IFR Future of IBD Roundtable 2015: Part 3
IFR: On the issue of capturing emerging opportunities, is there a right way or a wrong way to set up your coverage function versus your product function versus your country function in today’s world? Are there models that tend to work better?
William Vereker, UBS: It’s the right question to ask because the traditional investment banking business, as we discussed earlier on, is a very high ROE business. So the cost problem, per se, of a financial institution doesn’t for the most part lie in this part of the business; it lies in all the ops and technology and so on. There’s a lot to be done there. There is some relevance, but not an enormous relevance, within the traditional IBD businesses.
Within a European context, there is a structural challenge because the client relationship model is more complicated. You’ve got your country overlay with a sector overlay and a product overlay so it compounds the challenge in Europe relative to the US where, in the US, in absolute terms, you have a much bigger fee pool but a much more homogenous fee pool. The cost to cover it is, therefore, on a unit basis, lower than it is in Europe.
Is there a magic box of how Europe should be covered which is going to reduce that unit cost? At the margin, a lot more efficiency has gone into the model over the course of the last three or four years. I think all the institutions in Europe have fundamentally fewer people delivering their service to clients in a more efficient way. That trend will continue. But is there a revolutionary new way of serving a client base in Europe in this business? I don’t think so.
The way that returns are achieved in this business is much more around focusing your coverage model on the places where you are relevant and are going to be able to win. Because, as Ted will know better than we do, unless you’re a top-three service provider of traditional IBD products to a particular client, you’re not going to capture very much of their wallet; 50%, 60%, 70% of the wallet is going to go to their top three relationship banks. So, focusing on places where one is going to win within the context of the existing model is the way to go.
Saul Nathan, Morgan Stanley: One of the challenges for the industry is the ‘silo-isation’ of people’s skills. When you have people going into a product area, for example, out of university and they go into a particular product and they become very expert in that product, sometimes they lose sight of the bigger picture. Then we end up with people a little further down their careers who don’t necessarily make the best all-round bankers; they just are tremendously good product people. That is a problem for our industry as each area has become more sophisticated and more specialised and requires greater expertise.
Of course, many of these products really do require particular areas of expertise, experience and judgement and increasingly clients see the value of that judgement playing out in the choices that they make when they select banks to do things like IPOs, leveraged buyouts or acquisition financings. They want people who’ve done it before, know where the pitfalls are, and know how to make the judgements.
By contrast, having a pure generalist show up to say: “I can get this done for you” doesn’t work on its own. So we have to get the mix right. We’ve all invested enormous amounts of time, effort, and resource into developing the talent bases we have in our organisations, and the organisations sustain those talent bases because the business is there to be generated. I think we will continue to do that.
Sophie Javary, BNP Paribas: We have all become extremely specialised. When I started as an ECM banker I pretty much wrote the contract, did the bookbuilding and everything else. That would be unthinkable now. On the other hand, we want to have and be able to provide a holistic view; we want to be able to generate cross-sell and ideas.
So I think that inherent conflict within investment banking is something we have to reconcile by having on one hand all the specialists that the client wants but on the other hand, combining those specialists into one holistic advisory view for the benefit of the client and our relationship with them.
When you’re in the business of building long-term relationships you have the responsibility, as a banker, to combine all this expertise for something the clients will be happy with in the long run. I think it’s a challenge, and that’s why we need the talent of bankers and managers to be able to combine this. But this tension will not disappear.
IFR: John, does silo-isation make it impossible to manage investment banks properly?
John Langley, Barclays: It has evolved a lot over the last few years. Most if not all of us have capital markets businesses that are run on a very integrated basis. That allows us to be agile in how we deploy our resources and how we think about serving clients. It’s not about creating a workforce of generalists, but rather being efficient.
It touches upon a more important point, though, which is talent. I think one of the things that we’re all seeing is junior talent leaving the industry. Our ability to continue to attract, develop, and retain the best talent will therefore continue to be extremely important. We need to create more mobility opportunities for bankers which is not only good for their careers but also good for business because it helps to develop more rounded bankers.
I don’t think that banking operates on a siloed basis at all, actually. As William was saying we are all very focused on having an integrated coverage model across product, sector and country. These businesses cannot operate in silos; they have to be very joined up.
On the trading and sales side of the business we’ve seen more coming together of different product areas. Of course, we tend to think about origination verticals, which is not so much about pure origination, pure trading and sales, but actually thinking about, say, the equities vertical as an end to end business . I think that again highlights how we’ve become more integrated.
