Wednesday, 26 September 2018

Can investment banks ever be a disruptive force?

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Bank bosses are being pushed into making bold choices, says Keith Mullin

I HAD LUNCH the other day with the head of a European investment bank. It was a very pleasant affair; over some first-rate cuisine, he laid out his long-term vision for his firm and regaled me with tales of what he was doing now to prepare the groundwork for a major transformational shift he is convinced is about to happen in the structure of capital markets – one that would emerge, he said, long after his tenure at the helm.

While he was saying all this, I was thinking on one hand not only how altruistic and visionary this approach was, but on the other what would happen if he were wrong and things didn’t evolve as he was clearly expecting.

But it struck me that in this New World of horses-for-courses strategy design, that’s the point: you have to make bold choices. It’s change, risk becoming irrelevant, or die. There is no blueprint for investment banking success. It’s about making the right connections and optimising what you have. It also struck me that my reaction perhaps shows that I’m not a risk-taker and would have made a lousy trader.

My lunch companion’s strategy is to work the internal connections, break the barriers down, and make the investment bank less of a monolithic silo that is typically disliked by other divisions into a trusted partner that will act as a change agent for their businesses as those businesses morph into a disintermediated format. He wants, in short, to be a disruptive force in investment banking. I haven’t really seen that term applied to IB by an incumbent. But I kind of like it.

WE ALSO TALKED about regulation and the unintended consequences of the current set of rules that have been implemented or are on the docket to be implemented. The banker’s view was that regulators in Europe are blithely unaware of the potentially serious damage they are doing to the competitive landscape through their ill thought-out attempts to avoid systemic risk. They’re risk offering Europe on a plate to the US banks.

They’re similarly painfully unaware, he said, that the effective destruction of liquidity and price discovery in capital markets stands in complete paradox to their attempts to shift the balance of funding power to those same markets – and away from bank lending. But what can I do, he asked? Good point, I thought.

It’s also a point that set me thinking about Jeff Immelt and how fortunate a position he’s in at GE. Just as selling stock when they’re trading at their lows is no more than formally realising your losses, his decision to take GE out of the banking business is, in effect, the industrial equivalent of confirming in the most public way possible that the over-regulated banking sector is destined – through poorly-designed regulation – to be a utility business generating poor utility returns for the foreseeable future. Or longer. And that being zealously regulated as a SIFI is a fate worse than death.

Immelt’s comment that it is increasingly difficult for wholesale-funded financial companies to generate acceptable returns will have jived with every bank CEO out there – and will probably have a fair few hanging their heads in their hands.

THE FOUR US non-banks on the too-big-to fail list have adopted very different reactions: AIG took it on the chin; Prudential Financial had a go at a challenge but failed so dropped its objections; MetLife has chosen to sue regulators. But GE’s decision is by far the most extreme. Regulators had its behemoth CP issuance, its back-up lines of credit, its credit extension to mid-market borrowers, its large volume of on-balance sheet assets, high proportion of non-US assets and revenues, and long-term debt issuance in their sights.

All fair enough: GE emerged as the 15th biggest borrower in the world in IFR’s 2014 Top 250 Borrowers report, with US$29.65bn of borrowings from the syndicated loan, international bond, equity-linked and securitisation markets in the qualifying period of May 1 2013 to April 30 2014. Year-to-date, GE ranks 10th in US highly-leveraged lending according to Thomson Reuters data; 21st in all US lending and lies 24th in US project lending.

GE management didn’t request a hearing to contest the SIFI designation so had presumably pretty much made the decision to ditch the banking business by the time it was bestowed. Chairman and CEO Keith Sherin’s comment that the financial services assets can be more valuable to others was probably fair insofar as the firm sold most of the assets of GE Capital Real Estate to Blackstone; the performing loans to Wells Fargo and US$4bn of CRE asset to others.

But by the same token, he was probably past caring at that point. At a macro level, the lengths the firm is going to to avoid Fed oversight is extraordinary. The banks aren’t in such a fortunate position. They have no options but to choose heavily scrutinous and over-bearing regulation – and its death by a thousand cuts. Throwing the baby out with the bathwater isn’t, alas, an option. Unless they do an RBS. What a choice. Bring in the management consultants.

(Corrects to remove extra word in first paragraph)

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