The world's largest investment banks are on track to book record trading revenue in 2020 as COVID-19 triggered capital market volatility not experienced in more than a decade, but analysts expect growth to taper off in 2021.

Before the pandemic, the outlook for 2020 investment banking revenues was muted, with some impact expected around the U.S. election in November. But when the virus evolved into a global pandemic early in the year, the revenue outlook took a different turn as market volatility reached levels that had not been seen since the global financial crisis of 2008. In late March, the Cboe volatility index, commonly known as the VIX, hit 65.54 points for the first time since October 2008.

The spike of the index, which represents the market's expectation of 30-day forward-looking volatility, combined with massive government stimulus packages around the globe in response to the pandemic propelled global investment bank revenue to a five-year high in the first quarter of 2020. Year-over-year revenue growth rates continued to rise in the second quarter, leading to one of the strongest first-half revenue results in almost 10 years, according to Coalition, a research company owned by S&P Global Inc.

H2'20 slowdown

However, the second half of 2020 turned out to be calmer, with growth losing steam in the third and early fourth quarters. Volatility has simmered down and is expected "to fall back to historic levels" in 2021, with a dampening effect on investment bank revenue, Octavio Marenzi, CEO of investment firm Opimas, said in an interview.

The double-digit surge in revenue expected for full-year 2020 is unlikely to be replicated in 2021 unless markets experience a bout of volatility similar to 2020's, S&P Ratings analysts said in a written comment.

Fixed income, currencies and commodities, or FICC, trading revenue, which was the main driver of overall revenue growth at the world's largest investment banks, has already started to normalize from the record growth levels booked in the first half of 2020.

All 13 banks tracked by S&P Global Market Intelligence, registered double-digit declines in third-quarter FICC revenue from the second quarter, with 10 booking decreases of more than 30%. Goldman Sachs Group Inc. booked the biggest quarter-over-quarter FICC drop, at 40.92%, the data shows. The FICC drag led to a quarter-over-quarter fall in total revenue at 10 of the 13 banks, with UBS Group AG, Société Générale SA and Natixis being the outliers.

To download an Excel version of the Q3'20 data and historical charts, please click here.

The fourth quarter of 2020 was mixed, with October activity roughly continuing third-quarter levels, then picking up in November. The U.S. election and positive COVID-19 vaccine news helped fuel the increase, though levels fell again in early December as many "buy-side clients locked in their returns for the year" and were looking to ride out the market by 2020-end, Michael Turner, head of CIB analytics at Coalition, said in a December interview.

2021 market drivers

Some investors, however, started positioning themselves for big events, such as the end of the Brexit transition period for the U.K. and the EU, vaccine rollouts in various countries and the new Biden administration taking power in the U.S., Turner said, who added that these events could boost flows in early 2021.

Given ongoing uncertainty, not least in terms of geopolitics and the pandemic's trajectory, Turner said 2021 will carry some unpredictability but Coalition's base case scenario is for a "modest continual improvement" in the economy with interest rates remaining low and a smooth vaccine rollout. For investment bank revenue, trading dynamics across products are expected to change from 2020 as economies recover and market volatility eases. However, while 2021 revenue will fall year over year, he expects that overall it will be above 2019 levels.

Within FICC, credit is expected to be "more constructive" in 2021 thanks to the economic recovery, Turner said. This will benefit investment banks that are more weighted to spread products, which did not do as well as banks with a heavy macro business in 2020, he said.

Macro-heavy banks, some of which booked FICC revenue growth of 50% to 70% in the first three quarters of 2020, helped by volatility bouts in flow rates and foreign exchange, will probably experience a sharper revenue decline year over year, falling faster in second half of 2021, he said. Revenue at credit-heavy banks are likely to be more resilient as credit revenue improves in the second half of next year.

In equities, structured equity derivative losses along the lines of what were booked in the second quarter of 2020 and cost the industry about $2.5 billion are not expected in 2021, Turner said. Therefore, all banks with large structured books should see normalized revenues next year. This will mostly benefit the French banks, which should book "sizeable" equities revenue increases next year, he said.

However, the big boost in 2020 came from flow equity derivatives, with large U.S. banks benefitting in particular as some of them booked year-to-date growth of over 200% in that business. As flow equity derivatives trading normalizes in 2021, the major U.S. banks may see a faster fall in revenues than European peers as they also would not see as a large a rebound in structured derivatives, Turner said

One bright spot will likely be M&A given the more positive economic outlook for 2021, he added.

Deal volumes declined in 2020 due to COVID-19-induced uncertainty but seemed to be picking up at year-end, the S&P Ratings analysts said, noting, "That trend should continue into 2021 assuming the level of uncertainty seen in 2020 does not return."