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 Big risks remain in FICC Protium affair betrays muddled thinking at Barclays Capital |
SAM DEAN JOINED Barclays Capital as co-head of global equity capital markets almost two years ago to the day that he sits down with Euromoney to discuss the firm’s progress in building the business. “You have to remember that when I arrived, cash equity trading hadn’t started, there was no ECM team, and much of the banking platform had still to be hired. Now that we are leading major transactions, it’s hard to believe that that was less than two years ago. We have spent a lot of time ensuring that as we build each business, we keep them aligned with the others. It’s also very integrated. In my own team, we have put broking, cash ECM and corporate equity derivatives under one umbrella. At other firms these are often almost completely unco6nnected. We’ve built this the right way.”
ECM is one of the two signature investment banking businesses, the other being M&A, that the firm lacked during the astonishing growth of Barclays Capital from 1997 into a debt and rates powerhouse, after the parent bank decided to dismantle the old BZW. The acquisition of the US broker dealer of Lehman Brothers in late 2008 let Barclays back into both businesses but also handed it the task of building the European and Asian legs of the equities and ECM and M&A franchises.
That job is not yet finished, especially not in Asia where the competition for talent is fiercest and the firm still lags behind. But Barclays Capital insists that much of the investment has been made, that Europe is close to being built out and that the league tables don’t yet reflect the scale of the firm’s capabilities already assembled or their earnings power. “In Europe we are 70% to 80% through the investment; in Asia we are approximately 50% to 60% complete,” says Skip McGee, global head of investment banking.
Jerry del Missier, co-head of Barclays Capital, remains ambitious: “People should not think that we are done, though. We have always believed that the potential of the Barclays Capital platform is much greater than was the potential of Lehman’s, given that we have a much broader set of businesses and that so much market share has been up for grabs after all the turmoil and consolidation in the financial services industry. Remember that in building equity we have not been cold calling new clients. Most of these investors know us from the fixed-income markets as highly capable and committed for the long term. We see a lot more market share and revenue to come.”
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“It feels like we have crunched about five years-worth of growth into the last two years. Our challenge now is not growth, it is returns” |
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The bank’s senior executives now tell Barclays shareholders that equities will be a big contributor to the revenue gains through which they hope to restore decent returns, and so will M&A. As the best days of the FICC businesses appear, for now, to be behind them, Barclays Capital’s timing looks good. It is trying to build up in activities that offer decent revenues without demanding quite so much high-cost capital is put against them as regulators are demanding in FICC.
One of the key figures that persuaded Dean to join, US-based head of equities Gerald Donini (who sits on Barclays Capital’s executive committee) argues that the firm is now right on the cusp of the big league. “While we’ve been building, we’ve had to prioritize. The first thing was to keep the US because if we lost that we’d lose everything and we could never rebuild organically. In US ECM in 2009 we had primary market share of 5% when the leading firm had 18%. Now we’re at 9% and they’re at 12%. We’re already in the top three in equities overall. In Europe, we’re covering 460 leading stocks with top-quality research and it’ll be 550 names by year-end. On the primary side in Europe we’re in the top 10. We’re at eight for IPOs and we’ll get to the top five next year without too much difficulty.”
In Asia, he admits, it’s a longer story. The firm focused on Hong Kong in 2010. It is publishing research on 125 names and it will be 225 by the year-end. It’s picking its countries. It has hired a head of Indian equities. At the helm of the Asian investment banking business are two veterans of Morgan Stanley: head Matt Ginsburg and M&A chief Ed King. Both are among the most successful and highly regarded bankers in the region. As elsewhere, Barclays has a lot of work to do. But even rivals admit they have some put some very talented people in place. Elsewhere in the region, the firm will appoint a head in Korea. It’s looking at Taiwan, Asean, Australia. “And, as for everyone else, our big challenge is China,” says Donini.
