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AmericasMay 2 2017

European investment banks take stronger foothold in the US

The US is the most important market for investment banks, a fact not lost on the European players ramping up their activity in the country. Jane Monahan looks at how these institutions are competing against their American counterparts.
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UBS Stamford

For the past three years the US's leading investment banks – JPMorgan Chase, Goldman Sachs, Bank of America Merrill Lynch, Citigroup and Morgan Stanley – have held the top five positions globally from investment banking, equities, and fixed income, currencies and commodities (FICC), based on revenue. However, European banks may be starting to encroach on their home turf.

In compiling its 2016 regional investment bank league tables, Coalition, a London-based analytics company that works with banks to track industry trends, examined different markets’ businesses in the US and found that France’s BNP Paribas grew the most in real terms year on year in FICC products, which is generally the biggest asset class of an investment bank’s trading book.

Similarly, in US equity markets, including derivatives and futures and options, another European bank, the Swiss-based UBS, was one of the banks that grew most, when compared with 2015 figures. And in US fee-related businesses, covering advisory for mergers and acquisitions, bond and equity capital markets, and syndicated loans, the UK’s Barclays (and, again, UBS) grew the most in 2016 when compared with 2016, according to Coalition.

A much-needed boost

For these European banks, which are still in the throes of massive restructuring programmes – slashing thousands of jobs and selling off non-core assets worldwide – these US results are like a shot in the arm.

Jes Staley, a seasoned ex-JPMorgan investment banker and chief executive of Barclays since 2015, highlighted the UK bank’s noteworthy 2016 results on February 23, saying: “According to Dealogic, we finished 2016 ranked fifth in the US in terms of fee share and third in the UK, up one spot in each from 2015. So, I would challenge the notion that only US banks gained share in investment banking in 2016.” 

However, not all European investment banks were winners in the Americas. Germany's Deutsche Bank and Switzerland-based Credit Suisse tied for seventh place in 2016, down from jointly ranking sixth in 2015.

The decline of Deutsche Bank is particularly dramatic. After being in the US top five by investment banking revenues up to 2010, it has since fallen behind Citigroup and Barclays to now rank just ahead of much smaller Wall Street players such as Royal Bank of Canada (RBC) and Wells Fargo. In addition, Deutsche Bank’s share of trading revenue has also been declining.

Here to stay?

But will the success of recent European winners in investment banking and trading in the US persist? “It’s a bit of a game of catch-up right now and we’ll see where it goes,” says Stuart Plesser, a senior director at rating agency Standard & Poor's. “Over time, yes. But there are still gaps in the near term.”

In terms of return on equity (ROE), European banks are at a significant disadvantage because a bank’s profitability ratio depends on a country’s interest rate. And while interest rates in Europe have stayed at or near zero, effectively squeezing European banks’ margins, the US has raised interest rates four times since December 2015. And it is likely that they will increase on two more occasions before the end of 2017, as hinted by Janet Yellen, the chair of the Federal Reserve.

Interest rates are also closely related to the pace of economic growth. If there is no – or only very minimal – gross domestic product (GDP) growth in Europe in 2017, that will make it even harder for the European banks to match their earnings with their cost of capital.

In contrast, while expectations of a large boost in GDP at the start of president Donald Trump’s administration have now fizzled, the rate of US GDP growth remains forecasted at 2.3% in 2017, according to the International Monetary Fund, compared to an average 2.1% in the past three years, effectively helping US banks’ ROE profitability.

Market trends

European investment banks face cost pressures in the US, as do their US counterparts. These pressures are not just because of new regulatory capital charges after the crisis, set to better reflect the risk of trading in derivatives and other complex financial instruments, and the additional mandatory clearing of all over-the-counter derivatives trades, but also because of the shift to more transparent – and lower earning – electronic trading. Both automated non-bank trading platforms and liquidity providers in the bid-ask process have weakened large investment banks’ previous dominant market-making position in derivatives.

Three trends have developed under these conditions. First, all the large US banks have invested in electronic trading platforms, capable of executing trades across asset groups. Many European banks have also adopted this cross-asset approach.

In addition, as the declines in investment banking fee-earning, trading and derivatives revenues have been more severe in Europe in the past several years, analysts have seen a shift in some European banks towards simpler agency-type trading activities that preserve capital; they are also cross-selling investment banking products to their corporate clients. Barclays, for one, has made this type of move.

Third, while Morgan Stanley has stepped back from a full-service offering in its trading businesses, none of the other major US investment banks have done so. In contrast, the major European investment banks – Credit Suisse, UBS and Deutsche Bank – have withdrawn from entire businesses. That puts US banks in a stronger position as market conditions improve and the trading and business cycle turns.

Regulatory retreat

A major area of debate for US and foreign investment banks centres on the proposed changes that the Trump administration has promised to make to existing regulations enacted under the post-2008 crisis Dodd-Frank financial reform law. Such changes may be achieved either through legislation in the Republican-dominated Congress or by Mr Trump’s newly or soon to be appointed financial regulators, including the new Federal Reserve deputy governor, Stanley Fischer.

One issue that non-US banks are watching is how changes or modifications in existing US rules will affect the gaps that developed between European investment banks and the large US banks largely, and somewhat paradoxically, because of the Dodd-Frank Act. The act led to US banks adapting to stricter regulation and higher capital requirements, and encouraged them to put their balance sheets in order earlier.

