Andrea Orcel, who heads the investment bank at UBS, has a lot on his mind.
A few days before we met, on January 31, UBS reported fourth-quarter and full-year earnings. The investment bank division he heads announced a 34% drop in adjusted pretax profit from a year earlier.
The equities business, the crown jewel in UBS’ investment bank, posted a profit for the year of 3.5 billion Swiss francs ($US3.48 billion), down from 4 billion Swiss francs ($US3.97 billion), reflecting an industrywide slowdown in that business. While other banks posted a big rebound in fixed-income revenues, meanwhile, UBS’ downsized foreign exchange, rates, and credit posted a drop in revenues to 1.8 billion Swiss francs. The results explain why when I asked how business was going his answer lasted 15 minutes.
The bank decided in 2012 to slash its staff, specifically in the fixed-income-trading department, and refocus on equities and its corporate client solutions unit, which advises on capital raising and mergers and acquisitions. That strategy bore fruit, with UBS winning plaudits in the years that followed. The sudden strategic shift it employed came to be known as “doing a UBS,” and others were pushed to do the same. But now the environment is more challenging: The equities business suffered in 2016 and fixed income has rebounded.
The following interview has been edited for clarity and length.
Matt Turner: How’s business?
Andrea Orcel: There have been highs and lows. We’ve come off a strong Q4, but 2017 is looking as challenging as it was in 2016. It’s worth noting that the issues that drove our strong performance in 2013 to 2015 were the same that have been challenging recently — in particular, geographic diversity, FX, rates and credit, regulation, plus the carry piece.
There have been highs and lows. We’ve come off a strong Q4, but 2017 is looking as challenging as it was in 2016.
However, let’s not be too negative. In the segments in which we choose to compete, are we losing share, holding share, or are we increasing? We’re actually increasing. That’s the first positive.
The second relates to profitability. All we can look at when comparing to our competitors is the revenue line. If you say, “Hey, guys, in FICC, so-and-so increased 40%, you increased 10% — you’re underperforming.”
Well, not necessarily; it depends if that underperformance is in long-dated swaps or Level III assets, et cetera. Those are high margin; they will create a lot of revenue lift. But those have a relationship of more than 1-to-1 with equity, so the returns, notwithstanding the margin increase, are going to be diluted, because they absorb a lot of equity.
That is quite difficult for us. People look at UBS and say, “In crude terms they have underperformed in revenues, they have over-performed on cost, and they have had one of the most adverse impacts on pretax” — and that is what people stop at.
When we look at performance we look at return on RWAs [risk-weighted assets] or return on equity. In the first two we’re still first by a margin; in the third category we still remain top tier. If, in the most adverse year, we deliver that level of the profitability, clearly there are some things we’re doing right — not in all areas but in those areas that we compete in. Those are the areas that we judge ourselves on.
So for us, the name of the game is, can we still deliver return on equity in excess of cost of equity? Can we still deliver in the segments where we compete? And can we accelerate the rebalancing to address some of our idiosyncratic issues? Specifically, the ones we want to eliminate. I believe we can and have taken active steps to ensure that is the case.
Turner: Let’s work through regions and products and drill down a bit. In terms of the US, what are your expectations for the business? How do you address the underweight in the US? And third, given the new president and given the prospect of deregulation, how do you view the competition in the US?
Orcel: First of all, you start from a macro perspective that was and is going to continue to be better. Second, I’m not a specialist in US politics, but some of the things the president has been elected upon, like lower corporate taxes — with potential repatriation of profits from overseas — a reduction of red tape, investment into infrastructure, the old Keynes way of looking at things — are going to do two things.
They are going to increase the gap between the US and the rest of the world in terms of underlying performance, underlying confidence, and therefore underlying deal-making. And with a steepening of the curve, the US has that as an advantage over other places, so as an economic block, I am convinced that will support a level of activity that is markedly better than in any other country.
As a consequence, the level of confidence of corporates will be higher, and hence you’re going to see domestic and cross-border deal-making. You’re starting from a position of strength, where you say, “Let me take advantage of this.” You have a currency advantage too. I don’t know for how long, but certainly for 2017 that is the case.
The only disadvantage is if everything that Trump has said is already priced in. The only question mark is if some of these things, where everyone has depicted a blue-sky scenario, don’t come to fruition or come slower. Then there is an unwinding, because people say, “Hang on, I priced it all in because I was optimistic. I need to pull back.” Is that something that concerns me? It is something that will create volatility and it may create a little bit of a drag.
The only question mark is if some of these things, where everyone has depicted a blue sky scenario, don’t come to fruition, or come slower.
Turner: Markets have priced in tax cuts and deregulation. Have they priced in trade wars and border taxes?
