According to the winter edition of the London Stock Exchange Quarterly, published yesterday, member firms made total profits of pounds 131m in the first half of last year. However heavy dealing losses and falling revenues led to a loss in the third quarter of pounds 126m, as activity froze in the weeks before sterling's exit from the exchange rate mechanism. The exchange estimates that profits bounced back in the fourth quarter of 1992, to pounds 24m, and that 1993 has started well, with healthy turnover boosted by three big rights issues.
But securities dealing is still highly competitive and all the member firms are trying to reduce costs. They are cutting staff, paying the survivors less and replacing salaries with performance-related bonuses.
An upward swing in staff numbers in 1991 was reversed in 1992. Total jobs fell by 900 to 22,100 and bonus payments as a percentage of salaries rose from 14 per cent in the third quarter of the year to 25 per cent in the last.
The review had good news for London as a financial centre, with turnover in overseas equities increasing by 16 per cent on 1991 to a record pounds 329bn.
Competition and low turnover were so bad even in the first half of last year that a third of member firms were in the red. But the Stock Exchange claims that, despite returns being very low for the risk involved, 'firms must still judge the potential rewards to be high, since the long-forecast shake-out has not happened and shows no sign of happening'.
The number of market-makers in UK equities at the end of the third quarter was 27, two up on the total at the end of 1991. County NatWest cut the number of smaller company shares it made markets in, while SG Warburg pulled out of smaller company market-making altogether. Bikuben Whitefriars, a specialist in smaller companies, pulled out of market- making at the end of the year, with a lot of the slack being taken up by Smith New Court.
The exchange appears confident that there will not be a stampede of firms out of market- making in 1993. 'With commission rates stable, there is little evidence of firms pushing for market share in the short run. Instead they are cutting costs to protect themselves.'
Large firms often found it most difficult to make money. For instance, in the second quarter of 1992 only two of the nine largest firms were in the black, making total profits of pounds 28m. The other seven made total losses of pounds 41m.
In contrast, more than half of the firms capitalised at under pounds 5m made profits, with a cumulative total of pounds 22m, while the rest made a loss of pounds 8m. However, the Stock Exchange warns that a few sour deals by the biggest players can lead to a loss in a single quarter, which does not necessarily mean that small is better.
The review pinpoints four reasons why so many institutions are persevering with their market-making subsidiaries despite such a competitive environment. One is that many big institutions still feel the need to be financial supermarkets rather than specialist boutiques. Another is sheer corporate ego, the desire to be seen as a 'global firm' with operations in New York, Tokyo and London.
A third is the constant headache of trying to identify which bits of their operations are making profits and which losses at any particular time. The problem with cutting this year's loser is that it may turn out to be next year's winner.
Lastly, few firms are put off by one-off dealing disasters. 'Firms do not see themselves as chronic loss-makers, but rather as unlucky once in a while. Their remedy is to tighten up their risk management controls,' the review said.
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