Why is UBS sticking with investment banking?

It raises the question: why?

The bank appears to believe that it needs an investment banking division at least big enough to be an execution desk for the private bank, otherwise that division will suffer as a price-taker from third-party providers. But the industrial logic seems questionable.

Grübel himself told Euromoney in 2010, one year after joining UBS, that what had most surprised him was the strength of its private banking franchise with high-net-worth and ultra-high-net-worth clients. He reasoned that they had been pulling their accounts only because the bank was losing money because of the investment bank’s excesses in the credit crisis and would come back to UBS as soon as it turned profitable. "No one likes a bank that’s losing money," Grübel said.

It took the firm until the final quarter of 2010 to re-establish net inflows of client money after the investment bank of UBS suffered $50 billion in write-downs from the financial crisis, necessitating a state rescue. Grübel had slowly given the industry a sense that risk management was being overhauled. Now, with a $2.3 billion loss from allegedly unauthorized trades on its synthetic-equity trading desk, UBS’s reputation has once again been badly damaged. The bank explains that the so-called rogue trader had built up speculative positions in stock index futures and then matched these with offsetting trades in forward-settling cash ETFs that turned out to be fictitious.

It explains its failure to secure confirmations of these trades by stating that this was not an established market requirement. But, following best practice rather than standard practice, many banks do require confirmations. UBS’s failure to match best practice, in light of its horrendous experiences in 2008, is baffling. The world’s wealthy must once again be wondering why they should entrust their riches to such an accident-prone institution.

Surely it would be easier just to get out of investment banking altogether?

Bruce Weatherill, founder of industry consultant Weatherill Executive Consulting, who has been working in the wealth management industry for 30 years, argues that this desire for an integrated one-bank model is misplaced. "Only very rarely in my interaction with clients do they tell me that it is necessary for their wealth manager to have an investment bank," he says. "The main reason they choose a wealth manager is based on the financial strength of the organization and this has been threatened over the last few years by having an investment bank as part of such groups."

He adds that the concept of a wealth manager not being able to survive financially without an investment banking arm is also questionable from the viewpoint of clients. "Does UBS need the investment bank to subsidize the wealth management operations? If that is the case, then one has to think they are not charging enough for wealth management. If you have a good proposition in wealth management it pays for itself."

Operating profit from wealth management (including the Swiss bank) dwarfs that of investment banking – in the first two quarters of this year it was almost twice as much as investment banking. But wealth management profits have been dropping. Full-year 2010 operating profits from wealth management including the Swiss retail bank were SFr4 billion ($4.4 billion) compared with SFr6 billion for 2008.

The former head of a European private bank says that UBS has to keep its investment banking if it wants to stay ahead in wealth management. "Private banks have to offer some investment banking capabilities if they want to appeal to ultra-high-net-worth clients. If not, those clients will simply go elsewhere."

But he adds: "What UBS needs to do is understand that the investment bank is there to service their main business – wealth management. It really needs to reorganize and structure it so the investment bank is there integrated with, but ultimately reporting to, the wealth management business."

Weatherill argues that most investment banking lines are superfluous for private banking clients. "You don’t need M&A or corporate advisory, and these days there is no longer a need to be able to arrange IPOs for clients," he says. "If you’re just executing bonds at wholesale prices that is pointless too." He says the value lies in being able to offer value-added, high-margin structured products. "So yes, they need to keep some of it. I’ve no idea why they were still in proprietary trading, however."

Wealth management profits decline at UBS

Operating profit by business line

Source: UBS

Credit Suisse provides the best example of the integrated model. Grübel himself was responsible for building that strategy as group chief executive at Credit Suisse in 2006, alongside Brady Dougan, who then headed the investment bank. It has worked well, although whether that is attributable to the integrated model, or because of Credit Suisse’s position as being the Swiss private bank that did not need bailing out, is up for debate.

In an interview with Swiss business magazine Bilanz last month, Urs Rohner, chairman of the board of directors at Credit Suisse, said it is impossible to run the type and scale of global wealth management business that it does without a capital markets business and investment banking operation, particularly for entrepreneurial emerging market ultra-high-net-worth clients, the category with the most promising growth prospects, who require more than traditional investment products.