Something disruptive this way comes

Bunds were hardly a screaming buy at the beginning of 2016. Far from it: shorter-dated paper offered investors next to no yield at all; and even at the longer end, a 0.1% coupon on 30-year debt must have seemed like scant compensation for all the risks that might befall the investment during that time. But applying that logic might have cost you your job: Bunds were one of the best-performing assets in 2016. If you’d started the year buying German government debt maturing in 2046, by the end of July you’d have been sitting on a paper gain of more than 30%. Even after the third-quarter sell-off you’d be looking at a juicy return of over 20%. The performance of Bunds illustrates just how tricky bond markets have become to navigate. A decade of ultra-low rates and trillions of dollars of quantitative easing from central banks have made investment strategy more difficult than ever. Logic has been turned on its head: just when you thought yields couldn’t go any lower, they drop even further. “Developed market government bonds have been one of the best performing asset classes in 2016, confounding many predictions at the start of the year,” said Anthony Doyle, head of fixed income business management at M&G Investments. “Year after year investors predict that bond yields will rise and year after year bond yields make new lows.”Negative yields Indeed, yields have come down so far that some are now negative. Four years ago, just a handful of bonds had a yield below zero, but the scramble for yield – compounded by the adoption of negative deposit rates and the expansion of QE – have driven up prices and pushed down yields. Over US$10trn of bonds now trade with a negative yield. Negative yields turn the logic of fixed-income investing on its head: fund managers are in effect paying more for the bonds than they expect to get back. But many investors took the view at the start of the year that yields would go even further into negative territory. With that conviction, it made sense to buy bonds on the basis that yields would fall further and prices would rise in response. “Part of the logic of holding bonds is because you need to match benchmarks and even though effectively you can have positive yield by not holding these bonds, what managers are worried about is yields becoming more negative – and missing out on the capital gains that will result from that,” said Owen Murfin, co-lead manager for global bond strategies at BlackRock. “If you aren’t holding these negative-yielding bonds, you are running a lot of risk in diverging from your benchmark.” Fund managers also have little option but to buy these negative-yielding securities. If your portfolio is European government bonds, you simply have to hold Bunds – irrespective of where they might be trading. To find bonds that have a positive yield, some managers might need a complete change of mandate. And even those with more freedom might not be comfortable buying unfamiliar and potentially risky credits. “There is a psychological barrier for many investors at 0%, but once you pass through that where do you draw the line? How negative you are willing to go is a difficult question,” said Steve Yeats, EMEA head of the beta fixed-income team at State Street Global Advisors. “If you decide you want to remain in positive-yield territory, then that may necessitate going a long way down the yield curve and taking some very uncomfortable risks.”Comfort zone Nonetheless, many managers have responded to the drop in yields by doing exactly that: moving outside their comfort zone, either by moving further along the maturity curve to longer-dated paper with bigger coupons; or by moving into riskier credits that also offer extra return. Sovereign investors might move away from eurozone debt and buy paper from Central Europe; corporate investors might buy lower-rated debt. Issuers have responded by selling more debt. A record US$3trn of investment-grade debt was issued in the first 10 months of the

Few equity capital markets bankers will look back fondly on 2016. For most, the year was a long, uncomfortable ride that saw markets lurch from one extreme to the other – a year of political upheaval in the UK and Brazil, of a collapse in the wider commodity complex, and of ebbing confidence in China’s growth model. Along the way, deal after deal was caught out; almost every team came out the year scarred in one way or another. To make matters worse, many also finished one of the most challenging years in ECM with little to show for it. Fees from equity underwriting at around US$14bn are down by about a third on 2015 – itself a poor starting point – and for the industry as a whole, the pie is the smallest it has been since 2003. For the many teams still getting back on their feet after the post-2008 slowdown, it’s been a major blow. The year started as it meant to go on. Most major indices shed 10% or more in the first two weeks of trading, as nervous investors – still struggling to figure out what the US Federal Reserve’s first rate rise in a decade meant for their holdings – were panicked by bad economic news out of China and a gradual devaluation in the renminbi. A commodity sell-off followed, with some indices 20% down by mid-February. That marked the low point for most equity markets, with many indices posting a strong recovery in the months that followed. But while secondary prices rallied, primary activity never really took off. The initial public offering market in particular struggled: both the number and volume of listings globally