x Abu Dhabi, UAEFriday 19 January 2018

Financial fat cats may not get cream of the crop

Are we on the verge of a downturn in the global investment banking business.

Are we on the verge of a downturn in the global investment banking business? Many experts are predicting the "masters of the universe" are going to have a tough time in the second half of the current financial year. End-of-year results will be the opportunity, it is suggested, for slashing jobs and cutting costs in the gilded halls of the bankers, rather than the paying of obscenely big bonus cheques, as was the case last year.

There will be few tears shed for any casualties of an investment banking shake-out but their problems could be regarded as warning signs of broader difficulties in the "real" economy. There have been some recent straws in the wind. Just last week Abu Dhabi, via the investment vehicle PCP Gulf Invest 3, run by the British investment adviser Amanda Staveley, took the opportunity to rationalise its holding in Barclays.

This was a shrewd bit of work and also a sign of the times. PCP's deal with Nomura involved exercising warrants, hedging and institutional placing but the net effect was to lock in the profit it had made on Barclays shares. You would do that only if you had taken the investment decision that the shares were not likely to be as profitable in the future, that they would fall in value. PCP's complex set of transactions must have been some time in the preparation but the timing of the public announcement was spot-on. Released to the London Stock Exchange after normal business hours on Thursday, it came immediately after a series of presentations by Barclays to institutional investors in the City of London, in which Barclays warned of falling revenues from its investment banking business, Barclays Capital.

Barclays executives told analysts that revenue from Barlays Capital might be down some £700 million (Dh4.07 billion) in the current financial year. For a multi-billion pound operation, that is not catastrophic. Barclays made almost £4bn profit on investment banking in the first half of this year. But the loss represents an unwelcome reverse after 18 months of fast growth. Barclays Capital has been the powerhouse of the bank's thriving business since the financial crisis. It should be remembered that in late 2008 Barclays, along with the rest of the British banking system, was on the verge of collapse.

Two of its big rivals, Royal Bank of Scotland and Lloyds TSB, had already been forced to go to the British government for an emergency bailout and had to surrender their independence in return for state funding. Barclays did not want to do the same and instead found Gulf investors, including Abu Dhabi, to inject new capital into its balance sheet. The result has been win-win all round. Barclays kept its independence and, driven by Barclays Capital's thriving investment banking business, went on to emerge as a leading force in the global financial industry.

Abu Dhabi bought a seat at the top table of this business and thereafter, through a shrewd series of moves that culminated in last week's transactions, proceeded to make big profits from the Barclays investment. When the recent transactions are included, something like £2.25bn has been earned by the emirate from Barclays share dealings. Incidentally, that sum puts the emirate's relatively small investment in Manchester City Football Club in proper context - and in the shade.

The mechanism of the Nomura deal also means Abu Dhabi will maintain a long-term relationship with Barclays and thus benefit from any upside in the share price. How likely is it that there will be an upside? Well, if the market experts are to be believed, few in the investment banking business will be seeing surges in their share price in the short term. The bounce-back from the financial crisis was fuelled largely by the need of governments and banks world-wide to refinance themselves. State and corporate debt issuance soared as interest rates fell to near-record lows; proprietary trading and trading on behalf of clients in equities, bonds, foreign exchange and commodities and their derivatives took off as it looked as though the world economy was about to recover without a prolonged period of recession.

Now, two factors are weighing against these profitable investment banking activities. First, the world's regulators have begun to get their act together and impose new rules on the business. The kind of risky activities that led to the 2008 crisis are increasingly being curtailed and new capital requirements imposed. If the banks are forced to put aside large sums of capital to meet these requirements, they will have less to play with on the markets.

Second, the risk of a double-dip recession, exacerbated by fears over looming global currency wars, has made for a more cautious approach among investment bankers in general. It should be pointed out that not everybody shares this newly-pessimistic view. In the Middle East in particular, there are signs that mergers and acquisitions (M&A) activity might buoy the banks through a lean period in the trading businesses. A recent review by Reuters showed the third quarter was the busiest period on record for M&A in the region.

The bad news is that we might be in for a period of belt-tightening by the investment bankers. The good news is that their substantial girths should be able to take it.