Carolin Roth: Sergio, thank you so much for joining us here at CNBC in London. A lot has happened in the European banking space over the last couple weeks. We saw that Venetian banks have been rescued. Italy has taken a sizable stake in BMPS. We know that Banco Popular has been taken over by Santander. Now when it comes to the Italian banks there was a difference when it comes to the Spanish banks because mostly the taxpayer was still on the hook and that goes against new E.U. bail-in rules. Do you think it should have happened this way?
Sergio Ermotti: No it should not happen that way but it was almost inevitable considering the fact that bail-in-able bonds, so highly risky bonds, subordinated bonds were placed with retail investors. And I think that was a wrong decision to allow this to happen a few years ago. So it was almost inevitable, but politically speaking, and socially speaking was not acceptable in my point of view to have retail bondholders to be bailed in.
CR: So you don't think that those bail-in rules will ever hold in the future?
SE: I do think that you know there are banks like, if I can say UBS, under the Swiss regime it's very clear the subordination and it's also very clear who you sell those instruments to. So it's very important to be very careful in this process when you place the bonds to be sure that people understand the risk you are taking. And in my point of view those kind of instruments should never be placed with retail investors.
CR: If we go back exactly one year, confidence in the European banking space that was at a record low; we saw many of their share prices at a record low, in part because of concerns about NPLs coming from Italian banks but also capitalization issues and those two issues have now been addressed with some major capital hikes from the likes of Credit Suisse, Deutsche Bank, UniCredit, and then again the Italian banks have been dealt with. How much of a relief is that to you as the CEO of one of the biggest European banks?
SE: It's good the big systemic and global banks have been taken care of or they took care of themselves in addressing those issues. I think that what we see right now is probably what we could call second tier banks and third tier banks coming to difficult times. So the job has been done. It is clear that Europe is not one pot in which all banks are behaving the same way. There are winners and there are very strong players in Europe and there are still weak players that should be allowed to restructure or to be consolidated.
CR: But do you think that confidence in the European banking sector has been fully restored or is there anything that worries you and that you think that could come back to the fore and depress ratings or depress valuations further?
SE: In general European banks, I think you compared to a year ago, definitely much better placed. But still a little bit time, you know, more to go in the respect of restoring confidence. In order to restore confidence you need a prolonged period in which those kind of issues are not making the headlines. And unfortunately it's not the case. So I do think that Italy is one case. We saw in Spain some questions around the German banking system; it could be both. So in general I would say maybe another year to go in order to really assess how solid this recovery is.
CR: Assuming of course that the economic recovery continues because that is really providing the tailwind isn't it?
SE: Well look you know banks, in general, it's very difficult to be profitable and sustainably profitable. And if you have very little grow or no growth in the economy and you are operating in a low or negative rates environment. So the bread and butter of banking it's about being able to address those two issues. Maturity transformation on one side of the equation - on your liabilities - and with negative rates there's very little money to be made. And also granting credit to an economy that is growing really takes away a lot of pressure on your performing, um, on your provisions, on loans. Therefore banks need to have a strong recovery in order to be sustainable.
CR: I'll get to negative interest rates in Switzerland in a second, but obviously over the last two weeks there's been a lot of talk about tightening, or the first steps towards tightening in Europe, even though the ECB has been pushing back against it. But we heard similar voices coming from the BOE. For example we know that the Fed is in the midst of tightening and reducing its balance sheet. Do you think that Europe specifically and the corporate sector is ready for a pullback in ultralow monetary policy?
SE: The sector I would say is ready and probably also would welcome a little bit of normalization on the rates side in Europe. It is clear to me that we'll see what's going on in the U.S.. If the U.S. hikes more than once or two times it is going to be very difficult for the ECB to stay on hold for too long. I think that you don't want to create too much of an interest rate gap between the between the euro and the dollar. And in that respect also what I can say is that you will see these developments also playing out in how the Swiss National Bank is going to act on their side. We do expect the SNB to stay on hold and let the ECB go first and probably for at least a while before they also normalize their rates.
