Daniel Pinto’s eyes lit up.
Earlier in the day, his boss, JPMorgan CEO Jamie Dimon, said the bank’s markets business was heading for a strong finish to the year.
Dimon also let slip that Pinto, who runs JPMorgan’s giant corporate and investment bank, had put up a chart in an investor-day presentation that “no one understood, including myself at the time.”
Pinto took pleasure in explaining it. Taking a printout of the slide in question, he ran through the bars and dotted lines, making an argument for the benefits of scale in investment banking.
It’s a strategy JPMorgan — and Pinto — has employed with some success.
JPMorgan ranked in the top three in every investment-bank business line but one in the first six months of the year, according to the data analytics company Coalition, placing No. 1 in four of the 14 categories.
The corporate and investment bank, which Pinto runs, generated close to $27 billion in revenue in the first nine months of the year and $7.4 billion in profit. The unit is responsible for more than 40% of the bank’s profits, making it JPMorgan’s No. 1 business by profit.
In comparison, Goldman Sachs generated $22.4 billion in revenue and $4.9 billion in profit in the same period.
Business Insider sat down with Pinto on December 6 to discuss fixed-income trading, technology, and what that hard-to-understand chart really means. The following is a lightly edited transcript of the conversation.
Matt Turner: Jamie said Tuesday that you’re up 15% for markets revenues year-on-year. What does that look like? And to what extent is that a post-Trump effect, or was it already shaping up to be a strong quarter?
Daniel Pinto: I think that it is about momentum. If you look at 2016, the whole industry had a weaker-than-expected first quarter, and then the momentum gathered from the second quarter to the third quarter, and it continues into the fourth quarter, obviously with the normal seasonality. The fourth quarter is typically weaker than the third quarter, but the momentum continues. That 15% year-on-year increase in markets isn’t different than what we saw in the previous quarters.
Turner: We spoke in March, and at the time you seemed quietly confident that even though it had been a challenging start to the year, you’d make a lot of that lost revenue back. Is that how it has played out?
Pinto: Yes. In the second and third quarters, which were strong, there was a lot of momentum in fixed income. The equity markets have been weaker, but we have compensated for the reduction in the wallet with an increase in market share. As you know, equities is one of the areas of growth and focus for us.
Turner: Is that a rates story? Which business lines are performing?
Pinto: There’s been a strong performance in rates, in emerging markets, in credit — it’s all along the fixed-income complex.
Turner: What do you make of the post-Trump market reaction? In the equity market we’re hitting all-time highs, and in the bond market there has been a lot of movement, particularly for the assets most exposed to inflation.
Pinto: When you listen to his potential policies, the market reaction is pretty much the mirror image of what he might do.
When you listen to his potential policies, the market reaction is pretty much the mirror image of what he might do.
He is pro-US growth, so therefore what you have is higher interest rates and the potential for the Fed to be more aggressive than it would have been otherwise. The equity-market valuations we’re seeing aren’t low, but there could be additional momentum, particularly in financials. It is not such a surprise.
Turner: There is an argument that the market has priced in all of the best bits of his policies and ignored some of the potential negative consequences.
Pinto: If you watch TV, you’ll see that discussion repeatedly, but the market is not correcting. The market is pricing in tax rates going down, spending on infrastructure, some component of higher interest rates because someday down the line, when you have higher economic growth and an economy that is more or less operating near full employment, there will be a bigger Fed reaction. The curve is pricing in more hikes now than it was before the election. It’s a natural reaction, and the reality will come. How much will taxes be cut? How much will really be spent on infrastructure? How much regulation is going to be rolled back? How much of everything? The market will then adjust.
Turner: How did the trading in the immediate aftermath of Trump’s victory play out? You guys had record activity in bullion in Asia, and near-record FX volumes. Has that settled down now?
