What do you do with a problem like markets? It has been an increasingly thorny question for Goldman Sachs in recent years, and the bank's investor day on January 29 could not shy away from it. But its leaders faced up to the task with a raft of initiatives to improve returns and plenty of admissions of missteps along the way.
Over the last 15 months or so, the bank has been examining its global markets business, both internally and by seeking feedback from clients. What it was told, according to Goldman COO John Waldron, was that it had the best people – of course – but that it had made less investment in long-term relationships and was too siloed in its approach.
"We are working very hard to fix that," said Waldron. "But there is no silver bullet." The bank needed to pull multiple levers to improve its rankings, reduce its costs and increase its revenues.
But there was an echo of CFO Stephen Scherr's investor day commentary about the overall firm when Waldron cautioned that while measures to improve revenues were important, they were not the primary way in which the global markets division would improve returns. That would come from expense savings and an improved funding mix.
In 2019, Goldman's sales and trading businesses ranked third by revenues. JPMorgan is billions ahead of the pack, and Goldman was $600 million behind Citi.
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What it all meant was that Jim Esposito and Ashok Varadhan, co-heads of the securities division, had the toughest job of anyone at the investor day. Their businesses are clearly in the line of fire from the perspective of returns.
In 2019, global markets return on equity was about 7%, so a big drag on the overall firm. And that is after already strenuous efforts on the capital front. Firm-wide, market-related risk weighted assets are down 40% since 2015. Capital allocated to the global markets business is down 20%.
The medium-term target is for global markets ROE to exceed 10% – much better than now but still well below the group target of 13%.
Expense reduction is a big part of getting to the new target. There has been progress here, with $300 million already shaved off since 2015. But Goldman reckons it has identified another $700 million to be cut in the medium term.
It is forecasting lower litigation expense, adding some 125 basis points to ROE, with another 100bp to come from operating-expense efficiencies. A further 50bp comes from funding optimization.
Change of approach
That leaves just 100bp to be obtained from the work Goldman does for clients. There is much to do to achieve even that. Esposito painted a picture of the challenge.
This was a once-in-a-generation period of big regulatory and technological change that was impacting clients and impacting Goldman, he said. Market liquidity was lower, capital consumption was higher, and there was a continuing shift from active to passive investment.
More than ever, the business is one of scale. Bank of America's franchise, the fifth by revenues in 2019, is twice the size of Barclays', the sixth. Goldman's business was already at scale, Esposito said. And while many rivals were either retrenching or exiting the business – Deutsche Bank's closure of its equities business is the most obvious recent example of that – clients would continue to come to Goldman.
"It strikes us that the barriers to entry are very high and the barriers to exit are low," he said.
But for all his assurance that ultimately Goldman stood to gain from a concentration of business around scale players, there are obviously ways in which the firm needs to change its approach to sales and trading.
Esposito said one problem was that, historically, Goldman had focused on the highest returning trades rather than broadening its client franchise.
This plays into chief executive David Solomon's broader comments about the firm, that it must now pay more attention to developing a bigger suite of relationships than it has previously relied on, and ensure that those relationships touch as many parts of the firm as possible.
"We will now have a longer-term portfolio approach to the business," said Esposito.
That means being less selective on a per-trade basis, being more willing to conduct lower-return business for a client in the hope of also transacting higher-return trades.
As with so much of what Goldman is embarking on now, the trickiest part is how to change the approach without losing the firm's secret sauce. It had had too much of a principal mindset in the past, Esposito said, but the bank didn't want to lose those skills on its path to becoming more balanced and diversified.
He said that Goldman already had the second-ranked institutional client franchise, and deepening the client franchise is intended to help it close the $1.2 billion revenue gap to the top.
Not all of that gap was addressable by Goldman, said Esposito, but the gap was too big.
A constant theme through Goldman's plans has been the importance of better monitoring of its progress: in global markets it is now tracking no fewer than 1,000 client revenue gaps to close, something that it thinks presents a $500 million opportunity.
Shift to financing
The second issue is a familiar one to anyone who has listened to Goldman's quarterly earnings calls. A regular observation has been that Goldman's business has been much more heavily weighted to market intermediation than financing, making it less comparable with peers – and more volatile.
But it has slowly started to redress the balance. In 2015, financing accounted for 22% of global markets revenues. That had risen to 30% by 2019.
That story has been largely an equities one, though, and the firm now needs to tackle fixed income, currencies and commodities (FICC). It was only this year that Goldman began to break out the financing and intermediation split of its FICC revenues, as part of a rejig of its structure that saw much of the financing business moved into FICC from the old Investing & Lending division.
There has been no perceptible shift in the numbers Goldman has disclosed for recent years: in 2017, financing accounted for 18.5% of FICC revenues; in 2019, it was 18.6%. The US peer average is 32%. But the 2019 dollar figure was nonetheless a record for the firm.
As is now demonstrated by the firm's belief in its ability to shift that balance in the future, the historic focus on intermediation in the markets business was a deliberate one, and one that worked – until it didn't fit in with the overarching plan for more sustainable and predictable revenues.
The FICC financing revenue gap to the peer average is about $1.4 billion, said Esposito, and he said that while there was a plan to close that, the firm would be mindful of the credit cycle. Most of the increase will come from investment-grade equivalent risk in mortgage warehouse lending, repo and secured lending.
But there is work to do in equities, too, where the firm has identified yet another misstep. It underestimated the post-crisis opportunity in the systematic quant client franchise, where Esposito said the top-ranked bank made $1 billion more than Goldman in 2019.
"It is another large gap, and we are late," he admitted.
The firm certainly is: the wallet grew from $1.8 billion to $3.6 billion between 2012 and 2018. But fixing it now offered a chance to leapfrog incumbents, Esposito said. To do that, Goldman is building a new platform that will enable it to execute in 50 global markets and achieve a straight-through-processing rate of above 99%.
Improving the way in which clients interact with Goldman was a final leg to the strategy. Again, part of this reflects the firm-wide drive to bring the firm's operational engineers into the businesses that they support that Waldron had referenced earlier in the day.
In global markets, the bank has also created a cross-functional client experience team to ensure that a client has one point of contact throughout a trade's lifecycle. The bank's Marquee platform will also be a vital conduit of the bank's financial markets intelligence and risk-management tools to clients, which Goldman houses within a system called SecDB.
With the litany of challenges in a business where pickings are slimmer and slimmer, it was clear that global markets was the area where improvements will be hardest to achieve.
But it wasn't all bad news: Varadhan sounded a note of optimism.
"Capital is no longer a reduction story, it is a redeployment story," he said.