Calls to separate UBS’s private and investment banking divisions have resulted in a heated debate among defenders and opponents alike. Silvia Pavoni reports.
The ‘one bank’ model, bringing investment and private banking under one roof, has recently been challenged by poor investment banking performance.
UBS is the prime example. The Swiss bank and world’s leading wealth manager, which is undergoing a US tax investigation, has suffered $38bn losses since the subprime crisis began – the highest figure for a European bank. This has unnerved both clients and shareholders, and some have been more vocal than others. Private equity group Olivant, led by former UBS president Luqman Arnold, has called for a split between the wealth management and investment banking operations.
UBS is defending its business model and has organised a strategy review, the results of which will be made public in October. In the meantime, besides the investment division write-downs, uncertainty about the bank’s fate is hitting its private business hard, with both employees and clients leaving.
So, are UBS and its private banking rivals right to defend the one bank model, and what are its real benefits?
Sense of tradition
Since the mid-1700s, when the first private banks were created in St Gallen and Geneva as partnerships, the business of looking after wealthy individuals’ interests has evolved. A few banks are still in the hands of the original families, such as Hottinger and Mirabaud, which in Switzerland are called private bankers – a protected term – to distinguish them from the other private banks, which are more typical corporations. Independent private banks tend to be run on a family-style basis: joining them as a client gives access to the banker’s investment and private circle. There is a profound sense of tradition, trust and secrecy, and decisions are taken quickly.
Private banking has expanded to both the mass market, where high street banks sell investment products to their affluent clients, and the investment banking sphere, where the very high-end clients demand services and investment opportunities that until a few years ago were only accessible to institutional investors.
Investment banks are packed with smart traders, creative product structurers and insightful analysts, producing research any client would benefit from. The investment banking culture is based on incentives and risk-taking, while private banking is founded on trust, empathy and protection against risk. The one bank model does not present a cultural match, say some observers.
Furthermore, structured products can be bought from any provider, for very similar fees, whether the buyer is internal or external. So having them in-house is not essential – or at least that is how the independent private banks make their case.
“The reason why the independent private banks’ model is liked is because of the way they approach their value proposition: ‘we have our own money at stake’,” says Juerg Zeltner, head of wealth management in northern, eastern and central Europe for UBS. “However, I think that a firm that is part of the capital markets is an even more attractive partner because the conditions under which it has to serve its clientele have clear standards and practices, and report regularly to the public. Everything is open and transparent.”
Furthermore, most independent banks do not have a custodian network so they need to bring that business to another bank: cash pooling, tax reporting and reporting of wealth across all asset classes are activities that require a lot of technology investments and regulation.
“The bigger the client, the more he wants to have access to a global reach firm”, says Mr Zeltner, “but this doesn’t mean that he would not use an independent private bank too. That choice is more about a certain banking style.”
Competition benefits
In any case, competition between global and independent banks serves the clients well. Also, due to the standardisation of many investment products and the ability of wealth managers to shop for the best solutions on the market, the affluent clientele of private banks should not be affected at all by a split from the investment banking division – provided that the open architecture mantra is respected.
“If a private bank behaves as it should behave, being part of an investment banking group should make no difference,” says Mark Rushton, director of Fortis Private Banking. “But open architecture must mean genuine open architecture and not ‘guided’ architecture, which is a gentle way of excusing the use of an investment bank’s own products.”
If the independent private bank model offers clients a family-run style, speedy investment decisions and secrecy, while outsourcing all other services, global banks respond with something that only a diversified financial firm can offer: synergies.
Such synergies can be found in many business divisions – trading capabilities, for example, are important to planning and executing an investment strategy and are improved by deal flow, which tends to grow with the size of the investment bank. This is valuable to private banking clients, but the real synergies come from the capital markets.
Investable assets
High net worth individuals (HNWI) and ultra high net worth individuals (UHNWI), with more than $1m and $30m in investable assets respectively, have become increasingly exposed to investment banking and capital markets opportunities.
Nowadays, their behaviour is not considered far from that of institutional investors. The most evident synergies of the capital markets come from entrepreneurs, particularly when they intend to list their companies on the stock exchange.