Pinto: After every event — whether it is Trump or Brexit, the Italian referendum, whatever it is — you will have an increase in volumes, and then the market goes back to normal. The important thing in all of those things is that the market functioned normally. The liquidity was there — we did six times the normal trading in currencies in Asia, and there were no hiccups. The market is functioning properly. Higher volumes improve revenue. Clearly, we’re seeing increased client activity. That is good for us. We’re a flow house.
Turner: In the UK, it seems like every day or week there is a new development that moves the market.
Pinto: You will have a similar situation with the US administration. As promises become policy, you will have the market reaction, whether it is good or bad. The important thing is the market is functioning properly.
Turner: In all of the postelection analysis — and there has been a huge amount — there hasn’t been much to say about liquidity in the bond market. It seems to pass this test with flying colours.
Pinto: The markets functioned effectively. We didn’t have big gaps without volume. But liquidity is still a concern. There is a lot more capital per unit of risk. We have a lot more capital, we have a lot more liquidity, and therefore when the time comes, the amount of capital available to facilitate the intermediation process is less than it used to be.
There is a lot more capital per unit of risk. We have a lot more capital, we have a lot more liquidity, and therefore when the time comes, the amount of capital available to facilitate the intermediation process is less than it used to be.
In very extreme scenarios, around surprise events, you can get gap moves. You saw that with the pound around Brexit. It did trade in an orderly way, but it went from close to 1.50 to around 1.32, or something like that. Who knows what it would have been in a different capital environment, a different liquidity environment. The important thing is that during the Brexit, the algorithms that provide liquidity in the market were functioning. They were constant. They never stopped providing liquidity.
Turner: Brexit, the election of Trump, the Italian referendum maybe, they all seem to be breaks from the status quo. Everything is new. There’s a new party in government in the US. The UK is leaving the EU. Who knows what is going to happen in Italy. The market suddenly has to make sense of a lot more new information. Does that create more volume going forward?
Pinto: Probably. The important thing is that the market functions rather than the events or nonevents. The important thing is that at the time an event happens, the market should continue providing liquidity. When asset managers or clients need to reposition their books, in whatever direction, the market liquidity is there at a certain price. Higher volumes and more volatility in a continuous market, where it doesn’t gap, is a good thing. That’s our business. That is a positive thing. The last two or three events were positive events because there was volatility in a market that was functioning.
Turner: There is this distinction between good volatility and bad volatility.
Pinto: Bad volatility is where the market gaps and no one can trade in the middle. These recent moves have been continuous moves.
Turner: So with all that said, what are your expectations for 2017? Will the momentum from 2016 extend in to next year?
Pinto: It probably will. In the US, pro-growth policies will extend the expansionary cycle. There will be more action from the Fed, and that will create more opportunities on the interest rate side. Whatever policies the US takes on trade and globalization, it will have an influence on what does or doesn’t happen in emerging markets. You have plenty of events taking place in Europe. You have a new government in Italy, elections in France and Germany. You have the initiation of the Brexit process. There are plenty of things that create a benign environment for volumes. Growth in the US will create more opportunities in M&A, in equity capital markets. Some of the momentum from this year may go into next year.
Turner: You mentioned Europe. How does that market look? European banks have been struggling.
Pinto: The good thing, when you look at the results for the third quarter, it’s not that just one bank did well and everyone else did terribly; it’s that everyone did better. When you are restructuring your company, as a lot of European banks have been doing, you would prefer to do that when the wallet is growing rather than in the environment we’ve had for the last four or five years, where the wallet is continuously shrinking. It is good for the financial-services industry in general. A bigger wallet will make life easier as these companies adjust. That is a positive event for European banks, for us and everyone else, too.
Turner: Have we reached a turning point in the revenue environment, then?
Pinto: Probably, yes. In equities, we’ve been growing and growing, and now the wallet is shrinking a bit. We’ll see what happens next year. We have cycles. If you’ve been growing for a number of years, you sometimes have a period of consolidation. In fixed income, we’ve been shrinking for such a long period of time, I think this may be the first year that we’ll see growth.
