Bank of New York Mellon Exits Derivatives As Margin Compression Pounds Industry

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Bank of New York Mellon Exits Derivatives As Margin Compression Pounds Industry

The Bank of New York Mellon Corporation (NYSE:BK) is closing the door on its foray into the highly competitive derivatives industry at a time of historic margin compression.

Bank of New York Mellon shutting down derivatives business

Kelly Bit from Bloomberg is reporting that Bank of New York Mellon, the world’s largest custody bank, is closing its derivatives sales and trading business.

“BNY Mellon has decided to exit the derivatives sales and trading business that operates as part of the company’s Global Markets group,” spokesman Ron Sommer told Bloomberg.

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The move comes as activist investor Trian Fund Management pressured the bank to deliver higher returns.  Trian, with a 2.5 percent stake in the firm, expressed margin concerns to the bank after its pretax profits were smaller than peers State Street Corporation (NYSE:STT) and Northern Trust Corporation (NASDAQ:NTRS) during four of the past five years, according to Bloomberg data.

It is unusual for an activist hedge fund to challenge a large bank, as many of the larger banks are said to have breakup values that exceed their current market capitalization.

The Bank of New York Mellon Corporation (NYSE:BK) struggled to compete in the hyper-competitive derivatives industry.  While the major banks dominate the industry, garnering over 70 percent of all assets, BNY Mellon was ranked 39th in the Futures Magazine listing of the top 50 brokerage firms in the industry, behind not only many of the larger banks but also behind many smaller, family-run or closely held derivatives brokerages.

Bank of New York Mellon’s AUM as of 2013

As of the end of 2013, The Bank of New York Mellon Corporation (NYSE:BK) Clearing had but $116.56 million under management, down from $144 million the previous year. Traditionally family-run firms such as Dorman Trading, Rosenthal Collins, Interactive Brokers and RJO’Brien Associates all towered above Bank of New York Mellon.  At the top of the list is Goldman Sachs Group Inc (NYSE:GS), with over $18 billion in regulated derivatives assets as of 2013, followed by JPMorgan Securities, Deutsche Bank Securities and Newedge USA.

The move into derivatives was considered a longer term investment in diversification from equity market exposure.  However, the industry has been ravaged by low interest rates.  In certain brokerage firms, collecting interest on the “float” of money customers use as a margin deposit has typically driven nearly 50 percent of revenues in some years, while more institutional focused firms depend less on such revenue.

Regardless of the percent of interest income in a derivatives brokerage fiscal mix, low interest rates compress margins throughout the industry. It was low interest rates that drove former MF Global CEO Jon Corzine to risk investments in European sovereign debt that led to the intra-trade, marked-to-the-market margin call that led to the firm’s downfall, for instance. While the trade ultimately turned profitable, it was the liquidity squeeze that caught the firm.  The same may be true of The Bank of New York Mellon Corporation (NYSE:BK), which is pulling the plug on a long term investment because, with the overhead of 50 high-priced Wall Street employees, the near term balance sheet apparently didn’t deliver.

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)valuewalk.com

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