After starting in the business at Dresdner Kleinwort Benson in 1993 and a stint at Citi, Dean had risen to be co-head of global equity capital markets at Deutsche Bank. He had taken the initial call from the headhunter in May 2009 mainly out of curiosity to find out what a large European rival might be up to.
What he heard from John Winter, then head of EMEA investment banking, and from Donini about the firm’s determination to build a research-led equities franchise based on nurturing long-term relationships with investors and issuers reminded him of the ethos of Kleinwort Benson at the start of his career years ago. It wasn’t something he had heard much about in the interim, he says, and amid all the uncertainty gripping investment banking in the wake of the financial crisis, it was “an eye-opener”.
He says: “Having strong research content is essential to the ability to grow a high-quality cash equity business, which in itself is the key to taking difficult ECM decisions. Lehman had ranked number one in US equity research for something like seven years on the trot, really a very different model to what they had had in Europe. But now the plan was to build the global equity business consistent with the incredibly strong US business. The very strategic way that John talked about long-term corporate client relationships was something I warmed to.”
Having taken the job, on his second day at Barclays Capital he was surprised to learn how all this long-term strategic vision stuff was being translated into action. One of his new colleagues, perhaps a little eager or maybe mischievously interested to see how the new man would cope, had scheduled a pitch meeting with the chief executive of Enterprise Inns, a FTSE 250 company. Dean recalls: “It seemed a bit quick to be meeting clients but I took it as an opportunity to ask Ted [Tuppen] what he valued most in an ECM/broking business. After a while Ted asked: ‘So, do you have research coverage of us now?’ I had to tell him ‘no’ but that team had been hired recently. He asked ‘Do you have a corporate broking capability for us?’ And I had to admit that was in the process of being built too. He raised an eyebrow and told me: ‘Sam, we’ve met a little early, haven’t we?’ Fortunately what I could tell him about the philosophy of the business we planned to build fitted very well with what he said he was looking for.”
And the punch line is this. Within six months Barclays Capital had been appointed corporate broker to the company. Within a little over 12 months of setting up in the equities business it had been appointed corporate broker to 14 UK companies, half of those being members of the FTSE 100 index: an eye-catchingly rapid build-up and now the favourite statistic for all the firm’s higher-ups when boasting about its progress.
| Plans to deliver revenue growth targets |
| Projected revenue growth (sterling, billions) |
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| Source: Barclays |
Barclays Capital has made good progress in both secondary equity and equity capital markets and in M&A in the two years since it started to build on the breakthrough acquisition of Lehman’s US franchise.
In the 12 months ending in the first quarter of 2010, Dealogic ranked Barclays Capital 11th among global ECM bookrunners. In the 12 months ended in the first quarter of 2011, it ranked ninth. It had risen to sixth in the year-to-date US ECM bookrunner ranking by mid-June 2011. Added to the old Lehman Brothers long-established strength in US block trades, it is suddenly jostling with such banks as Morgan Stanley and Goldman Sachs in the US IPO league tables and has been a bookrunner on recent keynote flotations of GM, HCA Holdings and Kinder Morgan. In the first quarter of the year, it achieved a 9.6% share of US ECM, up from 3.8% in 2008 and above Lehman’s 8.6% share, it’s best ever, in 2007.
The new-issue league tables don’t quite capture the firm’s momentum because of the relatively long lead times for primary market deals and given that Barclays has been building a secondary equity franchise outside the US on which to pitch its ECM capabilities. During an investor day in 2009, Barclays promised to raise an incremental £5 billion ($8 billion) in income from its investments in equities, prime services and investment banking over the medium term. For 2010 it achieved £4 billion in income from these businesses and at its most recent investor day on June 15 promised additional income of £1 billion from each of them from now on.
“One of the questions in the back of my mind when I joined was whether management or the board would lose their nerve on the investment programme,” says another of the many high-profile investment-banking recruits to join in the past two years. “Well, they can’t lose their nerve now. The money is spent. They might as well just see the revenues follow.” The fact that Barclays Capital is now promising an extra £1 billion in profit above what it promised in 2009 from these investments suggests that, behind the scenes, confidence is growing.
