Scheldt Capital

Week in review: The cavalry has arrived

Like in a classic Western, the cavalry was late but arrived eventually. There is a pervading sense that banks’ funding problems are all but gone thanks to the recent interventions of the ECB. The pattern is copied exactly from the Fed and Bank of England, the cheap funding allowing banks to generate extra profits that reinforce their capital position. The effect on the credit markets was almost immediately visible with CDS spreads dropping sharply. Investors are also less risk-averse, re-entering markets that previously shut down, for example junk bonds. Still, a lot of caution remains and banks have been given a reprieve rather than having all their problems solved.

It was a busy week for market infrastructure, where consolidation (or lack thereof) is still the order of the day. EuroCCP provided a nice illustration of the pressure central counterparties face, as it announced significant market share growth by clearing trades at cost. As a result, the race for size is still very much on, with both NYSE Euronext and CME throwing their hat in the ring for the London Metals Exchange. On the other hand, in what is becoming a familiar pattern, question marks are being raised over the tie-up of the Tokyo and Osaka stock exchanges, with squabbles over valuation.

Lastly, the weekend provides a perfect opportunity to delve into some longer and broader pieces. Two weeks ago, New York Magazine looked into the structural changes hitting the financial industry after the crisis and the impact on bankers. The overall mood it paints is that of a reluctant acceptance that the crisis was not a blip. Some hard, painful changes will have to happen that are likely to have a permanent impact on the economics of the industry and even its attractiveness to potential employees.

Even broader, Fast Company has two related articles on the changing nature of business and work in general. Uncertainty in business is at its highest level in many years, giving rise to “Generation Flux”, whose members are aware of the chaos and look to capitalise on it. This is having a direct impact on work, the era of the 30-year career at one firm is gone and replaced by much shorter stints in different industries, leading to employees with a very diverse set of skills and original insights. It is interesting to contemplate how these changes affect your personal and corporate “business model.”

Week in review: everybody’s in Davos

Somehow the news seemed slow this week, perhaps owing to the fact all the world’s good and great are hobnobbing in Davos. Nonetheless, some newly installed bank CEO’s decided the potential negative impact on their image was too big and decided not to attend. One not-so-new CEO who is prominently present is Vikram Pandit, who is co-chairing this year’s edition. He ensured he would have a talking point by writing an op-ed for the FT the week before calling for more transparency in bank’s risk management, which was well received overall.

In other words, a good week to catch up on some background topics. The Banker has a great overview of the impact new regulations will have on the banking industry. It looks at the changes required in capital and liquidity, and more importantly how the business model of the banks will be affected, hitting upon the major emerging theme for 2012.

From a pure finance point of view, more and more people are starting to call into question the “efficient markets” hypothesis. What seems to be gaining credence on the other hand is trying to predict sentiment by analysing social media. This seems to have predictive power for stock movements. It will be interesting to see whether these trends combine and lead to new valuation models used in banks. And lastly, more evidence of another major theme of the moment, the rise of China: at the Big 4 accounting firms, headcount in China is about to overtake headcount in the UK.

Scrutinising Europeank bank funding

Conflicting messages this morning on Europeank bank funding. From Bloomberg:

European banks, shunned by investors and each other, may borrow as much next month from the European Central Bank as they did in a record offering in December as they seek refuge from frozen funding markets.

There are two arguments supporting this statement. The first one is technical and refers to the fact that the ECB is again (carefully) widening its list of acceptable collateral and the banks will (rationally) take advantage of that. The second is obviously macro-economic sentiment (“shunned by investors”), but it’s not at all that clear that it holds anymore. In fact, it seems that the signaling function—the ECB will act as the lender of last resort—associated with the refinancing operations is working. Says FT Alphaville:

US money market funds have begun moving back into European bank paper, a sign that central bank efforts to backstop key institutions are improving risk appetite

There other other indicators that the ECB operations are working, most notably falling yields on sovereign debt, and they should, since it is in effect the same recipe as the one used by the Fed and BoE, just implemented a little later.

