In the long run, banks always follow the money, and that means that Asia will, at some point, be the most important region on the planet for any bank that wants to be global, while its domestic or regional champions may, one day, bestride the world just as Wall Street firms do today.
“Fifteen to 20 years out, the shape of the world economy is going to be far more skewed to Asia,” says Matthew Hanning, head of corporate client solutions for UBS in Asia Pacific. “Three of the five largest world economies will be here, and I’d be surprised if any institution’s fundamental strategy didn’t recognise that. But the tactical response is to ask whether you can afford the fixed costs in the meantime, and whether businesses are driving the returns that shareholders like in the short term.”
The long run trend is obvious in the volume figures. Stephen Williams, head of the capital financing division for Asia Pacific at HSBC, says that while the top bank in Asia may have led $2bn of bonds in 2000, last year, the top firm, HSBC, led $20bn.
So there has been everything to play for. How, then, to explain the banks which are reducing their presence in Asia?
HUBLESS MARKET
Part of the problem is Asia itself — Not the economic dynamism or the many and varied cultures, nor the geography and history.
Asia lacks dominating hubs on the level of London or New York, which are unquestionably the hearts of financial markets in their time zones, with the main regional investment banking operations and trading floors of every credible global firm. Asia is a region of sub-markets, with Hong Kong and Singapore vying for the top spot, and several countries — Australia, Japan, and India, for example — which operate as mostly domestic markets.
Any bank wanting a piece of the regional action therefore has higher fixed costs, with more securities licences and subsidiaries, plus the overheads of offices, and national teams of bankers.
Fixed costs of this sort are squarely in the firing line of investment bank re-organisations, with many institutions now cutting client lists and preaching the benefits of “hubbing” (renting an office and buying plane tickets).
The structure of economic growth also raises costs. Whereas fast growth in the US might mean American multinationals taking out the corporate credit card and going on an acquisition spree, in Asia it often means firms taking their first steps in the capital markets.
“There’s a lot of new customers popping up all the time across the region, clients who have not yet had interactions with the capital markets,” says Williams. “Onboarding them so you can take them to the capital markets clearly involves cost. In the US, by contrast, a lot of mid-sized corporates are already filing with [the] SEC, with the Stock Exchange — executing a deal for them is far more straightforward.”
The costs, as ever, depend on who you are. UBS’s Hanning says: “Heavily resourced commercial banks that already have a lending relationship might not need to do much extra work to diligence a capital markets offer, but bulge bracket banks have limited headcount for these things, and Asia is a hard market to do waterfront coverage even with plenty of headcount.”
LARGER SYNDICATES
The higher cost base changes how banks have to think about the business, once they look at profit rather than revenue, changing the breakeven for institutions wanting to be involved in the market. For banks outside the top five or six through the cycle, it Is not necessarily that attractive.
What being in the top tier gets you is access to the juicier end of deal economics.
“The majority of the opportunity set accrues to the top three, perhaps the top two or four,” says Hanning. “You need to be in that part of the group to make outsize returns from deals.”
Some 70%-75% of an IPO’s economics go to the joint global co-ordinators, with an individual top line bank expecting perhaps 25% on a typical deal.
By contrast, banks at the wrong end of the ticket might see 1%-5% of the fees — but with the same administrative burden over due diligence, and a similar cost to keep bankers on the ground.
This is, to an extent, true anywhere. Banks in the driving seat for complex transactions, whether global co-ordinators, left leads, or lead arrangers, tend to keep a tight control of the process, and make sure they get paid for it.
But in Asia, again, it’s a bit more complicated.
The problem, much lamented but rarely altered, is the tendency of Asian firms towards ever larger syndicates.
“The Asian investment banking fee pool has actually shrunk over the last seven years, even as volumes have grown,” said Toby Pittaway, financial services partner at Oliver Wyman in Singapore. “Margins have come down rapidly, especially in ECM — it’s now not unusual to have 10 or 15 banks on a single IPO.”