IFR: I did want to pick up on the question of management. Has the quality of management in investment banking improved, Ted?
Ted Moynihan, Oliver Wyman: The tasks of a senior manager of an investment bank have radically changed over the last few years. Of course, different institutions work on different levels of the spectrum but you had very senior people whose primary role seven or eight years ago was to focus on clients and build the top line. Now you have to be an expert in the balance sheet, the capital side, and the cost side and the whole gamut so the skill set has really broadened out.
That’s a good thing; it’s probably a more interesting role as well but it’s certainly more demanding. One thought that comes off your comments, John, is: the culture of organisations has become a huge facet of leadership now. That links very well to this talent point, because one of the things which has been problematic for the industry – much more so, I think, on the sales and trading side – has been specialisation of talent leading to a point where people say: “if there’s nowhere else for me to go in what I happen to do, I will leave and I will go to another institution”.
That’s bad for loyalty to the institution, that’s bad for the culture of an institution, and ultimately bad for the industry. More and more banks are moving to a point where they’re starting to think about people’s careers and developing those people. That does mean moving them round. Some cost comes with that but I’m sure it’s a good thing.
IFR: One of the elements that plays into this is compensation. The ability of banks to be able to pay people what they used to be paid has clearly changed. Bearing in mind the regulatory caps that have be installed in Europe, how important is compensation today in terms of attracting, retaining, and building talent,
Thomas Huertas, EY: It’s extremely important for banks to attract and keep the talent but it’s also extremely important in terms of the cost equation. Aggregate compensation and in particular in this portion of the business – bonus – is a very significant proportion of total cost. Compensation is a key regulatory concern, as are the incentives that compensation gives to people to behave either in the correct manner or allows them to get away with inappropriate behaviour.
Solving and addressing the compensation issue, in my view, is important from a business model standpoint; it’s certainly important from the public perception standpoint and the regulatory standpoint, and it is in many of these discussions the elephant in the room.
William Vereker, UBS: Firstly, we’re all shareholder-driven organisations, and compensation decisions in all organisations that I’ve been part of – and certainly my current organisation – are fundamentally driven first and foremost by appropriate returns going to shareholders, and the balance being right between our people and our shareholders. We, of course, look very carefully at the regulatory framework and so on. But, ultimately, we have to be shareholder-driven organisations. That’s point one.
Point two: compensation is a very important tool for behaviour and making sure that behaviours, both near-term and long-term, are right. So a lot of the regulatory changes that have been put in place around the structure of compensation are very good – and healthy – changes for the industry. That has been a big positive. But trying to regulate the absolute levels of compensation which go to people, divorced from the economic returns of the organisation, is not, long-term, the way to manage this topic.
Thomas Huertas, EY: I would agree strongly on that score and was involved in some of the discussions around that. Unfortunately, it went what I would perceive to have been the wrong way with respect to the bonus cap in the EU.
IFR: Moving on, I wanted to pick up on the theme of Capital Markets Union. How does it change the nature of the IBD game in Europe, on the basis that one of the key tenets of Capital Markets Union is to enfranchise mid-caps into the capital markets space?
Does the panel think this is a realistic endeavour that has got a proper end-game? Are SMEs really the right kinds of clients to be brought into the capital markets? If the client base morphs over the next five years from where it is today – multinationals, banks, sovereigns and supranationals – into much more of a mid-cap credit space, it creates all sorts of challenges, it strikes me.
I suspect every one of you has been having discussions internally about how that plays out within your institutions. Some banks are going to be better placed to transform their service model to suit that kind of new client base but what’s the general feeling about CMU and how important it is from an IBD perspective?
James Esposito, Goldman Sachs: I don’t think we need to be defensive in Europe about the state of the capital markets currently. When you look at what’s going on in Europe right now, last year IPO volumes in Europe were actually greater than those in the US. Large-cap investment-grade companies in Europe have no problems accessing credit right now. When we start talking about Capital Markets Union, the risk is we sort of get on our back foot and get defensive about the way the equity capital markets or the debt capital markets are functioning.
The vast majority of the capital markets in Europe are doing absolutely fine and stack up quite well against any comparison to the US. That said, there are a couple of places where I think Capital Markets Union could have a big impact on Europe – you highlighted SMEs. For me, when we’re talking about SMEs and Capital Markets Union, it’s not like very small companies in the US access the public capital markets; they don’t.
This quickly becomes a high-yield bond market origination issue and over the last decade Europe has not enjoyed as deep a high-yield bond market as has existed in the US, so I think that’s an important place to look. Mid-cap below investment-grade rated companies are the ones that are going to feel a credit pinch as European banks start to pull back when we get to the other side of QE, and so I’m actually optimistic.
