At the end of 2011, bankers were hoping things would get better in 2012. One year on, some of those bankers are still in their jobs. Philip Alexander looks at the words and phrases that defined 12 months of pain, and suggests some words to watch in 2013.


Fast becoming a pantomime villain for regulators, as demonstrated by the European Parliament’s proposed curbs on high-frequency trading (see Reg Rage, page 204). The 'flash crash' in US stocks in May 2010 triggered the debate about the danger of computers operating trading programmes that are too fast and complex to be supervised by humans. There was plenty of fuel added to the fire in 2012. US broker Knight Capital suffered probably the fastest financial distress in history, losing $461m, or the majority of its capital, in a single morning due to a trading software error.

As yet, there is no consensus about how to monitor the computers. A study published by the UK government in October 2012 recognised that “while overall liquidity has improved, there appears to be greater potential for periodic illiquidity” as a result of computer-driven trading. The report recommended circuit breakers to tackle large price swings, and a more harmonised European minimum tick size to discourage very high-frequency trading on tiny market moves.

However, this report coincided with a study of the May 2010 flash crash by Giovanni Cespa of Cass Business School and Thierry Foucault of HEC School of Management. Their conclusion was that price-based circuit breakers alone were insufficient to tackle the problem of sudden losses of liquidity resulting from algorithmic trading creating tighter correlations between markets. The two academics proposed a kind of illiquidity-based circuit breaker, suggesting that “it could be an effective way to block an illiquidity spiral at its inception and thereby help traders to re-coordinate on a regime with higher liquidity”.

The rise of algorithmic trading was also something that concerned UK economist John Kay, in his July 2012 review of why UK equity markets are not fostering long-term corporate decision-making. The greater the volume of company shares owned for a few seconds by a computer, the smaller the proportion of shareholders who are likely to turn up and call executives to account at the annual general meeting. Some activist investors would like to see differential voting rights for longer term shareholders, although the Kay review stopped short of proposing this reform.


The possibility of senior unsecured bond-holders receiving a haircut to save a bank began to harden with the unveiling of the EU’s Crisis Management Directive in June 2012. But the predicted strangulation of unsecured funding and encumbrance of assets in covered bond pools did not materialise, at least in the short term. Instead, senior unsecured issuance rebounded, and banks even began dipping their toes back into the Tier 2 hybrid capital market that had been largely moribund since 2009.

Tim Skeet, a managing director of financial institutions, debt capital markets (DCM), at Royal Bank of Scotland, says institutional investors are increasingly operating separate risk buckets for covered, unsecured and hybrid bonds, charging a greater spread differential between instruments than pre-crisis and adjusting the portfolio depending on risk appetite.

“Investors seem to feel that the talk of burden-sharing was an inevitable consequence of the crisis and they have stepped up their credit analysis work in any case. Whatever the regulatory initiatives, they know that they must take a view on whether the bank is sound or not, if the managers have a clear strategy, and whether the bank has addressed any legacy problems,” says Mr Skeet.


Spain’s savings banks became the latest manifestation of the credit crisis that began with US subprime mortgages so many years ago, threatening to drag the Spanish government down with them. European assistance is on the way, but simply pumping capital into the cajas may be unwise. The future business model and revenue sources of the banks are unclear and their capital needs are a moving target.

“There is still no sign of a major pick-up in European growth in 2013, which means NPL [non-performing loan] formation in Spain can only carry on going up, and the existing level of NPLs has already been re-assessed several times. Provisions will not begin falling until the economy normalises,” says Barry Norris, chief investment officer of European equity fund Argonaut Capital Partners.

Entry card

Is it still working? By late 2011, investment bankers were openly beginning to talk to journalists about overcapacity in the industry. In 2012, they started to act on it. RBS led the way, withdrawing from its fairly limited cash equities business.

