Any other business | 24 September 2011

UBS: the bank that lost the formula to turn Mr Hyde back into Dr Jekyll

‘Thank you, UBS,’ writes the FT columnist Martin Wolf, who as a member of the Vickers commission on banking reform was one of its strongest proponents of the ‘ring-fencing’ of retail banks to protect them from the casino follies of securities trading. There could hardly have been ‘a better illustration of the unregulatable risks to which investment banks are exposed’. Indeed, the management failure that allowed Kweku Adoboli to rack up $2.3 billion of trading losses over a three-year period offers such vivid evidence for the ‘casino’ label that only the owners of real casinos can now seriously object to it — on the grounds that they apply far tighter risk controls than banks do. I’m reminded of a scene in Martin Scorsese’s 1995 film Casino, in which one ‘rogue trader’ has his skull crushed in a vice.

Whether Adoboli turns out to have been dishonest on a grand scale or just blindingly incompetent, the episode highlights two disturbing aspects of the banking scene. The first is the nature of the stuff he was trading. ‘You have been warned,’ I wrote on 4 June about explosive growth in the market for ‘exchange traded funds’ that mimic the performance of stockmarkets and commodities. A relatively simple, low-cost device for investors, ETFs offer scope for the banks who create them to make extra profit through complex derivatives deals — that was Adoboli’s role — rather than merely holding a basket of the assets whose value the ETF is supposed to reflect. The Bank of England and the Financial Stability Board in Basel already regard ETFs as a ticking bomb; this story proves them right.

The second lesson to be drawn is the way in which banks mutated into monsters during the easy-money era, and have lost the formula that turns Mr Hyde back into Dr Jekyll. UBS is the product of the 1997 merger of the arch-conservative Union Bank of Switzerland with the slightly racier Swiss Banking Corporation, which had by then also acquired London’s pre-eminent investment banking name, SG Warburg — whose founder Siegmund must be spinning in his grave. Having also bought two Wall Street firms, Dillon Read and Paine Webber, UBS tried to turn itself into a trading powerhouse  to rival Goldman Sachs.

But it racked up multibillion losses on toxic securities in 2008, as well as a huge fine for the way it sold them and an even bigger fine for allegedly helping US clients evade tax. It was bailed out by the Swiss government, but instead of scaling back as domestic shareholders and customers might have wished, it set out to rebuild its trading activities — letting loose the likes of Adoboli. Somewhere along the way, the prudent, low-profile, client-driven tenets of traditional Swiss banking, the core of the nation’s reputation, were forgotten. If I were a Swiss citizen with a UBS deposit account, I’d be yodelling for a ring-fence as high as an Alp.

Franco-Greek exposure

Mind you, it’s easy to get your position wrong. At the height of the 2008 crisis, fearful for the UK banks, I remitted a chunk of savings to the account with Crédit Agricole through which I pay the bills on my French holiday house. Crédit Agricole is in every way a pleasure to do business with, but now I discover it has a Greek subsidiary with a €24 billion balance-sheet. Likewise, Francophile leanings and the received wisdom of a couple of years ago that French banks had come through the credit crunch relatively unscathed persuaded me to invest in a bond issued by Société Générale, which I now know also has a big bundle of Greek exposure. Both banks were downgraded by Moody’s credit-rating agency last week, both have seen their shares prices plunge — and it turns out that a significant piece of my net worth was at the mercy of French exposure to Greece. I got out of the SocGen bond at a small loss, but close scrutiny of the ‘global’ fund products in my portfolio (some perhaps containing ticking ETFs) will no doubt reveal more of the same, or worse. I can hardly bear to look.

Escape valve

On the euro front, we need to know precisely how difficult it would be for Greece or Ireland to leave the single currency, if that is the will of their citizens. Just because the benighted contraption was designed without an escape hatch doesn’t mean the technocrats can’t bolt one on if the politicians instruct them to do so. It would need total control of capital flows, I’m told, and the rewriting of euro-denominated contracts; but it can’t be ‘impossible’, as europhiles in denial claim. The Slovaks, for example, have changed currency three times since they were freed from the Soviet yoke: from a rouble base to a free Czechoslovak crown, to their own crown and finally to the euro. They must be the people to ask; their answer might be that they wouldn’t mind getting out as well.

Hats off to Tata

My item last week about the potential for a new wave of foreign-owned factories if only we can get the sales pitch right, might have sounded incongruous against such a grim economic background. But hey presto, Jaguar Land Rover, owned by Tata of India, has announced a new £355 million factory in Staffordshire — creating 750 skilled jobs, and part of a £1.5 billion programme which could eventually create 3,000.

Tata’s turnaround of Jaguar Land Rover is a bright spot in our industrial landscape. Bought from Ford for £1.5 billion when it was racking up losses in 2008, the company achieved £1.1 billion of profit in 2010 on the strength of rising exports to India and China, and reversed a decision to close one of three existing plants. Tata executives stress — rather tetchily, in my experience — that they always wanted to reinvigorate Jaguar Land Rover as a great British company, rather than (as befell MG Rover in Chinese hands) just acquiring the marques and building the cars cheaper elsewhere. They’re doing an impressive job; let’s hope others are inspired to follow.