UBS rethinks the impossible

October 29, 2012

By Dominic Elliott

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

UBS is going where no bank has yet dared to tread. The Swiss wealth manager and investment bank is poised to reveal a radical strategy that could see it pull out of fixed-income trading. Such a plan would be expensive and slow to execute – that’s why rivals typically think such moves are impossible. But the decision could prove an industry game-changer.

Sergio Ermotti’s reported assault on fixed income goes way further than the strategic review he unveiled after being appointed chief executive in November 2011.

It’s easy to see why. Trading losses have ruined the bank’s attempts to bolster risk management. Fixed income, currencies and commodities (FICC) has barely contributed to the bottom line in recent years while consuming about half of the group’s allocated equity.

But winding down a FICC business would be no walk in the park. Trading books have credit and derivative exposures that would pose risks – and hog capital – for years. Keeping key personnel like investment banking co-head Carsten Kengeter wouldn’t be cheap – and there would be no new business revenue to help out. There would be opportunity cost too if markets recover. The cost-benefit analysis may be favourable only on a very long view.

Plus there are questions about the management of UBS’s investment banking rump, likely to be led by rainmaker Andrea Orcel, co-head of investment banking alongside Kengeter. He lacks the risk management skills associated with running foreign exchange and equities trading.

Execution of any strategic renewal is going to be perilous. But Ermotti’s long-term focus makes intuitive sense for UBS. The investment bank could plausibly emerge as a kind of mega-boutique with an advisory and finance franchise serving corporate clients, piggybacking off an equities business focused on investment clients – consistent with the old Warburg business at its heart. If that’s really what Ermotti has in mind, ripping apart the current structure is probably the only sure way of getting there.

Some firms may rejoice that UBS is cutting capacity, and take it as an excuse to stay in the market. That would be a shame: having fewer desks around will assist in global deleveraging.

Of course, Ermotti wouldn’t be alone in culling entire businesses. Royal Bank of Scotland has cut equities and advisory while keeping fixed income. But Ermotti’s peers generally prefer snipping jobs here and there to destroy-and-rebuild. If shareholders cheer his vision when the plans are fleshed out, UBS’s rivals would find it harder to defend their current business models as the only game in town.

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