Brexit job moves, Deutsche Bank and Barclays' disappointing Q3s and Gordon Brown's book.
Patrick Jenkins and guests discuss how "back-to-back" trading mechanisms could help keep more jobs in the City post-Brexit, why Deutsche Bank and Barclays had such bad investment banking results in the third quarter and the hottest banking revelations from the new memoir by former UK prime minister Gordon Brown. With special guest Jacqueline Mills of European bank trade association AFME.
Presented by Patrick Jenkins and produced by David Blood
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Welcome to Banking Weekly from the Financial Times with me, Patrick Jenkins. Joining me in the studio today is Martin Arnold, our Banking Editor. And we have a guest from AFME, the European banks' trade body, Jacqueline Mills.
This week we'll be discussing the latest news on Brexit and banks' potential mitigation of job moves into the European Union. Also, a look at Deutsche and Barclays and pretty bad quarter three results from Europe's biggest investment banks. And finally, a look at Gordon Brown's memoir. What does he say about 2008?
First though to that tale about city of London banking jobs and a potential mitigation tactic, which we've been reading about over the past few days. Martin, this was sparked really by something that UBS said alongside its quarter three numbers last Friday where Sergio Ermotti, the Chief Executive, said that the number of jobs that they planned now to relocate to the EU 27 was going to be far less than they originally thought, 250 instead of 1,000. What do you think is going on?
About a year ago, or even earlier than that, even before the break Brexit vote itself, banks were pressed to estimate how many people they might have to move if the Brexit vote went in favour of leaving. So banks laid out kind of the worst case scenarios. And I think now what's happening is that as the negotiations progress, albeit very slowly, and the UK government seems to be coming round to asking for a lot of things that the banks have been saying they want, most importantly, the transition period, implementation period If you want to call it that, whereby from the date where the UK leaves the EU, there will be a kind of extension period of a couple of years at least that allows-- an adjustment period that allows businesses to adjust to the changed environment and to the new rules, whatever they are. And perhaps time also for the UK and EU to finalise those rules and to set up a new trading relationship between the UK and the other 27 countries in the block.
And so that's given bankers some optimism that perhaps it's not going to be as sudden or as brutal as perhaps they first feared, because they have had to assume the worst in their contingency plans, which regulators have forced them to draw up. And they've had to look at the worst case scenario of a totally hard Brexit and a cliff edge-type event where the UK leaves in April 2019, and there's nothing to replace its relationship except for WTO rules, which don't really include anything on financial services. So in theory, much of the business they do between the UK and the EU could be forced to stop in that scenario.
Now one bit of jargon that's emerged over the last few days around this whole debate, and that we gather is kind of crucial to UBS's view that maybe job moves don't have to be so dramatic-- and also we're hearing this from some other banks as well-- is this term back-to-back trading, or back-to-back transactions, which is basically a way in which banks may book their transactions locally on the ground in the EU, but then carry out a parallel transaction in London, essentially keeping a lot of the trading activity and a lot of the risk management in London rather they having to relocate all of those jobs to Europe.
Now to kind of explain more about the technicalities of that and whether this is a really appropriate tactic to pin city job hopes on, I'm joined by Jacqueline Mills from AFME. Jacqueline, welcome. Thank you for joining us.
I outlined there rather, probably, clumsily what back-to-back is. Maybe you can tell us a little bit more and a bit more precisely, and how it's been used up to now. I don't think it's something that's actually that complicated. It basically involves different entities within the banking group transferring risk or exposures between themselves in a kind of matched way. So it's a way of passing on risk and exposures from one entity to another. And banking groups usually use this in order to be able to centralise risk management functions. So to take risk and manage it in a place where there is the best set of skills, where they have the best capacity for doing that.
And of course, this hasn't been necessary for kind of a Pan-European banking operation up to now really because the single market and UK'S position in the single market has meant that everything flows naturally within one unit. But it has been pretty important way of bringing to London a lot of international business, non-EU business, hasn't it? Particularly for a lot of the American banks.
Well, yeah. So actually, you back-to-back transactions are nothing new. They're done today between different entities. And UK banks will do them with group entities in other countries today too. So it's not actually a new technique, if you like.
But do you think it's going to be a likely tactic that is plausible to manage the post-Brexit situation?
So in terms of local EU 27, supervisors might be requiring-- on the ground, do you mean?
Yes, absolutely. It is going to be a kind of balancing act, isn't it? Between satisfying local regulators who might want risk managers on the ground and what the banks might want to keep as efficient as possible while keeping a lot of these operations in one single place in London, for example.
I mean, it is a technique for risk management and capital efficiency. These transactions are allowed today. The regulatory framework allows for that today. The issue is that supervisors will always want to be sure that if something goes wrong, so with the back and the back to back.