Orcel: That is an important question. If you take Europe at the moment, it is a lot more subdued, has a lot more problems, but if you look at Europe going forward, what do we have? We have elections in the Netherlands and then the ones in France, which are quite a big deal given some candidates are running on the basis that they will exit the EU. And then at the back end of the year is Germany. You have Article 50 in March. Everyone says, “Oh yes, Brexit has happened.” It hasn’t happened. They haven’t even invoked Article 50. What is the implication of that? And for the European banks in particular, you have the last step of Basel III being announced, with all the upfront pricing of what is in it in the first part of the year. Do I think that all of these things have been priced in? No, I don’t think so. On these big uncertain blocks, the market has said, “OK, I’m aware of them, but let me park them on the side.” These are elements that can have a significant — at least in the short term — impact.
What I think is more interesting is, as an industry, we have moved from trying to manage risk — where you prepare for it, you have historic series, you have hedges, you make decisions, you debate them, you plan for different scenarios — to managing uncertainty. Uncertainty is very different. Uncertainty is, “OK, there’s going to be an election. Is Brexit going to happen?” How do you judge that? If it happens, what’s the consequence? How do you hedge? How do you price for actions as a result of a tweet or a throwaway comment without getting it wrong?
It’s very difficult to position your trading book — or position the bank versus client activity that is going to be coming — for events that you’re just rationalizing. It’s not a mathematical equation, and when they happen, you’re just rationalizing what the market will do, and actually the market does the opposite. Everywhere we have this and are likely to see a lot more of this.
Turner: You mentioned being underweight the US? How do you address that?
Orcel: On the underweight US, for us, we have been improving markedly our position in equities, because there you leverage a broader global franchise, and a lot of the clients like to deal with a global franchise, which has our strength. We have more distribution than anyone else. As you rebuild your talent, and you spend the time with the clients, you build market share. On research, it is similar. If you look at our II [Institutional Investor] ranking in the US, we were eight three years ago; now we are fourth. In FRC we are very targeted. The US is a credit market, and we’re doing well in credit, but in terms of weight, it’s very small. It is what it is. We can increase, but it’s not by much.
Where it’s most difficult, and there isn’t a platform effect, is investment banking. You need to attract the right people, give them time to embed with the culture and the place, give them time with the client to get them to agree they can deliver for them, and then get them to deliver. That takes time. It’s not something you can do by saying “I’m hiring 300 people.” It’s one at a time. It is slow but critical, because it impacts so many of the other businesses.
It’s not something you can do by saying ‘I’m hiring 300 people.’ It’s one at a time.
So what are we doing? It’s not about the next quarter. It is about the next five to 10 years. It is by hiring 20, 30, 40 of the right bankers each year. When you hire that number, normally 25% don’t work out; the other ones do.
The fact that you see us emerging with roles on Walgreens and Molson Coors shows momentum. We are not in every sector; we don’t have the coverage breadth of some of our competitors. So for us to be successful, we really need to get everything right. The sector needs to do well and the banker needs to do well. We have to bring the best ideas and best execution to the table to emerge with a role. This can mean that, by definition, a lot of things can happen away from us.
Turner: How do you find the next generation of dealmakers in that scenario?
Orcel: Usually it’s word of mouth from clients, where you’re told that so-and-so banker is excellent. The difficult thing with the next generation is that you need to find a rationale for them to move, so you also need to be patient.
Turner: On the issue of deregulation, do you think the proposed changes in the US will make it harder to compete with US banks?
Orcel: Regulation in financial services is fundamental. If you don’t get it right you’re not profitable. Having a more flexible, deregulated market here, where the pendulum seems to be swinging in that direction, versus in Europe, where the pendulum does not seem to be swinging in that direction, will clearly be a competitive advantage.
One interesting thing will be NSFR [net stable funding ratio]. NSFR is, depending on how it is implemented, especially adverse for big balance sheets and impacts things like prime brokerage in particular. This should be the key item for this region to have flex on. We’ll see.
Turner: I want to turn to Europe. I know you will have been asked a version of this question a hundred times, but how big a deal is Brexit really? Is it going to change how you do business or is it moving a hundred people to Dublin or wherever it might be?
Orcel: It is very dependent on the negotiations that are going to occur. London is a very important financial-services center and it has positioned itself as the window into Europe. That window is about to be reduced, or shut. You take MiFID [the Markets in Financial Instruments Directive]. If I want to apply MiFID, by the book, I will not be able to do any business in Europe from London.
My view is that when the UK goes into negotiations, there are a number of situations. First, the negotiation with the EU: Are they going to find a level of compromise that is in the best interests of all parties? The second thing is, if they can’t, then there is a question around the percentage of business that needs to be executed within the EU.
Then there is a third issue. Should the current government in the UK focus more on redefining the offering of the UK as a country for financial services rather than focusing how they lose the least to Europe?
