UBS is the first bulge bracket investment bank to make drastic strategic changes since the financial crisis, but few would bet on it being the last. Other banks, notably European rivals Deutsche Bank and Barclays, are breathing a sigh of relief at the retreat of a competitor in a number of markets, but sources say they are also watching closely to see if UBSs gamble pays off.
The Zurich-based bank said on October 30 that it was largely withdrawing from fixed income trading, reducing its funded balance sheet by Sfr300 billion ($319 billion) or a third over three years, and cutting headcount across the group by 10,000 or 16 percent of the total. Some 2,000 front office investment bankers will be axed. Its a bold step.
There has to be an element of doubt about whether you can run a successful investment banking division and equities business without fixed income, but strategically it makes sense to allocate capital to the strongest parts of the bank such as wealth management, says Andrew Stimpson, banks analyst at Keefe, Bruyette & Woods in London. This is a doubt shared by former group CEO Oswald Grubel, who told Institutional Investor in an interview in February 2011, you cannot run a global bank without something as basic as fixed income trading.
The reasons cited by CEO Sergio Ermotti for the shift in strategy, however, could apply to a number of the leading banks. In a conference call with analysts on October 30, Ermotti said that many areas of fixed income have been made uneconomic by changes in regulation and in the markets.
Higher capital requirements now makes capital-intensive fixed income business less attractive. UBS faces particular challenges as a Swiss bank since it is required by regulators to reach a core tier 1 capital ratio of 10 percent by 2019, higher than Basel IIIs 7 percent. And UBS has not been able to break into the top 5 in global fixed income trading. Reports compiled privately for the big banks by Coalition Index show that JP Morgan Chase, Deutsche Bank and Barclays are the pre-eminent players in that market. Its such a capital intensive business that you need to be in the top five to make it worthwhile, says Frank Braden, banks analyst at S&P Capital IQ in London. A UBS investor said, There was a scale problem. With only $2.5 billion of revenues in the third quarter of 2012, UBSs investment bank is much smaller than most of its peers who typically generate over $4 billion each quarter. Fixed income, currencies and commodities typically account for half of UBSs investment, but the Swiss group said it would stay in the currencies markets as well as in certain areas of fixed income closely related to its debt capital markets business, without giving full details. This retreat will allow the bank to cut risk-weighted assets in the investment by SFr 100 billion, some Sfr 60 billion more than previously announced, down to Sfr 70 billion over the next five years.
UBSs ambition to deliver higher returns to its shareholders meant it had to take radical action to jettison less profitable businesses. Return on equity in UBSs investment bank in the year to September 30 was 9 percent, well below the cost of capital of around 12 percent, and well below the level achieved in the happier days before 2008 when it regularly managed over 15 percent. Ermotti told analysts he wanted the investment bank to achieve ROE of at least 15 percent by 2014.
Some senior rival investment bankers doubt that UBS can make a success of a firm shorn of a core product. Most clients are multi-product users and some might choose to move to a genuine universal bank. This is fraught with execution risk, and its great news for the rest of the industry, says one wryly.
One the other hand, if it is a success, other big banks with relatively weak units might be tempted to emulate UBS, or Royal Bank of Scotlands investment banking business which exited its equities business piecemeal in the first quarter of this year. Citigroup, for instance, as new CEO Mike Corbat will note, has a comparatively small equities business that produced only about a fifth of the $3.7 billion generated by fixed income, currencies and commodities.