If you look at high-yield bond volumes in Europe, they’ve grown at something like a 30% compound annual growth rate since the financial crisis so the market here is starting to get its legs underneath it. I think that’s a very healthy thing for the European economy. CMU is going to involve a deeper high-yield bond market, as well as deeper and more robust securitisation markets. If you think about securitisation, that’s a way for the consumer to access credit, so that’s going to be an important consideration.
Are we going to devise or innovate around SME financing in a way that the capital markets are going to be a big solution? I think small companies are still going to access credit from the banks – the banks who know them, who’ve built up a relationship with them over the years. The extension of credit to SMEs, particularly very small SMEs, has been – and I think will remain – a very local affair, so I’m not sure that’s going to change as dramatically. We have to be careful how we define the issue and what it is we’re attempting to solve for.
John Langley, Barclays: I completely agree with that. We’ve already seen some developments in terms of larger SMEs looking to access the capital markets for the first time, to take advantage of very attractive interest rates; over the longer term. At the smaller end of SMEs it’s a more of a local affair. It’s much more about domestic bank-client relationships, and I don’t see that changing dramatically in the short term.
IFR: Sophie, you mentioned earlier about the way that the investment bank is positioned internally. How does the handover between the small business bank and the investment bank work in the new environment? How do you work the Capital Markets Union theme into the fabric of your business banking network?
Sophie Javary, BNP Paribas: Within the investment banking division we are integrated with our domestic banking network so we provide all of the investment banking services to their clients, with cross-selling arrangements. It’s a win-win situation where the mid-size corporates get access to the pool of expertise and sophistication of the large corporates, and we centralise this expertise.
I imagine other banks are organised that way too on the basis of an integration model. There have been discussions within banks as to whether you should decentralise some of the expertise but integration is probably the best way to proceed. Then you have the question of adapting your level of service to that clientele.
The way we do it is by having specialist teams that interface with the networks and provide expertise to the local bankers who may not have as much sophistication as senior bankers to a large corporate. But one way it is happening already is in private equity. In the private equity space all of the financing is largely done through capital market transactions with CLOs so the banks only keep a small proportion of the risk, which is the revolver.
The level of sophistication is the same in Europe as we have elsewhere. There are, however, some areas where Europe has been more sophisticated than in the US, such as hybrid capital for corporates, for example. A number of US corporates are looking at what has been done in Europe where there is continuity between equity to short-term debt of all the elements of financing a balance sheet, which is also something where investment banking in Europe has been ahead of the game.
Ted Moynihan, Oliver Wyman: I might just break the cycle of violent agreement here. I don’t know if I disagree with what’s been said or if I just have a different angle but when I think about the SME market in Europe on the banking side, it’s an under-competitive market, in some countries a poorly served market and a very un-transparent market where SMEs are not able to move from one banking provider to another.
Do I think there’s going to be a revolution in who provides the credit? No, but I think there could be a very disruptive revolution in transparency and, therefore, their ability to have banks compete with each other to provide them with their services. That could be very good for the investment banking world, for example, because I think that would also lead to a lot of innovation around how to re-open securitisation markets and get some credit out into the capital markets and into the buy-side, where it actually belongs and not necessarily all on bank balance sheets.
So, I think there could be some really interesting things that happen there in the next few years. When you look at Capital Markets Union, one of the big problems today is that there are no products which are really cross-border in the Eurozone. We’re still a long way away.
There are a lot of things wrong with UCITs, but at least they’re a passport-able asset management product. The minute you see an SME product or, for example, a retail product which is truly transportable from one country to another, there are massive cost advantages for banks to be cross-border. That is when you will see a very different M&A landscape in the banking market in the Eurozone.
Right now there’s not a lot of synergy for a bank to say: “If I’m a bank from one country, I can buy a bank in another country but I just have to deliver the services that they’re already delivering better. Where is the actual synergy to an M&A transaction?
IFR: How will the mobilisation of retail savings play into the CMU theme, Saul?
Saul Nathan, Morgan Stanley: We have a highly fragmented retail savings infrastructure in Europe, and it’s very local and there’s isn’t a strong equity culture. You also have a highly fragmented asset management industry in Europe and you have an under-penetrated pension fund industry. Making a like for like comparison – and the European Central Bank and Commissioner Jonathan Hill have already laid out some of this in their document – suggests that there is quite a lot of room for improvement, to get to some of those levels that you see in the United States.
