As US banks’ shadow lengthens, Europeans plan their fight back
Each year brings another retreat for European investment banks, as their seemingly invincible US competitors edge further into the European market. While the Europeans are far from capitulating, the pressure is relentless. As Jasper Cox reports, they are trying to redefine success by concentrating on the markets and segments where they are strongest
The pain keeps on coming for European investment banks. US competitors have cemented their dominance for the foreseeable future and Europeans are trying to fight for smaller victories.
First in 2019 it was Société Générale, announcing cuts to trading. Then Deutsche Bank slashed its equities business after its failed merger with Commerzbank. As the year wore on, it was the turn of HSBC and UBS to announce plans to restructure investment banking. All the while, the US banks continued to look magisterial — even if they are not immune to a spot of austerity.
As the charts below show, the top five US banks have substantially outperformed the top seven Europeans in global investment banking revenue over the past eight years.
“We’ve seen the American banks pick up market share and become more dominant, and the response from the European banks is not to invest and win that market share back, the response is: ‘Let’s get more attrition, let’s cut down even more,’” says an analyst of European investment banks. “That’s the message for this year.”
Not everyone has crouched into a defensive position of rationalisation and cost-cutting. Barclays has fought back against activist investor Edward Bramson’s assault on its investment bank, while BNP Paribas snapped up Deutsche’s unwanted equities platform. But in general, Europeans are in defensive mode, trying to protect what they have rather than carrying the fight to Bank of America, Citigroup, Goldman Sachs, JP Morgan and Morgan Stanley.
“The fight for wholesale investment banking, really large scale investment banking in Europe, was lost a long time ago,” says Andrea Vismara, chief executive of the Equita Group, an independent Italian investment bank in Milan. “All of this is happening faster than we could have expected it to happen, but the trend was very clear.”
How have Europe’s investment banks found themselves bobbing along in mid-table? And how should they adapt?
The primary reason for the dominance of the US banks is the strength of the US domestic market, helped by the country’s GDP growth outpowering the EU’s in recent years.
Some argue another factor is that Europe has so far failed to complete its Capital Markets Union, which in theory would dismantle barriers to capital flows and allow institutional debt markets to provide more capital instead of banks. This would favour big investment banking operations.
At the moment, many banking activities remain localised, and the lack of progress on the CMU holds up consolidation between banks, which would benefit investment banks that now fight over scraps of business. One of the US banks’ advantages is the large market shares the top five banks enjoy in their home market.
But progress on CMU has been tricky, and banks are not holding their breath for it to be completed.
Bond underwriting appears to exemplify the effect of having numerous competitors. “Standard bond fees are lower in Europe because of market dynamics,” says Frazer Ross, head of investment grade debt capital markets syndicate for Europe, the Middle East and Africa at Deutsche Bank in London. “US banks have clearly historically done a better job fighting fee compression in their home market than European banks have in theirs.”
The US is already in effect a large capital markets union, giving its domestic banks a big helping hand. In markets like corporate debt and securitization, the US is simply larger.
The playing field is more even in rates and foreign exchange. But the revenue pool for the biggest houses in fixed income, currencies and commodities trading (FICC) has shrunk more than it has for equities and for origination and advisory work in recent years.
Low rates and low volatility, induced by central banks, are one cause.
US banks have also pulled ahead in equities trading. The analyst points to their investments in technology and success in attracting hedge fund clients.
Meanwhile, the US banks’ persistence in maintaining operations in different regions of the world, covering a wide range of products, creates a self-perpetuating advantage in the form of better diversification. European banks have been retreating home, where the market has been tougher of late.
Some also point to the effect of regulation. Europe’s rulemakers have pushed MiFID II and greater capital requirements on to banks in recent years (although European banks did have more need for the capital).
Under the administration of president Donald Trump, US regulators have made louder pro-industry noises, including moves towards slimming down the Volcker Rule.
Regardless of which region’s banks face the tougher rules, regulation in itself favours big incumbents by putting up a barrier to entry.
