Macaskill on markets: Investment banks and the sharing economy

News and opinion on finance

The trend towards US dominance is particularly acute in investment banking, where JPMorgan is now the top revenue generator in Europe, as well as globally.

So exploration of a link between Deutsche Bank and UBS to bolster both firms by exploiting their relative strengths in fixed income trading and equities had a clear logic.

A full-blown merger between the two firms has been explored before, and numerous UBS staff with an equities background – led by co-head of investment banking Rob Karofsky – previously worked at Deutsche, so there was a shared familiarity with the two business models.

UBS adopted a light presence in debt sales and trading after its 2012 restructuring, while Deutsche remains the biggest European bank by fixed income revenue, despite loss of market share amid relentless management upheaval.

Bankers regularly joke that attempting to reach consensus across a range of financial institutions is like herding cats 

Even during its recent convulsions, Deutsche still generated €2.83 billion of fixed income revenue in the first half of 2019, or the equivalent of $3.14 billion. 

The $845 million of fixed income revenue at UBS was not much more than a quarter of Deutsche’s total.

UBS had equity revenue of $1.82 billion in the first half of 2019, which was roughly twice the Deutsche total of €837 million, or the equivalent of $929 million.

So UBS may have been a potential net winner from any revenue pooling agreement that involved referrals of equity business from Deutsche and steering of its own fixed income client flow to the German bank, after talks that reportedly continued as recently as June. 

Deutsche chief executive Christian Sewing ultimately opted for a self-directed restructuring that was announced in July and featured a wholesale withdrawal from equities trading. And two months later UBS took steps towards folding its FX, rates and credit group into a single securities unit that will be dominated by its equities activity.

Alliances not mergers

These decisions partly reflect the challenges of creating banking alliances that fall short of full mergers. Not for the first time, European banks seem to be left with few viable answers to apparently intractable problems.

European bank executives with a trading background talk almost wistfully about the potential benefits of a shift towards a shared model for business lines such as FX and government bond dealing.

A high proportion of the client activity in these markets is done at very low margins for banks. Any solution that pooled resources to cut the cost of this service provision while allowing banks to pitch higher added-value products to customers would have an obvious appeal. 

This would in theory allow banks to exert some control over trends such as the automation of fixed income markets, rather than simply cutting costs by firing staff each time there is a downturn in revenue.

A move to restore some agency to the daily lives of bank executives by cutting the cost of providing routine dealing services – and shifting business to an agency model – could also risk delaying tough decisions, however.

The recent Deutsche and UBS talks seem to have concluded relatively quickly, presumably because of the urgent need for action at Deutsche and an internal business review at UBS.

Any more ambitious attempt to pool resources across a range of European banks could easily turn into a talking shop that wastes the time of all involved, in an unfortunate parallel to some of the activity conducted by existing pan-European organizations (which in turn fuels populist political resentment).

Bankers regularly joke that attempting to reach consensus across a range of financial institutions is like herding cats. 

Revenue sharing would also involve greater transparency, which might not be welcomed by some managers 

Investment bank executives with a background in sales and trading were bred in a culture of aggression and suspicion. Only the paranoid survive, to use a phrase made popular by a tech industry executive, Intel co-founder Andrew Grove. 

This helps to explain the obsession with the motives of Goldman Sachs managers in previous cross-industry consortiums, for example. Without necessarily providing concrete examples, rival bankers regularly allege that Goldman has a secret plan to outflank its peers whenever it engages in collaboration with other firms. 

If a relatively senior Goldman banker agrees to sit on a panel, that is taken as a sign that a profit-gaining plot is afoot, while dispatching a junior employee can be seen as indication that the failure of the initiative is secretly planned. 

A gathering of European banks would not feature Goldman representatives, but there would be plenty of speculation about the motives and relative strengths of all parties involved.

This would be analogous to the distrust between existing divisions of investment banks, but without an arbiter in the form of a chief executive to resolve disputes. 

Revenue sharing would also involve greater transparency, which might not be welcomed by some managers.

With bid/offer spreads tight in many markets and electronic trading venues cutting margins for dealers, one of the few ways for banks to make money is by taking some risk when hedging exposure from client activity. 

In the wake of the 2008 financial crisis and restrictions on proprietary dealing, this ‘prop-lite’ activity is generally conducted as discreetly as possible. 

The planned changes in the Volcker Rule will hand yet another advantage to US banks over their European counterparts. 

The adjustments to the rule that were approved by US regulators in August will essentially allow US banks to mark their own homework when deciding whether or not trades held for less than 60 days are actually functioning as hedges.

The European Union in 2017 backed away from a law that would have forced local banks into a complete split of trading and retail activity, but the few distinct proprietary trading desks left in Europe are mostly being shut down and investor confidence in regional bank stocks is at such a low ebb that any expectation that a relaxation in US rules will force all banks to take on extra dealing risk will not be seen as positive.

A step towards sharing investment bank functions could further curtail the scope to profit from hedging decisions by individual managers, as any joint revenue deals would need to include insight into customer flows.

Air of despair

Challenges such as these may explain the apparent air of despair even among some European bankers who might seem well placed to mount a fight-back against US dominance, such as Jean Pierre Mustier, chief executive of UniCredit and recently appointed president of the European Banking Federation. 

Mustier has downplayed the ability of European banks to compete with US banks for investment banking business and stressed that cost-cutting should be the main driver of any transformational cross-border mergers within Europe. 

Perhaps Mustier is keeping his cards close to his chest and hoping to pull off a deal that creates a European champion bank that can compete globally.

But for now, the most vocal proponent of stronger European investment banks and an alternative to US firms for clients in Europe is Jes Staley, the chief executive of Barclays. 

Staley, of course, is a native of Boston, Massachusetts.

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