Where are the key EM growth market opportunities over the next three years?
Its difficult to make a longer term forecast in the current environment and obviously the growth data in most of the key EM economies has been disappointing in recent quarters. Some of the larger EM economies are transitioning towards a lower growth trend.
One of the things we are seeing is the more developed market economies showing signs of recovery, particularly in the US but also in the euro area. So, while the EM economies clearly continue to grow at higher rates than developed economies, those that are positioned to benefit from the cyclical recovery in the developed markets those with manufacturing or export-oriented economies could benefit disproportionately.
A month ago if you said, what is everybody worried about in the developed markets and what is going to constrain or unlock the opportunity, people would have said, were worried about tapering. Were worried about Syria. Were worried about the German election. Were worried about Chinese growth. Were worried about the debt ceiling in the US. Were worried about Fed succession. Some of these have receded somewhat but theres still a lot of uncertainty around many of those things. Its fair to say that from where we were a month ago many of them are trending in a more positive direction, which is going to continue to underpin the recovery in the developed economies. So, from an EM perspective, those economies that are geared to manufacture and export are where you want to be focused.
And how does that tie in with your banks strategy for EM? Where are Barclayss key areas for development in emerging markets?
In investment banking, Barclays has two very strong, large home markets the US and UK but we have a global strategy. Weve made very significant investments to be present and relevant across geographies. We now have very high quality teams on the ground in Asia, in Russia, in the Middle East, Africa and in Brazil. We are in those markets to not only serve our global client base but also to take advantage of selected local opportunities. You have to be in those markets both to position yourself for what the world is going to look like 10 years from now but also to serve your clients in the more established markets. Last year we did an M&A transaction for a first-time, EMEA-based client. Wed been covering them for quite a long time and the first deal they asked us to do was to sell an Asian asset to a Chinese buyer. So, even if your home markets are Germany or the US or the UK, youve got to be global.
Youre describing the growing importance of emerging markets and being on the ground. Does it make sense, though, for developed market banks to start buying up local banks or local institutions?
You have to be very embedded in these markets to understand the markets and have the right kind of relationships with the local institutional and corporate and government entities to do business there. But you also have to be on the ground and plugged in to understand the risks youre taking in these markets. Theres two ways of doing that. You either do it organically or you do it through an acquisition. But the reality is that if you look at at least on the investment banking side where the action has been in terms of fee dollars, its moved disproportionately to America.
If you look at market cap relative to GDP in the emerging markets, you can see theres huge potential. You can almost feel the capital markets developing in certain emerging market economies. What everyone is struggling with is how much do you invest and how quickly can you capture that future opportunity because the marginal investment dollar right now has a higher ROE in the developed market. Thats the trade-off that everybody is struggling with because you cant just invest in the fully developed economies. Youre going to wake up in two years, three years, or certainly in five years and youre going to have missed a fantastic opportunity. But shareholders are demanding banks be return-focused. You have to look at the incremental return thats the struggle in every CEOs office around the globe right now. Where to invest that incremental dollar and how much do you invest for current return versus how much do you invest for your future.
So, what would be your advice to your CEO on that?
You have to be balanced. The trouble is that once the opportunity is apparent, it can sometimes be too late. So, you have to constantly question the status quo. Barclays has a somewhat unique opportunity, at least on the investment banking side, because were a newer franchise and so we have scope to grow in our home markets. We have scope to take share and grow in the United States. We have scope to take share and grow in the UK and continental Europe as well as in the emerging markets and Asia. So, we probably have a slightly different starting point than some of our peers.. But what we try to do is not only look at what the next 12 months will look like but also focus on the key issues that might potentially shape the next three to five years and try to find that balance. Thats all you can do continuously question the status quo and look at your leading indicators in terms of whats happening in those markets.
Emerging markets of course have been positively affected by QE over the last two or three years. But what will happen when Bernanke decides to start tapering the asset purchase scheme?
The risk of an EM-wide meltdown due to the end of QE now seems to be more reasonably contained. If you look at whats just transpired the Fed not beginning to taper QE in September it shows that while we are going to have some volatility as the unconventional monetary policies begin to be unwound its now going to be done in a very thoughtful way. Its apparent that any actions will be done with people thinking about not just domestic implications but the global ones too.
