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CommentP&M Notebook

P&M Notebook: French fancy

The French election looks like it has delivered another reprieve for Europe. But earnings season will surely show the Europeans slipping still further behind, after a storming start from the US firms.

France fever gripped the markets on Monday, with a sea of green as Emmanuel Macron and Marine Le Pen won the right to face off in the second round of voting, with the fascist expected to be roundly trounced by the socialist ex-investment banker.

The country is the focus of the long-running US vs EU banks meme. Frederic Oudea, the chief executive of Société Générale, is perhaps the most high profile advocate of two theories — that Europe’s companies need home-grown investment banks, and that regulation is tilted in favour of the US. 

France’s top banks, despite extensive efforts, have never quite made it to the corporate finance big time, and the country’s home-grown investment banking market is still split between the universal financing banks strongest in debt, and the likes of Lazard Freres looking after advisory.

The US bank chief execs, of course, continue to insist the playing field is tilted against them, despite their institutions topping nearly all global investment banking league tables, dominating on the Europeans’ home turf, and being well into capital return at a time when European champions are still doing multi-billion rights issues, this belief is gaining traction in Washington, DC.

The Volcker Rule in particular, is widely held to be expensive, complex, and largely useless in making the financial system safer. Elements of that view has now spread outside the hardcore Republicans, and even policy makers like the outgoing Fed governor Daniel Tarullo are happy to ditch it.

Rule revival

The question, though, is what can replace it, and now talk has turned to a “21st century Glass-Steagall” — a revival of the Depression-era rules which split investment banks from corporate banks (turning the house of Morgan into JP Morgan, Morgan Stanley, and Morgan Grenfell).

Gary Cohn, ex-Goldman president and Trump administration official, seems receptive, while Jamie Dimon at JP Morgan and Mike Corbat at Citi managed to dismiss the idea on their earnings calls without using any actual profanities.

A revival of this regulation would, arguably, level the playing field with the UK banks, but they’re far less integrated than the US universal institutions. HSBC and Barclays are hit hardest by the UK rules, but HSBC’s investment bank is rooted in Asian trade financing and global bonds, and Barclays is strongest where it has built on the Lehman acquisition. In both cases, the UK retail arm has little to do with it.

For the likes of Citi, Bank of America, and JP Morgan, though, their US retail and corproate lending feeds directly into their dominance of US investment banking — and gives them some of the reach and scale to be the global collossi they have become.

A move to split out US investment banking from US lending therefore hurts them badly — and may give a corresponding fillip to Goldman and Morgan Stanley

Goldman could have used the help in its first quarter, with a big miss in fixed income (revenues up just 1%, compared with 30% or more across the Street) drumming up schadenfreude from commentators and competitors.

The bank blamed commodities and currencies for the poor performance, but also noted issues in credit trading, which rivals cited as one of the strongest areas in the quarter. Add in Goldman's 'investing and lending' revenues, many of which would be bundled in with fixed income at Goldman's rivals, and things look markedly better, but shareholders and observers alike have been used to seamless outperformance.

Marty Chavez, the firm's new chief financial officer, stonewalled six different attempts to elicit info about fixed income performance on the earnings call, sticking to the line that the firm simply failed to navigate the markets as well as it should have.

That's less than reassuring for Goldman shareholders, but it'd be a mistake to say too soon that Goldman is losing its touch.

Jefferies jumps in

As well as the pure play US investment banks, the foreign firms may find a Glass-Steagall revival helpful, since the likes of Deutsche, Credit Suisse and Barclays would then be far more able to compete in the US with their purely wholesale operations. Their US businesses are already ring-fenced in intermediate holding companies, which are already, in effect, pure investment banks.

It’d be foolish, too, to discount a boost for smaller US operations. Jefferies, for example, seems to be perpetually seeking new business lines and ways to expand beyond its US fixed income base. It’s European corproate finance operation has a strong pedigree, despite occasional hiccups, and its trading counterparties rate it highly.

It’s now plotting a major expansion into CEEMEA trading, and, eventually, the primary markets. Lots of the senior staff for the secondary build-out are in place, and, with ‘juniorisation’ of sales desks becoming increasingly problematic for investors, the focus on classical fixed income sales-trading is likely to be welcomed.

But primary will be harder — lending and coverage need to be in place long before any bond mandate can be expected.

Jefferies built out a top notch European ABS trading operation after the crisis, adding on origination in 2010, but few mandates were forthcoming. A couple of trades where Jefferies had a captive investor, some private deals and some swap roles, but nothing like a sustainable primary operation.

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