Sophie Roell discovers how the heads of global equities at four investment banks are adjusting to a world of falling commissions, the pressure for greater risk taking and mushrooming technology costs.
For the equities business, 2005 was not a bad year. Recently the poor relation of booming fixed income, commodities and real estate businesses, it put in a decent showing, helping to drive revenue growth at several of the large investment banks.
But some are starting to question the overall direction of the cash equities business: towards an unpalatable cocktail of lower commissions and greater risk-taking. Goldman Sachs’ value-at-risk (the amount it could potentially lose in a single day) in equities rose to $34m in 2005. Despite the bank’s reputation for aggressive proprietary trading, it is no secret that everyone is feeling the pressure to risk more of their own money. If it is not to run a proprietary trading or principal investment, then it is because clients are demanding it. And all this comes when the technology spend required to remain a cutting-edge player is running into hundreds of millions of dollars a year.
Even following round after round of lay-offs, some equities sales and traders do not see much future for themselves in the business. “I don’t think my job is even going to be around in a few years,” says one. “Everything will be done by a computer. Maybe I’ll open an art gallery.”
Others disagree, saying that the role of equity sales and traders is not disappearing but changing. But how?
In an era of fundamental change in the business, The Banker asked the heads of global equities at four investment banks to identify what they think are the most important trends and what they are doing to stay ahead. Their answers differ radically. That is no surprise, however – banks are developing different models to cope in this brave new world and, to quote Dan Coleman, UBS’s head of global equities: “To some extent over the long run, we may not be competing with each other that much.”
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UBS Dan Coleman co-head of global equities |
Of the companies that have stood by the traditional, client-friendly brokerage model, few offer a better example than UBS. With a huge global footprint, the bank’s business model is predicated on size and the advantages that delivers. “We try to have a scale business throughout the world,” says UBS co-head of global equities Dan Coleman. “And try to be a top three player in all major markets and try to provide value for our clients in that scale.” He emphasises the bank’s successes. “We trade more stocks than any other firm, we’re the number one trader of stocks in the US, we’re the number one trader of stocks globally and, to the extent that we can bring order flow together, we think we can provide better execution, on average, in the long run, for our clients.”
An integral part of the client service is research. Again, Mr Coleman says scale or, in this context, coverage is vital. “Anyone can put together a research department in a region with a few good analysts, but getting that information across the globe efficiently and effectively to our clients, I think that scale is hard to match.”
The question on everyone’s lips is how profitable can it be in the long term? “I know if there’s a significant margin compression, no-one in our business is going to be really happy about it, and it’s something we’re always concerned about,” Mr Coleman says.
Volume helps. “From an efficiency point of view, from an operational point of view, of processing that order flow, scale is going to matter a great deal to being profitable.”
Mr Coleman singles out the unbundling of research and execution services as an important trend that UBS has been “working towards for the last few years”. Speaking about the rules on unbundling issued by the UK’s Financial Services Authority, he says: “It’s an interesting experiment where we will finally see with some clarity, at least in Europe, what our clients think they should pay for research, separately from execution.
“And it’s something that, from a competitive point of view, we welcome in UBS because we’re extremely strong in both products. You have to be. You can’t be competitive in one and kind of OK in the other, and try and get the full commission anymore.”
UBS clearly believes it can and will be able to continue to get full commission for its services. However much things have changed in equities, in some fundamental ways it believes the business will remain the same.
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Goldman Sachs Jana Hale Managing director, global equities |
Goldman Sachs has a very different approach. Early on, it took a view on the direction that margins in equities brokerage were going (down) and decided that the future lay in automation. Jana Hale, managing director at Goldman Sachs, says: “I’ve seen a tremendous amount of change and if you were to have asked me six or seven years ago, do you believe all this change, I would have told you I was surprised. Now I can tell you I am even more shocked at how rapid the change has been in the equities market and how the market continues to evolve with speed and efficiency.” While other firms were indecisive about cannibalising their existing, higher margin, business, Goldman embraced the logic of electronic trading. It made a number of acquisitions – most importantly that of New York Stock Exchange specialist firm Spear, Leeds & Kellogg in 2000, through which it acquired its REDIPlus trading platform – that mean it continues to be mentioned by analysts as a leader in the electronic execution field.
“Five years ago, we didn’t have an absolutely clear view of what the future would hold, although we expected change to occur,” says Ms Hale. “In response, as a firm we made investments in a number of different opportunities to make sure we would be well positioned to take advantage of certain likely outcomes.”
Goldman now provides every kind of electronic option to its clients, from direct market access (DMA) (routing orders to the best liquidity pool) to program and algorithmic trading, the product that Ms Hale is responsible for rolling out.
She expects the trend towards automation in the equities business to continue. Altogether, electronic execution (encompassing program trading, DMA and algorithms) now accounts for about 65% of all flows. Ms Hale predicts that by 2007, this percentage will be 70%-75%.
In the process, the role of equities staff has changed beyond recognition. “The average sales person has transformed into an ‘execution consultant’,” says Ms Hale. Internal training has been key. “We have to make sure that our professionals are well versed in the entire suite of equity-based products we offer, and they can go to each individual client, understand their needs and then bring the right set, or combination of that tool kit, to those flows,” she says.