Barclays Capital now ranks fifth in secondary US equity market share with 7.1%, up from 3.6% in 2008. In Europe, the firm is attracting more broker votes from which to win commission revenue, rising from 16th ranked by this measure in 2009, to 10th in 2010 and ninth in the first quarter of this year.
In M&A, it’s a similar story. Barclays Capital is outside the top five right now but the direction of travel must be unnerving its competitors. In the trailing 12-month Dealogic league tables from first quarter to first quarter that Euromoney uses for its global awards, Barclays Capital ranked 13th in 2009 and had risen to eighth in 2011. In the first-half 2011 league tables of both completed and announced M&A deals, it is up to fifth in the US and seventh in Europe.
The firm’s share of the global investment banking cash fee pool has risen from 1.5% in 2008 to 3.9% in 2010. In 2010, the firm brought in £8.8 billion from FICC, £2 billion from equities and prime services and £2.2 billion from investment banking. Within investment banking, debt capital markets still brings in the most revenue, but ECM and M&A have grown their combined share of investment banking revenue from 18% in 2008 to 35% in 2010.
In the years when he was building Barclays Capital from the end of the 1990s into a FICC powerhouse, Bob Diamond would often argue that, as an adviser to companies on their capital structure, a leading provider of financing and hedging for all manner of financial and other risks, Barclays Capital was a genuine contender among the world’s leading investment banks. Adding M&A capability onto that is a natural fit.
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“Organizationally Barclays Capital is as flat as a pancake, and culturally it is unified” |
Thomas King, the former global head of M&A at Salomon Brothers and Citigroup who led the acquisition of Schroders and later was head of EMEA banking at Citi, joined Barclays Capital in October 2009 as co-head of global corporate finance, reporting to Lehman veteran McGee.
King had already decided to leave Citigroup and join another firm when Barclays Capital called him. “Having talked to Bob, I couldn’t give up the chance to be part of this. The hardest part of building a global investment bank is cracking the US oligopoly and they had done that very efficiently and impressively with Lehman. The investment bank was so strong already in Europe, and it made such obvious sense to build off the DCM and risk solutions businesses new revenues streams from less capital-intensive businesses, that it presented a once-in-a-lifetime opportunity to attract great corporate finance and M&A talent in a quiet market.”
King adds: “Aside from all those other capabilities, which investment bankers love being able to provide to their clients, one of the joys of this place is that organizationally it is as flat as a pancake, and culturally it is unified. That makes it very powerful.”
King got an early taste of the potential of Barclays Capital just two months into his new role, on taking a call from an acquisitive European client. The call came on a Thursday night. The client wanted a third bank to come in and support a capital raise for a deal due for imminent announcement and, in return for the short notice, because it needed a substantial commitment within 24 hours, would give up some M&A fees and league table credit as well as financing fees: a tempting offer.
| In equities, client momentum is building |
| Equities broker votes, Europe |
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| Source: Dealogic, broker votes |
Barclays Capital went to work, conducting a morning of due diligence, coming up with a suggestion for a slightly different deal structure by late afternoon and, with two hours to deadline, getting its capital commitment committee on the line and receiving approval for the proposed transaction. King was taken aback that it could be so quick. So was the client. King says: “I was still new and this was not a small amount of capital. The team assured me that Barclays would be good for it but I asked to get senior management, including Bob, on the line. They listened, asked some questions, asked who else was in the room and had worked on it… and we were done.”
The client was so impressed with all this that two months later, when it decided to launch another €3 billion acquisition, it made its first call to Barclays Capital, asking it to take the lead on M&A advice, bridge funding and take-out finance.
It was a taste of things to come. The firm was contacted by BHP Billiton, then being advised by JPMorgan on its bid for Potash Corp, when the mining company needed support from a small number of banks that could underwrite the bridge financing and also provide other services including advisory. Since that assignment, it has become a broker to BHP as well as a core adviser, advising it on the $5 billion acquisition of shale assets from Chesapeake Energy, for example.
