It has not been an easy few years for the super-brained investment bankers that used to work on prop desks or create those products that now live on only in infamy, such as the CPDO squared.
A lot of them have gone off to work for the hedge fund industry and quickly realized that without the support of their bank’s trading machines and concurrent information flows they are as much a punter as any other market trader – producing great returns in some markets and terrible losses in others.
Some have stayed within the investment banking industry, not always to great effect. Take the team running JPMorgan’s chief investment office: they were a bunch of former prop traders, some of them the prime movers in the creation of the credit default swap market, who proceeded to lose billions of dollars through bets on that very same CDS market.
It doesn’t have to be like this. And in some banks, it isn’t. Increasingly, leading investment banks are getting their smartest minds to work on highly complex structured deals that actually deliver value to their clients.
Two examples stand out over the past few months. The first involved GM, the second insurance company Aegon.
One of the biggest problems facing companies and governments alike is pension liabilities. They are dragging on the balance sheets of many of the world’s largest corporations.
Last month, General Motors brought a groundbreaking deal to reduce its pension obligations, which totalled $134 billion globally – with a $25 billion funding shortfall. In the deal, GM will hand over $26 billion of assets and obligations to Prudential through the purchase of a group annuity contract.
Throughout, GM was advised by Morgan Stanley – which has been involved in every step of the auto company’s rehabilitation from bankruptcy in 2008. Morgan Stanley’s bankers had been working with GM on the pension liabilities since the company’s re-IPO in 2010.
The GM transaction dwarfed any other deal that corporates had agreed with insurers for their pension liabilities, but analysts predict it will clear the way for other deals in the months to come.
Longevity risk – the risk that policyholders will live longer than expected – is a major challenge for insurers and pension funds. But historically it has been difficult and expensive to hedge in size because of the limited number of institutions willing to take on the risk. In February, Deutsche Bank completed a €12 billion hedge for Aegon, the Dutch insurer, the biggest longevity hedge ever done.
The critical breakthrough was opening up the market to institutional investors to which most of the risk on the Aegon deal was transferred. And the key was the structure used. Historically, real-money investors have been put off buying longevity risk because of the difficulty in analysing it and its exceptionally long duration.
Deutsche Bank found a way to address both concerns by linking the payments to a national population longevity index and reducing the maturity down to 20 years while still delivering the hedge required by Aegon.
Deals such as GM and Aegon show what the financial advisory community can bring to clients. They’re also, rightly, lucrative for the firms that spend years working on the deals and put their capital to work on behalf of the client where necessary.
Expect to see a lot more of this type of deal over the coming months. If only the banking community were to come up with such solutions to the seemingly intractable problems facing Europe’s balance sheet right now.