Is it harder to trust the Fed now?
There are lots of experts looking at all kinds of data every day just like the Fed does and it is very hard to predict. Its positive that the Fed can build in real-time changes and make policy decisions based on the latest information; not just what the market expects. The Fed has done a fantastic job in terms of navigating the US economy through an incredibly and historically difficult period, which has benefitted the wider global economy. I respect someone who is always willing to build in the latest piece of new information into their decision making process and thats exactly what I think the Fed did. Current issues in the US around the debt ceiling prove that out.
How should we describe Barclays nowadays? Is it a global universal bank or a regional specialist?
No, our aspirations in investment banking are clearly global. Its likely we will see an environment with only five or six global banks at some point competing for advisory, financing, and trading flows. There are probably eight candidates presently who want to be in that number and we are one of those. Were definitely a global bank, which has a strong full-service global investment bank.
Its fair to say that before the crisis hit, everybody wanted to be that. How has the crisis shaken up banks ambitions?
Some fundamental things are happening with banks. Some banks are retreating to their most defendable market positions and those might be geographic niches or product specific areas. There are some very high profile exits from some big businesses taking place. That makes sense because shareholders are calling for returns, not scale for its own sake.
But have you been surprised actually at how few [bank exits] there have been considering what people have been going through?
No, not really. This is an industry where we very rarely see capacity come out and finally youre now seeing some come out and that can only be a healthy thing. You could argue about pace, but historically weve never seen any capacity come out through the cycle.
Even within those banks that are choosing to be global competitors there will be a real focus on returns. So, even if you want to be global there is perhaps less emphasis on having to be the number one bank in one particular country or product. Youve got to look at it market by market and product by product and you have to look at a curve of growth versus ROE. At some point theres an inflection point where you grow, but it costs you in ROE terms. You want to push your inflection point out as far as possible and then never go past it.
People are saying, Ive got to have a portfolio of businesses, countries and products that give me an ROE that exceeds my cost of equity. That may mean that across different markets and products Im going for top three or top five depending on each scenario. Thats a real change. It used to be that everybody wanted to be one, two, or three in every product in every geography or at least you had eight or 10 banks with that aspiration.
On the flipside, though, youll probably see new competitors coming in from the emerging markets; possibly Chinese banks, maybe a couple of Russians, maybe a Brazilian, maybe a Middle East bank perhaps one day.
It could. But one of the things about this business is that many pieces of it have very high barriers to entry. There are businesses that are real scale businesses. Take rates trading thats a real scale business and if youre not in it, its a very hard one to get into. If you are in it without the scale then its a very hard one to make money at. So, as you see some banks exiting and that will accrue to those firms that stay because they already have the scale needed. Equities is a business like that. The economics of it are very tough. The difficulty of building a global equity platform is just very considerable.
But history has shown that as soon as one bank exits, theres another taxi on the rank...
Youre right. I agree with that observation. But the recent evidence also suggests that capacity is coming out of the market for the first time. Banks are rescaling their investment banking operations to concentrate on their genuine world-class businesses, be it wealth management, cash management or corporate banking. Theres real tangible evidence of banks retreating to defendable market positions and that makes sense.
Can we expect a truly level playing field with Basel III or can we expect the US to pick and choose what it likes and thus give its banks an advantage?
Its not just a Basel III issue. There has always been some degree of inconsistency in terms of regulation and the pace of adoption.
So, whats it like running a UK investment bank in the US? Does it feel like a level playing field?
We have all the tools we need to compete. We have the ability to put capital to work for clients the same as the American banks. We have the intellectual property to compete. If you look at some of the key transactions weve delivered for clients in the US, our performance would back that up. We know that weve gained a lot of market share in the US with the Lehman acquisition; more so than anybody else in this marketplace and weve seen that positive momentum with US clients continue even further.
Does the threat of having to have local capitalisation worry you?