Finally, Europe’s negative rates — which do not look likely to let up any time soon — add pressure to lending as well as fixed income trading activities.
How to cut
With little prospect of the structural problems that beset them being eased any time soon, European houses are working out how to respond, in an age when shareholders are not so keen on grand expansion plans.
One answer is to regard the investment bank as a support mechanism for other parts of the business, like wealth management or serving corporate clients more broadly. Another is for banks to focus on what they do best, perhaps even partnering with outside companies for some products.
Firms may well retain mergers and acquisitions bankers, because they can take advantage of lending relationships to get a seat at the table for this activity, which also does not soak up capital.
But advisory work could change from a technological perspective. Banks that use big data may gain an edge in offering insight. And rather than waiting for clients to come to them about M&A opportunities, the savviest banks can seek out opportunities for clients in advance, according to Matt Long, head of capital markets in Europe at Accenture in London.
Equity capital markets is another way European banks can use existing relationships, and this can also be a strategic line of business.
“When you’ve got the ECM capabilities, you can have a strategic dialogue with your clients, you can talk to CEOs,” says Pierre Palmieri, head of global banking and advisory at Société Générale in Paris. “And then, when you talk to CEOs, you can come with ideas that will have a positive impact on other areas of activity.”
But Deutsche’s decision to retreat from secondary market sales and trading in equities has raised questions about the viability of this business for many in Europe, and about what it brings to a bank.
“Equities is a market that in Europe nobody knows who’s going to take care of,” says Vismara at Equita.
Bankers tend to think that Deutsche’s decision will harm its remaining ECM franchise, although the bank boasted in its third quarter results of having completed, priced or won more than 50 equity origination mandates since July.
“How do you do ECM if you do not have the secondary activities?” asks Vismara. “If you execute an IPO for a company without having secondary activities, and without having reputable research, it means that you’re only using your relationships, which means that you’ll probably do it mostly for your home companies, so German companies, because you know all the investors. And yes, of course, that is feasible, but it doesn’t mean that you’re a player in the equities market.”
What about the impact on other lines of business?
“The impact of DB withdrawing from equities trading on the DCM business is very low,” says Ross at Deutsche. “What DCM clients appreciate is our focus on and commitment to capital markets.”
Working out the damage to the sum of the parts is the crucial issue when banks weigh up whether to cut business lines.
Shutting businesses down cannot be done lightly, not least because it is expensive to turn off infrastructure. “It takes a huge amount of investment just to chisel away,” says Long at Accenture. “You’ve got huge pipes that you can’t just suddenly downsize, just because the volume of what you’re flowing through them has significantly reduced.”
This is particularly the case when technology and operations are intertwined with businesses outside the investment bank.
Not all bleak
Still, encouraging results for Barclays and BNP Paribas this year suggest Europe still has room for at least a couple of big, home-grown investment banks. And Deutsche’s retrenchment could help them.
“It is positive for Barclays,” says John Cronin, financials analyst at brokerage Goodbody in Dublin. “But I wouldn’t make any assumptions about where those clients who might migrate from Deutsche would go; it’s so relationship-dependent. I think it’s positive for the remaining incumbents. But equally, the US banks will be fighting hard for that business.”
For other banks, the answer appears to be playing to their strengths. This could include being pickier about clients.
“We need to be relevant to our clients. But also the clients need to be relevant to us,” says Palmieri. “There’s capital selectivity at the client level.”
Natixis is an example of a bank with a sharp focus, in its case on sectors like energy and natural resources, infrastructure and aviation.
“The game today is to be relevant,” says Marc Vincent, head of corporate and investment banking at Natixis in Paris. “We are not a CIB offering everything to everyone. I don’t think we can compete on size, and therefore the flow business is not for us.”
UniCredit stresses that its investment bank is important in servicing smaller companies. “We have to be close to both the real economy and our clients in their everyday life,” says Richard Burton, CEO of corporate and investment banking at UniCredit in Milan. “This is a very important distinction between a big global bank and a pan-European bank like ours. A big global bank doesn’t have the same presence deep into the country, the closeness to mid-size corporates and an understanding of their day-to-day capital needs.”