Week in review: shifting business models

Banking business models

The week saw more signs of a shift in banking models, with all banks still under pressure from the fallout of the financial crisis. Goldman Sachs’ results were telling; although their profits exceeded expectations, this was despite revenue falling even more than expected. The most worrying sign is the return on equity (RoE), which came in at 3.7%. With all the regulation constraining capital and leverage, it is becoming increasingly clear that RoE targets of 15% are unattainable. The effects of the crisis (financial and sovereign debt) are widespread: even custodian banks are feeling the effect of a decline in trading and a shift to cash.

On a positive note, it seems banks are waking up to the transformative potential of technology. In the UK, the Payments Council is looking to set up a database linking customers’ mobile phone numbers to their bank account, to enable money transfers using mobiles. In Spain, BBVA has again teamed up with Google, but this time to market economic indicators that are based on search statistics. Faced with the slowdown in their traditional business models, I would expect many more such initiatives in the coming months.

The regulatory debate continues

Meanwhile, regulators everywhere are still working to shape the industry’s regulatory framework. The European Commission launched a review of its policy on bank structure, prompted by the proposed ringfencing of retail banks in the UK. China nicely illustrated the macro-economic impact of these regulations by explicitly relaxing its regulatory constraints to give its economy a shot in the arm. At any rate, if this piece by The Reformed Broker on BofA’s appointment of a “Chief Image Officer” is any guide, the political pressure for more regulation is unlikely to abate soon.

Week in review

Economic uncertainty continues

Mario Draghi earlier this week stated that the ECB strategy for battling the eurozone sovereign crisis was starting to work, only to suffer a setback yesterday with S&P’s ratings action, stripping France and Austria of their AAA rating and downgrading Italy to BBB+ from A. Beyond the obvious impact on investors, there will also be a technical impact for banks, especially in Italy, that may now be unable to enter into critical swap agreements, for example.

Banks still affected by economic situation

The effects of the economic turmoil in 2011 on banks’ results are plain to see. Expectations are that banks’ profits for Q4 2011 will be lower across the board. JP Morgan announced a 23% drop in profits yesterday, ahead of announcements from most major banks next week. The lack of confidence engendered by the eurozone crisis is most often cited as the reason for the lacklustre performance.

Unsurprisingly, 2011 has been a bad year for employment in the banking sector, with the WSJ positing that the job losses reflect more than a cyclical dip. Last year also saw an unusually large number of partners departing from Goldman Sachs, mainly due to the shrinking business, although they may just have decided they were wealthy enough and called it a day.

Hedge funds arguably came out of 2011 looking even worse than banks however, with 60% posting a loss, even though they should nominally be able to make profits in down markets.

Regulatory pressures continuing

Meanwhile, the introduction of new regulations for the financial markets continues apace. The Basel Committee declined to extend the deadline for banks to meet imposed liquidity buffers, although they offered some concessions on the level of the buffers in times of crisis and the overall composition.

In addition, the Financial Stability Board extended the applicability of the “too big to fail” rules to include what it calls local “systemically important” institutions (i.e. within a country) and also clearing and settlement institutions. With regulators wanting to see more OTC derivatives trades cleared through CCP’s, this rule makes sense, but it will be interesting to see how the CCP’s and their clients respond.

Market infrastructure consolidation continues to rumble

In the market infrastructure landscape, the week was dominated by the news that the European Commission advised blocking the proposed merger between Deutsche Börse and NYSE. Apparently undeterred by the failure of $37bn in deals last year however, Nasdaq is reorganising its top management structure, perhaps to facilitate future takeovers. The last word on consolidation in the sector has not yet been spoken.

Technological evolutions

Finally, Spanish bank BBVA announced it is moving all its 110,000 employees to Google Apps, including using Gmail for email and Google Docs for office productivity. Bold move.

Targeting the ECB’s “stealth bailout”

Slate’s Moneybox takes issue with the ECB’s “stealth bailout” of Italy:

Basically, as an alternative to directly guaranteeing the Italian government affordable loans the ECB is guaranteeing super-cheap loans to European banks. The banks are then able to plow that money into government debt at a profit and the strong demand for government debt assures that borrowing costs fall. [….] The whole thing is incredibly slimey and I have to suspect that it will end poorly, but for the time being at least it’s working.