That Goldman’s own traders use algorithms also helps to finesse the product, she says. “Having our traders use our algorithms before rolling them out to clients adds an element of quality. You can back-check your algorithms all you want, but adding the little subtle changes that a real practitioner can provide with their feedback I think does enhance our performance – and the overall user functionality and feel – once we’ve rolled out our algorithms.” Although it is a US-led trend, electronic execution is spreading rapidly. In August, Goldman launched its REDIPlus product in Tokyo and Ms Hale says Europe was the largest and fastest growing part of the firm’s electronic trading business last year. “We anticipate that we will see a similar experience in Asia,” she says.
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Credit Suisse Tony Ehinger co-head of equities |
Goldman by no means holds all the cards on the electronic trading front. Credit Suisse’s AES system has been cited as the industry standard when it comes to more complex algorithmic trading. “We’re definitely one of the leaders,” says Tony Ehinger, co-head of equities at Credit Suisse. “But we don’t feel any great comfort in that because it’s extremely competitive and everyone’s investing, cutting prices, you name it.” These are days when execution is key, and electronic trading is a vital part of that. “You have to be absolutely cutting edge on best execution and you have to do it globally, you have do it with a high level of risk tolerance and there are not many firms out there that have the entire portfolio of execution products,” Mr Ehinger says.
“You must have an electronic trading capability and you must be distinctive, and being a first mover is a significant competitive advantage. Frankly, there are not many people in the frame who are doing it very well right now.
“But they’re coming, everyone needs to get it right. It’s an important function, it’s a big investment spend, you still have to be hugely innovative and just because you have a lead right now, no one can rest easy.”
One theme that Mr Ehinger singles out above all others is client segmentation. “Everyone is getting squeezed in a hypercompetitive world and therefore we need to be more deliberate, more careful, more focused,” he says.
“Ultimately, it may well end up with the number of clients you focus on for high touch getting smaller and smaller and the remaining client base getting a lower touch service, where you have a more scaleable approach so that you can provide the service profitably.”
By definition, that means taking bets on clients. “You’re forced to think in a forward-looking way of who the winners and losers are going to be. You have to anticipate [and then plan] who you’re going to partner with and where you’re going to focus those precious resources.”
It is no secret which clients are in vogue these days: hedge fund-driven prime brokerage mandates that have traditionally been monopolised by Goldman Sachs and Morgan Stanley and viewed as a kind of holy grail by heads of equity across Wall Street. According to Mr Ehinger, prime brokerage has become one of Credit Suisse’s fastest growing equity businesses. “We’ve separated from the pack,” he says, citing two prime brokerage mandates that the bank was awarded in 2005.
If the current strategy means that Credit Suisse has a smaller footprint than some of the scale players, Mr Ehinger sees that as a good thing. “You need to be nimble, you need to be innovative, you need to have a footprint that’s appropriate for the uncertainty in the equities business,” he says.
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Merrill Lynch Rohit D’Souza Head of global equity markets |
At Merrill Lynch, head of global equity markets Rohit D’Souza argues that it is impossible to pinpoint any one theme as key to the equities business right now because there is too much going on. “We have such a variety of different businesses and it’s a global market place. In the US, the move to electronic markets due to regulatory changes and client demand is happening so rapidly that the business environment is changing seemingly daily… but in Asia it’s very different.
“It’s a growth cycle there, you’re seeing China and India pick up. The types of things you need to do there, the kinds of services you need to provide there are inherently very different.”
The bank recently upped its stake in its Indian venture, DSP Merrill Lynch, from 40% to full ownership. “Clearly we plan to have an outsized focus on the emerging economies that we think are going to be big growth stories in the long term,” he says.
Merrill, like UBS, adheres to the scale model of brokerage. Like the Swiss bank, it is a premier player in the cash business – ranked number one in trading of US-listed stocks in 2005 (with 12% market share) and number three on Nasdaq.
“Cash equities has been the core of our global equity business and we intend to invest in technology and people to keep our lead there,” Mr D’Souza says.
In the electronic trading arena, the bank has made advances and it can now boast a full suite of offerings – including algorithmic product across the globe. “It’s a big push for us in the equities business to make sure that customers know that and can leverage the electronic product segment at Merrill Lynch,” Mr D’Souza says.
It is all part of a major revamping of the cash equities business. “We’ve created a tremendous amount of change in that business over the last two years,” Mr D’Souza says. Automation has freed up staff to focus on more complex tasks: traders can “focus on difficult and value-added situations in all cases, rather than simple processing”, he says. Those in research sales, meanwhile, “can really focus on idea generation”.
The bank is also looking elsewhere for growth. Equity derivatives is an important area in which Merrill is putting “a tremendous amount of emphasis going forward”, Mr D’Souza says. “We think there’s going to be a lot of growth there, both in Europe and in Asia, as well as some segments of the Americas.”
Prime brokerage is also key. “We’ve invested significantly and have already seen big gains in our market share over the last couple of years,” he says. “We will continue to invest in the business.”
Like other banks, Merrill is feeling the pressure from clients to put its own capital at risk. “As exchanges evolve and clients absorb Securities and Exchange Commission and other regulatory changes, there could be an increase in block trading,” Mr D’Souza predicts. “Regardless, clients want Merrill Lynch to commit capital, so making sure that we have the best capital commitment capabilities is something we continuously focus on,” he says.
Also, like most others, Merrill is preparing for a world where equities no longer exist in isolation. “Money managers are getting more and more complex in the way they look at the world and we need to be able to adjust our own solutions to be able to create product for them,” he says.
“So we’re working a lot more across products than before, our sales structures are connected across debt and equity a lot more than they have been before – and that’s how we’re attacking the marketplace.”
