Macaskill on the markets: Goldman’s move to build a more balanced bank signals a shift for whole industry

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Jon Macaskill
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Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Goldman Sachs posted weak fourth-quarter results in January and released a code of revised business principles that threatened to slow its legendary speed in closing deals.

The two events can be taken as a sign of a weakened investment banking industry in 2011 and beyond, where lower fixed-income revenues and regulatory constraints undermine profitability. But they also mark a levelling of the competitive playing field, with a coming emphasis on equities and advisory growth.

The slump in Goldman’s fixed-income trading numbers certainly signals a shift for the industry, with implications for the career prospects of individual senior bankers – at Goldman and elsewhere.

The 48% fall in client revenues for Goldman’s fixed-income, currency and commodities (FICC) group from the comparable quarter in 2009 was a clear disappointment. Under the firm’s new split reporting lines, FICC client revenues were just $1.64 billion in the fourth quarter. The new reporting approach punctures one bubble of Goldman’s mystique, as the firm is unlikely to announce future quarterly FICC numbers that exceed expectations by multiple billions of dollars and leave rivals wondering what they missed in terms of revenue opportunities.

Lower FICC revenues and the drive to build a more balanced bank could also cloud the succession prospects of Goldman’s number two, president Gary Cohn.

The leading role played by Michael Evans in producing the widely heralded new code of business principles led to speculation that he is being groomed as another potential successor to chairman and chief executive Lloyd Blankfein.

As head of Goldman’s Asian operations Evans is based in a target area for growth and his background in capital markets and equities insulates him from the areas of past trading controversy that were concentrated in FICC business lines.

Bankers with a FICC background had limited representation on the committee to produce the new business principles and sections of the January report seemed to reflect continuing resentment of high-handed behaviour by the fixed-income traders who once ruled the roost at Goldman.

Goldman’s Blankfein and Cohn hope the firm’s new business principles will keep regulators at bay
Among the four global co-heads of securities at Goldman, equities chief David Heller and sales head Harvey Schwartz were represented on the committee. Ed Eisler and Pablo Salame, with their backgrounds in rates and FX, were not.


Of the two European co-heads for Goldman, Richard Gnodde, an investment banker, was on the committee, while Mike Sherwood, who rose through FICC, was not. Michael Daffey, global head of equities sales, and Matthew Westerman, global head of equity capital markets, featured on the committee. Fixed-income sales and debt capital markets did not have specialist representation.

This weighting could explain some sections of the 63-page report that went beyond platitudes about the need to put clients first.

The investment banking group within Goldman will now get to keep any revenues from derivatives transactions directly related to advisory and underwriting assignments, for example. That is an important shift that will boost reported investment banking revenues, while also serving to obscure the extent to which derivatives are contributing to the group bottom line.

Underwriting and origination in controversial areas such as mortgage- and asset-backed securitization will move from the securities division to investment banking.

Business units planning structured product deals will have to disclose all benefits to the firm before obtaining approval, including derivatives returns as well as underwriting fees. This does not cover bilateral derivatives transactions but it should reduce the risk of future embarrassment for the firm from deals sold with an offering document that end up in legal disputes with a client.

Email communications between securities division staff and clients were also restricted, in another apparent move to reduce the risk of providing ammunition for lawsuits or regulatory investigations.

Goldman is certainly aggressively rebranding after its reputational shellacking in 2010 – from its blanket global advertising campaign in recent months you might think it was an asset management firm that dabbles in trading and banking.

Its fundamental approach to business remains unchanged, however.

The appointment in December of Theo Lubke as chief regulatory reform officer in Goldman’s securities division reaffirmed the bank’s commitment to the principle of Government Sachs.

Lubke was a senior Federal Reserve Bank of New York official who handled details of over-the-counter derivatives industry reform until last September.

Another indication of Goldman’s commitment to keeping as close as possible to policymakers came in mid-December, when European co-heads Sherwood and Gnodde were seen having drinks in the Andaz hotel in London with Boris Johnson, the city’s mayor.

Johnson is a useful and vocal counterweight to fellow members of the Conservative party who advocate tightening restrictions on investment banking. No doubt Woody (as Sherwood is known to acquaintances) and Gnodde (who is not widely known as Noddy) were keen to supply him with talking points for resisting further change.

Goldman may be suffering from a temporary dip in its FICC form, but few doubt that its market-leading franchise will rebound, possibly on the back of commodities performance. The firm also remains number one in overall equities revenues and topped the global M&A league tables last year, so it is hardly out for the count.