fell by about 40%. At about US$120bn, proceeds from IPOs are the lowest since 2008.Volatility Bankers say that regular bouts of volatility were to blame. Each time markets – and sentiment – recovered from one knock, another blow would hit. The IPO market, with deals often taking many weeks of planning and pre-marketing and often restricted in timing to just after earnings updates, was perhaps most exposed to the regular bouts of volatility. Most major equity indices had five substantive sell-offs through the year. “IPOs take time to get done and any spike in volatility can depress activity for quite some time,” said Sam Kendall, global ECM head at UBS. “A series of knocks – the China worries, the sell-off in commodities, political uncertainty in Brazil, and the Brexit vote – pushed deals further and further into the distance. Unsurprisingly, companies were not keen on selling in these conditions and, likewise, investors were cautious.” But even those deals that managed to launch in windows between volatility hit resistance – especially in the second half of the year. The investor universe, which had been steadily pushing up equity valuations to multi-year highs, suddenly seemed to balk at the price of some of the listings on offer. Whether it was because of rising rate expectations, rising bond yields, or other factors is not straightforward. “It is clear that the market turned more price-sensitive after the summer and that price ranges needed to reflect that sensitivity,” said Richard Cormack, co-head of ECM for the Europe, Middle East and Africa region at Goldman Sachs. “It is also true that the burden of proof on issuers around their outlook and guidance became more acute.” UK waste management company Biffa was one of those caught out. It was forced to relaunch its IPO, cutting the price by a third from the previous top of the range after investors pushed back on the valuation. Others, including Spanish telecom towers operator Telxius and British banking software firm Misys pulled deals entirely. Even those that met price targets such as Danish digital payments company Nets saw little support in secondary markets.Asia proves immune Not all regions were hit as badly. Asia held up relatively well, helped by listings out of China. Chinese companies accounted for seven of the 15 biggest IPOs globally during the year, including the year’s biggest – the HK$57.6bn (US$7.43bn) listing in Septem

China completed its takeover of the Asian capital markets in 2016 – at least in terms of numbers. Combining debt and equity in all currencies, nine of the region’s top 10 underwriters are Chinese. Where four global banks ranked among the top 10 in 2015, only HSBC – arguably the most Chinese of the global banks – managed that in 2016, ranking ninth on the Thomson Reuters league table. The step change in 2016 has come from the growth in outbound investment from China, sluggish deal flow elsewhere in Asia and the continued growth of China’s local capital markets. “The rise of the Chinese banks is a trend that has been discussed for quite a number of years, although I think that there is a marked difference this year compared with the last,” said Alan Roch, head of Asia debt syndicate at Australia & New Zealand Banking Group. “Most of the pipeline in Asia has been overwhelmingly in China in the past year, which plays into the strengths of the Chinese banks because of their relationships in the mainland. I think this is a trend that is likely to continue.” Samson Lee, head of debt capital markets at Bank of China International, argues local arrangers have benefited as their onshore clients have expanded. “I think it’s primarily due to a change in the market landscape. In the last few years, the amount of international DCM business from China as a proportion of overall Asia revenue has grown significantly,” he said. “At the same time, whereas previously most of the issuers were central SOEs, which may have favoured the foreign banks, we’ve seen more private corporate and domestic SOEs lately coming to market.”Rethinking ECM In equity underwriting, mainland brokerages Haitong Securities, China Securities and Guotai Junan Securities now rank among the top 10, displacing bulge-bracket banks such as Goldman Sachs and UBS. “A lot of our peers were previously concerned about the Chinese banks establishing a foothold in the debt capital markets but what we’ve actually seen is more Chinese brokers entering the equity market as a result of business in Hong Kong,” said an ECM banker at a major international bank. Whereas, previously, global investment banks benefited from a steady stream of listings from some of China’s major state-owned enterprises, the number of new offerings from this sector has gradually started to dry up, and the ones that do look overseas are now looking to reward mainland relationship banks with IPO roles. This trend has coincided with a steady decline in the role played by global institutional investors in the Hong Kong capital markets with the influence of friends and family corporate investors from the mainland rising “The problem lately for the western banks is that the foreign institutional investors have lost interest in the Hong Kong IPO market,” said Henry Shi, head of corporate finance at Haitong International, currently the top arranger of Hong Kong IPOs in 2016. “The reason the Chinese banks are top of the league tables is their connection to investors, particularly the Chinese corporates.” “Most of the Chinese banks, including Haitong International, also provide financial support to the subscribers for an IPO. Some of the western banks do provide this also but it’s usually from their private banking arm rather than their investment banking division.” The importance of mainland relationships has also inflated the number of bookrunners on recent deals. For instance, Postal Savings Bank of China appointed 26 bookrunners for its US$7.4bn IPO in September, even though it sold 77% of the shares to six cornerstone investors. “Bookrunner roles perhaps don’t mean as much as they used to,” said an ECM banker. “It’s obviously great for league table roles but it’s usually only the joint global coordinators and sponsors that get paid on any deal.”DCM down A similar trend is playing out in the debt capital markets, where Asian issuers traditionally needed to appeal to US and European fund managers in order to sell in

