LONDON & NEW YORK--(BUSINESS WIRE)--Fitch Ratings has concluded its periodic review of inter-dealer brokers (IDBs), which comprises four entities, including three securities firms with different business models that focus on intermediating between dealers largely in over-the-counter derivatives markets.
Fitch expects revenue diversification, cost control and further consolidation to remain features of the IDB industry, as structurally low bank client trading appetite and flat yield curves have pressured revenues and challenged business models. Aside from large-scale acquisitions, we expect leading IDBs to continue grow inorganically by adding selected desks where they lack scale, thus garnering further liquidity and pricing power.
Fitch has affirmed the IDBs' Long-Term Issuer Default Ratings (LT IDRs) at their respective levels, reflecting our view that the franchises are well positioned to withstand further profitability pressure while maintaining adequate leverage relative to the ratings.
Fitch-rated IDBs have invested heavily to broaden their product offering in less traditional brokerage markets. ICAP Plc ('BBB'/Outlook Stable) is positioning itself as a provider of electronic broking platforms and risk mitigation services, BGC ('BBB-'/Outlook Stable) has developed a real estate brokerage franchise, and Tullett Prebon plc's ('BBB-'/Outlook Stable) acquisition of an oil broker and new energy and commodities business line is in line with its strategy to diversify revenues towards areas less correlated with bank clients' risk appetite.
BGC is viewed as a core subsidiary of Cantor Fitzgerald (Cantor, 'BBB-'/Outlook Stable). Cantor's ratings reflect an established position in the middle-market brokerage space and increasing business diversification, including into commercial real estate operations. The ratings also reflect a moderate risk profile, and controlled leverage. BGC and Cantor's ratings remain constrained by key man risk associated with BGC and Cantor's CEO.
The IDBs' ratings reflect strong company profiles offset by a reliance on transactional and bank client revenues, which provide an element of earnings cyclicality and limit ratings upside. We expect slight increases in leverage for the UK-based IDBs ICAP Plc and Tullett Prebon plc to remain within the upper bound of 2.5x gross debt to EBITDA commensurate with investment-grade ratings. BGC's leverage metrics are likely to improve to similar levels from the current 3.1x after the repayment of $160 million debt in July 2016 and as it continues to capture cost synergies from the GFI acquisition.
Credit risk is low and limited by the nature of IDBs' operations, acting as intermediaries between trading counterparties in matched principal or name give-up transactions. Fitch views operational risk as the most relevant for IDBs given the importance of system resilience and the track record of heightened conduct risk for voice and hybrid brokerage.
The gradual introduction of mandatory central clearing, margining and reporting for certain in-scope asset classes, largely for over-the-counter derivatives and fixed income instruments, has reduced counterparty credit risk and enhanced market transparency. IDB disintermediation as a result of lower credit risk could challenge their business model, but we expect them to retain their role as liquidity providers for bespoke financial instruments.
Under the Market in Financial Instruments Directive II, to be implemented in January 2018, certain transactions will need to be reported and executed within regulated organised trading facilities (OTFs), similar to the U.S. swap execution facilities (SEFs). We expect large IDBs to continue investing in operational resilience ahead of implementation, particularly if SEFs and OTFs gain further traction.
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