ECM vs equities: Has Deutsche Bank got it right?

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Deutsche Bank has taken the radical step of getting rid of its equities business, but thinks it can still offer ECM. Can it?

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Deutsche Bank CEO Christian Sewing

Deutsche Bank’s exit from global equities, through the transfer of its prime finance and electronic business to BNP Paribas and the shuttering of most of the rest, understandably raised eyebrows when it was accompanied by CEO Christian Sewing’s assurance that the bank would continue to offer a “focused” equity capital markets (ECM) service to clients.

How, many wondered, could this be possible? After all, the received wisdom for decades has been that the two businesses operate in lockstep and that to be truly credible in primary ECM required the secondary market intelligence that only a big equities sales and trading platform could provide. 

Indeed, Deutsche first broke into the upper ranks of the ECM arranger rankings on the back of its secondary trading prowess.

However, times change. The reality is that while this may have once been largely true, it has not been for many years. 

ECM bankers know this, even though many are reluctant to admit it publicly. For the moment they want to seize the opportunity to tell clients how Deutsche cannot be expected to serve them properly now. 

Many issuers, particularly the inexperienced, may well believe them, on the basis that surely something must have been lost at a firm that is closing a big, apparently related business. 

Given the choice, who wouldn’t want access to an arranger with a big trading platform, even if today these are dominated by automated systems that can hardly be said to provide actionable intelligence for an IPO?

The question is not whether anything has been lost at all, but whether what has been lost still matters for ECM.

Trading transformed

Trading has not only been transformed by electronification but also the unbundling demands of regulation, particularly Mifid II. Sales, meanwhile, has for a long time been a shadow of what it once was. Many leading investment banks have quietly downsized these operations for years. 

Gone are the days where salespeople could earn their keep arranging golf days and helping portfolio managers talk to research analysts. 

At the big banks, the key buyside relationships reside with syndicate, not sales. Big buyside firms have their own analysts. Increasingly, they have their own ex-bankers on staff to manage the relationship with syndicates.

The fact is that this change has not been embarked upon from a position of strength, but of weakness 

When it comes to distribution, the bulge-brackets tend to focus on the biggest accounts, leaving the mass of smaller investors – arguably vital for the successful distribution of a large IPO – to the smaller brokers who have steadfastly continued to service them in spite of the financial pressures of regulation. 

Given all this, Deutsche’s decision to drop sales and trading looks like it shouldn’t automatically spell the end of its ability to offer ECM. At least, that’s the theory.

What will make the bank’s life difficult, however, is that the clients’ perception of the change might not match that theory. 

Context is all, and Deutsche cannot escape it. The fact is that this change has not been embarked upon from a position of strength, but of weakness. 

Radical reshaping

The bank has been fighting all manner of pressures during the past few years, culminating now in a radical reshaping of its investment bank. 

A stronger firm doing the same thing might have been hailed as creating some bold new paradigm, but this is Deutsche.

And this is why defining its ambition correctly is critical. 

Its ECM business may well have to gradually content itself with being little more than an additional service provided to the bank’s existing corporate clients, on the basis that it would be hard to claim a full-service corporate finance capability with zero ECM. 

Sized correctly, then, and with that more limited ambition in mind, it could and should be able to provide clients what they need – even if it should not expect to lead global coordinator rankings any time soon.

But will it pay? While Deutsche is cutting expensive infrastructure and a big team, the parts it is retaining – some spec sales and all of its research – are not exactly cheap. 

If it can no longer expect to pitch new clients on the basis of its ECM franchise, and if it will not be earning the biggest fees from the transactions that it does execute, will it earn enough from its broader work for those same clients to make the strategy justifiable? Does the retained ECM business pay for itself or is it an investment in defending other revenues at the corporate bank?

This is the challenge. If it is to survive, investors need to see Deutsche restore its profitability. They may have little appetite for understanding the cross-subsidies.