But the closure of large parts of the UBS fixed-income franchise in October 2012 caused rather more of a stir. Capital-intensive it may be, but UBS had a market-leading position in sovereign and supranational bonds, and bond markets in Europe can only become more important as banks scale back balance-sheet lending. Ratings agencies cited the lower risk profile of the bank as a reason for optimism, and the Swiss regulators also appear to favour this outcome. But one equity investor says he downgraded his earnings forecast for the bank, given the smaller pool of potential revenues.

And UBS investment bank is considered rather brave by its rivals to pin its hopes on its equities business, at a time when one senior investment banker at a competitor describes the whole cash equities industry as “dysfunctional” due to falling volumes and tiny trading margins. The consensus appears to be that while further exits from equities could well be on the cards, other banks are unlikely to emulate UBS in the fixed-income space. In fact, Société Générale, known as a market leader in equity derivatives, has been cautiously adding headcount in parts of its fixed-income and DCM businesses.

“We are a corporate lender, so debt is a natural product for our client base. And institutional investors such as insurers are becoming more focused on fixed income due to regulatory changes such as Solvency II, so there is increased investor need for this product,” says Demetrio Salorio, global head of DCM at Société Générale Corporate & Investment Banking.


Greece's exit from the eurozone was avoided, thanks to a 70% net present value haircut for bond-holders in March 2012 and the election of a pro-reform government at the second attempt in June. But there is still no coherent plan for returning Greece’s finances to a sustainable footing. As one veteran restructuring adviser not involved with the Greek deal succinctly puts it: “When we restructure a company, it is supposed to be solvent the day after the deal is done, not in 10 years' time.”

Libor and LTRO

The Libor rigging scandal dominated the headlines for so much of 2012, but the question of whether to replace Libor or try to repair its damaged credibility remains unresolved. In what seems to be a recurrent theme, UK and EU regulators decided to tackle the matter separately, with Martin Wheatley issuing a report for the UK government and the European Commission launching a similar consultation process.

“This is perhaps inevitable but also unfortunate, especially where differing conclusions and recommendations are made. In the present instance, however, both the Wheatley Review and the Commission consultation appear to be proceeding along the same lines, with an apparent recognition of the need to maintain the current benchmarks on pragmatic grounds but to undertake structural and governance reforms to restore market and public confidence,” Charles Proctor, financial markets partner at Edwards Wildman Palmer in the UK, writes in a client briefing.

The European Central Bank’s (ECB) Long-Term Refinancing Operations (LTRO) struck a more positive note, at least at first. Credit spreads have rallied across Europe, and the gradual reopening of markets to peripheral sovereigns and financial institutions accelerated after ECB president Mario Draghi promised in July 2012 to do “whatever it takes” to restore eurozone sovereign financing conditions. That facilitated the return of Spanish banks to senior unsecured debt markets in September and even Portugal’s Banco Espirito Santo joined the party in October, with Bank of Ireland issuing the country’s first covered bond since 2010 in November.

But fundamental questions over sovereign and bank solvency remain unresolved. Richard McGuire, senior fixed-income strategist at Rabobank, calculates that Spanish banks’ ability to continue purchasing Spanish sovereign bonds with funds raised through LTRO will begin to expire by February 2013, potentially creating a fresh rise in government bond spreads unless other measures are implemented.


... no longer wanted as chief executive. Two of the most high-profile banking chiefs departed in 2012, but the manner of their departures could hardly have been more different. Bob Diamond exited in a blaze of recriminations, taking Barclays chairman Marcus Agius and chief operating officer Jerry del Missier with him, while making a passable attempt to damage the career of Bank of England deputy governor Paul Tucker.

By contrast, Vikram Pandit’s departure from Citigroup just after releasing third-quarter results in line with analysts’ expectations, caused barely a ripple in the market. Michael Corbat had already been flagged as his potential replacement and appears to have the confidence of investors. It was a lesson in succession planning that Barclays may hopefully learn.