In European M&A, its market share has increased six-fold since 2008 and it has risen from 22 in the league tables of announced deals to seventh for 2011, year to date. It was financial adviser to EDF on the £6.9 billion sale of its UK electricity distribution networks. Barclays Capital advised SAP on its $7.1 billion acquisition of Sybase as well as providing finance and risk management. And it advised Resolution on the £2.75 billion acquisition of Axa’s UK life insurance business.
“That deal for Resolution was particularly satisfying because it required not just advisory but also financing and because Resolution has some very smart people who’ve worked in the financial industry and are good judges of what banks can do,” says Mark Warham co-head of EMEA M&A. The firm beat off some fierce competition to advise the London Stock Exchange. “The LSE had a new management team following the departure of Clara Furse, which was reviewing its advisory bench. We were chosen along with Morgan Stanley as financial advisers and in particular have advised on the TMX transaction announced this year.”
His colleague, Matthew Ponsonby, draws gratification for being appointed to advise the supervisory board of MAN, another hotly contested role. “Similarly we advised the Supervisory Board of MAN on its €14 billion mandatory takeover offer from Volkswagen that was triggered by VW crossing the 30% voting share threshold. Now, board adviser in a mandatory offer may be a technical role but the MAN board had a very wide choice because let me tell you: each of the multiple banks that deal with the company was lining up for that job. That we managed to win it was a testament to the confidence that the company had in us and the relationship our bankers have with the company.”
| A more balanced investment bank |
| Cash revenue by business area |
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| Source: Barclays |
Other noteworthy cross-border deals included advising Prudential Financial on the $5 billion acquisition of certain AIG subsidiaries in Japan, and Bharti Airtel on the $10.7 billion acquisition of African telecoms assets from Zain. Barclays Capital had originally been appointed to help finance the Indian bidder’s offer for MTN in South Africa. When that deal fell apart, Barclays Capital, having gained entry to Bharti Airtel’s inner circle, brokered the idea of buying the African assets of Zain instead and promoted itself from provider of finance to M&A adviser.
In New York, McGee and Paul Parker, chairman and global head of M&A, are at pains to point out that desire to earn a return on the firm’s investment in its M&A business – which has grown since 2008 to now employ 120 M&A bankers in the Americas, 80 in mainly developed Europe and 50 in Asia Pacific, complemented by 1,100 industry sector specialists and coverage bankers – does not instil an urgency to chase deals that are not in the client’s interest.
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“In Europe we are 70% to 80% through the investment; in Asia we are approximately 50% to 60% complete” |
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“Sure you’ve got to do some deals to pay the bills and that’s important. Our strategy has been to focus on fostering long-term relationships and getting the right people in place so we build a durable platform. But while a lot of firms are very transaction focused and chase deals, we’re trying to build this methodically,” says McGee. “So in recruitment, for example, we must have interviewed 60 candidates in Europe until we found Mark Warham and Matthew Ponsonby and when we did the fit was perfect. In Germany, we recruited Hartmuth Jung last year, who is incredibly well connected, and our M&A revenues in Germany increased by 60% within a year. But I would rather have left that seat unfilled than fill it with a B player, if Hartmuth hadn’t been available.”
Parker pushes the boy-scout claim by referring to the firm’s work for Thermo Fisher Scientific, a laboratory equipment maker, whose traditional adviser is JPMorgan. It brought the bank in to work on a proposed acquisition of Millipore that would have been a transformational $6 billion deal for the company. When this proceeded to a competitive round of bids, Barclays Capital recommended that Thermo Fisher show price discipline and withdraw. Merck eventually paid more than $7 billion for the target.
Clearly Thermo Fisher was impressed to receive advice from a bank not to do a deal for which the bank would be handsomely paid.