In fixed income, we’ve been shrinking for such a long period of time, I think this may be the first year that we’ll see growth.
I expect that momentum to continue into 2017. In banking, there has been a substantial contraction in the wallet in equity capital markets and some contraction in debt and M&A. I don’t see why for next year, given where we are, the wallet for banking will be any lower than this year. There will probably be some upside there, too.
Turner: On the fixed-income side, that market changed a lot in that extended period of contraction. There are fewer traders. New technology has been introduced. Is that work finished? Or do you still have work to do?
Pinto: We’ve been doing a lot of work. Some portions of the business are more electronic than they used to be, and that process may continue. For me, I’ve made it very clear, it is a business where success relates to your scale. To maintain your success, you have to maintain your scale. To maintain your scale, you have to adjust to however your clients want to execute. That is why David Hudson, who runs markets execution services, is creating an environment for the clients to execute through us in any way they want. That is not over. It will continue. We will continue to adjust because we’re mirroring what our clients want.
Turner: For a lot of these markets, they’re undergoing change right now, and it’s not always that clear what they’re going to look like in the future. What have you learned along the way? And have there been failures along the way?
Pinto: The SEF aggregator is something we built, and no one uses it. Maybe they will one day. The world for me — the way I see it, for asset managers, more and more of their business is going to passive. That is the trend. Margins are compressing. Efficiency in the way they execute is more and more important, and so we need to face that. We need new ways to do things that are more effective for them.
David has a very good graph that has the components of the trade cycle, from client onboarding, to how they consume research, how they use pre-trade analytics, how they execute on our platform, how that cycle goes into settlement, into custody. For example, I spent a lot of time at our investor day talking about how the investor-services business, the custody and fund services business, will have to transform. All these clients, their margins are compressing, so they may not be able to do a lot of the things they do today. They may not be able to maintain big middle and back offices. They have to outsource that. We want to do that in a way that is scalable. What David is doing, looking at these products and the cycle of a transaction and making it more client-friendly, more cost-effective, easier to use with better analytics, better execution, that is what he is working on and we are investing in.
Turner: Doesn’t that also eat away at your margin? I understand that you’re trying to prepare for the future, but don’t you cannibalise your current business in the process?
Pinto: We have no choice. The worst mistake that you can make, in my view, is to try to hold on. If margins are going to compress, they are going to compress.
The worst mistake that you can make, in my view, is to try to hold on. If margins are going to compress, they are going to compress.
Either you roll with it or you ignore it. If you ignore it, you will lose your scale, lose your market share — you’re going to be in a bad place. If you embrace it, you can always control costs. That is why scale is the key of this business. There is no way that you can become profitable in fixed income by cutting costs or cutting lines of business. It is about having the scale and processing that volume in the most efficient way possible. That’s what it is. You have to be as effective as possible, and if, with all that, you’re not profitable, then pricing has to adjust.
We have the evidence in businesses like the repo business. The spread did adjust. It wasn’t a question of being efficient or having scale. It just wasn’t profitable on any scale. And pricing adjusts.
Turner: Can you explain this chart that Jamie doesn’t understand?
Pinto: This is fully loaded ROE for all the business lines in fixed income. This is what we produce. This line is the cost of capital, and every single business, on a fully loaded basis, is delivering a return ahead of the cost of capital, except for commodities, which is going through a process of adjustment. The most important part is if you were to eliminate one of those, not all of the capital goes away, not all of the cost goes away, so essentially the marginal impact, the ROE you would lose by closing the business, is far higher than 15%. That’s why, for me, the completeness is very important.
Turner: Why is that? Is that shared infrastructure?
Pinto: It is shared infrastructure. Revenue flows go away, but capital related to operational and credit risk doesn’t. That doesn’t change just because you close a line of business. It just gets reassigned to different businesses. That’s why when you start cutting you say, “I don’t like rates — I’m going to cut rates,” well, the marginal ROE of what is left is worse. And as you cut more, it gets worse and worse. In my view, when you start trying to cut costs in this type of business, you don’t know when you’ll stop cutting. The more you do, the more painful it will become — all in an environment where the wallet has been shrinking.