Another issue is whether changes in the US may lead to divergence with international banking regulations, such as Basel III’s minimum liquidity and capital ratios, as well as additional leverage ratios and substantial long-term debt-raising requirements. The Basel regulatory framework is designed to ensure that the world’s biggest banks – the 30 globally systemically important banks – maintain sizeable financial cushions that can absorb losses if a bank is failing, otherwise known as the Financial Stability Board’s total loss-absorbing capacity requirements, which the Federal Reserve adopted in December.

Concern regarding divergence came to the fore when foreign banks, whose non-branch US assets amount to $50bn or more, had to establish a Federal Reserve-regulated intermediate holding company (IHC) for their US subsidiaries in July 2016. These entities are also subject to the same risk-based and leverage capital standards as US bank holding companies.

The IHCs must submit regular capital plans and pass annual stress tests. Additionally, they must draw up a resolution plan by July 2018 covering all of their US businesses, to show how they can be wound down without support from the US government and without any damage being done to the broader US financial system.

Summarising the US regulators’ motives for such a sweeping move, Joo Yung-Lee, head of North American financial institutions at Fitch Ratings, says: “It was largely to create greater regulatory oversight of foreign bank organisations, whose non-banking broker-dealer businesses had become some of the biggest players on Wall Street. In addition, it was an attempt to level the playing field with US banks.”

Foreign-owned banks complained the US rules discriminated against them by imposing an added layer of regulation on top of what their parent companies face at home. However, the European Commission then proposed a similar framework for US banks operating in the EU.

Top 15 banks by global investment banking revenue, 2016

Political uncertainty

With continued gridlock in Congress, bankers and Wall Street lawyers are exploring what may be achieved outside the congressional process. At an Institute of International Bankers (IIB) conference in Washington, DC in March, H Rodgin Cohen, senior chairman of Wall Street legal firm Sullivan and Cromwell, said that considerable relief could be provided to banks simply by “tweaking” the definitions of what counts as highly liquid assets, liabilities and recognised obligations to comply with liquidity coverage ratio tests.

There is also expectation among foreign bankers that there will be changes in the Dodd-Frank Volcker Rule, which bans proprietary trading. Sally Miller, CEO of the IIB, is critical of the rule’s alleged extra-territorial aspects. “I think the draftees, according to legislative history, really thought the Volcker Rule would stop at the water’s edge. But, through an interpretative process, it has been applied to wider activity that has no bearing on the US. The IIB is focused on its full repeal.”

In this chequered and uncertain regulatory and economic environment, foreign investment banks appear to be making the most of what they can offer while they can.

In prime position

While Credit Suisse, Deutsche Bank and UBS are paring back their investment banking businesses, some analysts believe Barclays is well placed to help fill the European bank void. According to Coalition, Barclays has the strongest investment banking franchise in the US among European banks. In 2016, the US accounted for more than one-third of the Barclays Group revenues – roughly 35% – and with the US dollar’s strength relative to sterling, this made the US earnings even more valuable, according to Mr Staley during the February results call.

Barclays, as with other non-US investment banks, is at a comparative disadvantage, however, when it comes to US banks’ corporate lending, lacking the cheap funding of the immense retail networks of, for example, Bank of America Merrill Lynch and JPMorgan Chase. But as a value proposition, and with the bank’s tilt towards corporate rather than institutional clients, Barclays is emphasising its entrepreneurial and intellectual expertise, along with its ability to provide talent and services in London and New York, the world’s most important financial centres.

In an interview, Joe McGrath, who joined Barclays in 2006 and is now CEO of Barclays corporate and international Americas business, said: “We have a good combination of both leading with our content and our strategic advice. We don’t lead with our balance sheet. We do, however, lead with our intellectual capital in and around our various industry groups, product areas, regions and in our expertise in markets.” As an example of the latter, Barclays participated in confectionery company Mars’ acquisition of VCA, a US pet healthcare provider, earlier in 2017.

Expanding possibilities

The gradual change in the US credit and economic cycle also presents openings. US companies that borrowed heavily during a prolonged period of low interest rates in the US may increasingly want to hedge against the risk of a credit default as interest rates rise. That presents investment banks with opportunities in the credit default swap (CDS) market, as well as in the more lucrative single-name CDS market.

BNP Paribas has seen its corporate and investment banking business in the US grow 46% in the past three years, rising from €1.5bn in 2013 to €2.2bn in 2016. The bank also has a significant US retail footprint: it owns Bank of the West, with an extensive branch network in western US states, and First Hawaiian Bank based in Honolulu. Together, the two banks’ loans grew at a compound annual rate of 7.2% between 2013 and 2016; and their combined revenues increased from €2.2bn to €3bn over the same period.

Barclays’ sole US consumer business, on the other hand, is a credit card business, Barclaycard US, based in Delaware. A high-margin business, it has grown significantly in recent years and is now one of the fastest growing credit card issuers in the country. Much of the growth comes from its co-branded cards with well-known US companies such as American Airlines, Apple and LL Bean.

RBC, whose US capital markets revenue fell 6% year on year, from C$4.3m ($3.23m) in 2015 to C$4m in 2016, is doubling down on its US wealth management business following its recent acquisition of City National Corp, with a roster of rich celebrities among its clients and a presence in some of the largest US wealth markets, including Los Angeles, San Francisco and New York. RBC CEO Dave McKay has hopes to double the firm's total US 2016 earnings of just under C$1bn over the next seven years.

In short, despite the uncertainties and challenges, bankers and analysts believe the US market will remain the most important market for big foreign-owned investment banks in coming years. Amrit Shahani, lead researcher at Coalition, is optimistic. “I do not think any of the big European banks are looking to scale down their business in the US. Instead most are looking to invest in their American business and therefore stand to gain market share in 2017,” he says.

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