Following is the unofficial transcript of a CNBC interview with Axel Weber, Chairman of UBS, by Julia Chatterley at the IMF Spring Meetings, Washington, on Monday 20th April 2015.
Julia Chatterley (JC): The IMF warned coming into this meeting about the possibility of a super-taper-tantrum. How concerned are you?
Axel Weber (AW): I'm not concerned of a taper-tantrum too. I think what the FED has made very clear is that the pace of changing rates will not have a historical pattern, and they will be very data dependent. Our economists expect the FED to start sometime in September but I think they're going to take a very slow trajectory in raising rates. Um, I'm more concerned about that the speed that we are going to see, is that in line with the need for the economy and the need for financial markets to not continue to run away. I think financial markets have been in a boring situation for a long period of time. The longer QE lasts, and it's not just US – you're looking at Europe, you're looking at Japan, it's global QE- financial markets are driven by that excess liquidity, yields on sovereign debt are very, very low, close to zero, negative in some cases. So, part of the equity boom that we've seen is actually liquidity induced, and it could easily reverse once monetary policy is normalised. So, in that sense I think there is a concern.
JC: And isn't that the bigger risk here actually, that the FED is unable to raise rates because of the sensitivity of the markets now to the punch bowl that they've had for so long?
AW: I think they're able to raise rates but they have to take a lot more than in the past the situation into account that is in financial markets and the financial stability, and how that could impact on the economy, how it could impact on the more broader settings. So, and they're very, they're knowledgeable about that. They know that, they've said, 'look, we're going to take a different pattern than in the past'. And if they change rates now, they still go to just 25 basis points. Twenty-five basis points is not a high rate, if you compare it to the consolation of unemployment rate, inflation readings we have, or the strength of the US economy. So they're going to be different pattern than in the past. I don't expect rate hikes at every second meeting. I expect the first rate hike, and then the FED's going to look at what the impact of that is on markets, on the economy, and then they're going to be very data dependent when the next move will come will not be automatic. It will be some time off. Actually it will be delayed quite a bit in my view.
JC: You feed into a broader picture about the liquidity, and the liquidity contraction that we've seen throughout the financial crisis or the period afterwards, 80-90% of the bond market according to some estimates. As a money manager how do you price that risk?
AW: Well, one thing that we've seen and it's not been an unintended consequence, it's been an intended consequence of the re-regulation of the financial market, that liquidity management now is different. I mean, we have now a very conservative liquidity ratio that we manage, and one of the lessons of the last crisis was long before you encounter solvency issues, you actually encounter liquidity issues. And we've had some taste of that in October, that liquidity in a good situation is always there, but liquidity when the markets seize up, tends to vanish very quickly. And so, a prudent long-term oriented liquidity management is now very important for money managers, for financial institutions in general, and it's part of our rule book with banks with the liquidity coverage ratio, and with you know, more longer term liquidity planning that is driven by regulators. So, that's I think an important change we've seen in financial markets and monetary policy as they are contemplating to tighten monetary policy, they have to take that into account that a lot of banks will sit on their liquidity because they need it for regulatory purposes, will not be there for financing market based finance and liquidity issues there. It's kind of a conservative plan now that banks have, and there's a lot less liquidity in a stress situation than maybe has been in the past.
JC: When we look at that contraction in liquidity, we look at the growth in the asset management industry, in particular over the last few years too. It's effectively a free option for investors if we look at real money. They don't have the gates to exit, they can get their cash out when they like. But yet on the other side, the managers don't actually have the ability to go out to the market and offset that risk.
AW: Well if you look at, for example, what we in our asset wealth management, you know, we are doing on clients' behalf is, there are a number of very big consensus traits in the market, a long dollar, short euro position was a consensus trait. It was a consensus trait at around forty; the dollar came all the way towards parody. A long US equity position was a consensus trait. Now a long European equity position with Europe recovering, with Europe looking better at least from the current readings is, people are shifting their liquidity into European equity and into the equity markets. But the problem still remains that fixed income markets are unattractive. Take Switzerland. Swiss sovereign yields are negative sixteen years out. So, there's a lot of dynamics in the real markets, you know, equity, corporate debt markets. There's M&A activity, leverage buy-outs, all this is very, very active and investors are putting money to work. The problem is that fixed income investors are sitting on the side lines and instead of being in fixed incomes they're moving into cash, because cash in a negative yield environment, and maybe with some deflationary forces, is not such a bad investment. At least many view it as that. So there is a challenge that cash actually has a different return profile now, in this environment than it usually has. So, there's a lot of liquidity out there parked in cash. What we would like to see is our clients who are still, you know, very highly liquid and who sit on cash, to move that cash back to investing in the real economy. We're seeing that for some because I think real growth is coming back, but it's taking a long time, and in Europe it hasn't been there- it's now starting. So we're seeing a recovery in Europe that is also liquidity driven but supported by better economic outlook as well.
