BREAKINGVIEWS-UBS needs a refurb as well as a carve-up
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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
By Dominic Elliott
LONDON, Dec 12 (Reuters Breakingviews) - UBS (UBSN.VX) thrilled investors with its plan to de-risk investment banking by cutting fixed income to focus on equities and advisory. The mega-boutique that is left could potentially resemble a jumbo Evercore Partners. The snag is that this rump will need a lot of love to be a destination employer again.
After a 20 percent rise in UBS's shares since the plan leaked in late October, most investors won't fret if the investment bank misfires in the short term. They will put their faith in chairman Axel Weber, who says his tenure at the Bundesbank showed him how redrawn financial rules will affect investment banks. And, most importantly, UBS has first-mover advantage in executing its radical reshaping. That will be especially helpful in selling down now non-core credit positions.
On paper, the new strategy makes intuitive sense. UBS is exiting the riskier elements of the fixed-income business to focus on traditional strengths. Its mix will be more like that of a boutique bank – a model that has performed well in the downturn. Revenue at Greenhill (GHL.N) and Lazard (LAZ.N) were down far less than the drop in global M&A volumes as of Sep. 30; at Evercore (EVR.N), the acquisition of Lexicon Partners boosted revenue by a third in the first nine months.
Yet these firms are still much smaller than UBS. Evercore’s make-up is most similar to “new UBS” but it's hardly an apples-to-apples comparison: investment banking revenue last year was 20 times less than at UBS overall. Moreover, the boutique's equities business is two-and-half years old and tiny. Compare that with an equities business at UBS that will account for 51 percent of investment banking revenue in 2015, according to research by Espirito Santo Investment Bank.
Making the boutique model work on a grand scale will depend largely on UBS’s ability to retain clients now at greater risk than ever of defecting. Sniping rivals will argue that UBS can no longer provide “full-service” investment banking. At present, it looks tough for UBS to counter that. After all, outside equities, it will offer trading only in the most liquid or short-dated rates and credit instruments. But with a long-lead time to wind down fixed income, Weber and chief executive Sergio Ermotti have some wiggle-room should they wish to fine-tune. They may need it.
At least UBS's relationships with one set of clients should be relatively unaffected. Asset managers and hedge funds tend to apportion trading business on the basis of “best execution” – the lowest-cost desk. They will go elsewhere to structure exotic instruments but that won’t stop them returning to UBS for equities or foreign exchange if the Swiss bank can still offer the tightest spreads. For European corporate clients starved of loan finance, it's a different story. UBS will probably struggle to win debt capital markets business given its lesser secondary trading business. The lower fees offered by the balance-sheet driven commercial lending giants will be more appealing.
But UBS has a mountain to climb. Management called the revamp a "strategic acceleration from a position of strength". While, that’s true of the wealth management side, the investment bank has – understandably - drifted in recent years. The once world-leading equities franchise is now ranked fifth or sixth by market share, according to analysts. UBS could also do with a leg-up in equity capital markets, where it is seventh for the year to date in Europe and eighth globally by deal proceeds, according to Thomson Reuters data. And in mergers and acquisitions, it's ninth globally and outside the top 10 in Europe.
Hence a significant outlay will be needed for the core businesses to thrive. UBS has to be prepared to pay up in order to lure star dealmakers and retool the technology needed to power its lower-margin, higher-volume trading businesses. But with only 1.5 billion Swiss francs earmarked for group investment over the next three years, that won't be easy; particularly given UBS has been one of the stingiest payers among investment banks for the last four years. Deciding what to chuck out was the easy bit for UBS. But what’s left will need a refurb too – and shareholders should be ready to pay for it.
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- Alex Weber, UBS's chairman, said in an interview with German magazine Der Spiegel on Dec. 3 that his experience as a regulator had helped him to construct a plan for the Swiss group's investment bank that was announced six weeks ago. Weber said under the plan UBS would fulfil its capital requirements earlier than rival banks, whose finances would be like those of the "northern German lowlands relative to the Swiss Alps".
- UBS announced on Oct. 30 a plan to split its investment bank into a core unit and non-core unit, which it plans to wind down over several years. UBS is exiting some fixed income businesses to concentrate on advisory, research, equities, foreign exchange and precious metals. The businesses that the Swiss bank has left or is leaving include structured credit and rates, sovereign, supranational and agency debt underwriting, correlation trading, and most long-dated or complex derivatives.
Carsten aside [ID:nL3E8LU39Q]
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Banking mythology [ID:nL3E8M5384] - For previous columns by the author, Reuters customers can click on [ELLIOTT/]
(Editing by Chris Hughes and David Evans)
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