“Thermo Fisher is a very good example of the kind of long-term relationship we are aiming also to build with big-cap clients. We have done strategically important things for them and also helped them with the conclusion not to do some other deals. Through this we developed a good relationship with senior management,” says Paul Parker.
In December of last year, the firm advised the company on its $2.1 billion acquisition of Dionex and, just a few months later, again advised the company on the sales of its Lancaster Laboratories unit to Eurofins Scientific. Most recently, in May 2011, the firm then advised ThermoFisher in its €2.47 billion acquisition of Phadia.
At the top of Barclays Capital, senior management is delighted. Rich Ricci, co-head of Barclays Capital, says: “If you had told me in late 2008 that by the end of 2010 we would be number four in announced M&A globally and number two in US announced, I would have laughed at you. Even Lehman didn’t get that high.”
Barclays Capital becomes arguably just the second bank after Deutsche Bank to graft top-quality and global-scale traditional investment banking capability onto a strong FICC markets business. Having been almost the only leading investment bank hiring consistently through the malaise that followed Lehman’s bankruptcy – although quite a few were also rebuilding from 2009 – it has attracted a great deal of notice. The senior management team remains unfazed. They have done this before, many, many times, building not just the FICC businesses at Barclays Capital but also Barclays Global Investors, which they monetized two years ago.
“If you look at the scale of what we’re doing in equity and ECM and M&A, look at the numbers we’re hiring and the investment risk, it’s actually comparatively quite small,” says del Missier. “Remember that this is an organization that has been absolutely geared to growth almost since 1999. From then until 2007 it was ‘grow and invest, grow and invest’ and we went from around 4,000 people to 16,000 people. Then, after the crisis came Lehman and it feels like we have crunched about five years-worth of growth into the last two years.” But such growth cannot continue unabated at such pace. “Our challenge now is not growth,” says del Missier, “it is returns. And in recognizing that and trying to get ahead of the curve on that, this organization has had to turn on a dime.”
| Strong momentum in investment banking and equities |
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| Source: Dealogic, Bloomberg |
It sounds as if managing for returns might not be quite so much fun as managing for growth. At least Barclays Capital can point out that the division has generated a 16% return on equity with a cost-income ratio of 65% through this latest phase of investment. So it has been doing something right.
Reporting a 7% return on equity at the overall group 2010 results, Diamond told investors that this was unacceptable and that the bank would review every single line of business in every division for its potential to meet an acceptable hurdle rate of return and not shrink from exiting any that did not pass the test.
Inside the bank, the widespread assumption has been that the target for much of this new discipline will be the retail and commercial banking businesses that used to report to Frits Seegers, who, after a flag-planting exercise of higgledy-piggledy growth in new markets, quit 18 months ago when the corporate banking part of commercial banking was subsumed into Barclays Capital.
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“We have spent a lot of time ensuring that as we build each business, we keep them aligned with the others. We’ve built this the right way” |
The bank had paid £750 million at the top of the market for a retail bank in Russia, which it has since decided to get rid of. It acquired a bank in Indonesia with no FX licence. It is trying to fix its operations in India.
Ricci observes: “Barclays had been a loose confederation of businesses which meant that different divisions – Barclays Capital, the retail bank – often had their own overlapping support functions, such as premises, payments processing and so on. So there is plenty of low-hanging fruit to go after on costs. This is a unified management team that has known each other for a long time and built businesses together. They’re not going to be precious about giving up a bit of sovereignty over payments processing.”
Division of responsibilities is an issue that del Missier and Ricci have had to wrestle with as co-heads of Barclays Capital since their old confederate throughout its creation, Diamond, stepped up to head the whole bank. Ricci’s background is in banking and operations, del Missier’s in trading. The two men decided it would be dangerous to split their responsibilities along those lines precisely for fear of dividing the business and allowing inefficient separate support functions to grow up. Rather, they try to be more interchangeable. Nevertheless Ricci has naturally taken a close interest in the integration of the corporate bank into Barclays Capital.