Will we get there? I don’t know, but we do have some structural impediments in Europe around, for example, IPOs. If you want to raise a price range in the US, it’s a pretty straightforward thing to do. If you go to a retail offering in Europe, it’s very rigid; it’s hard to be flexible, it’s hard to adapt to market conditions. If we could change some of these practices, it would be helpful in terms of the formation of capital for smaller businesses. It would make some of those processes more nimble and that would be helpful.
But we’ve got still quite a long way to go before we get to a pan-European retail market. As an organisation, Morgan Stanley has a very big retail business in the US; and it would be mighty hard for anyone to replicate that in Europe on a homogenous basis at this point.
IFR: Thomas, do you think the European Commission’s starting point was the right one in terms of this how it articulated the theme?
Thomas Huertas, EY: They certainly identified the right issues. How much progress they can make is really open to question, because – take retail – there’s a very strong desire to have that on a national basis; the hook into pension and taxation for most countries is very much nationally focused.
With respect to SMEs, it really brings out the importance of looking at the firm as the firm.
For many SMEs, they access credit as individuals who happen to own a business, and the combination of individual credit and credit to the firm is quite fluid. If you go to the capital markets, it’s only the business portion of that and it comes squarely back to the pricing issue that was talked about earlier.
If you have the two in combination, it is possible to have a much lower rate on the loans of the business. It appears uneconomic if you look at the business alone, but if you also have the house as security by virtue of the mortgage, it’s a different picture and much more amenable to bank financing as opposed to capital markets financing.
Mark Rodrigues, Thomson Reuters: I always felt the SME space was a highly lucrative one but it’s expensive to cover so from a capital markets perspective it’s not where the banks have gone. There are a lot of tax and legal implications for serving that market; again it lends itself to a pooling concept, but it’s still early days.
IFR: We’ve broadly discussed a range of themes here but in terms of where we go from here in IBD, where do you see opportunities? What are the challenges? Are you excited? Are you concerned?
Saul Nathan, Morgan Stanley: We feel pretty excited about the prospects for investment banking. Those of us who’ve done it for a long time have always been able to see that whenever there are challenges there are also opportunities, and our business is one that is extraordinarily good at adapting to challenge. I think you will see this in Europe, in Asia and on a continuing basis in the US. We get very excited when we look at the M&A statistics, for example.
This market sees an enormous amount of inbound and outbound investment. It’s coming from new markets and new players. We think that’s very good news for those organisations that can service clients on a global basis and provide ideas to them.
In a world where information is plenty and judgement is valued, trying to sort through the noise from the data is something that our clients increasingly recognise is different and valuable. Those organisations that can do that and connect that to capital sources in an efficient way are going to thrive, so we’re pretty excited.
Sophie Javary, BNP Paribas: The single European market will offer opportunities and we are going to see consolidation, concentration and specialisation, and this is an opportunity. The second thing is the importance of leadership in this business. Those that will make the difference are those that can manage change and can adapt. These new skill-sets that are needed in investment banking are important.
The challenge ahead of us is the challenge of restoring our public image, which we all have to face. It’s been badly damaged and that speaks to our codes of conduct, it’s the way we must continue to engage with all our stakeholders, with all of the regulators, governments and people in the information industry. It’s a challenge we have to face in a responsible manner.
William Vereker, UBS: The opportunities for the business of traditional investment banking to continue to develop are tremendous over the course of the next few years. Our business is all about clients and serving those clients. The client base changes, and what they need changes, but we’re fantastically good as an industry at adapting to those changes and serving them. I see a very strong set of opportunities for the traditional investment banking business.
More broadly, the challenges for the industry, and how the traditional investment banking business fits into different financial institutions, and the particular strategies that they have, are profound over the next two, three, four, five years. The organisations in four or five years which are generating sustainable, attractive, risk-adjusted returns on a whole-company basis will be those which best address those challenges. The traditional investment banking business will, to some degree, be affected by how different institutions address the challenges.
John Langley, Barclays: It’s an exciting time to be managing businesses like ours through these times. There’s a lot to think about but there’s also a lot to play for. From a client perspective, things are becoming interesting. There is more confidence in boardrooms; we’re seeing more M&A activity as a result of that. The financing markets have been in pretty good shape but we’re now seeing greater uncertainty and increased volatility. We’re about to see a change in the rates environment so I think from a fundamental point of view it’s very interesting and clients will need our support more than ever.