Turner: Right. It’s not like Jenga. You can’t push one bar out and leave all the other business lines untouched.
Pinto: The more you cut, the less you can do for your clients.
The more you cut, the less you can do for your clients.
By definition you’re going to cut the business that is less profitable, but that is a business that may be very important to your clients. Let’s say you cut rates. You know that the marginal return that you have left will be a bit worse. To compensate, you need a higher market share in your remaining products. It’s not obvious that the clients that need that product that is less profitable will reward you with business that is more profitable. The complete set of products is important.
We were in a privileged position where we had scale, we didn’t have to cut major businesses. We only cut the pieces that were less relevant to the franchise, or from a regulatory point of view, the things that a bank shouldn’t do in this environment, like physical commodities.
Turner: A lot of people who used to do X, Y, and Z have now decided to just do X and Y. Their focus on those remaining businesses then becomes much more intense. X and Y is all they have left. What does that look like?
Pinto: That’s absolutely true. An example of that is equities. We will see how it plays out when equities goes into a down cycle. Everyone said, “We’ll cut fixed income and focus all of our energy on protecting our equities franchise.” Fine. Equities was growing. Now we have the first year where the equities wallet shrinks, and we may have another one. I don’t know.
Turner: You’ve talked in the past about focusing on client profitability, and it’s a topic in the news right now. How does that process work?
Pinto: We look at client profitability on a long-term basis, not just this year. We measure quite accurately all of the resources we provide to the clients, capital, liquidity, the cost of everything, and then we give them credit for the resources they provide to us. They could leave their deposits with us. And then any other business we do, we calculate a marginal ROE, an absolute ROE, and we look at cycles rather than just one year. What it does is it gives you information to manage the relationship with the client. You can sit down with the client and say, “This is what it is, over the last number of years it has been X,” so they know where they stand with us. It helps the salespeople to have an intelligent conversation with the client.
Turner: On a related topic, one recent hire that caught my eye was the appointment of Debra Herschmann as head of user experience for the corporate and investment bank. What does that encompass? And how important are things like user experience or design standards at a time when more and more trading is being done electronically?
Pinto: It is very important. You want to have a setup where when you onboard a client, you onboard them once for all the products, rather than having to do it 17 times. When you go into the markets business, if you are an equity client, you want to be able to direct them to the things they’re interested in, rather than them having to navigate everything. Research gets delivered to them the way they want to receive it. They can access our trading platforms and analytics in a way that is useful for them. It is all these little things, throughout the transaction life cycle, that you want to make better.
We’ve been public about the work we’ve been doing with BlackRock on Aladdin. We are essentially integrating their infrastructure with ours to reduce the manual intervention in the settlement and custody process. Aladdin is being used by many of our clients, not just BlackRock. All these things should make it easier to connect and transact and monitor your positions.
Turner: It’s interesting that you bring up the partnership with Aladdin, as I wanted to ask about your partnership with Virtu in the rates market. It speaks to this trend of establishment players partnering with newer, tech-savvy firms.
Pinto: There are layers to the markets business. The first layer is the client franchise. That is ours. Then you have the middle layer, which includes order routing, algorithm, that kind of thing. Connectivity is the lower end. The algorithms you have, that is a lot to do with the microstructure of the market, so how do you split an order and route it in order to have the best possible execution. Virtu are very good at that. Could we extend this into other things? We could. In foreign exchange, we do all of that ourselves. In other asset classes, we will do it ourselves. But if there is someone who can add value to us, we will be very open to it. Could we do more with Virtu? Yeah, we could. At the moment, we are testing the things that we’re doing with them. This piece in the middle, they are really very good at it. In that particular asset class, we hadn’t focused on it enough. Their infrastructure and their connectivity is really good.
