Most of the top European trading banks have ploughed through brutal restructurings in the past three years. Barclays, Credit Suisse and Deutsche Bank have gone through heavy rounds of cost-cutting and fundamentally reshaped their trading businesses, while UBS did the same years earlier.
BNP Paribas, though, is different. Like its competitors, it has cut costs and risk. But there hasn’t been any wholesale blood-letting. Instead, there’s been a careful tweaking of the bank’s business model, selective pushes into more profitable market niches, and a growing sense of confidence as the bank gathers market share from its troubled rivals.
“In the first half of 2017 we’ve continued to outperform most European and US banks in terms of market share,” said Osty. “I’d expect the third quarter to be tough for everyone though — some banks have already announced they expect business to be down.”
In the second quarter, global markets revenues at BNPP were down — but only 2.3% to €1.52bn. FICC was down 15.9% to €883m, against a difficult comparison quarter. That’s in line with other global banks (and well ahead of Goldman’s 40% drop). Where the bank has outperformed, however, is in equities and prime brokerage, which was up 25.7% to €640m. Arch rival SG, which prides itself on its equity derivatives franchise, was 5% down and most of the US firms were roughly flat on the year.
BNPP’s relative stability and capital strength should have given it an advantage when it comes to winning financing business — particularly with several of its rivals trying to cut costs. But margins are falling for investor financing.
“Balance sheet is less of a constraint right now — the price of balance sheet across the Street has cheapened,” said Osty. “Banks are getting better capitalised, but they’re also getting better at managing their capital and making sure it is readily available to clients who deliver a sufficient return. For the bigger hedge funds and asset managers, it’s got easier to get cheap financing than it used to be.”
The European boss of an international bank confirmed this trend, pointing to aggressive financing terms available from Japanese banks in particular as pushing down margins in Europe.
Nonetheless, BNPP is determined to consolidate its gains. It recently announced that it had hired Citi’s Matthew Clark as global head of prime brokerage sales, in part to build out its delta one execution and financing business, alongside Jerome Bassot, who’s come up through the BNP Paribas ranks.
While balance sheet might be cheaper than it was, new regulations will shake up the whole market — changing how banks compete for equities business, and how clients will pay their banks.
“Cash equity research sits with Exane [BNPP’s joint brokerage venture], so we are looking to build up our synthetic execution and financing capabilities without providing research,” said Osty. “With MiFID2, clients will have to pay for research that they used to receive for free, so that levels the playing field, and clients are very focused on making sure they’re paying banks for the financing they receive.”
New architecture
Three years ago, as the bank reeled from its monster $8.9bn US sanctions-busting fine, it revamped the management of its corporate and investment bank, promoting the architect of the firm’s equity derivatives division, Yann Gérardin, to run it.
One of Gérardin’s first acts when he took over was to combine equities and fixed income in a single global markets division which he initially ran himself, and shortly afterwards, promoted his deputy, Olivier Osty, to head it.
With two equity derivatives structurers running the show, BNPP scaled up its presence in the market, acquiring portfolios from RBS, Macquarie, ING and Crédit Agricole. But it also applied insights from work done in the equity derivatives businesses to other product areas, emphasising automation, technology, and cross-divisional co-operation.
Co-operation with other divisions is still at the centre of Osty’s plan for the business.
“We’re expecting a significant part of our revenues to come from joint ventures with other parts of the bank by 2018/19 — both on the corporate banking side, with cash management and trade finance, and on the securities services side as well,” said Osty. “This is where we are different.”
Global markets and securities services already work together on an execution and clearing joint venture, and securities services use the spot FX execution services in markets.
“BNP Paribas Securities Services is also the biggest European custodian out there with $10tr assets under custody, so we have a great asset base to leverage on, offering lots of opportunities to help our clients optimise their collateral,” said Osty.
Building up BNPP
Aside from these cross-divisional ventures, the bank has been ploughing efforts into certain business lines within markets — preferring more lucrative financing businesses to vanilla flow.
It is building out synthetic execution and financing at the moment, but last year, it was the turn of securitization, which was carved out of the bank’s wider markets business into an “asset finance and securitization” division, which went beyond flow structured finance to cover infrastructure, reserve-based lending, project financing and other structured fixed income. A flurry of hiring quickly followed — a specialist syndicate team is now three strong, and the bank hired a new head of ABS trading, with a mandate to bring electronic trading to a market that’s large voice-based.
