Banks are rethinking and recalibrating their sovereign, supranational and agency (SSA) debt businesses with the market becoming more attractive. There are even rumours that UBS could make a comeback, two years after quitting the business.
The rising cost of posting precious capital against counterparty credit exposure on large quantities of long-dated derivatives with SSA clients, and the meagre fees for leading deals for these demanding borrowers, forced several banks to shrink their operations.
UBS attracted headlines when it pulled out of the SSA market in late 2012, but others quietly came to the same decision, at a time when writing associated derivatives was central to the SSA DCM business but most high-quality issuers declined to post collateral to their banks.
Bank of America Merrill Lynch, which had scaled down its SSA business in the years after the financial crisis, last year decided on a reboot, making two senior hires from Deutsche Bank to support its plans. Now UBS is said to be considering moving back in – two years after it very publicly pulled the plug.
Marc Tempelman, co-head of debt capital markets and corporate banking, EMEA, at BAML, says there are various reasons why it decided to build up again in SSAs, not least the importance of this business to the broader DCM franchise and to the bank’s fixed-income investor base, which often links buy or sell orders in other bond markets with associated opposing trades in SSA debt: selling SSA bonds to fund allocations to yieldier credit, for example.
The economic dynamics of this market have changed, making the business much more commercially viable today than it has been
“The economic dynamics of this market have changed, making the business much more commercially viable today than it has been,” says Tempelman. “It’s no longer a loss-leader, and while we’re not chasing primary dealerships, we are re-establishing key issuer relationships.”
Highly rated issuer clients face a more crowded primary market, as governments seek to boost the spending of state and supranational development banks. Busier issuers see the point of paying banks to help access pockets of demand.
There is an increasing willingness among SSA borrowers to use two-way collateral agreements, or credit support annexes, with their underwriting banks, which is helping to drive down capital costs on long-dated rates derivatives.
Fabio Lisanti, head of global debt capital markets and client solutions at UBS, confirms to Euromoney that he too has heard similar rumours of UBS reassessing its SSA decision. But he says this is not part of the bank’s fixed income strategy and there is no plan to rebuild the SSA business it once had.
“I would be astounded if they did,” says the head of DCM at another large European bank. “It would not simply be a question of putting on more risk, but rebuilding an entire trading infrastructure, rehiring former staff now spread around the industry, or equivalents that would no doubt demand a big uncertainty premium in their pay. In addition, clients want assured continuity of coverage. You can pare back and build up, but it’s really tough to exit and then re-enter a business like this.”
UBS was last year ranked outside the top 10 as an underwriter of SSA bonds globally, according to Dealogic. Yet it maintains a number of primary dealerships – Italy, France, the UK, Germany and Japan, for example – is still active in the secondary market, and facilitates private placements for its investor clients.
Any move to rebuild its SSA business would raise eyebrows, not just among DCM rivals, but especially among equity investors who re-rated the bank in approval of its initial retreat from FICC in 2012 and might look askance at a big financial investment in personnel, systems and infrastructure to reverse that.
That does not make it impossible, however. UBS’s broader DCM business, for instance, is down but far from out. The Swiss bank was ranked 10th globally in FIG DCM last year, and as high as sixth in European FIG, according to Dealogic. In addition to that, it’s still a top tier DCM house in Asia-Pacific and across various markets.
UBS has always said it will maintain capability in corporate debt capital markets, and it has, although it now ranks outside of the top 10 rankings for investment grade and high yield in Europe, according to Dealogic.
This may be disappointing given both markets were booming in the past year, driven by a powerful combination of deep investor demand chasing anything with yield and issuers seeking to lock into record low rates to refinance debt, and increasingly finance mergers and acquisitions.
UBS has been strengthening is corporate DCM business in EMEA. Last year it named Melanie Czarra, former head of primary markets at Mizuho, as co-head of corporate DCM EMEA with Isabelle Toledano-Koutsouris.
The bank established an event-driven team within DCM last year to work closely with advisory bankers to capture more of the financing and hedging business linked to M&A.
The question is whether it can be big again in these selected, higher margin niches without also edging back into linked trading in SSA debt.