TRANSACTION BANKING: THE NEW NORMAL

With transaction banks in a state of global change, what is the impact for corporates?

The transaction banking market is in an ongoing state of flux, as new entrants join the market, some traditional players depart and the biggest global transaction banks completely restructure their operations. Driven by global banking market change—from continuous growth and stiffer competition in transaction banking, to lost revenue on the investment banking side, to regulatory changes and cost-cutting efforts in the face of it all—it is clear that these transformations are having, and will continue to have, a big impact on corporates.

Gareth Lodge, analyst at consultancy Celent notes: “Over the last four years every bank that we surveyed had undergone some kind of reorganization. Many have done multiple iterations.” Why? It’s all about the money, according to Lodge. “We have seen quarter-on-quarter growth in transaction banking—often in double-digit terms—every quarter since the crisis and even before that,” he notes. He says this growth can’t continue indefinitely, and when it does slow down, the market will start to see some serious consolidation. But in the meantime, the big global banks are revamping their transaction services units to cut costs, make them more central to overall operations, glean a greater share of wallet from their clients and take greater advantage of their relationships from a cross-sell perspective.

All of the largest global transaction banks have revamped their organizations in recent years—generally increasing the profile and management level of treasury services. In most instances they have also tied transaction banking more closely to investment banking.

Bank of America Merrill Lynch began its reorganization with the purchase of Merrill in 2008, but has had a pretty consistent, relatively thin management structure for the past three and a half years. GTS falls under the Global Banking division. The big change was the recent announcement that Paul Simpson—who took over the reins of GTS in 2011 and folded the custody business into the unit two and a half years ago—has taken up a newly created post overseeing the Equities Asset Management Services group, which sits within Global Markets. His former boss—Paul Donofrio, head of Global Corporate Credit and Transaction Banking—will now have direct oversight of GTS.

At J.P. Morgan, in July 2012 the bank began merging its Treasury & Securities Services line of business with the tradi- tional Investment Bank and formed the Corporate & Investment Bank. In April this year, the management structure of CIB was further streamlined, and a number of JPM vets were given posts of greater responsibility. Jeff Bosland, who had been co-head of Americas sales & marketing for Markets & Investor Services, took over as head of Treasury Services.

HSBC underwent a three-year transformation—moving to a shared-service model for support functions and restructuring into its component parts, according to Payments and Cash Management head Diane Reyes. Transaction processing services are split into PCM, Securities Services and International Trade and Receivables Finance, and Reyes and her counterparts report in to both Commercial Banking and Global Banking and Markets.

Deutsche Bank realigned its businesses into four “pillars” in September 2012, of which Global Transaction Banking is one—demonstrating the importance of the business to the bank. Werner Steinmueller, head of GTB and a member of the group executive committee, reports directly to DB co-CEO Anshu Jain.

Citi removed an organizational layer last year and Treasury and Trade Services (TTS) now sits within the Institutional Clients Group.

The big banks are becoming more sophisticated in their approach to transaction banking—and raising where it sits in the bank hierarchy—in part because they are facing stiffer competition. “Asian banks are now creating transaction banking units from scratch,” says Celent’s Lodge. “We are still having ongoing discussions with banks looking to enter the [transaction banking] market for the first time.” And it is not just the regional players that are trying to take a piece of the pie. Technology vendors are “cherrypicking” the transaction banks’ business, notes Lodge.

But while competition is increasing in many markets—such as the US, Asia and the Middle East—in some, most especially in Europe, a number of local and regional banks are weighing whether they can compete at all. The cost of regulatory compliance and further commoditization of payments under the Single Euro Payments Area is driving some banks out of the business altogether.

TIES TO INVESTMENT BANKING

Another big driver of change among the largest global banks is the loss of revenue on the investment banking (IB) side in recent years. One analyst noted that the need to get out of proprietary trading and other risky businesses is driving this as banks focus more on fee-based businesses that don’t require capital.

The transaction banking business is all about attracting flow and liquidity. Because payments have become so commoditized, notes an analyst: “The key for banks is retaining sticky balances that come with the cash management business.” Transaction services is not episodic—as is IB—but rather provides very reliable long-term revenues, which both bank senior management and shareholders like.

Says Steinmueller: “In days of negative interest rates, banks have tremendous pressure on the revenue side. Banks must have dynamic business models: Fee-based income becomes increasingly important in a low-interest-rate environment.”

