UBS's move to radically trim the investment bank has yet to be officially announced
Move is already sending shockwaves through the sector and may spur similar moves
UBS’s move to radically trim the investment bank has yet to be officially announced but it is already sending shockwaves through the sector.
Analysts say the bold step will put pressure on other subscale banks to restructure and will accelerate market share gains by those that already dominate fixed income trading.
Like others, UBS has made a big push in the past few years in the one and only bright spot of investment banking since the onset of the financial crisis: fixed income trading.
The business of underwriting and trading bonds, credit derivatives, structured products and currencies made up almost two-thirds of UBS’s investment bank’s operating income in the second quarter.
Fixed income had a record year in 2009 and is expected to make up more than half of the $240bn investment banking revenue pool this year, according to estimates by Deutsche Bank.
But while this business is booming, it comes at a cost for banks. Incoming capital rules – called Basel III – force banks to hold a lot of capital against such trades at a time when they are already under pressure to increase overall capital levels.
This makes it much harder for the medium-sized players to compete. “Too many banks [are] still pursuing businesses in which they are subscale,” said Matt Spick, analyst at Deutsche Bank, in a note.
According to his estimates, UBS had a market share in fixed income, currencies and commodities trading of 3.9 per cent in the first half of this year. This compares with 11.2 per cent at JPMorgan, 9.9 per cent at Citigroup and 9 per cent at Barclays.
These so-called “flow monsters” – which includes Deutsche Bank – typically have lower volatility in their revenues and are better able to address fixed costs and cope with higher capital charges.
This raises questions over the strategy of banks such as Morgan Stanley and Credit Suisse, which had a 4.4 per cent and 5.1 per cent market share respectively in this trading area in the first six months.
Credit Suisse has a narrowly focused fixed income business that is strong in securitisation and high-yield bonds as well as electronic trading platforms in rates and foreign exchange.
Analysts say the bank, which last week announced a further round of cost, balance sheet and risk-weighted asset reductions, would need to consider a similar step as UBS.
“We would like to see Credit Suisse take a more decisive approach to closing businesses in FICC [fixed income, currencies and commodities],” said James Chappell, analyst at Berenberg Bank, in a note this summer.
But even beyond the fixed income space, banks are being forced to rethink their models as almost none are able to earn their cost of capital and investors and regulators increasingly see them as too complex and difficult to control.
“The ‘all things to all people’ mantra has paralysed banks,” says Mr Chappell.
A number of smaller investment banks such as Royal Bank of Scotland in the UK and Japan’s Nomura have already reacted by reining in their cash equities and advisory businesses in particular.
Analysts also ask if Deutsche Bank needs to reconsider its global equities trading business, which has failed to repeat its success in building up a market-leading fixed income franchise.
UBS’s move will also reduce complexity in the investment bank and in turn tackle another big problem for a number of European investment banks: their ballooning back office costs.
Investment banks’ average cost-income ratio – a key measure of efficiency – has risen from 60 per cent in 2007 to 80 per cent last year, according to data by Morgan Stanley and Oliver Wyman.
Both Deutsche Bank and the Swiss banks are notoriously inefficient, but they have recently started to reduce and relocate to low-cost countries their back and middle office workers. Deutsche Bank is aiming to carve out €4.5bn in costs in that way, while Credit Suisse is targeting SFr4bn ($4.3bn) in savings.
For UBS, the more radical path might have been easier to take not only because its trading business has been weaker than rivals but also because its market-leading wealth management provides it with a highly profitable cushion to fall back on.
“We are early adopters because we can afford to be,” one senior UBS banker says.