CR: You've been very critical of the SNB's negative interest rate policy in the past. If you say you're expecting them to stay on hold for the time being what does that do to consumers, to your business in Switzerland?
SE: I'm not being so critical other than saying that, you know, one has to consider the negative effect of negative rates. It's not only positive. I do believe that the tools available to the SNB at that time were limited and negative rates was one consideration. But I think today is also time to consider the negative effect of negative rates. As I say, it is going to be very difficult at this stage for the Swiss National Bank to move away from this policy without the ECB moving first. And so we need, you know, we need now to wait and see how the ECB is performing.
CR: UBS in the past has upped its fees for corporate and institutional clients, as well as raising mortgage rates by 50 basis points. Are there any further steps that you think you would have to take if these negative interest rates persist for much longer?
SE: Well look, you know, to pass the cost of negative rates to the borrowers it's, you know, it's a counter-intuitive measure in any case and it's going to be very hard. I think that at this stage we are limiting and we basically are not passing the cost of negative rates to so-called retail investors. But we have been passing more and more the cost of negative rates to wealthy individuals or family offices and corporate clients. So I do expect if there is a deterioration of the situation that we would be forced to take further measures in that sense.
CR: We're obviously in the midst of summer trading and that's usually very quiet; volatility drops off a cliff and so do volumes. Do you think that if we're seeing a further push towards tightening by global central banks, that would be quite positive for your trading business, as it usually is, without injecting too much of the bad volatility into the markets?
SE: Well right now there is no volatility at all. So I think that we are not even discussing about bad volatility in this environment. Of course we do see now for the last five/six months personal, individual clients being more active and constructive about markets than institutional investors, which are of course highly correlated to the volatility of financial markets. We have almost correlation one across many asset classes in terms of volatility. So I do see a little bit of a stagnation of business, and a little bit of volatility and change in policies may help to give a little bit of momentum to the business.
CR: And I'm sure you would welcome that maybe we'll see that in the third quarter as we move through the summer. What about capital market activity? Can you talk to me about some of the trends that you're seeing? IPO has made quite a quite a resurgence. M&A in some patches is active and others not so much. In the U.S. for example we're seeing clients being pretty, I guess, cautious about the outlook of Donald Trump's policies. What are you seeing?
SE: Yes I think that we do see this change in sentiment. I mean, of course if I go back at year-end and at the end of the first quarter, we are measuring investor sentiment and corporate sentiment was very constructive, very positive, although on a wait-and-see and to see exactly what we will see out of the new administration. I would say that right now the momentum is losing a little bit of tailwind, as people do still believe that we will see some positive news from the new administration. But the goodwill is eroding very fast and people want to see concrete actions before engaging in M&A, before engaging into major discussions in respect of strategic moves.
CR: What does it mean for some of the clients that you're advising, simply when it comes to the wealth management side? Are they equally cautious when it comes to investing in products, just because they don't know what's going to happen on the policy side?
SE: There has been a little bit of more constructive tone and attitude by individual investors in the last five months. It's clear if I look at the cash balances as a percentage of wealth we manage, they have been coming down from the high-20s to around the mid-20s. So this is clearly a sign that people are willing to invest more, but still very cautious. You know 26/27 percent cash balances is still almost twice as high as we had five years ago.
CR: Yeah that's an incredibly high number. What do you think will ultimately unleash animal spirits across the world, not just maybe North America? Do you think it really all comes down to Donald Trump's tax reform?