Naveed Sultan, global head of TTS at Citi, says bringing the unit under the institutional clients umbrella—alongside Markets and Investment Banking—makes for a more balanced portfolio. “So, for example, if Markets and IB businesses are under pressure…[and] if TTS is growing, let’s grow it even more to help alleviate stresses in the overall portfolio.”

Another reason for the tight ties with IB is creating sticky customers. When doing episodic transactions, investment bankers are being asked to try to attach the cash management or transaction banking business to the deal. Transaction bankers are now often driving conversations that investment bankers once wanted nothing to do with. “They didn’t ‘do’ transaction banking,” notes an analyst. For the extremely jaded market watcher, having transaction services under the investment bank umbrella also means that the higher-ups in the investment bank are still getting their returns—and thus their bonuses—at a time when IB is suffering.

IMPACT FOR CORPORATES

According to the banks, all the restructuring has been a good thing for corporate clients—bringing together disparate services that companies rely on their banks to provide. But the key questions are what impact this is having on both the cost of capital and access to capital.

Banks are dealing with a number hits to the bottom line: loss of revenue from the end of proprietary trading under the Volcker Rule, suffering IB businesses against a backdrop of low-to-negative interest rates, and huge legal expenses. All of the big banks have faced large regulatory fines and legal expenses for a plethora of alleged and admitted wrongdoings—from money laundering to benchmark fixing, and securities to mortgage-related fraud. The vast majority of bank investment dollars are being eaten up by legal proceedings and regulatory costs, and those expenses will eventually find their way down to corporate clients in the form of bank fees.

Meantime, companies could also face increased cost of capital as a result of regulatory changes affecting the banks. As an example, the end of prop trading by deposit-taking banks means these banks are no longer market makers for bonds. Thus there could be less liquidity in the market, driving up corporate bond prices.

Hugh Davies, associate director at consultancy Zanders, says some companies may find it more difficult to access funding through traditional sources “and turn to alternatives such as debt markets or retail bonds, for example. [And] pricing is likely to increase because of the increased cost to the banks—or products will be withdrawn from the market.”

Counterparty credit risk is an identified risk and we have a process to manage this real-time.

~ Ruud Roggekamp, Boeing

Although access to capital will not be a concern for the biggest corporates, as banks continue to review their relationships it could become an issue for second-tier companies. Most of the banks interviewed for this piece in one way or another noted that they had reviewed their client base as part of their restructuring process.

As BofA’s Paul Simpson noted in an interview with Global Finance (before his move out of GTS was announced): “Generically it has forced pretty stringent client selection protocols. We have had to relinquish some clients that were on the outskirts—who were not working with us extensively. While those clients who we do work with extensively we have continued to support and look for ways to grow our relationship even further.”

Bosland at J.P Morgan puts it this way: “[As part of the restructuring process] we reviewed who were the target clients, looked at where the relationships sat across the bank, and looked to see how we can potentially leverage those strong relationships.”

This general trend is exacerbated by Basel III capital rules —banks will no longer want to lend to companies that don’t have significant, stable account balances. Anthony Carfang, partner and director of consultancy Treasury Strategies, predicts that 80% of companies could see at least one major change in their banking structure as a result of Basel III.

Of course, the key thing that most treasurers are most concerned with is bank safety. Notes Francois Masquelier, head of corporate finance, treasury and enterprise risk management at RTL Group: “We are all quite concerned by the fragility of the banks.” He says that companies are once again in scare mode when it comes to their bank counterparties and are regularly evaluating counterparty risk. Ruud Roggekamp, assistant treasurer at Boeing, agrees: “Counterparty credit risk is an identified risk and we have a process to manage this real-time. We monitor a series of credit factors in order to establish credit limits for all counterparties.”

This raises the age-old debate of diversification versus concentration in bank partners. Says Davies: “Of course diversification is good, but there are more ‘mouths to feed’ to meet the banks’ hurdles for returns. But generally the trend is towards concentrating services such as cash management with a smaller number of core banks where possible.”

Many companies went through a banking-partner diversification process after the crisis hit in 2007-2008, so for some the current market developments will have little impact on the composition of their core banking group. Notes Roggekamp: “We have not made any major changes to our core banking group of 38 banks.” He notes, however, that they have added some banks in growth regions, such as the Middle East, India and Asia.