Tier 1 FX prime brokerage that was ‘open for business’ makes enormous loss

It is always a great shame to see a good quality division of a Tier 1 financial institution have its destiny and fortune diluted by the antics of a less professional division of the same company.

Financial giants, and in this case juggernauts, such as Royal Bank of Scotland (RBS) have grown to such large proportions and encompass so many sectors from retail banking to being the largest dealers in global institutional Tier 1 capital markets, and often it is the banking division that creates woes for the entire organization.

RBS has not been free of expensive decisions over the past decade, the first notable one being the disastrous strategy of aggressive expansion primarily through acquisition, led by odious Fred Goodwin, including the takeover of ABN Amro, eventually proved disastrous and led to the near-collapse of RBS in the October 2008 liquidity crisis.

The €71 billion ABN Amro deal, of which RBS’s share was £10 billion, in particular stretched the bank’s capital position – £16.8 billion of RBS’s record £24.1 billion loss is attributed to writedowns relating to the takeover of ABN Amro.

Aside from the removal of his knighthood by the Queen, Mr Goodwin got away with his ill deeds, and actually fought to keep his enormous pension and golden handshake package when he left, lining his pockets and leaving RBS in absolute tatters, the bank collapsing in 2008 and being bailed out by the British government, leaving the taxpayer to pick up the pieces under the UK Government bank rescue package.

Since then, RBS has, along with several other Tier 1 banks, been subjected to regulatory fines totaling hundreds of millions of pounds for the part of some of its traders in the FX benchmark rigging cases four years ago, and more recently, the misselling of Payment Protection Insurance (PPI) by its retail banking division to retail customers.

Of course, RBS was not alone in the mis-selling of this worthless product which has resulted in many British people seeking recourse by claiming back all of the premiums they have paid to PPI insurers, however the damage done to the balance sheet is considerable.

Just two years ago, FinanceFeeds met with senior executives at NatWest Markets, the investment banking division of RBS, who told us that whereas other Tier 1 FX prime brokerages were turning OTC derivatives business away on the grounds of counterparty credit risk following the issuance by Citigroup in 2016 of a document that stated that Citigroup expects a 56% default rate on the extension of credit to OTC derivatives firms by banks for the purposes of using them as counterparties, NatWest Markets was very much open for business and wanted to onboard far more FX firms by extending counterparty credit to Prime of Prime brokerages so that retail brokers can process their orders direct to the bank via their liquidity provider.

Indeed, to make its alignment appear even more friendly, NatWest Markets operates from the firm’s 250 Bishopsgate office, which is in the City among the prime of primes, institutional trading and technology firms, rather than here in Canary Wharf among the towering Tier 1 global banks and their combined 67% domination of the global FX market.

Unfortunately, this has not helped RBS and since then the company has not gained the top slot for FX prime brokerage. That is filled by XTX Markets which is a non-bank market maker rather than a Tier 1 bank, which for the first time in history has not only gained the biggest market share for FX dealing in the world, but has hung onto the top slot for almost a year, usurping all of the banks.

RBS is not even in the top 10 in terms of market share, and its contemporaries are also taking a hit with giants sucha s UBS, Goldman Sachs, Deutsche Bank and HSBC having a far lower market share than non-bank entities Jump Trading and HC Tech, with Jump Trading and HC Tech in positions three and four respectively.

Yesterday, the company’s end of quarter results were published, and RBS experiened an eyewatering loss during the last quarter as a rush of PPI claims caused a £900 million cost to the lender’s balance sheet.

RBS reports an operating loss of £8 million for the nine months to the end of September 2019, a total contrast from the £961 million profit the bank made in the same period last year.

Unfortunately this time it is not just the back street antics of the high street banking division of RBS that caused the losses, because NatWest Markets, which is the very same entity that FX prime of prime brokerages would face, also contributed with a flagging performance.

Total income at NatWest Markets plunged by £419 million year on year to £150 million in the wake of flattening yield curves, however FinanceFeeds has close relationships with a large number of institutional trading firms across the world who are unimpressed with NatWest Markets as a Tier 1 liqudity provider and tend to avoid their service despite the company’s willingness to extend counterparty credit.

Most of the executives we speak to would rather put up the vast sums of capital required and go through the lengthy due diligence and continual monitoring that most other Tier 1 Prime Brokerages require in order to access what they consider to be a higher quality prime liquidity service that they can then pass on to their clients, be they brokers or hedge funds.

Thus, if this can be used as a yardstick, it is lack of demand and a lackluster product that has hampered NatWest Markets, whilst PPI claims has hit the retail banking division at parent company RBS.

The bank’s Common Equity Tier One capital ratio, a key measure for financial health, was 15.7 per cent during the last three months, falling from 16 per cent in the same period last year, so it is not at risk, however the reversal from almost a billion pounds in profit to an 8 million pound loss over the same period year on year is not comfortable reading for the board.

Conduct and litigation costs have hit £750 million for the third quarter of this year, bringing the year-to-date total up to £810 million.

New CEO Alison Rose begins her tenure next week, marking a milestone as she is the first female leader to have been elected CEO of a Tier 1 Bank, however she has this to face which is no easy task.

Perhaps the popularity of the non-bank market makers is easy to understand. They are specific to our industry, do not insist on using outdated single dealer platforms that force last look execution onto their liquidity takers who in turn would be in trouble if they did that to their clients (imagine the outrage if a prime of prime last looked its broker clients!) and do not end up in court for selling worthless insurance policies to senior citizens or get involved in aggressive expansion deals that break not only their own businesses but the taxpayers too.

Here’s a thought – Why do institutions still trust firms that make enormous losses and still give them enormous escrow capital to take counterparty credit from in order to risk client capital when trading? If a brokerage even had a $1 loss, nobody would trade.

Go figure!