Opportunities still exist in some areas, such as investment products. Vincent at Natixis says low rates are opening avenues here, while Palmieri at SG points to the ageing population as creating demand.
European banks still have advantages. The region remains poised between the American and Asian time zones. Those in the industry — and not just bankers at European firms — say European companies want Europe’s banks to continue to serve them.
Politicians probably wish this as well, so that they can keep more control over the sector. The German government was said to be keen on a Deutsche-Commerzbank merger. This factor might in the end help win the banks some relief from tighter regulation or progress on CMU.
But for any serious challenge to the US hegemony, the conditions are not there in the medium term. For most banks, finding profitable niches is the way to keep the show on the road.
Europeans’ sustainability lead
In September, the United Nations launched the Principles for Responsible Banking. Some 130 banks holding $74tr of assets signed up.
The main European investment banks were almost all present, except for HSBC and UniCredit. But in the US, of the five large investment banks, only Citigroup has signed.
While joining the Principles does not necessarily mean a bank is more sustainable, this is one area where European banks hold their heads high. It is not that US banks are neglecting environmental and social issues, but they cannot claim to be ahead of European peers; indeed, some would say they have some catching up to do. The PRB commit banks to shaping their businesses around the goals of the Paris Agreement on Climate Change and the UN’s Sustainable Development Goals.
Toni Ballabriga, who is global head of responsible business at BBVA in Madrid and has been involved from the initial drafting stages of the PRB, highlights two features of the Principles.
First, signatories must conduct an impact assessment to examine their own impacts on the societies, economies and environments where they operate — negative impacts as well as positive ones. Second, they must set targets for improving their impacts.
“It is a pity that some big banks didn’t join the initiative at this time,” says Ballabriga. “I would think there will be more banks joining the initiative.”
Change in investment banking
Sustainability has for a while been important for a subset of capital markets issuers and investors, and investment banks are familiar with products like green bonds. But as sustainability concerns seep into all sectors and are taken up by all investors, investment banks’ relationships with clients look set to change.
“You will go from a more transactional discussion to a more strategic debate,” says Ballabriga.
SG’s Palmieri adds: “Sustainable finance has become a strategic topic for companies, and we see this more and more in our discussions with clients, including at the CEO level.”
Investment banks hope to work on sustainability issues with carbon-intensive companies as well, even though some argue that the climate problem is so urgent that these firms should be blacklisted altogether.
“All the clients, not only renewable clients, even the oil and gas clients, we can accompany them through the energy transition,” says Palmieri. SG has committed to raising €120bn of financing for the energy transition between 2019 and 2023.
Natixis this year announced a new internal capital model for its CIB, which will weight green activities more favourably and disadvantage brown ones. Regulators may make a similar adjustment to actual capital requirements.
But Vincent at Natixis rejects the idea of a total boycott of brown: “Deciding to ban financing is not the appropriate answer to a problem.”
The European banks that embrace sustainability fastest and most deeply may well reap a commercial advantage. And this advantage could extend beyond Europe, as sustainability becomes more important in different regions around the world.
“The sooner you start this journey, the more capabilities you will have and the more experience to develop solutions that help your clients to make the transition,” says Ballabriga. “We think that is a clear advantage to be a first mover on sustainability. We see that sustainability is a big opportunity for European banks to mobilise not only Europe but also other countries.”
Banks that manage climate risks may also be more resilient. Central banks are now increasing looking at financial stability through the lens of climate.
But the advantage on sustainability is unlikely to be a gamechanger for the Europeans, even if it eventually becomes financially imperative.
“In the green and socially responsible area I think Europe has an edge,” says Vincent. “But I’m not sure that in our industry you can count on a leadership to be sustainable for a long time.”
“That is something that can be replicated by US banks very quickly if they perceive that there is a business opportunity,” adds Equita’s Vismara.
Which would be better for the planet, but not for the European banks.GC