JC: You're brought it back to Europe. Forty per cent now have sovereign bond yields in negative territory. If we look at the likes of the pension funds and the insurance companies having an incredibly tough time, particularly given regulation on just what they can buy. What needs to change there?
AW: So absolutely. So it's solvency too and some of the defined benefit schemes that are still out, and almost predominant in Europe are finding it very hard to deliver those returns, promises made in the past. And we've seen it before. When we had the burst of the dot com bubble, many corporates and pension funds, and insurance companies in Europe were not really invested in equity. They asked for an increase of their quota to be invested in equity and they went into the equity markets just as equity reached their peak. So when equity markets then fell, valuations were stretched and a round of problems developed. So again there's been an example of this. Investors got burned last time around, and that's why some of them are cautious to actually move more money into equity despite the fact that maybe now the ability to do so is higher. Some of them are tied down by regulation to have sort of a fixed income environment in which they invest. But others aren't just sceptical of the sustainability in particular of the European equity dynamics, because remember there is a home bias in many pension fund regulation that they can invest in sovereign debt. But it's very often the sovereign debt of their own country or of their region but not global sovereign debt instruments. And equity is also much more restricted. So what we're seeing is really an environment where our investors that are free to choose you know wealthy clients that have been investing money in equity, in real estate, in even private equity have been doing pretty well, but –
JC: They're being pushed down the credit quality curb though as well.
AW: Absolutely, and if you look at – there is no equity mentality say in Germany, and so a lot of German retail clients will miss the equity boom and they've already missed a big part of that boom because 25 per cent increase since the start of the year is actually quite an outstanding performance. Investors that are free to invest in asset classes and be globally diversified across all asset classes have actually gained if they've had equity (inaudible) in the past. Fixed income driven or dominated investors have suffered and it's part of the QE side effects that you always see and I think that this will continue.
JC: And for how long, because I spoke to Mario Draghi and I asked him what the risk here is of unconventional policy becoming conventional policy.
AW: I think the risk is more that they will continue to have this kind of policy in place and therefore it will look a lot more like an orthodox policy, because it's the dominant policy, but I do think they carry a lot of side effects. I think the longer these unorthodox policies are in place, the more the direct benefits of them are disappearing and the side effects become more pronounced. A fixed income investor, a pension fund can survive a year where pension entitlements are lower because returns of fixed income instruments are lower. But if it becomes 2 years, if it becomes 3 years, if it becomes a more persistent outlook, they suffer more.
JC: We're looking at insolvencies.
AW: We're looking at least in challenges at meeting those guaranteed requirements. So, you know, one thing has to give. In my view, what has happened in the past is these defined benefit schemes were scaled down. So, what is a defined benefits might not hold up. So, ultimately, I think it's not efficient to look at pension funds or insurance companies. You have to look at the clients behind these institutions and ultimately if those institutions cannot deliver on those promises, they will have some adjustment on the regulatory environment to allow them to not move towards insolvency, and then it is about scaling down the promises they've made to their wealthy clients. So if you look through the institutions, it's actually the pensioner, the man on the street, the savers that are being crushed. And savers are being crushed anyway. We're in an environment that favours debt, so savers, you know, have a bad environment to start with, but once it actually just goes beyond fixed income instruments, and once it actually touches pension funds, insurance, life insurance policies and all of that, a large part of pension promises does actually take a hit. And I think that that will be a very bad environment for consumers and for pensions, in particular for the older part of the population. Because the younger part of the population can actually you know, react. If you are already in a pension, or at the end of your working lifetime, there's very little you can do about these entitlements, their real impact on your ability to consume, and therefore a big need for adjustment in that particular part of the population. It's going to be unpopular with these people.
JC: It's an unpopular policy in many corners, it's not just in German for one. Mario Draghi today was talking about the pick up that we're seeing in consumption. How long before the Bundesbank and the Germans start getting itchy about the inflation readings we're seeing in that country?