That keeps competition more vigorous, and margins thinner, in the mid-tier institutions — banks which have paid in lending and coverage for a seat at the table, but which are duking it out for a minor fee-paying role.
LONG TAIL
But with banks under pressure worldwide, it’s no longer sufficient for them to simply send tombstones back – group management wants to see profit, meaning the trend to bloated syndicates may have peaked.
“It’s changing more from the bank side now. There’s a cost to being on an IPO, there’s documents, due diligence, people’s time, and whatever other obligations,” says Hanning. “Some banks are starting to think about whether it’s worth doing that just to be on the ticket. Banks are increasingly focused on the real costs, rather than the league table credit.”
The creep up in the number of bookrunners was driven by both sides. Banks have been competing themselves into the ground in an attempt to prove their credibility, but Asian issuers have also chosen to spread their banking business widely, and faced few pressures to shrink their banking group.
A typical Asian corporate has many more relationships than is normal in the US, for example, because banks have been less disciplined around lending in order to cross-sell and have been keen to invest, and the corporates have had it pretty good,” says Oliver Wyman’s Pittaway. “But they’re realising that tighter, more strategic relationships can have a value, while the banks are cutting the tail end of clients who are not justifying the investment.”
It is questionable, however, whether corporates are voluntarily cutting their bank relationships, or banks are forcing the pace. As some institutions slash their Asian exposures, that is forcing certain clients to take notice, and to change the way they treat their banks.
“Customers are streamlining the number of banks that they deal with,” said Williams. “Rather than being used to dealing with 30-40 banks, they’re asking for more, but from a smaller number of institutions.”
He adds: “We’re seeing a change in the mindset of customers — they’re now more focused on the longevity of institutions and commitment to the market.”
Banks that can demonstrate they are not pulling back can now use this as a way to differentiate themselves, and, perhaps, to move up the value chain, from work like transaction banking and cash management to M&A advice.
Banks everywhere are trying to push cross-selling as a reason to be hopeful, against a landscape which is flat or shrinking, but not everyone can be successful at getting more from the same clients.
ANCILLARY BUSINESS
As in other geographies, ancillary business is crucial — but it’s finite, and might be a smaller pool in Asia than elsewhere. The ratio might be as much as $4 of ancillary revenue for every $1 in headline fees, through offering the full package of financing, foreign exchange, bridge financing and other products.
But ancillary business does not just cover the products directly tied to event finance. Bridge financing from an M&A transaction is an obvious route to some extra juice for banks that have the balance sheet, but primary markets transactions in other geographies also come with a flow of extra business from investors and other niche opportunities.
Some of these, however, are simply not available in Asia.
“The cross-sell between lending, transaction banking, foreign exchange in Asian capital markets is as good as anywhere else, but cross-selling, say, structured derivatives behind an M&A trade is far less developed in Asia than in other markets, because local currency derivatives markets themselves are less developed,” says Pittaway.
Creating bespoke structured notes, embedded derivatives, or complex packaged derivatives trades depends on developed and active derivatives markets in vanilla products, which are often absent in Asia.
Investment banks should, perhaps, receive the majority of their payment from the business they are hired to do, rather than being rewarded by investors for getting hired by issuers — but whether right or wrong, the resulting flow helps keep franchises afloat.
MAKING IT WORK
The challenges of doing business in Asia are not insurmountable but they exist, and it is not a region where every bank can thrive.
“Banks that have done well in Asia tend to fall into two rough models — commercial banks following trade flows, which also drive rates and FX, or asset management, and private banking orientated institutions doing well on the back of the large amounts of wealth being created,” says KPMG’s Michael.
That sounds about right. Banks which are doubling down include Credit Suisse and UBS, both private banking houses par excellence, while HSBC is also shifting capital to the region, on the back of the oldest, widest and deepest commercial banking relationships of any global bank (it is, after all, the Hong Kong and Shanghai Banking Corporation).
