Or at least what it tells analysts.
BarCap’s Roger Freeman and Eric Bertrand have hosted a get-together with Goldman president Gary Cohn, CFO David Viniar and global sales and trading co-heads David Heller and Harvey Schwartz. There was a range of topics under discussion but of particular interest, in light of Thursday’s discussion paper from the UK’s Financial Services Authority, are the Goldman representatives’ purported thoughts on latent changes in banking regulation.
Here they are, summed up by BarCap:REGULATION
Not surprisingly a focus of the meeting, it was clear that senior management is spending an exorbitant amount of time thinking about potential regulatory and policy outcomes and educating regulators and policymakers on the intricacies of financial markets. There is still considerable uncertainty on most fronts, and while the company is actively involved in the debate, it is not planning for any particular changes. Management noted that the regulatory discussion has become much more rational and less heated as debate has shifted to the details of achieving the objectives of the administration, Congress and legislators. In those exchanges, in which GS has been actively taking part, relevant parties are gaining a better appreciation of the complexity of markets and the risks of unintended consequences. Management appeared increasingly comfortable with the notion that the regulatory outcome would ultimately be supportive of capital markets, not disruptive, and in that context, would likely be a positive outcome for GS. This view is not dissimilar to comments we have heard from other industry participants, including exchanges, who have been spending considerable time in Washington meeting with regulators and members of Congress.
Importantly, we believe that the regulatory and market structure issues are being handled by senior management, while business heads and employees broadly remain focused on their jobs. Management seems to be making an effort to minimize outside distractions, drawing from resources within the organization as needed to address areas of concern for regulators and/or policymakers. Key issues along these lines discussed were capital requirements and market structure.
Capital
Management indicated it is going to take quite some time to arrive at a coordinated global regulatory outcome on capital requirements, and we found it interesting that the company had a fairly strong view that a coordinated global set of rules and regulations was the most likely outcome. In that context, management believes that the Fed will not likely enact rule changes on its own because of the risk of making US markets anti-competitive. The company noted that Basel II alone took seven years to formulate and several more years to implement. Management believes that leverage has serious shortcomings as a measure of risk, as we have discussed before, because of its inability to distinguish between assets of different risk profiles, citing the same example as in our last meeting with the company with respect to its Treasury trading business, which employs a lot of leverage given narrow bid/ask spreads to generate a appropriate ROE. Increasing or decreasing the size of this business, in fairly short order, can materially affect the company’s overall leverage. In fact, we believe that ongoing QE has been keeping secondary Treasury volumes somewhat muted, which has had a knock on subduing effect on dealer leverage ratios; however we believe this is purely a function of the environment and that this could very well reverse as QE ceases and more Treasuries find their way into the market. Management also cited that its leverage ratio is artificially high right now because of the sizeable excess cash position sitting on its books.
CFO David Viniar said he feels the company may actually have too much liquidity at present, but it still feels unnatural to take that liquidity down with sufficient market and economic risks remaining. On a separate, but related note, Mr. Viniar reiterated that it could take 12-18 months, perhaps even longer, to be in a position to make any meaningful changes to the capitalization of the firm (that could result in a buyback). That comment is based on the view noted above that the global capital framework will take some time to evolve. To the extent that clarity on the outcome is achieved earlier, a recap could take ahead of this time frame.
When asked how capital requirements could impact the company’s ability to make longer-dated principal investments such as private equity, Mr. Viniar acknowledged that restrictions on private equity investing could emerge, but that GS’s strategy would be to invest a greater portion of its capital in its client-facing private equity funds. The company already co-invests with clients in these funds, but could look to increase the percentage of these funds that it seeds in the future.
Market Structure
On the topic of market structure, centralized clearing was most focused on topic. GS is very supportive of central clearing as a means to reduce systemic counterparty risk. Management does not necessarily buy into the notion that extensive netting of positions across different asset classes within a clearing house was the best outcome and even suggested multiple clearing houses could be an appropriate outcome, noting that the events of the past year demonstrate how cross-asset class correlation can break down. One development that management believed could be particularly beneficial would be standardized margining across the board that would take away dealers’ ability to compete on terms. GS believes that it loses trade opportunities with clients most often to competitors offering more favorable client terms (position netting, lower margin requirements, etc).
Oh, and because there can be no discussion of regulation without touching on compensation issues:
COMPENSATION
Not an easy topic to discuss, compensation is getting considerable attention from senior management. The bottom line, however, is that the firm’s policy is to pay for performance, and management intends to protect its talent, who it notes has been increasingly targeted by competitors trying to rebuild their businesses. Given GS’s outperformance this year, the company has little chance of avoiding media and political scrutiny around full year and year-end compensation. We expect GS will try to manage the message, but simply cutting compensation is not a viable alternative from a self preservation standpoint.
Management does not favor clawbacks at an individual level, citing that it runs counter to its one-firm culture. It also does not believe tying compensation to individual unit [Return on Equity] targets necessarily arrives at a desired outcome because such targets could actually encourage risky behavior to maximize ROE.
Expect more friendly blood-sucking from the bank that’s come to be known as the giant vampire squid then.
Related links:
Limited edition Vampire Squid pen holder – The Long Room
Banks too big to (excessively) bonus – FT Alphaville
Leverage ratios are the new VaR? – FT Alphaville
Musings on regulation and risk from the Morgan Stanley CFO – FT Alphaville