JPMorgan trading bonanza creates bonus dilemma

JPMorgan’s first-quarter trading revenues were robust, with a record total for its markets group of $7.2 billion, which was 32% higher than the same period in 2019.

But although fixed income revenue rose by 34% to $5 billion and equities by 28% to $2.2 billion, some of the gains may be fleeting and insufficient to balance an expected prolonged slump in deal-making fees.

JPMorgan also now faces a dilemma over how to compensate trading staff who are able to profit from the volatility in markets caused by the onset of the coronavirus crisis.

JPMorgan chief financial officer Jennifer Piepszak cautioned investors against assuming that markets revenues will remain strong enough to partly offset the lower deal flow and huge increase in credit reserves required by the downturn.

“Low rates and economic activity may even be a headwind,” she said on the bank’s quarterly earnings call with analysts.

A strongly performing global markets division is nevertheless incorporated in the updated assumptions that JPMorgan provided on its expected overall revenues for 2020.

Fixed income revenue growth in the first quarter was driven by increased client activity and wider spreads in rates, currencies and emerging markets trading

JPMorgan is the clear market leader in fixed income dealing, so high volumes and wider spreads would be expected to boost revenues.

Volumes were also exceptionally high in listed equity markets, with many exchanges reporting new records for activity in stocks and options.

JPMorgan’s boost to equity revenues seems to have come disproportionately from the more complex derivatives trading that requires a lot of input from experienced staff, however.

Low rates and economic activity may even be a headwind 

 – Jennifer Piepszak, JPMorgan

Piepszak said that much higher equity derivatives revenue was driven by increased client activity – to pre-empt any speculation that JPMorgan’s dealers had been indulging in proprietary risk taking.

The distortions in complex equity derivatives during the first quarter were on a different scale to those seen in cash instruments, nonetheless. As the VIX measure of S&P500 equity volatility hit an all-time high of 82 in March, bid/offer spreads were at times as wide as 7% of its price, for example, and bid/offers for variance swaps (which are derived from strips of option prices) went as high as 20%.

This created exceptional opportunities as well as high risks for derivatives dealers with the experience to run large positions in choppy markets – including deciding whether or not to use automated inputs.

Spike in volatility

There have been numerous reports that JPMorgan’s equity derivatives dealers generated around $1.5 billion of revenue by the end of the first quarter, or around twice the level that might have been expected before the coronavirus crisis fueled the spike in volatility.

If that number is correct, then cash equities and prime finance may have had an unexceptional quarter, despite very high listed exchange volumes.

JPMorgan’s total equity revenue of $2.2 billion implies that cash and prime revenue was only around $700 million.

That means that keeping equity derivatives specialists – and their fixed income counterparts – motivated will be an important job for senior managers at JPMorgan and other banks for the rest of this year.

This involves both the carrot of a promised bonus payment and the stick of exhorting some employees to view themselves as key staff who need to physically stay on trading floors.  

The concept of designating key staff for financial market trading can seem absurd – or at least deeply self-absorbed – when compared with healthcare workers and others who put their lives on the line to help provide essential services.

And even on Wall Street, where most employees understand and accept the trade-off between unpleasant working conditions and financial reward, there has been tension recently between managers who are keen to maximize revenues in volatile markets and staff who are fearful of sitting on dealing room floors.

Jason Sippel, JPMorgan’s global head of equities, drew unwelcome attention when a recent news report highlighted his role in pressing markets employees to continue to come into the office, for example.

Tensions ahead

There are also likely to be tensions ahead as staff try to gauge whether or not they will be paid the bonuses that would be expected from a big rise in the revenue they generate under normal circumstances.

JPMorgan’s first-quarter results gave an indication of the pressure likely to be felt in other areas of the bank as the year unfolds. Overall profits were down by 69% compared with the first quarter of 2019, and credit reserves were increased by almost $7 billion to $8.3 billion.

Higher reserves brought down profit for JPMorgan’s corporate and investment bank unit by 39%, while revenue was down just 1% to $9.9 billion. Strong markets revenues helped balance a 49% fall in investment banking, where a mark-down of $820 million in the bridge loan book had a particular effect.

JPMorgan stressed that its bridge loan book of about $13 billion was roughly a quarter of the exposure it had going into the 2008 financial crisis, but marking the positions to market nevertheless had an impact.

Traders within JPMorgan’s global markets unit must be looking nervously at the rest of the bank as they gauge their personal risk/reward exposure.

And dealers at other banks that lack JPMorgan’s scale and balance sheet strength have even more reason to question what the future holds for the prime reason they joined the industry: financial compensation.

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