks into different risk markets has not eluded me. Second, see my earlier post on EM - it looks heady here. Admittedly, this would not happen overnight (for those with their finger on the BUY button) and I still believe that there are better, lower entry points ahead.
It's hard to believe that diversifying into EM trading will replace proprietary trading. From an investment standpoint, it might make sense to focus on the U.S. money center banks who generate revenues from in the EM's. Take a look at Citigroup's Q3 2010 earnings release. Revenues were powered by the bank's foreign presence in Asia/Middle East/Latin America.
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