We’ve talked a lot about costs and capital, and perhaps we’ve all been focused on trying to solve those issues on our own. I think there’s an opportunity to work together more as an industry, whether that’s outsourcing of shared services, finding more efficient ways to do certain things where there is duplication; or developing smarter ways to create velocity of capital through more efficient origination and distribution. This is still ahead of us, so I think fundamentally there’s a lot to be optimistic about.
James Esposito, Goldman Sachs: I’m wildly optimistic about the state of the investment banking industry going forward, simply because if you think about the major trends that are going to play out around the globe in the next decade, the next 25 years, I don’t think anyone around the table will debate that we’re going to see further signs of globalisation of the economy. We’re going to see greater growth in large emerging-market countries and we’re going to see a middle-class that continues to emerge.
All of those things put a terrific wind at our back in terms of the services that we provide to clients, and so the trends that are playing out in the global economy are such that you’d have to be optimistic that there is a role and a purpose and a place for a large investment bank. With those trends growing, I think investment banking prospects will grow along with it.
Thomas Huertas, EY: I agree on the potential; I agree very much on the importance of getting the culture right. I’m somewhat reserved on the mutualisation question in terms of mutualising certain functions and putting a single point of failure in place. If mistakes are made or if they fail, the system as a whole comes into question – certainly an issue with CCPs and resolution of those entities.
I’d also end, perhaps, with a comment that the flexibility of global banks is such that they can adapt to do business practically anywhere in the world, and the challenge that the UK is effectively posing is one that should not be underestimated with respect to where all of this activity will be conducted. Five years from now, will we be having this type of conversation in London, given continuation of the bank levy, given intensification of restrictions on immigration and a possible exit from the EU?
Mark Rodrigues, Thomson Reuters: I am not bothered about the single point of failure on mutualisation. There are all kinds of risks in the industry but I think that there are ways to manage that. If you have more participants sharing things, there’s a better chance of flushing out something that is asymmetrical or won’t clear the market. If it’s just a single institution, that to me creates potential risk. I’d be willing to bet on the benefit of the trade-off.
We at Thomson Reuters are very keen on the point around standards ¬– when it comes to compliance as well as with on-boarding and things like KYC, where we think it is important to have a single passport to the industry. That saves a lot of time. It brings efficiency and reduces risk.
There are other things around risk transfer that could be brokered better by industry participants in an industry-owned context. Those things have precedent but they have to accelerate. This industry used to benefit from opacity; it didn’t like transparency, because it made money from arbitrage. That has changed. This part of the business has seen its image and reputation unfairly damaged even though it wasn’t behind a lot of the problems. That damage has impacted the kind of talent it can get. It has impacted the almost ridiculous – from an economic standpoint – regulatory capital charges that have been levied.
So, I think the call to arms for the industry is to go against what would have happened in the past. It is to look for those areas of commonality, to seek standards and to remove some of that friction in areas that aren’t obvious competitive differentiators, but actually would make the industry safer.
If we can do that, I think it will then improve liquidity and it will also improve creativity. I fear that without that, you still get the hammering, the bad reputation, the over-reaction from regulators. Just as important, you lose creativity and end up behaving like the Registry of Motor Vehicles: innovation becomes a bad thing and it becomes something you get punished for.
This industry has always been at its best when it has had big personalities and creative deals that not only served the client but also served the shareholders. We don’t want to lose that.
Talent won’t ever come to an environment that becomes just a mechanical, procedural, compliance thing. There’s a responsibility to encourage creativity and innovation that should be maintained. I would argue that the starting point is not only ethical behaviour, but the need for some common industry thinking and transparency around matters like compliance and risk transfer.
Ted Moynihan, Oliver Wyman: There is a point that we haven’t talked about much, which is there is a huge responsibility on both the regulators and the leaders of the industry to get to a point where the industry truly is a resolvable industry because then all of these institutions can behave like the shareholder-driven institutions they are. They’re built to operate that way. We’re not there yet. Put that to one side.
It’s a very interesting moment for the industry, because you’ve got enormous segments of the global economy that need financing – all of the entrepreneurs that are going to build the business/SMEs from the bottom up, the emerging markets, all of the infrastructure needs of the global economy. On the other side, you’ve got enormous pools of savings in the pension industries, in the insurance industries that need somewhere to go to get a decent return.
This industry has been brilliant over time at finding out how to connect those things together. It will be, for the industry as a whole, for the winners and losers in the industry, the leaders choosing strategic selection very carefully and building cultures that do what the industry has always done: build the best talent teams which win.
IFR: Ladies and Gentlemen: thank you for your comments.