So in this case, it's let's talk about transferring risk from a subsidiary entity in the EU 27 to a parent perhaps in the UK, the EU 27 supervisory authority is going to be concerned that if something goes wrong and the parent in the UK default, the entity in the EU 27 for which it is responsible can manage residual risks, unwind any transactions that it needs to so that that entity doesn't create a financial stability risk to the EU 27 system. So they're still going to want to have sufficient local risk management capabilities in place for firms to deal with that risk, which is a worst case scenario kind of risk. The local host supervisor will always want to be reassured that what is present in its territory can handle the risks it might be exposed to.
That's a crucial point, isn't it? Getting this balance right. Let me bring Martin in for a final word on this, because it's interesting that the noises we're hearing from some banks, not least UBS, are that they've been reassured by regulators in Europe that they're happy for this back-to-back transaction structure to go on for some time after Brexit. I guess it's an open-ended question as to how long that would last. But they seem surprisingly happy about this.
Yeah, the European Banking Authority came out a few weeks ago with its first position paper on Brexit. And it said that back-to-back transactions would be allowed, but it warned very sternly that what it didn't want local host regulators to allow was the setting up of shell companies, which have very little in terms of risk management capacity or capital. And I think capital is the crucial thing here because the banks manage their businesses and allocate assets around the world based on trying to get the most capital efficient model.
And the reason for doing back-to-back transactions in the first place is so that they can have a lot of the risk, not just from European trades, but trades from around the world, Asia, Africa et cetera, all in London, all centralised here, managed here with capital against that here, because they've got some economies of scale, if you like, of putting all those trades together and managing them here. And if local host regulators in the rest of the EU allow them to do back-to-back transactions but force them to keep quite a bit of capital locally, that's going to essentially remove a lot of the benefits from doing that.
So I think in the end, a lot of the outcome of this and whether or not banks can keep a lot of their operations in London or not will not just come down to what kind of deal is negotiated between the EU 27 and the UK, but it'll come down to how regulators implement it at a local level and what they require each bank to do with each office, with each transaction, how much capital [INAUDIBLE]. And so that kind of thing is going to be-- the proof of the pudding is going to be in the eating.
A lot of uncertainty still remain, clearly. Well, thanks for that, Martin, and thank you also to Jacqueline Mills from AFME.
Well, let's move on to our second story and look at the results from Europe's two big investment banks, Deutsche and Barclays, which are obviously universal banks as well, but it's their investment banking operations in the third quarter of the year that have attracted a lot of attention. Pretty bleak reading, those numbers. Martin.
Yeah, they weren't great. I mean, overall, both Barclays and Deutsche reported a big jump in quarterly profits for the groups as a whole. But there was a lot of noise in the numbers. And what most investors seem to focus are the large investment banks that both groups contain, and have been for years struggling to turn around their performance of those, particularly the trading businesses. So the fixed income currencies and commodity trading businesses in particular are the source of a lot of angst, and particularly shareholder angst. And management, both banks have been investing a lot of time trying to turn that around.
Barclays and Deutsche both historically have been more fixed income focused houses rather than, say, M&A advisory or equity trading houses. So that's really their core strength. And that's the area of investment banking that has had the most problems recently because of this extraordinary low period of volatility in fixed income markets, which is a product of the record low levels of interest rates around the world.
And therefore, there's really no spark for investors to trade government, bonds or to trade interest rate swaps, or to trade corporate debt. It's just very quiet out there. So there isn't a lot of business for the traders to do. So they're not making very much money. And that is a big problem for Barclays and Deutsche because already they have fallen behind in market share and in return on equity and in just revenue, behind their big Wall Street rivals who are all surging ahead. And these two big European banks are really struggling as to what strategy to come up with to cope with this environment.
Now as you said, both of the banks are of so-called FIC specialists, fixed income specialists. But their FIC business has suffered more than the US banks' FIC businesses. Why is that do you think?
It's a good question. I think the US market has been slightly more buoyant than-- or slightly less quiet maybe than the European one. And the likes of JP Morgan, Citigroup, Morgan Stanley, Goldman Sachs, and Bank of America have obviously a naturally stronger and have a bigger share of the US market than Barclays, and particularly Deutsche do. The Barclays and Deutsche are stronger in Europe, which has been quieter.
We saw this week with BNP Paribas' results that they had a 25% fall in revenues from their fixed income trading business. Deutsche's was down 25% if you strip out a business that they-- the impact of stripping out one part of that business. Barclays was down more than 30%. The US banks were down between 15% and 25%. So there really is a difference there. And I think it's explained by the fact that the US have already started raising interest rates, and therefore, there's a bit more activity in the US.