Youre talking about Dodd-Frank, section 165. Thats a direction of travel, but its 2015-plus implementation. The web of regulatory change is pretty complicated and our philosophy is that we have to be prepared for each piece of it and be thinking through various scenarios. But at the end of the day all we can really do is be thoughtful and be ready for it. There are a lot of regulatory planks that have been laid, but the implementation is still in the early stages and is being decided. We have a range of options to address each challenge based on what we know today.
But do you think youre at a disadvantage, though, to US banks?
No. I wouldnt say its necessarily putting us at a disadvantage. At the end of the day what we need is a safe global environment for banks to operate in but also one that provides a backdrop where banks can do what theyre supposed to, which is to help people finance themselves and grow their businesses.
So, there has got to be a sensible landing point for all of this where the proposition for shareholders works and the proposition for regulators works too. Over the next three to five years were going to find that equilibrium because banks are going to play an absolutely critical role in the global economy as we emerge from this very difficult period. You cant simply rely on government funding to drive the global economy from here. Banks have to play their role and so we have to find a balance between a sensible set of regulations that provide a safe banking environment and a set of rules where banks can do what theyre supposed to do and shareholders can earn a sensible return and Im hopeful we will find that.
On that subject, do you think the capital regulations are too tough and that they have been and will be responsible for a slower economic recovery than we would have had otherwise?
No. I don't think that. We can deploy capital and earn a good return on it in the regulatory environment that weve got. The foundations have been laid but with the implementation still to come and that all needs to work for the regulators and work for the shareholders. But theres no other choice than to find that equilibrium and Im confident that we will.
Is banking out of the doghouse?
There have been periods where theres been a lot of noise and focus around banks generally and a lot of it is probably deserved. Look; I think certainly at Barclays were trying to do a lot of things to make sure that we care and were focused as much on how we do business as how much business we do. So, we are trying to get that balance right and I think that most banks are.
We work hard every day to try to make sure that were doing business in the right way and I think that if we can continue to have that focus alongside our commercial focus, then we will earn the confidence of our regulators, stakeholders and clients.
It was a popular belief three or four years ago that banking would have to become more utility-like. Has that gone away?
Banking has derisked a lot, balance sheets are now stronger and products are much simpler. Youve got far less proprietary risk taking going on in banks generally. I wouldnt call a bank a utility because theres still a lot of intellectual property that banks deliver to clients. As an industry, weve already gone a very long way to simplifying what banks are and to making them less risky by virtue of stronger capital positions and less leverage.
Youre hinting at the general deleveraging that has been going on. Last reports I saw were that in Europe at least banks have deleveraged by around 3.2tr and that perhaps theres another 2.9tr to go, suggesting were probably halfway through this process. Does that feel about right or does it feel that were further ahead?
Theres a longer term trend towards less leverage in banks and banks have made a very significant start in commitment towards that. Its very hard to make a judgment about whether were a third of the way, halfway, or two thirds of the way, but the overall direction of travel is clear.
European and UK economies now appear to have turned the corner. The US has been in recovery mode for longer. You said at the beginning that weve worked through quite a few problems or at least gotten to a better place on some issues such as tapering, Syria, the German elections but others are still ongoing.
The recovery is still fragile and the fact that the Fed was unwilling to ease off of QE and let the economy take over is evidence of that. There are clearly things that could still undermine the recovery at this point. The risks are to the positive side in terms of a global macro recovery and certainly some of the very bad outcome tail risks have been shortened. I dont think people are taking a global macro recovery for granted at this point in the cycle.
Yes. Unemployment is still a persistent problem in the US and obviously parts of Europe. Does that not bode badly for the future?
There are still a lot of structural issues in many parts of the global economy that will take a very long time to address. To really fix employment in a sustainable way in many markets requires difficult structural changes and reforms to be implemented.
Is part of the concern, though, that we are seeing recovery and therefore there will be less of an incentive for policymakers to really go deep into the changes perhaps they need to make?.
I lived in Europe for many years and know that some of the changes that need to happen are structural changes around institutions and policies and philosophies that are very deep-rooted, which means that it can be harder to drive change. Its unambiguous that any economic recovery can sometimes reduce the pressure to make any far reaching changes.