AW: I think we're seeing an environment where basically because of the addition of a huge amount of labour at the global level, the global production front gets pushed out. China has been you know 10 per cent of growth 20 years ago, 20 per cent of global gross 10 years ago, it's now 30 per cent of global gross. So they're contributing to global gross hugely. And what was China yesterday, is other parts of Asia now, and it will be Africa in the future. So, the output gap is not really closing on a global level. And I think that drives a lot more now global inflation, and I do see some deflationary impact from that, and therefore, central banks will have it much harder to reach their old inflation targets. Actually they might be aiming at an inflation target that in the current environment, particularly given oil prices and other deflationary forces like ageing or technological innovation, all have deflationary implications – it might be much harder to achieve. So in a way they might over stimulate the economy in an attempt to get the economy back, because those forces would probably need to be looked at more as persistent forces and not as cyclical forces that you can deal with with monetary policy. So I see a big risk that central banks will not achieve a reflation of the economy, is what they're doing. I see a much bigger risk that this liquidity remains in financial market and drives asset returns rather than consumer price inflation. And therefore, central banks are undermining the value of money in a more general sense. And if you look at the relative value of money, the exchange rate, that has been coming down quite a big way - in the US where the perspective for monetary policy is different from Europe or Japan, where the exchange rate has actually depreciated relative to dollar for the yen and for the euro, and that's a sign I think of the differential course of monetary policy at a global level that we've seen so far. Something has to give, and I think what will happen is that since Europe and Japan will stay on an easing track, and since China is joining that, Korea and other emerging markets are joining that, the Federal Reserve outlook will probably be one where they will not be able to do more than a handful of rate hikes to the end of the cycle, because of these forces and that will be a different consolation than the market is currently pricing.
JC: If any, if any rate hikes.
AW: I think they will do some. I think because it's very clear that the current environment is an unhealthy one in the consolation. The US economy is actually back to growth. They lead the cyclical recovery. So in a way, the central bank should not ignore that, but they have to be much more sensitive to the spill over effects that US monetary policy has on the rest of the world. The US cannot decouple from the rest of the world. Every time I hear economists talk about decoupling they've always been wrong, and actually every time every time the recoupling happened it was brutal and it was fast. So I think central bankers have to be concerned about the spill over effects that their monetary policy may produce, but first and foremost they've got to concentrate on their home environment. And there I do actually see some fragilities in the US economy also emerging. You know the typical arguments – participation rates, the impact of a much lower dollar in a translation of into dollar returns for corporates, the ability of the US to export. The dramatic coming down of the oil price is totally different thing from how fracking and how shale gas will not contribute to the reindustrialisation of the US. A lot of that used to add quite a bit of gross dynamics when oil was at 100 or above. It looks quite different now that oil is at 50. So there are some headwinds for the US economy that the FED would probably take into account. And let me remind you, I'm not much more concerned in my new role, not as a central banker – I don't tell central banks what to do – I'm more concerned about telling our clients and investors what central banks are likely to do so the outlook I portray is one that I think is the likely output to come? I might have a different view as a former central banker on what central banks should do, but I think where central banks are now we're probably going to see only a very muted rate hike scenario for most of the central banks.
JC: Let's talk about that then. Just give us a sense of how UBS has done in Q1.
AW: Well, we'll be meeting the markets very soon so our CFO and CEO will have a rendezvous with the market on fifth of May, and they will give you all the details. I don't want to speculate on the first quarter but I think generally if you take a three year perspective on the recovery of the brand UBS, it has been a very interesting journey. We've changed the business model of the bank, we've focused on our previous strengths and that has been paying off over these three years. We've become profitable in every business area if you look at the last quarter reporting for last year. Every business area has been contributing to profitability. We are profitable across the regions. So UBS is one of the banks now that has one of the highest capita ratios amongst our peers, and I think going forward, capital will be a key strength of banks. It's not something that in particular in our wealth management franchise and in the asset management, clients do want to see that you're well capitalised. They do want to see that your liquidity planning is conservative so that events like in October don't hit you. And so, UBS I think has done a lot to perform better. How that translates into quarter to quarter results, our CEO will tell you.
JC: Of course, I apologise for asking. What we have seen though from the likes of JP Morgan of Goldman Sachs so far is again that we're seeing this pick up, benefit of the volatility and their fixed income divisions. We're going to ask you this for sure, quarter after quarter, any concerns that you'll be missing out going forward, given the increasing strength we're seeing there?
