Morning Coffee: Deutsche Bank – the final humiliations. Don’t get too excited about a return of prop trading
While Germany’s soccer team heads for the World Cup as joint favourites, its national champion in the investment banking industry continues to be somewhat less of a source of national pride. The Wall Street Journal revealed that the Federal Reserve has assigned the bank’s US operations to “troubled” status, a regulatory sanction which triggers all kinds of invasive action, including requiring senior-manager hiring and firing decisions to be approved by the Fed. The share price has fallen to all-time lows and the CDS spread has widened sharply.
It is even a little worse than that, as the Financial Times points out. Deutsche actually has two major regulatory badges of shame; while the Fed thinks it is “troubled”, the Federal Deposit Insurance Commission regards Deutsche Bank USA as a “problem” bank. Last, the FDIC published statistics indicating that although the number of “problem” banks in the U.S. had fallen, their assets had increased by roughly the size of a single large bank. In the market speculation as to what the identity of that bank might be, the forecasting maxim “It’s Always Deutsche” appears to have proved to be accurate. Although “trouble” with the Fed has apparently been going on for over a year, the “problem” with the FDIC is more recent, the status having been acquired during Q1.
The company has put out a press release commenting only on the WSJ story, not directly denying it but claiming that the regulatory relationship is confidential and that Deutsche has “resolved” a number of outstanding allegations. Deutsche also makes it clear that any troubled or problem status only refers to its US entities, not to the parent company in Frankfurt.
It is easy to make an educated guess at the root cause, given the newsflow. The Fed and FDIC both rate banks using a system called “CAMELS”. It’s an acronym for Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity (to market risk). In the case of Deutsche Bank’s USA subsidiaries, the problem is unlikely to be Capital or Liquidity, because both of these are underwritten by the parent Deutsche Bank AG back in Germany. It’s also unlikely that there is much of an issue of Asset Quality, as Deutsche in the USA is not much of a lending bank. But the other three …
Sensitivity to market risk is always going to be a regulatory concern given the size of Deutsche’s trading operations, but the Fed has had concerns dating back to 2013 that the reporting and accounting systems aren’t good enough for Deutsche to be fully in control of the risks that it’s taking. This is also a Management issue, as are the conduct fines that Deutsche has racked up in the USA, for Volcker Rule compliance failures and Russian mirror trades, among other issues. And as for Earnings, the weakness of the North American investment banking franchise was one of the key reasons why it is having staff numbers cut.
And although the corporate press release points to the “resolution” of four enforcement actions, it does not appear that the problems are anywhere near to being all in the past. Only two months ago, during the last days of the John Cryan era, Deutsche was called into the Fed for what was reported to be an unusually blunt meeting in which ultimatums were delivered about overdue improvements. Christian Sewing has reiterated Deutsche’s commitment to the U.S, but given the circumstances it seems likely that people will wonder if this is a relationship which is possible to save.
Separately, there was happier news for the trading industry from the Fed in its proposed changes to the Volcker Rule. However, it doesn’t seem that we should expect prop desks to be back in the hiring market any time soon. While welcome to the industry, the actual rule changes are about reducing compliance costs, not permitting anything which was previously forbidden. The key points all involve changing the burden of proof in certain situations; no longer will a holding period shorter than 60 days be taken as prima facie evidence of prop trading, for example. It is likely to be easier to build inventories, as the cost of proving to the Fed that they are not being used for proprietary purposes will be lower. But we won’t be seeing bank employees competing against the hedge fund rich list and client flow trading will still be where the action is for the foreseeable future. As if to underline this, Bank of America poached David Kim, the head of equities flow trading, from JP Morgan and Credit Suisse has started cutting rates trader jobs to emphasise electronic trading.
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Jamie Dimon is still the highest paid CEO in banking, up 4% on last year. (Fortune)
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