Banks are under pressure to improve the consistency and transparency around their so-called corporate centres due to concerns that the units have become “black boxes” that are used to make other divisions appear better than they are. Eleven major banks lost more than US$60bn in aggregate in their corporate centres over the past four years, according to IFR calculations. Such losses are not a surprise given that many of the units carry big central costs and bring in little revenue, but investors and analysts said there is concern about the wide variance in what corporate centres include and the opaqueness of some. The biggest worry is that corporate centres can mask the true performances of business divisions when bank bosses are supposed to be making hard-nosed strategic decisions on which businesses to keep and which to get rid of. “It can create a smokescreen around the reality, deliberately or not,” said Jeremy Sigee, an analyst at Barclays in London. “That can create a confused discussion and weakened scrutiny and accountability of divisional management. “The biggest danger is the wrong business decisions get taken, because companies delude themselves about the real profitability of some of their businesses.” “They [management] allow businesses to remain and grow, when the economic reality is some areas are not clearing their cost of capital and they should be shrinking and restructuring, not growing or ‘business as usual’.”Big losses The use of corporate centres is common among big, complex banks. They handle functions used across a bank, such as treasury, capital management, foreign exchange and other hedging functions. They are also used for shared resources such as real estate, human resources, technology, legal, compliance, finance and risk management. JP Morgan employed 31,572 people in its corporate centre at the end of September, which is 13% of its headcount and 11,000 more than at the start of 2013. UBS has 24,059 corporate centre staff, or 40% of its employees. Others use them sparingly, or not at all. Goldman Sachs and Morgan Stanley do not operate with them and allocate all costs and equity to their business divisions. The 11 banks with a corporate centre assessed by IFR lost US$52bn from 2013 to 2015 and another US$9bn in the first nine months of 2016, according to their published results. (see chart) Those losses included some lumpy costs. JP Morgan’s corporate centre booked US$10bn in legal costs in 2013 and BNP Paribas took a €6bn charge in 2014 related to its settlement with US authorities. Citigroup had US$4.4bn of corporate centre legal charges in the same year. Swings in the carrying value of banks’ own debt can be significant items in the central centre, as can complex accounting issues, often related to tax. Of course, there can be big one-off revenues too. This year European banks booked substantial income in corporate centres from the sale of their stakes in credit card company Visa Europe, for example. Banks’ results show costs are far more common than income, however, and often include goodwill charges on past bad acquisitions, or restructuring expenses. HSBC reports its central costs in “other”, which made a pretax loss of US$3.5bn in the third quarter of 2016 alone. That included movements in the value of its own credit and restructuring costs. In recent years HSBC has reported an annual loss of just over US$2bn in “other”. Santander’s corporate centre incurs the cost of hedging the capital adequacy of its overseas subsidiaries and with the gap between high interest rates in Brazil and low euro rates that annual cost has been substantial. Santander was also criticised for booking charges relating to mis-selling payment protection insurance in its British business through its corporate centre, but the bank said legally all the PPI charges were booked through the UK business and were fully in the UK unit’s accounts. It said the losses were included in the corporate centre because they covered his