Now the third quarter was always going to be a tough quarter for these banks because if you remember the third quarter last year was after the Brexit vote, and there was an awful lot of activity and volatility in the markets that drove trading activity for them all. So they had a good third quarter last year and the comparisons were always going to be tough this year.
Now I think it's also worth pointing out between Barclays and Deutsche that they are at slightly different stages because Deutsche held on for longer before launching a restructuring of its investment bank. And it's in the middle of still cutting jobs, and it's still in the middle of trying to restructure itself to get to a point.
Whereas Barclays says, and Jes Staley, the Chief Executive, says, the restructuring of Barclays is done. They're finished. And so therefore, they're going back on looking for growth. They're looking to regain market share. They're looking to invest again. They're transferring assets and capital from low returning business in the corporate bank into the trading businesses, some of the trading businesses to try and regain some of this lost market share. And that's got some investors in Barclays quite concerned because they say, well, that's the lowest returning part of your business. Why are you putting more resources into that? Why not either return it to us or put it into your credit card business or your UK retail business, which are much higher returning?
Deutsche, slightly different debate. As I say, they're still in the middle of a restructuring. So they're still a year or two from coming out the other end of that. And also, Deutsche don't really have other businesses to fall back on. So there isn't the same debate at Deutsche because they haven't got that highly profitable domestic retail banking business, and they are in the process of spinning off their asset management business, which is a bit undersized. They don't really have another big business to fall back on. So they've just got to fix this investment bank.
And as you say, shareholders getting impatient with both chief executives. It'll be interesting to see how many quarters of underperformance those shareholders will accept.
Let's move for our final segment to look at Gordon Brown and an interesting memoir that he is publishing. It looks back to the financial crisis. And there's some great nuggets in there, Martin, relating to his memories of the events of 2008, in particular. What's your top pick?
Gordon Brown is a pretty controversial character in the city. He-- no friend of the banks. But he's credited with a lot of people in having stepped in after the financial crisis as British Prime Minister and got the G20 countries to come together and agree, a kind of post-crisis consensus, on the need for all the banks to raise their capital levels and to introduce certain financial stability rules that should prevent a future crisis. So he's a bit of a marmite figure, if I can call him that. You know, you either love him or you hate him.
But he certainly isn't a natural friend of the banks. And that comes through. He's very, very critical of the British banks, particularly RBS and Barclays. He's very critical of the fact that bankers' pay remains extremely high, that the banks remain guaranteed and reliant on a government guarantee should things go wrong. And yet-- so they have reward for failure is his argument.
He also says that it's a scandal that no bankers have been sent to gaol. I would say that actually, that's not quite true. We've obviously had several of the libel traders, including Tom Hayes, the ex-UBS and Citigroup star trader, who are serving gaol time right now. And we, of course, had the HBOS bankers, who were convicted earlier this year of defrauding small businesses. HBOS, they're in gaol as well. So it's not totally true that bankers haven't been put in gaol for pre-crisis actions.
But I guess what he's talking about-- and he focuses a lot of his attention on Fred Goodwin and says it's a scandal that he was allowed to keep his bonuses, that he didn't have to give up all of his pension, that he wasn't banned from ever working in the city again-- not that he ever has worked in the financial services industry since he quit after Gordon Brown's government bailed out RBS to the tune of $45 billion pounds.
One extraordinary nugget that Gordon Brown throws into his book is this idea that Barclays, as well as bidding for Lehman Brothers in 2008, also tried to buy RBS at the peak of the crisis. I mean, I find that pretty extraordinary idea. I've checked it out with Barclays and a few investment bankers who were involved with those banks at the time and nobody gives it very much credence. But it does show the extraordinary combinations that were being talked about at the time I suppose.
And in the comments section of the article today online, a lot of our readers have made the point that it's quite hypocritical of Gordon Brown to be criticising the state of British banking today when he was the one who put in place a lot of the post-crisis rules.
And of course, that pre-crisis, when he was Chancellor of the Exchequer, he arguably stoked the boom.
And he oversaw what was touted as a light touch regulatory regime, and a very welcoming jurisdiction for international banks to come and trade a lot of these assets. So that's, so yeah. He went-- I mean, he does address this in a way. He says that he only got part way through his reform ideas and plans for the sector and would have liked to have done a lot more. He talks about a financial constitution that he would have liked to impose on the sector worldwide, but he said that he ran out of time.
Well, that's exactly the same as us. On that note, that's it for this week. All that's left for me to do is to thank you, Martin, and also to thank our guest, Jacqueline Mills from AFME. Remember, you can keep up to date with all of the latest banking stories at ft.com/banking. Banking Weekly was produced by David Blood. Until next week, goodbye.