Should the current government in the UK focus more on redefining the offering of the UK as a country for financial services rather than focusing how they lose the least to Europe?
Are they going to go to India, Russia, Singapore, the Middle East, Hong Kong, and Zurich and say, “Look, the EU is the EU, but all of us are fragmented everywhere. I am London. I have very strong ties with you. London is still the center. Let’s have bilateral agreements and redefine London as a financial center in that way, within the metrics of what Brexit is.”
I would add: If you can do that, first of all, you gain more than what you lose with the EU, and second, you can turn to the EU and give them a choice to join.
The reality, though, is that I don’t know what’s going to happen. I don’t think anyone really does at this juncture. The government has two years, and probably one, to put forth all these things. It’s a lot to do. And the reality, by the way, is to relocate 200 or 300 people, you can probably do that in a year. To relocate 1,000, and a whole booking center, it becomes two, three, four years. And then if everyone does the same at the same time, then it compounds the problem. Everybody is looking at this scenario.
Turner: Turning to Asia, I recently sat down with Terry Duffy, the CEO and chairman at CME Group, and he asked: “Who has gotten paid from China?” How difficult is it there right now?
Orcel: It is very difficult, particularly for us, as it is critical to us and we intend to maintain our presence there. In Asia, historically, where we have had outsized returns vis-à-vis others and adequate profitability is China. We were there early, we have been stable, the brand is known, we have the right partners.
When China did well, we were able to capture share at the appropriate returns. At UBS, to date, it was, “How can we maximise the contribution?” However, a lot has changed. A lot of the positive views of China became more negative around the third quarter of 2015. Now they are quite neutral, and the level of activity is a lot lower.
At the end of the day, there is a minimum amount of infrastructure, of people, of cost, that you need to keep; you can’t go lower. At the moment, it is a challenging region, particularly for us because of how critical it is to our business.
We believe two things — one, that if you take a medium to long-term view, China will come back. If you want to be optimistic, maybe the end of the second part of this year, if not 2018. Second, we’re in a strong position for when it comes back.
For us that is a worthwhile investment, we’re committed to it, we know we can do well, and we will be patiently waiting. We anticipate that 2017 will not be meaningfully better than 2016.
Turner: In fixed income, it looks as if 2016 was the year that FICC outperformed equities across the industry. Is that the beginning of a broader shift, and how do you tackle that?
Orcel: I still feel that — and this is obvious, because if I didn’t I’d be positioned differently — that the equity cycle on a relative basis is not over, and I still feel that that is particularly the case if you look more granularly into the FICC performance. How much of that performance is a lot of volume, a lot of revenue, and little profitability, and how much of it is core profitability? It is difficult to say. I would have no problem recommending a different strategy to Sergio [Ermotti, Group CEO] if I believed otherwise, but I still do believe that most of this volume in FRC, in terms of returns, has not yet paid out.
I still do believe that most of this volume in FRC, in terms of returns, has not yet paid out.
In terms of our business mix in fixed income, we have maintained those areas where we had a competitive advantage, and where we could generate sufficient returns — areas such as macro, FX flow, rates and some credit, where we will, at the fringes, do more.
In the US, we have completely recomposed our team in credit flow, and they’re doing very well. But are you going to see us all of a sudden becoming a credit house? No. But on a top line of 1.8 billion Swiss francs in FRC, it is quite easy to have an impact. For us, there are adjustments we need to make, but it isn’t us piling back in.
Turner: I get the sense that you feel that UBS’ strategy isn’t fully understood or appreciated.
Orcel: I think it is broader than that and not specific to us. What I think everyone needs to accept is that there is no longer a one-size-fits-all for investment banks. Firms will excel at different aspects, so comparing on a like-for-like basis will be difficult if it is to be meaningful.
For example, it is important that those who cover our industry do some of the hard work necessary to say, “Fiat is not the same as Audi, and Audi is not the same as Porsche, and Porsche is not the same as Ferrari. They are all in the auto industry, but they are addressing different markets and, depending on the dynamic in those segments, they are likely to do better or worse. The revenues are not the key determinant in terms of performance — ROE, or profitability, in terms of what is returned to shareholders, is a more significant measure of success.”
Equally, I don’t think there is quite the European-versus-American setup that is currently the accepted wisdom. There are firms that are very active in certain areas that are doing well or less well. At the moment, because a lot of us were or are restructuring, it looks like the Europeans aren’t doing as well, but when you look at some of the traction in some of the segments, some of the Americans aren’t doing nearly as well either.
As an example, I’ll leave you with a surprising fact … If you look at 2012 through 2016, UBS’ IB is the second highest in terms of revenue growth and share gain, and delivered the most profitability overall. Would you have said that given all that you read on the decline of the European investment banks?