ICAP thriving on uncertainty

Investors prefer bull markets. Things feel so much better when prices are on a rising trend. The picture becomes less comfortable in a bear market and positively horrid when there is no real certainty at all. But ICAP – being a broker – doesn't care about that. It revels in uncertainty, so long as institutions are dealing. So a sovereign debt crisis, uncertainty in foreign exchange markets or heavy issuance of government debt are all good for ICAP.

Operating as the world's largest inter-dealer broker, ICAP provides the means whereby banks and other institutions buy and sell financial instruments in a wholesale market. Put simply, ICAP provides a platform to match buyers and sellers – the so-called over-the-counter market – and takes a commission on transactions completed. So its revenue stream is there whatever the market trend, and it faces no risk because it does not act as a principal; it simply takes a slither of the value of everyone else's investment decisions. In really liquid markets, such as US Treasury bills, transactions are done electronically, but ICAP has voice broking, too. Instruments it trades include interest rates, credit swaps, commodities, foreign exchange and equity derivatives. In aggregate, these generate daily trading volume over $1,400bn, of which around 40 per cent is done electronically.

The electronic broking side has driven growth in recent years. ICAP now operates the world's leading electronic trading platforms in over-the-counter foreign exchange and fixed-income markets, and the division's operating profits in the year to March grew by 23 per cent to £123m. The BrokerTec fixed-income platform has been especially successful, with average daily volumes up 27 per cent at $627bn. Combined with providing information services, this side now accounts for 54 per cent of group operating profits.

The division should maintain its growth rate partly because ICAP has persuaded more EU governments to recognise BrokerTec as an official platform. In addition, a significant upgrade of the platform's capabilities is under way and should be finished around this time next year. ICAP also has a number of electronic platforms that have been developed to handle credit derivatives. US institutions, in particular, are showing increased interest in these platforms in anticipation of the introduction of new regulatory requirements because, according to ICAP, they will be fully compliant with the new regulations.

On the voice broking side, trading has been a little more subdued partly because, as activity increases in one segment of the capital markets, it tends to decrease in others. So while interest rate derivatives and commodity-related trading saw strong growth in 2010, credit and equity derivatives performed less well. And last year’s performance was hindered by the defection of 38 brokers, which hit trading in the Asia-Pacific operation. Throw in a number of one-off costs, and operating profits for voice broking last year fell 7 per cent to £194m.

ICAP also operates a post-trade risk and information service that is designed to help customers reduce their operating costs and improve their risk-management procedures. This is a relatively small part of the business; even so, its revenue grew by 30 per cent last year to £184m and operating profits were up 14 per cent at £79m.

So what does the future hold in store? ICAP thrives on uncertainty because this drives up trading volumes as speculators, banks and other institutions jostle their positions. And the current outlook suggests that uncertainty will continue to dominate. Sovereign-debt worries in several EU states and rising inflation almost everywhere are two key factors that engender uncertainty and are unlikely to go away just yet. Exchange rate volatility is also working in ICAP's favour, especially given the possibility of Greece pulling out of the Euro.