Heinz Geyer, managing director of executive recruitment firm Temple Associates, believes banks should be replacing the “court of the chief executive” with a more collegiate management style. He suggests boards of directors should be aware of possible successors not just for the chief executive, but also for the heads of key individual business units within the bank.

For Michel Péretié, who was chief executive of Société Générale Corporate & Investment Banking until January 2012, one of the advantages of ring-fencing proposals such as those of the Vickers report is that it may push universal banks to transform themselves into holding companies for relatively autonomous management units.

“In retail banking, you know to within two or three percentage points what your profits will be each year. The focus is on break-even levels and cost management, rather than revenues. In investment banking, of course costs must be controlled, but it is the revenues and risks that must be managed the most, because these can cause a 30% margin of error. These are two different cultures and systems that should not be blended too much,” says Mr Péretié.


... based in London. There were many strange aspects to the outsized credit derivatives loss at JPMorgan’s Office of the Chief Investment Officer. One former JPMorgan derivatives trader expresses astonishment at how a unit of the bank was allowed to trade credit derivatives in isolation without using the long-established risk infrastructure of the bank’s own credit trading desk. Especially as this happened five years after internal hedge funds at Bear Sterns, and Dillon Read Capital Management at UBS, had done so much damage to their banks. Risk management is not supposed to be conducted in silos anymore.

The episode also underlined the limitations of the US Volcker Rule banning proprietary trading at systemic banks. JPMorgan’s Office of the Chief Investment Officer had not breached the Volcker Rule because it was theoretically engaged in asset and liability management for the bank.

“The largest proprietary trading desk in any bank is and has always been the bank’s treasury, looking to manage asset and liability gaps on the bank’s balance sheet,” says Mr Péretié.


Investment bankers expect the bond markets, which historically provided no more than 30% of corporate funding in Europe, to begin taking more of the burden – the proportion in the US is 70%. But the European investor base has not quite caught up yet, and European banks were themselves large bond-holders historically.

So issuers turned to the giant US bond funds and found a hungry market. Foreign issuance in the US – known as Yankee bonds – reached $620bn in the first three-quarters of 2012 according to Dealogic, up more than 10% year on year. Investment-grade and high-yield bonds were both welcome and even financial institutions began to find buyers in the third quarter. The trend is widely expected to continue in 2013, and US investors even appear willing to overlook fresh bouts of eurozone crisis, provided the individual corporate credit story is good enough.

Words to watch in the coming year

As for 2013, a quick look at the lexicon for 2012 shows there are likely to be plenty of events in the financial sector that blind-side all of us. But here are a few topics that look to be bubbling up to contribute to the changing perspective for the financial sector in 2013.

Austerity, US-style

In the absence of a deal between president Barack Obama and the Republican-controlled Congress, the so-called 'fiscal cliff' of severe budget cuts and terminated tax exemptions comes into effect in January 2013. The consensus view is that the outgoing Congress will agree a stop-gap to avoid the fiscal cliff, leaving it to the new Congress to negotiate a permanent deal some time in 2013. But whatever the eventual outcome, US government spending is one driver that the world cannot rely on to help deliver economic growth in 2013. This means continued quantitative easing by the US Federal Reserve is almost certainly on the cards – see ‘V’ below.


The UK Conservative Party has long been known for grass-roots scepticism about EU membership. Now the opposition Labour Party is calling for a cut to the EU budget. Meanwhile, the European Commission is pushing not just for a banking union, but for a full economic, fiscal and political union in the eurozone, with other EU countries joining if possible.

There is growing tension between these two approaches and, in October 2012, UK foreign secretary William Hague launched a review of the impact of the EU on the UK financial sector.

“The banking union debate is heating up – and looks set to be a major event in UK/EU relations. Is UK industry and the City now waking up to the real risks of a fracture of the single market, and can such a fracture be avoided in the longer term?” asks Graham Bishop, British consultant on EU financial regulation and former adviser to the European Commission.