“In the corporate bank we made a lot of mistakes often in trying to compete with the local banks in new countries. The danger is that you end up trying to compete with local banks with local products and that you under-price to build market share on the asset side.”
The bank has been rethinking in Spain and elsewhere.
It has turned away from working with small and medium-sized enterprises, concentrating its efforts instead on banking the local subsidiaries of large-cap multinationals that are natural users of Barclays Capital’s marquee financing and risk management capabilities. Onto these Ricci is grafting some more plain-vanilla offerings. The bank is seeking to regain lost ground in cash management, for example with a £200 million upgrade of Barclays.net. Barclays might be one of the few financial institutions in the world trying to use its expertise in high-value investment banking services to hook clients onto its cash management platform. Most large universal banks go at it the other way around.
That still leaves one big nagging question for many at Barclays Capital. Amid the eagerness to build out and cash in on the investment in equities and M&A, what happens to the signature businesses that gave Barclays the chance to compete for these revenues in the first place? Does the axe hang over many of the FICC businesses, several of which – secondary credit trading, securitization spring to mind – don’t make the benchmark return?
Del Missier’s core view on the business still sounds rather cautious. “All the capital raising and financing that had to be done in 2009 instilled a somewhat rosy view of the business in the wake of the crisis and encouraged a surprising number of firms to stay in and others to try to get back in 2010. Since then, the realization has been dawning that the outlook for the business is not quite so good.”
Del Missier says: “With FICC, we’re at the point in the cycle where the highs are behind us. We’ll have a very hard time getting back to 2009 revenues. But these are still absolutely core businesses that are very important to our clients and they are cyclical. It doesn’t take much and I can see the better firms driving at least 15% returns and we are top three in many areas and can still take market share.”
Del Missier suggests that the deep dive Diamond and Barclays group CFO Chris Lucas are taking into individual business lines should not lead to the jettisoning of those that are only temporarily producing below-the-hurdle-returns. “It should certainly identify those that are chronically producing returns below cost of capital but also distinguish those that may only be suffering at a point in the business cycle or through an investment phase but that have superior potential.”
Ricci highlights one example, securitization. “We realized that you’re not going to make money just buying and selling mortgages and nor can we compete against some banks originating their own mortgages.
“We still see opportunities to support our clients. We can act as an intermediary to the markets for those other banks that want to access liquidity and that might be happy to retain a 5% portion in their portfolios.”
Del Missier says that while the intention is to protect the FICC franchises, the firm won’t seek to boost returns from them simply by dialing up more risk. “Many clients have got very large and you have to stay close to clients and sometimes that requires taking more exposure to help them execute large risk transfers. But this is not an environment to take more risk as a sustainable way to boost returns. Excess liquidity has driven credit spreads to their lows. Rates are low and emerging markets are fully priced.” He adds: “It would probably be beneficial for rates to go up, as that would at least increase volatility and client activity.”
Barclays Capital’s rivals will testify that while M&A fees on big deals can be quite chunky, the real juice is often in the financing and hedging revenues, where it built its businesses in the first place. Competitors hoping that Barclays Capital will grow so enamoured of its new businesses as to allow its old ones to fade shouldn’t hold out too much hope. Ricci says: “The people who built the FICC flow monster are still here, still running it, still on the Barclays Capital executive committee.”
It’s a close-knit, collaborative management team whose former chief is now running the whole bank. When the old BZW gave up the ghost on the equities business in 1997, it left the field open to such firms as Dresdner Kleinwort Benson, Commerzbank, ABN Amro Hoare Govett. The management team of Bob Diamond, Jerry del Missier, Rich Ricci and others has fought its way back. That team itself is a distinguishing feature of the firm. “The people who built it are those that still run it,” says King.
The time will come when that presents a thorny transition problem to the Barclays board. But that’s a worry for another day.
see also:
Barclays Capital: Big risks remain in FICC
Protium affair betrays muddled thinking at Barclays Capital