That wasn’t a unique move — HSBC, Société Générale and Barclays have taken similar approaches, as the wallet available in financing legacy asset portfolios has grown — but it shows the firm’s determination not to let this lucrative activity become an exclusive playground for the US banks.
Earlier this year, BNPP reorganized its credit trading operations, combining the high yield and distressed desks under ex-Barclays trader Steve Snizek, while the former high yield head Mike Wheeler moved on, eventually landing at a specialist broker. The French bank also hired two investment grade-focused traders from Goldman in the spring, bulking out in sterling credit and financials.
Regulation
No trading business, however, can ignore the march of regulation. Banks are working flat-out to prepare for the Markets in Financial Instruments Directive (MiFID II), which comes in from January 2018, and further off, will be preparing for the Fundamental Review of the Trading Book, which threatens to raise capital costs for higher yielding and structured debt.
The Basel Committee is also still in negotiations over the “output floor”, which limits the amount banks can cut capital allocated to assets by using their own models. A deal was supposed to be reached in January, but is being held up by uncertainty over who is managing negotiations on the US side.
Regulators meet again on October 4-5, but market participants aren’t optimistic about a deal — though and BNPP and other banks have to figure out how to handle the regulations anyway.
“Nothing has been decided on regulation yet, but we’re pricing our balance sheet very conservatively,” said Osty. “Although it looks like Basel IV has got a bit stuck, on a long-dated swap we factor in the extra cost of capital that will come in and incorporate it into the price. I’m not sure all banks are doing this.”
He continued: “Many regulators understand the big banks have plenty of capital, and that the risks are rather to growth than to stability. The shift has already happened in some areas of politics.”
Part of the difficulty in anticipating international agreement on capital rules is that US authorities have already proposed their own reforms to capital rules.
The US Treasury’s paper “A financial system that creates economic opportunities”, issued on July 12, proposes cutting US government debt and initial margin out of the leverage ratio, plus some unspecified benefits for foreign banks —the US is proposing undermining the leverage ratio even before its technical implementation date.
But US moves could prompt wider revisions to long-planned regulation.
“If the US takes out Treasuries from the leverage ratio, that raises the question of whether Europe will take out sovereign bonds too — European politicians will want to keep a level playing field,” said Osty.
In any case, MiFID is the more immediate concern. The rules had originally been planned to come in from January 2017, but the European Securities and Markets Authority, as well as European member states asked for extra time. Even with another year, though, preparations are expected to go down to the wire.
The final list of which bonds will be subject to which transparency requirements, for example, is expected in November.
“Not everything is ready for MiFID 2 at the level of the industry, but we’re all spending lots of time on it,” said Osty. “We expect, though, that European regulators will be accommodative. There’s no ‘no action letter’ concept in Europe, but regulators will not be expecting everything perfect immediately — they will want to see proof we’re doing the best we can given the late specification of the details. In our case, we are.”
This message has been echoed by the UK’s FCA, which has indicated that firms need to show that they’re “making an effort”.
Marvellous Marylebone
Regulation will depend, in part, on how Brexit works out. BNP Paribas group earned €2.58bn in the UK last year, and has 6,501 UK-based employees — many of whom are in Osty’s markets business.
BNPP doesn’t need any new continental entities to cope with Brexit — much of its UK business is run through a branch of the main French bank — and many of its UK employees are EU27 nationals.
But the location of euro swaps clearing is still a crucial issue for the bank. European authorities wanting to move euro clearing into the eurozone have several tools at their disposal.
Rules across the EU27 countries that require euro clearing onshore risks antagonising US authorities, which have worked hard for years with their European counterparts to get to mutual recognition of certain market infrastructure — with an agreement on “equivalence” for clearing houses in March 2016.
Alternatively, eurozone supervisors could require institutions they supervise to clear their euro trades within the eurozone — potentially including BNP Paribas. This would be the worst of all outcomes, since it would fragment the liquidity pool concentrated at LCH’s Swapclear, domiciled in London.
“In the current status of the EU proposal, in case of a forced CCP relocation, US firms and funds will remain on LCH London if they are not forced to move — 70% of euro swaps trades have no EU27 leg, so the liquidity will still be better there,” said Osty. “It is therefore necessary that, in case of forced relocation, the EU forces everyone to clear euro swaps on a CCP within the EU, and not only the EU27-domiciled banks, because it then avoids fragmenting euro swaps liquidity and we need to maintain the level playing field.”