AW: More than 50% to the overall profitability of the bank. Our investors are wealthy families they're ultra-high net worth clients and in that space many of these family officers and wealthy clients are focussed on very long term investment returns, they want to secure the income and the wealth of the next generation in many times, so they have a very long dated investment horizon and for this long dated investment horizon the equity environment that we've seen and the buoyant dynamics there have actually been very, very favourable, very often they run their own companies and they invest in their own companies but if they have money to invest outside and diversify, they're investing in equity, they were investing in real estate, private equity, so they have a very clear focus on the dynamic of what drives the real economy, and it's a 5, 6 year investment portfolio that we have for these wealthy clients so they're diversified globally across fixed income and across real assets, but with an investment horizon that is much longer dated than that of many investors in the market.
JC: You're very much focused on the wealth management business obviously, you're still getting those noises from (inaudible) saying look that part of the business is funding the investment bank, you need to spin it off, what's the response to that when you continually hear this criticism of how you're running the bank?
AW: Well look I mean I am a very active chairman, I travel the world, I just was on a 4 week tour seeing most of our large investors, I've been in touch with over 120 of those investors, and the message we're getting from out investors is very clear, you're on the right track, keep continue what you've been doing, 4 years ago, 3 years ago when we started this there was a lot of scepticism, can UBS do the kind of lighter investment banking and be focussed a lot more on the clients in the equity markets on corporate clients and private clients and scaling down the fixed income business, now many of the international press are being told you have to do UBS, so if it were so wrong what we done, why would we have such a strong support, almost across our entire shareholder base, you can never win every single shareholder and you know there will always be one or two shareholders who disagree with the strategy of the bank but I can tell you from my outreach to the top 120 shareholders, they're absolutely behind the strategy, they're behind the board, they're behind management implementation and disciplined and focused implementation of that strategy and they don't want to see that strategy change, so I'm pretty comfortable that as we go into our general assembly, we get a broad support by everyone, it's not unique support, it's not support by each and every shareholder but that's not what we're aiming for, we have our main shareholder, our shareholder base behind us and we do have that.
JC: And you're happy with the investment banking business as it stands now you don't want to spin that off completely?
AW: You need to drill deeper down on why as the predominant bank in Switzerland with a market share of above 20% and as the global predominant wealth management franchise, why we do need an asset management business and investment banking business that helps us, if we take meetings with ultra-clients, and those clients would be clients that have 200, 300 million of assets of the management with us out of a total portfolio of liquid assets of 2, sometimes 3 billion, they are very interested in structured investment that come from a very sophisticated front end and for that to happen you need the structuring capabilities of an investment bank, phasing those family offices is no different to phasing an institutional investor or a fund, and if we wouldn't have that capability, I think we would lose traction in the ultra-business and ultimately for UBS the ultra-business is, I would say, the top of the range of private clients we want to service and without that ability we wouldn't be able to do so, so I do understand that if you're in an affluent business questions can arise about how important an investment bank is in that context, the business we're in, unique business model, almost every second billionaire in Asia being a UBS client, we need an investment bank and structuring capabilities and deals to show to these clients where they can invest their balance sheets along with us, we're balance sheet light, we've reduced the risk, we've refocused the investment bank, we've scaled down the balance sheet, we've (inaudible), we've focused on corporate clients and on private clients, but for those clients that are the core of our strategy, we need that part of the bank in order to be a holistically, value creating counter party for many of these clients and that's why I think it's part of the picture.
JC: One of the elements of risk here in the past few years is litigation. Have we moved on from any further concerns as far as UBS is concerned and trading activity litigation, no more skeletons in the closet?
AW: Well look we've done a major transformation of the bank, when we were here last year and we talked about it, I described the process, we probably were in the fifth inning of that transformation, we are probably now in the seventh and eighth inning of that, we're bringing all of these cases to a close, we very actively worked with all the authorities, we've been bringing these cases to the authorities, we were very transparent that we want to change that behaviour and we're totally clear internally, there is a very clear message from the top, from management, from the board, from everyone that carries a responsibility that these things have to be a thing of the past, we want to behave different in the future, we have a very clear messaging and a very clear transformation program we run in the investment bank and yes that will gain traction, we're not quite there, there are issues to be resolved…
JC: *INTERRUPTS*… New cases?
AW: I would not think we have to talk about new cases, I think our focus is on solving the cases that are on the table with law enforcement and with the agencies, and that's our focus at the moment.
JC: As far as investors are concerned, there's going to be no future surprises, things that we don't already know about?
AW: We're working towards that, so I can only promise you from what we've seen from where we've looked, we're transforming the bank, we're dealing with the issues we've found, and we will make sure we change the way we operate so that future cases will not come up.
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