“The main benefit of the one bank strategy is for the HNWIs, who want all services in one bank – both for their own wealth and, if they are entrepreneurs, for the wealth of their company,” says Sacha Holderegger, financial analyst with Clariden Leu.
Another particularly lucrative capital markets exposure for clients with deep pockets is provided by the initial public offerings’ (IPO) primary market. Before a company lists on a stock exchange, investors are given the opportunity to underwrite its shares. On the first day of trading, share prices usually go up significantly in value and the underwriter that sells its stock is very likely to make a healthy profit.
This market has traditionally been reserved for banks and institutional investors, but is now more and more often on the radar of private bankers. The portion allocated to individual clients is not significant enough to affect the investment banking division’s revenues but is big enough to give clients good returns.
“I think that clients and banks have generally benefited over the past 10 years from wealth management and investment banking being close together,” says Chris Meares, global CEO of HSBC Private Bank. “If you look at the IPOs in China, the private banks that were closely aligned with those that did the IPOs saw large inflows of net new money.”
Without a strong connection to the investment bank, the chances of accessing such opportunities for an independent private bank are more limited. “If the private bank is just an [external] client of the investment bank, you will only get a small portion of the whole allocation [of pre-IPO shares], or just nothing at all,” says Mr Holderegger.
Global coverage
Even if not affiliated to top-tier investment banks involved in headline-grabbing capital market deals, being part of a group with a wide geographical coverage helps too. This is particularly true in emerging markets, where legislation often requires investors to have a local presence. To get a local currency exposure, in, say, Hungary, a private bank will either have to go through an investment bank or will need to be physically present in the market. Again, in the case of a fund, this time in Brazil, three parts of a global bank would come together: the investment bank to get access to the local capital market, the asset management division to structure a basket of local investment opportunities, and the private bank to give international clients access to the fund.
In universal banks, the measure in which each side of the equation – investment banking and private banking – benefits from the relationship is interesting to consider. There is only a limited number of groups where one division does not overshadow the other. UBS is the only case where wealth and asset management provides half of the operating revenues of the whole group (see table, overleaf). The challenge for the banks is to get the two halves functioning together.
A solution is, of course, to set well-defined referral mechanisms that incentivise both sides to share clients and business opportunities. Credit Suisse offers a good example. The bank has developed a system called single global currency, which tracks and rewards referrals within the bank across divisions and geographies.
Set up a couple of years ago, it seems to have convinced even the more sceptical of bankers. Because the bonus pot that it distributes is separate from individual divisions, and the system is managed centrally, it does not affect traditional performance bonuses, which are assessed separately.
| According to Jeremy Marshall, CEO of Credit Suisse UK, referrals between divisions led to significant revenues with approximately 10% of global net new assets in 2007 driven by cross-divisional referrals. He expects the trend to continue. |
Others are more sceptical about these dynamics. Olivant has made clear that it believes the synergies between investment banking and private banking are overestimated.
Divided from its investment bank, UBS wealth management could either develop corporate advisory and capital markets capabilities in-house or consider partnering with a non-competitor.
“It is simple for a private bank to have joint client meetings with the [group’s] investment banking clients,” says Mr Holderegger. “But this just makes things easier. It can’t be the only reason to have an investment bank. This is something you can also do if you have a joint venture with a close partner.” In UBS’s case, Lazard, the bank’s current advisor, comes to mind as a possible candidate.
Despite such criticism, it seems clear that having private and investment banking under one roof can be useful, as long as both operations are run effectively. As one senior manager at a leading private bank says: “The real question is not whether you should have an investment bank. The real question is whether you are capable of running an investment bank.”
Knock-on effect
It is also clear that if one part of the business is doing particularly badly, the rest of the bank’s divisions suffer too. Reputation is important in any corporate activity and banking is no exception. The difference between investment and private banking is that in the latter, reputation is much more difficult to restore once lost.
“Building reputation back with private clients takes a long time,” says Mr Marshall. “With private clients there is an emotional element. If a client feels let down due to poor investment performance, that client may never come back.”