Capital optimisation

There’s a phrase we have not written in this magazine for a few years. In theory, banks need to wait for the final format of the EU’s Capital Requirements Directive IV before deciding how and whether to issue hybrid capital. In practice, they gave up waiting in the third quarter of 2012. Reluctant to pile on yet more equity that dilutes shareholder returns, they still need to find ways to protect senior unsecured creditors from bail-in. Subordinated debt is the obvious answer and banks are likely to continue diversifying their capital mix in 2013 if markets allow.

“Parts of the industry are turning from survival mode into consolidation mode, asking how to generate acceptable return on equity in the new economic, financial and regulatory environment,” says RBS's Mr Skeet.


In August 2012, the Bank of England’s executive director for financial stability, Andrew Haldane, published a paper entitled 'The Dog and the Frisbee'. To oversimplify its contents, Mr Haldane suggested that post-crisis regulation may have become too complex, making the banking sector even more difficult to risk-manage and supervise. The Libor scandal and JPMorgan’s beached whale delayed any nascent backlash against excessive financial regulation in 2012. But if even the regulators are starting to have doubts, this is surely on the cards for 2013.

In a report on corporate governance at Europe’s 25 largest banks released in November, consultancy Nestor Advisors warned that increased regulatory complexity might be pushing boards of directors to “miss the forest for the trees”. According to the firm’s managing director, Stilpon Nestor: “Directors increasingly feel that their primary accountability lies with their supervisors, not with the institutions they lead. In this looking glass world of regulated uniformity, stewardship becomes a subset of compliance and supervisory hyperactivity becomes a governance risk.”

Insurance company

Need a loan? Ask your insurer. While banks are shrinking their balance sheets, the EU's Solvency II Directive is driving insurance companies towards credit. Pre-crisis, insurers accessed small business, consumer and mortgage loans through the asset-backed securities markets, but these are still not functioning properly in Europe. So direct lending is the new trend. French insurer Axa formed a joint venture with Société Générale in May to create an alternative small business funding platform. In the UK, the Centre for Economic and Business Research published a report in October suggesting that insurers would more than double their stock of commercial real-estate loans over the next five years, to £52bn ($82.7bn).

Swap execution facilities

The US Commodity Futures Trading Commission is set to rule on whether institutional investors or corporates will be able to join the Swap Execution Facilities mandated by the Dodd–Frank Act. If it decides that they can, this could be a transformative moment for the US derivatives market, says Mathieu Gaveau, global head of interest rate options and inflation trading at BNP Paribas.

“This could mean that banks would no longer be the main provider of risk and liquidity for the rest of the market. As a result, it would potentially reduce their role as a principal and push them to change their business model much closer to a brokerage. In any event, we are likely to see further consolidation of derivatives trading among a few market-makers because infrastructure and reporting needs for derivatives trading are heavy," says Mr Gaveau.

Velocity of money

Quantitative easing and the LTRO continue to flood Western financial systems with liquidity. But most of it is simply sitting on bank balance sheets, especially in Europe. The pressure is growing for central banks to be more inventive in getting money moving around the system. The Funding for Lending Scheme in the UK, and the US Federal Reserve’s decision to buy mortgage-backed securities rather than treasury securities, are both manifestations of this new strategy. Expect more experiments in 2013, perhaps even from the European Central Bank.

Xin Jinping

Hu Jintao’s successor as leader of the world’s most populous country and second largest economy will need to get up to speed quickly on global economic diplomacy. He will also need to maintain the delicate balance between overheating and job creation at home.

“China needs reforms to secure economic growth and avoid the middle-income trap; in other words to avoid following a period of fast economic growth with stagnation. We expect more reforms, especially in the legal and economic spheres. Some of the reforms will not be easy, but if they are implemented they will make growth more sustainable in the future,” says Gustav Rehnman, portfolio manager of East Capital’s China equity funds.


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