Does RBS’s “return to roots” spell the end for its global FX ambitions?
Perception is everything, so the saying goes. After the announcement on Monday by the UK Chancellor George Osborne that the Royal Bank of Scotland would be returning to its roots as a UK-focused lender, doubts have been raised as to whether RBS can challenge its rivals as a serious global FX player.
Rewind to 2008, and the bank was on the cusp of being a top-three player, with a state-of-the-art options business and risk appetite to boot. Now it sits in seventh place. Perception might suggest that its best years are now behind it. However, it might be too early to judge. There is little doubt that some businesses will be shed as the focus shifts within the bank, though insiders say nothing has been decided. To be fair, RBS isn’t alone here. Many global banks are in the same boat, and will operate with smaller balance sheets and have to exit capital-intensive businesses.
That is something FX is not – capital intensive. According to McKinsey, FX will be the least-affected franchise within the capital-markets complex when the plethora of new regulations is implemented. Its return on equity (ROE) is likely to be about 16% post-implementation, down from about 30%, while flow rates and credit look set to suffer the most, with yields falling into single digits from the high teens.
It’s something that hasn’t been missed by senior management, and those within Treasury, that help oversee RBS. Technology budgets on FX have been increased, and thus, by definition, the footprint for FX within the bank seems to be increasing. Profits at the division are also up versus last year. In an interview last month, Tim Carrington, the bank’s global head of FX, told EuromoneyFXNews that year-to-date revenues were up almost 20% on 2010.
Technology spend holds the key. It’s the easiest way to boost volume, and thus drive economies of scale and higher ROE. Without it, you are only going to go one way. RBS knows this only too well, and it now forms a crucial part of its FX strategy.
However, foreign exchange is a global business, and for all the brand recognition that its FX franchise has, and with UK corporate at its revenue core, the question remains: will the bank’s masters continue to support RBS’s main trading hubs, particularly the nascent Asian region, when current government rhetoric suggests a more regional bent? Is RBS going to become what RBC is to Canada, or Westpac is to Australia?
That doesn’t necessarily need to be the case. Extending the balance sheet isn’t compulsory. Take Deutsche Bank, the No.1 FX house for the past seven years. It has managed to build a strong Asian and emerging markets business without giving away much balance sheet, or building a large on-shore presence, if at all.
As far as its institutional clients are concerned, RBS has, post-2008, adapted to a more product-focused approach to dealing with real money and hedge-fund clients – who are not necessarily big banking clients –which involves little use of balance sheet. Even under the Capital Requirements Directive 4, FX has not needed any further balance sheet usage, sources say.
The final piece will be whether it has the flexibility to manage client risk – in other words, whether VAR limits are sufficient. Again, rhetoric suggests there will be less risk put on the table, not more, and it will be up to the risk managers to squeeze more out of what it has.
What does all this mean for the bottom line? For FX, it’s a hard one to quantify, but if its overall revenues are anything to go by, RBS isn’t losing ground fast. Last year, 69% of its revenues came from the UK and Europe, and just 8% from the emerging markets. In the first half of this year, the UK and Europe made up 74% of revenues.
Consolidation today doesn’t necessarily imply a long-term strategy either. It’s about focusing on core businesses, such as FX, and then building those out. Over the medium-to-longer term, RBS FX will need an emerging-markets-focused strategy. Rewinding to 2008, again, and emerging market FX revenues were 38% of the total FX wallet. The consultants Coalition forecast it could almost breach the 50% mark for the first time.