Investment Banks in Asia face hard time to work
Rumblings from China have caused Asian markets to throw a summer tantrum. This has been difficult for stock-market bulls, but not as bad for investment banks operating in Asia. For now, anyway. Our Journal colleagues write that investment banks have enjoyed higher revenues in recent weeks thanks to busy trading markets, but say the longer-term outlook is likely to be more dire, thanks to falling markets and a drop in investor confidence.
But if the downturn in the region persists, a new report from Societe Generale says the investment banks that will do better amid the turmoil will be the ones that focus on dealmaking, rather than trading.
Although IPOs and potential deals could dry up if the volatility persists, any long-term downturn in trading tends to hit the bottom line of investment banks much harder. This is because - despite recent regulation - trading businesses have a much higher capital requirements than, say, an M&A team. A trading business needs an inventory of stock, and a significant enough size to make economies of scale matter. An M&A team needs a willingness to travel, and a good rolodex.
Global investment bank's return on equity, "particularly in several areas within fixed income, commodities and currencies businesses, were significantly below the cost of capital," according to the SocGen note published Thursday. Across the investment banking industry, post tax return on equity in 2014 was only 8.5%, below the accepted break-even rate of 10%.
And any slowdown in China would mean a slowdown in Asia, which means further pressure on return on equity, which means a further expectation to "re-visit expense/de-leveraging plans."
For Goldman Sachs Group Inc., Morgan Stanley, Citigroup Inc. and UBS AG, their investment banks all have significant exposure to Asia.
But in terms of business make-up, UBS and Morgan Stanley are weighted more towards investment banking activities, whereas Citi and Deutsche Bank are weighted to trading in the region.
This means in the short term, as markets bounce from red to green from day to day, the traders are well placed to benefit. But in the long term, if regional growth slows, the costs of running large trading desks may need to be addressed.