Credit Suisse treats Asia very differently from every other geography. The rest of the world breaks into products, while Asia is one whole universal institution. That is a reflection of the benefits of having a successful private bank and an investment bank together in Asia.
“It’s frequently the case that relationships with a firm start in the private banking world, but there’s a symbiotic relationship,” said Hanning. “We might sell a high yield bond via our private bank, which takes a brokerage fee on selling it down, while the private bank might bring us business owners ready to take their steps into the capital markets.”
The question for these firms, however, is how the model works through the cycle. In hot markets, where IPO allocations are heavily in demand and when new businesses are floating all the time, it opens the door to some of the most lucrative products. However, businesses based on commercial lending can usually count on a steady stream of refinancing revenues, even when the broader market is weak.
DRAGON THEIR FEET?
Though the countries still in the same place in organisational charts, China and south east Asia are very different propositions for the investment banks that want to be involved in the region.
For one thing, China is vast, skewing every league table or regional analysis, and weighing on bank management choices. For another, it is now home to the largest financial institutions in the world, some of who want to grow internationally.
All of the largest IPOs and debt offerings in the region have been Chinese, while other juicy prizes accrue to those who can bank the Chinese state sector. HSBC’s role advising ChemChina on its $43bn Syngenta acquisition is a strong example (ChemChina’s side of the fees is believed to be $95m).
It is exactly the sort of business that helps banks remember why they bother with Asia — the largest outbound Chinese acquisition on record, with HSBC the only international bank advising.
However huge China is, it is brutally hard to break into the onshore market.
Forming a securities joint venture (JV) to handle onshore business is only the start. Citi, Credit Suisse, Deutsche Bank, JP Morgan, Morgan Stanley have minority stakes in JVs; UBS and Goldman Sachs have the top tier brokerage licence that lets them do onshore IPOs too, while HSBC has recently set up a majority owned debt-focused JV.
But the Chinese state wants control of its financial markets as it liberalises, and that means international banks need to know their place.
To make matters worse, the fee pot is also starting to skew towards onshore Chinese business.
“Recently there’s been a notable shift in wallet towards onshore China, which can only be accessed by the domestic firms and the securities JVs,” says Hanning. “You can get lost in the big picture — fees might be up 6%, but onshore is up 40% while offshore is down 30%, while some of the onshore business is not risk that international banks would necessarily want to intermediate.”
APPETITE FOR DESTRUCTION
Longer-term, the question for international banks in the region is to what extent the Chinese firms will take their market and run with it. Wall Street firms dominate Latin America; should Chinese firms own the south-east Asian market?
So far though, they don’t seem to be doing much. Several firms clearly have an appetite to expand, but with limits. Haitong bought a UK brokerage from the wreckage of Banco Espirito Santo, while ICBC bought a chunk of Africa-focused Standard Bank, and seems intent on turning it into a commodities-focused investment bank, with proper syndicate and solutions operations.
What they have not done though, is buy many regional firms.
“The Chinese majors are also showing more interest in parts of the mature Western markets where there’s a capital problem,” says Michael. “Chinese banks have shown more inclination to go out and buy UK banking and brokerage licences rather than buying banks in Taiwan or Singapore.”
It is also not obvious that the retreat of other firms creates room for new entrants.
“It’s not like there will be loads of market share up for grabs, or that it will be easy to see where it goes,” says Hanning. “Barclays shuts down cash equities, perhaps everyone else’s market share ticks up a bit, but it isn’t like we therefore need another firm the size of Barclays.”
The best way to win in Asia, therefore, is probably to already be winning. Like any investment banking market, it can be savagely competitive, but it has its own unique challenges, and represents a huge opportunity.
The banks leaving the market now are leaving a market, which will surely get larger and wealthier in the years to come, but it is perhaps harder than in any other region to capture that benefit.