Morgan Stanley’s Gorman has reinforced the positions of Kelleher, Fleming and Taubman but sidelined Chammah and jettisoned DiMaio
Morgan Stanley enjoyed a rare moment of broad relative outperformance of its old enemy when announcing fourth-quarter results in January, but chief executive James Gorman is well aware that the clock is ticking on his planned overhaul of the bank.


Morgan Stanley’s FICC performance remains well below par and whatever the relative growth prospects of different sectors for investment banks, fixed income will remain too important an area for underperformance in 2011 and beyond.

Morgan Stanley recorded a $29 million fixed-income sales and trading loss for the fourth quarter. This underscored how badly it lags behind rivals in rates, credit and foreign exchange, as the bank still ranks alongside Goldman as top two in commodities.

The loss also explained why Gorman replaced rates, credit and currency head Jack DiMaio with Ken DeRegt in January. This looked like a case of out with the old and in with the even older, as DeRegt had a previous spell as head of fixed income in the 1990s. It is also technically a step down from the role DeRegt held then, as his former title was head of FICC – including commodities – whereas now he is head of fixed-income sales and trading excluding commodities.

DiMaio’s year and a half at Morgan Stanley was clearly not happy and it is difficult to escape the conclusion that he was a poor cultural fit for a firm run by Gorman, a former management consultant with a more recent background heading broking at Merrill and Morgan Stanley.

Gorman might have been thinking of DiMaio when he gave a speech at an industry conference in November condemning the hero culture that still prevails on much of Wall Street. Gorman remarked that larger-than-life personalities don’t make institutions, in a comment that could be applied to DiMaio or to Mitch Petrick, the former head of sales and trading at Morgan Stanley, who was ousted as Gorman took the helm at the bank. DiMaio and Petrick are both tall former traders with a reputation among former colleagues for domineering behaviour. Both are now plying their trade on the buy side, which is not exactly short of outsized personalities, but where conflict tends to be hand to hand, rather than between battling fiefdoms.

JPMorgan chief executive Jamie Dimon shares Gorman’s distaste for egotistical investment bankers and his appointment of the relatively low key Jes Staley as head of the firm’s investment bank appears to vindicate the view that the franchise is normally bigger than the banker.

JPMorgan’s investment bank certainly does not seem to have suffered since Dimon fired former co-head Bill Winters and pushed veteran Steve Black into retirement.

The bank announced record results in January, helped by surprisingly strong fixed-income markets revenues of $2.875 billion. It also remained number one in investment banking fees for 2010, while lagging Goldman in revenues.

Staley is a contrast to Winters, with an internal reputation for methodical, often painstaking application rather than the air of effortless achievement projected by the former investment bank co-chief executive.

The Staley way obviously suits Dimon and also leaves the group chief executive without an obvious internal candidate for the succession, which should help him to set the terms for his own eventual departure.

JPMorgan’s commodities head, Blythe Masters, might have bought herself some time in the role if her group made a late-year contribution to the strong fourth-quarter fixed-income results at the bank.

Masters is coming off a 2010 when she made headlines for all the wrong reasons and her reputation as a one-time protégé of Bill Winters might not help her in the new-look bank.

A widely publicized coal-trading stumble, then a series of leaks of internal presentations to her group, put Masters in the spotlight and highlighted the lack of progress in catching up to Goldman and Morgan Stanley during the year.

Commodities will be a key area of competition in 2011, as asset prices are rising and related M&A deals and listings should provide plenty of scope for well-integrated investment banks to profit from both corporate finance and related trading and hedging opportunities.

But the sector also provides plenty of potential pitfalls for dealers, as a suspension in European emissions trading in January demonstrated.

And commodities professionals are among the few bankers who are able to exercise upward pressure on their compensation levels at the moment.

Adam Knight, head of commodities at Credit Suisse, resigned from the bank in January in a move that seemed oddly timed given the approach of bonus payments. He is expected to take up a new role, perhaps at Glencore or former employer Goldman.

His departure could also be a sign of dissatisfaction with Credit Suisse’s tough new approach to deferment of bonuses. Credit Suisse has cut its threshold for deferral to SFr50,000 ($53,000) of variable compensation, increased deferral rates to a 35% to 70% range and extended its vesting and clawback period to four years.