It’s commonly acknowledged that 2016 has been a difficult year both for traders and investors. Volatility, the life-blood of performance, has been sporadic and very much a case of feast or famine. The current year always feels much tougher than the last so no doubt we will find ourselves looking back at 2016 and agreeing that it wasn’t all that bad after all. Volatility is a little bit like a car with two steering wheels. The first one comes from the very nature of the fear and greed factors, but the second is the matter of liquidity which is, in itself, a function of the depth of markets. Many of the questions surrounding the “flash crash” in sterling in early October were framed in terms of what happens when traders hit a thin market hard. In terms of volatility things might be in the process of becoming fundamentally worse. One of the most significant but underreported events of 2016 was the merger of the two asset managers Henderson and Janus in an all-share deal. This was not an aggressive expansion by the one or the other but a defensive move by two active asset managers who see their business being eroded by passive funds. The rise and rise of the passive fund is, by the by, yet another result of the low interest rate environment.Back to brass tacks I reflected recently on the problem facing hedge funds. If one is leveraging 6% rates three times, one returns 18%. One can take fees of “2 and 20” out of that and still give the punter a generous return. If one is leveraging rates of 0.5% three times, one gets just 1.5%. I know this is a gross oversimplification but when one strips out all the beta-disguised-as-alpha and go back to brass tacks that’s broadly all that’s left of the hedge fund model. The simple truth is that long-only active managers are also being squeezed by the low return environment because a normal fee structure struggles to be supported by the underlying returns. Passive funds can theoretically be managed by computers with no mortgages, no school fees and no dreams of owning a Porsche. Not surprisingly, they are much cheaper to run and, where fees chew up such a large proportion of the return, it’s no surprise that they look so attractive to end-users. Subsequently, the passives are growing like Topsy while the actives are struggling to hang on. The result is the merger of Henderson and Janus in a drive towards greater efficiency – or, in plain English, cost savings.Feel the fees While we have all spent a large part of this year contemplating the issues surrounding Deutsche Bank and the “too big to fail” phenomenon, we are at the same time watching a similar situation – or problem, if you prefer – developing within the asset management space. Never mind plurality, feel the fee structure. If there is one thing the internet has brought with it, it is the belief that information and knowledge (or wisdom, if you prefer) are the same thing and that they are a free gift. As the old chestnut has it, knowledge is to know that a tomato is a fruit but wisdom tells us not to put it in a fruit salad. No actively managed fund can outperform quarter after quarter, year after year (unless of course it is managed by Bernie Madoff). But why, for heaven’s sake do clients expect this to happen or, more to the point, why are they so scared of it not happening?Rapid growth It has been suggested that about a fifth of assets are managed in passive vehicles but that the proportion is growing rapidly. A passive fund does nothing other than buy the aggregate of all active managers’ trades and positions. Now imagine there was only one active investor in the world and all other managers would have to follow his or her moves because he or she would be the only one who could move relative pricing. One CIO wrote to me on the subject: “I have long held the view that the rise of passive funds will see us sleep walk into dysfunctional markets where the last active manager standing ends up making investment decisions for the whole world

Global mergers and acquisitions activity fell in 2016 from the previous year’s record, but there was one pocket of extraordinary growth – the record volume of cross-border acquisitions by Chinese companies across Europe and the US. Chinese companies have been busy buying Western assets over the last three years, diversifying overseas to combat a slowdown in their domestic economy. But this trend accelerated dramatically in February 2016 when China National Chemical Corp, or ChemChina, launched a US$46.6bn bid for Swiss pesticides group Syngenta, the biggest outbound acquisition on record. This deal helped propel foreign acquisitions by Chinese companies to a record US$195bn for the year to November 7, eclipsing the US$107bn of deals signed in the whole of 2015, according to Thomson Reuters’ numbers. Chinese companies are now a significant force in global deal-making and Chinese M&A accounted for 20% of announced global deal activity in 2016, its highest on record and double the proportion three years ago. The bulk of the action is taking place in Europe, where Chinese companies announced deals with a combined value of US$75bn, compared with US$26bn last year. In North America, the value of China-backed M&A sky-rocketed to US$57bn from just US$8bn in 2015. Chinese buyers, whether state-owned enterprises or privately-owned companies, have the financing and advisory expertise in place to execute multiple deals in quick succession and many sellers look east as a matter of course when trying unload assets. For example, Blackstone Group has sold three businesses to Chinese buyers in the space of two months, including the sale in October of a 25% stake in hotel group Hilton Worldwide Holdings to Chen Feng’s HNA Group for US$6.5bn. “Chinese companies have gone from left-field buyers of assets to prolific serial acquirers in a relatively short space of time,” said Rob Pulford, head of financial sponsors coverage for Europe, the Middle East and Africa at Goldman Sachs in London.Cutting red tape The impetus for this M&A boom began three years ago when China launched its Made in China 2025 initiative, which aims to pivot China away from being a low-cost manufacturing hub and reduce its reliance on foreign imports of technology. Then, the government’s 13th and most recent five-year plan strengthened this resolve by highlighting 10 sectors where