Turner: So we can expect to see more partnerships in the future?
Pinto: You cannot afford to not have the best technology in the organisation.
You cannot afford to not have the best technology.
In my view, that is a mix of your internal resources and partnerships, either with vendors or with companies that you’re going to partner with to deliver a product. All that talent, you need to have access to all of it in order to be successful. I have no issues partnering, or buying services from others. Clearly, we’ve been upgrading the technology of the whole organisation in the last few years. All of the things that we do, it is all about having access to the best possible talent.
Turner: How do industry utilities fit in to that?
Pinto: Industry utilities are a bit more challenging. I am quite keen on them, but they tend to be more difficult. For example, KYC (Know Your Customer) would have been a perfect example of an industry utility, and so far we haven’t really got there. The industry has tried with DTCC and others. At some point we will, but it looks like it will be a slow process.
Turner: To what extent is that because there are too many voices around the table when you enter into an industry consortium?
Pinto: It is often easier when you partner with someone, make some progress, and then bring other people in, rather than getting a bunch of banks together and get them developing something from zero.
Turner: You referred to the need to access top talent. How do you do that, exactly?
Pinto: I think that in order to attract talent, you have to run the company in a way that is appealing to them. That’s why we have a clear technology strategy, and have communicated externally about how vibrant and flexible JPMorgan is. It’s a way to attract top talent into the organisation. The more people you hire from top tech companies, the more talent comes along with them. You have to do what is right, and you have to communicate it too. The reality is that it is a vibrant institution, we’re looking forward, we’re successful, so therefore people want to join. We haven’t had a problem attracting talent. Seventy-seven per cent of our new hires into the corporate and investment bank last year were millennials, and they already make up more than 50% of the organisation.
Turner: You’re a big institution at a time when startups are considered cool and finance isn’t as sexy as it once was. Don’t you have to fight those perceptions?
Pinto: The industry might have been shrinking for a number of years, but we were not, so that is helpful. And technologists like challenges. An industry that is going through such a deep-process transformation, where it has so much legacy tech that needs to be changed, when you have the challenge of moving from internal infrastructure to the cloud and you’re redeveloping all the applications, that has its challenges. We’re able to source people from tech companies, and they come here because they find these challenges interesting. I feel like we’re in a good place.
Turner: The last thing I wanted to ask you about is regulation. There is a new administration. There is talk of Dodd-Frank being repealed. What does that mean for JPMorgan?
Pinto: Almost every regulation that is in place, in my view, serves a purpose. Most of the time it is a rational piece of regulation, but there is a lot of overlap. This government, or any other government, at some point will have to think: “We’ve put all these regulations in place. Which of those are really necessary? And which of those are overlapping one another? And what is affecting the economy?” Someone will do that at some point. I think that is a good exercise. I think the banking sector is in a good place. It’s better regulated. It is far more secure in terms of capital, liquidity, and controls. That’s a good thing. But the pile of regulations, one on top of the other, has created a degree of bureaucracy and cost for a sector that is a bit challenged from a returns perspective.
The pile of regulations, one on top of the other, has created a degree of bureaucracy and cost for a sector that is a bit challenged from a returns perspective.
At some point, that needs to be addressed. Someone starting that process would be a good thing. It doesn’t mean at all that you want to go back to a place where you create risk. That is not what we’re looking at. There is a lot of noise about the Volcker rule, whether that stays or goes. We will not do anything differently at all if the rule is eliminated. The way we would do business would not change. We may avoid some of the bureaucracy around all the reporting and checking and all of these things, but the way we do business would not change.
Turner: That gets to another question. If the rules are rolled back, and let’s say proprietary trading is allowed again, would everyone suddenly rush back into proprietary trading? Or would they say: “You know what, we’ve learned our lesson. We probably shouldn’t do that again.”
Pinto: Well, we were never big in prop to begin with. We are not going back. Our business is built around taking risk to provide clients with liquidity. Are we going to do anything massively different? The answer is no.