The firm has been keen to get ahead of regulatory reform initiatives since the crisis began in 2008 and its changes are likely to be forced on UBS by Swiss regulators. Credit Suisse could nevertheless be at a temporary competitive disadvantage to rivals from other regimes because of its compensation policies.

Keeping a lid on dissent among existing senior staff could also be more difficult in the wake of the untimely death in November of Credit Suisse investment bank chief executive Paul Calello.

Group chief executive Brady Dougan is an investment banker by background who is used to managing sales and trading professionals. He has a reputation for clinical personal behaviour, however. That worked well during his long-standing partnership with Calello, who was a warmer figure, but Dougan might now be tempted to rule more by fiat.

Calello played a key role in convincing senior Credit Suisse staff of the potential benefits of a novel scheme to pay some bonuses during the 2008 crisis in impaired securities owned by the bank. That worked out well for participating employees, as illiquid asset prices rebounded in 2009.

Dougan is at least dealing with a relatively long established investment banking management team.

His counterpart at UBS, Oswald Grübel, presides over a disparate array of bankers who were mostly assembled in the past couple of years. A number of these bankers share reputations for aggressive pursuit of market share and an equally sharp-elbowed approach to carving out fiefdoms within their banks.

Carsten Kengeter, who took over as sole chief executive of the investment bank at UBS in November, is less experienced than most of his peers at rival banks, and is also much younger than most of his direct reports.

The investment bank slumped to an unexpected loss in the third quarter of 2010, as its sales and trading businesses underperformed. Kengeter must now hope that managers such as Deutsche Bank veterans Yassine Bouhara and Rajeev Misra, and old Merrill hand Dimitri Psyllidis can deliver improved performance quickly.

UBS might be helped in this goal by an industry-wide shift towards greater reliance on equities revenues in the coming years. In late January stock analysts from both Bernstein and Morgan Stanley named UBS – along with Credit Suisse and Société Générale – as their top-three picks among European investment banks, in large part because of their roughly equal weighting between equities and fixed-income revenues.

This does not simply reflect a view on likely product demand, but a take on the extent to which Basle III changes will affect the cost of capital for fixed-income products. Banks that currently derive 70% or more of their revenues from fixed income – including Barclays Capital, BNP Paribas, Deutsche Bank and JPMorgan – will have to rework their franchises without giving up ground as fixed-income flow monsters.

Both BarCap and Deutsche Bank could see a reshuffling of the investment banking ranks as this change takes place against a backdrop of group-level management changes.

Former BarCap head Bob Diamond is now established as group chief executive of Barclays and is expected to mandate further changes, possibly including the appointment of Jerry del Missier as sole chief executive of BarCap.

At Deutsche Bank, investment bank head Anshu Jain is a strong contender to succeed Josef Ackermann as group chief executive, but is less than a year into an integration of the banking and markets businesses within the investment bank. That leaves open a series of other potential shifts.

Managers who are disgruntled by change at their employers – or are fired – can still expect to find work with firms that are seeking to cut their way into the investment banking magic circle.

Nomura is making the highest-profile global bid to enter the top tier, but other houses are battling away, from Mediobanca and Santander in Europe to Citadel Securities and RBC in the US.

Their chances of success are minimal, but they can prove to be a serious irritant to established players. The obvious route to building a sales and trading franchise for a new player is to buy market share, which can reduce or eliminate margins for existing dealers. Hedge fund managers report being offered "choice" markets in certain sectors by recent entrants, where the bid and offer prices for a trade are the same. This is a fast track to losses for the dealer involved and a threat to margins for all market makers in the sector.

The biggest threats are systemic and regulatory in nature.

A renewed European sovereign debt crisis is obviously the single biggest threat to investment banking profitability.

But there are also potential threats from the most micro of regulatory changes. Bankers have absorbed the thrust of the regulatory shifts under way and are working to adapt their business models. Big investment banks are well placed to cope with the sheer weight of regulatory changes, given the high numbers of trained staff they can bring to bear on business problems.

However, some bankers report being caught off guard in recent meetings with relatively low-level Federal Reserve staff about implementation of aspects of the Volcker Rule, for example. The junior regulators opened one discussion with an assumption that value at risk for the desks handling client trades would be expected to be zero. A zero VAR rule would in practice involve shutting down a series of desks, especially those that handle structuring, and would hamstring sales and trading operations at investment banks. This approach is unlikely to be enforced, but it was a reminder to bankers of the need for constant vigilance about potential threats to their business models.