China wants to develop world-class expertise – from robotics, to financial services and telecoms. At the same time, the government has created a more conducive climate by softening regulations on outbound M&A to cut red tape and ease execution. This commitment has unleashed a wave of activity but also helped to shift the perception away from Chinese buyers as unreliable bidders who are unable to deliver after showing an initial interest in auctions. Now, bankers tasked with selling assets for Western corporates or private equity firms visit China regularly and consistently find motivated buyers ready to do deals. “Chinese buyers tend to have local bank funding in place and while they are keen to use banks for advice on deals, we rarely receive requests for financing,” said Pulford. This flow of easy money is reminiscent of the M&A acquisition spree led by Middle Eastern sovereign wealth funds in the run-up to the financial crisis, but bankers believe the sheer amount of firepower at the disposal of Chinese companies and the long-term commitment to re-balancing the Chinese economy make this M&A boom more sustainable. “There is a ‘China premium’ and they can pay to win because they are taking a long-term view,” said Pulford. In the past, Chinese buyers either avoided using banks for advice or balked at paying fees but now they are keen to have Western banks on their side as a sign of their commitment. So much so that in one recent auction a Chinese bidder said it would pay a Western bank a fee purely so it could name it as its adviser, one M&A banker said. Chinese companies

Politicians, bank regulators, supervisors and central bankers the world over have spent close to 10 years trying to eradicate the root causes of the 2007–08 global financial crisis. Bank leaders have spent the same period trying to modify and mould the structures and profiles of their institutions to meet the requirements and obligations of what has become a veritable regulatory onslaught. But has the regulatory tsunami started to lose its most potent force, as unintended consequences are finally acknowledged, and as populist tendencies to exact retribution for banks’ role in the financial crisis fade over time? Donald Trump’s victory in the US presidential election and his espousal of light-touch regulation certainly set the cat among the pigeons and has led to intense speculation about what “light-touch” might mean for US banks; and for US engagement with global policymaking at the Basel Committee on Banking Supervision, the Financial Stability Board and indeed the G20. It has also led to concern in Europe around what any moves to lighten the burden on already stronger US banks in an openly competitive deregulatory process might mean for the international competitive landscape. With Dodd-Frank and the Volcker Rule back under the spotlight, the prospect of regulatory dissociation between the US and the rest of the world is casting a long shadow over regulatory developments elsewhere. “We’re in an extremely tight regulatory era [in Europe] at a time when the economic backdrop is far from supportive and other jurisdictions are about to ease their constraints. This won’t be conducive for Europe and it isn’t competitive on a global basis,” said a credit portfolio manager at a major buyside firm.Reversing course Even before Trump’s shock election there were signs that the regulatory onslaught is losing force – and even at times reversing course. In its broad package of proposed reforms to strengthen the resilience of EU banks unveiled on November 23 (but prepared before the US election), the European Commission was at pains to stress two aims: addressing outstanding challenges to financial stability at the same time as ensuring banks continue supporting the real economy. For many of the intervening years since the financial crisis, those aims had seemed to have been treated separately as monetary and regulatory bodies took separate paths in mutual ignorance of each other’s actions and outcomes. “The likelihood that banks will do a proper job, give a decent return to shareholders and continue to finance the economy will depend mainly on the skills of regulators,” said a senior executive at a European bank who is actively engaged in conversations with senior national and European regulators. “Banks will be forced to adapt but the economy might suffer. Regulators need to know what they want; I’m not sure they do. “If you ask regulators what their mission is, they’ll tell you they’re in charge of making the system safer. Fine, but in that case who’s in charge of making sure the economy is financed?,” he asked. “It will be down to private-sector banks. The EU wants to shift the financing of the European economy to the US model. Again, fine. But that will take 15 years.”Linear correlation The realisation that there is a linear correlation between regulation and the transmission of money into the economy seems to have been a relatively recent phenomenon. Optically, it may always have been part of the narrative but it is now starting to seep into the fabric of the regulatory discourse and is increasingly manifesting itself through a dial back from the most extreme levels of regulatory burden. “Europe needs a strong and diverse banking sector to finance the economy. We need bank lending for companies to invest, remain competitive and sell into bigger markets and for households to plan ahead,” acknowledged Valdis Dombrovskis, European Commission vice-president for financial stability, financial services and capital markets union, at the unv