The inter-dealer brokerage (IDB) business is expected to remain under pressure from reduced trading activity, but cost cutting is limiting the bottom line impact, says U.S.-based Fitch Ratings Inc.

The rating agency has downgraded one of the IDBs that it rates, GFI Group Inc., but has affirmed its ratings on the three others, ICAP plc, Tullett Prebon plc, and BGC Partners Inc. Their rating outlooks remain stable, but the outlook for GFI, which had its rating reduced to ‘BB-‘ from ‘BB’, remains negative.

Fitch says, in a new report, that the IDBs “continue to face a challenging operating environment.” It notes that global trading activity remains subdued due to persistently low volatility, the tougher regulatory environment for dealers, and the uncertainty generated by the ongoing regulatory reform of the over-the-counter (OTC) derivatives markets. And it believes that “some of these trends will continue impacting brokerage revenues in the near to intermediate term.”

In the longer run, Fitch says that it expects that many of the OTC reforms, such as the use of central counterparty clearing, the introduction of swap execution facilities (SEFs), and mandatory trade reporting, will increase liquidity and trading in derivatives markets, “potentially offsetting declines in margins/commissions from increased competition.”

In the meantime, it notes that the IDBs have responded to the decline in brokerage revenues by reducing their costs “with an emphasis on cutting compensation costs, which has helped to stabilize profit margins.” Additionally, it says that IDBs are looking to diversify their revenues by growing non-brokerage businesses, either organically or through acquisition.

Fitch says that it expects further cost saving actions, which it believes will help create positive operating leverage, and benefit the firms in the longer run. It also says that it believes that the IDBs will properly manage funding and integration risk when pursuing acquisitions. However, it warns that, “a return to aggressive compensation practices or large cash/debt funded acquisitions could put pressure on the IDB sector or individual companies.”

The downgrade for GFI “reflects increased pressure on the company’s liquidity position, driven by increased working capital requirements, continued earnings pressure and continuation of the approximately $6 million quarterly dividend payment to shareholders,” Fitch says in a separate report explaining its rating action.

And, it says that its continued negative outlook on the firm reflects its expectation that GFI will be hit harder by low trading volumes due to its smaller scale and less diversified business model. “Lower earnings, combined with continued regulatory related costs, could further impact liquidity levels,” it notes.