Of course, not only are the Fed and BoE using exactly the same mechanism in the US and UK, by providing banks collateralised funding nearly for free (albeit at shorter tenors), they also add a big dollop of QE on top. Primary dealers in government debt are being encouraged to buy bonds from the Treasury, which the central banks then buy back at a higher price. Result, governments are funded, yields go down, banks make profits and are thus able to recapitalise.

In fact, the above was a stated objective of QE when it started in 2009. The ECB was never able to do this due to German opposition, at least until the agreement on deeper fiscal union in December last year. With that in place, this intervention by the ECB was to be expected and it is merely playing catch-up with the US and UK.

The Digest - Weekend edition

Business Week profiles Palantir, whose software is used by police and intelligence agencies to detect and disrupt terrorist plots. The data mining software is now also used by banks to detect fraud and even generate trade ideas. — Business Week

Moving OTC trading to a central counterparty (CCP) is often seen as a silver bullet to reduce systemic risk, but as it turns out it’s not that simple. — Deus Ex Macchiato

And with all the attention for sovereign ratings these days, this post from Nate Silver, written at the time of the US downgrade, puts their value (or lack thereof) in perspective. — FiveThirtyEight

The Digest is an overview of interesting stories in financial services technology and management.

The Digest

Another “Banks’ business models will have to change” story, this one looking at cost of funding and impact on lending. — FT

Hedge funds are delevering, due to banks having to reduce their lending and increasing margin calls on their positions. — Reuters

The European debt crisis in eight graphs: nice overview of the economic forces at work. — Wonkblog

The Digest is a daily(-ish) overview of interesting stories in financial services technology and management.

The Digest

ING chief says assets cannot be sold on fair terms in the current market and asks the EU to relax its demands for disposals following state aid — Bloomberg

“Tech is the new rock’n’roll.” The UK government pins its hopes for an economic revival on the startups of Silicon Roundabout. — The Guardian

An interesting idea for saving the Eurozone: conditional eurobonds. — vox.eu

Bloomberg is steadily turning itself into a full-fledged, vertically integrated media company, moving far beyond its roots as a financial data provider. — Daily Beast

Disintermediating the financial intermediary: peer-to-peer lending companies see business soar. — FT

A UK regulator calls for an end to free bank accounts and for more pricing transparency in retail banking. — FT

The Digest is a daily(-ish) overview of interesting stories in financial services technology and management.

The Digest

There are two major themes in today’s links, so it made sense to group them accordingly.

First off, the ride isn’t getting any easier for banks. They are having to scramble to raise capital and are reluctantly coming to terms that there are many more lean years ahead.

“If the book value of a bank is higher than the share price, […] the book value is going to be diluted.” Banks’ share prices all factor in future capital raising — FT

In Spain, Santander and BBVA are using all possibilities, including asset disposals and innovative securities, to increase their core Tier 1 ratio. — FT

Meanwhile, in Japan Nomura is also looking at selling assets not directly related to its core business. — Reuters

And lastly, Deutsche Bank is looking at options for its global asset managment division. — Bloomberg

On top of all that, EU commissioner for the internal market Michel Barnier is to set up a group to study banking reform that could include far-reaching restructuring or ringfencing similar to what the UK’s Independent Commission on Banking recommended. — Reuters

Faced with this combined regulatory, market-driven and political (Occupy Wall Street?) onslaught, banks are slowly coming to terms with the new reality of changing business models and decreasing profitability. — Reuters

Secondly, market infrastructure providers everywhere have decided that the only salvation lies in size:

The Tokyo and Osaka Stock Exchanges have agreed to merge in 2013, creating the world’s third largest exchange. Reuters

And Turkey’s government plans to merge the Istanbul Stock Exchange (cash equities) and TurkDex (derivatives). — FT

The Digest is a daily(-ish) overview of interesting stories in financial services technology and management.