SE: Not really only that. I think that, you know, there are many fronts open. The U.S. is one but Europe is still somehow, you know, people are now looking to see how the new administration in France will perform. And remember that five/six months ago people were concerned about the Dutch elections, the French elections, and now those things are now normalizing. But there are a lot of hopes about the new administration in France, not only for France itself but also for what it means for Europe. And in that sense also closing a little bit of the chapter of the stability of Europe will be essential to restore investors' confidence. We need to see what's coming out of Asia, and China in particular. The geopolitical front is. you know. quite worrying in respect to what's going on almost every day. So investors are really fundamentally touched by all those dynamics and they need to see a very prolonged and stable pattern going forward. You won't take 25 percent cash balances down to mid-teens in a few quarters. It's going to take a year or two of stable markets and stable geopolitical issues being resolved.
CR: UBS is the biggest dedicated wealth manager in Asia and you're very much focusing on the high net worth individuals over there as well. What is the biggest issue? What's the biggest concern to those investors right now?
SE: I would say for sure people are concerned about valuations. Clearly they do see market valuations being extremely high. And again the backdrop of, you know, lack of clarity from the macro front and geopolitical front is really the major issues affecting client sentiment.
CR: What about a slowdown of China's economy or do you think that's been pushed aside?
SE: It's true that it's a kind of concern that people have, but I would say compared to a year ago it is much more embedded in the way they invest. I do see a little bit of a more constructive attitude towards taking a risk, a pickup on leverage. So investors usually you measure appetite of investors in their ability or willingness to take a little bit of leverage on their positions. We have seen a little bit of a pickup there. But in general I would say very constructive about China going forward. If you think that China only by growing 5 percent a year for the next 15 years will double the size of its economy. So people do realize that the secular trend of China are there. But maybe the cyclical one will be more bumpy than the one that we had in the last 10 15 years.
CR: Sergio, can I take you back to Europe because you mentioned Macron, you mentioned the Netherlands before and it seems as though over the course of the spring European voters have rejected populism in Europe. Yes we still have Brexit going on, but it seems for now we're in the clear when it comes to populism overall. Is there a sense that the outlook for Europe is much brighter than ever before?
SE: I would say that people want to give another chance to Europe. That's my reading of the story I think that this aversion, to call it populism or a need of change, has been somehow limited. If you look at France, Macron in itself is a change. He's a very untypical figure. He's not a populist, but he's a change. So I think that in France people were able to find a solution that was not extreme. Now Macron needs to fulfill the expectations on him; they are extremely high. And he does in that sense I do think that Europe needs to really think about its construct. Is the Europe as we know it today the right Europe for the future?
CR: Well, do you think it is?
SE: I don't personally think it's the right construct, but maybe I'm biased because of my Swiss background. Or, you know, also looking at the U.S. Today it's almost unthinkable to have a different Europe. But I do believe that the more federal Europe, with a common finance policy and fiscal policy, with a common defense policy, with a common foreign policy is the only Europe can succeed, truly. And you know, I don't think that… Europe has a huge potential but in the current construct it's very, very difficult to succeed.
CR: Some of the Federalist tendencies that you just mentioned -- a common defense budget or common budget overall -- do you think this will ever happen? There seems to be so much resistance from the Germans especially.
SE:I don't think it's only from the Germans, because people got used to, basically through the common currency, for years and years after the introduction of the euro, they thought that they found a magic formula to basically have access to funding at a very cheap level without all the obligations and the cost associated with having one currency. And now, so people don't want to lose the sovereignty; they want to keep the euro and not lose the sovereignty. And I think it's going to be very difficult going forward. So I don't know if the German resistance is against the federal system or is against people taking too much advantage of that system. But I do believe that, you know, it's going to be very hard for the current state of Europe to be successful. I hope and I believe changes are needed.
CR: Well one of the big changes that we'll see in the next two years is Brexit and of course the very bumpy negotiations that we're facing. At this point we don't know whether we'll see a hard or soft Brexit. How do you prepare for that? As you've got a major presence in London and you've said in the past you will have to relocate some jobs to mainland Europe. How do you prepare with this new reality of more uncertainty even about the Brexit talks?
SE: As we speak we are narrowing down the numbers of options available. So when things started we have different -- actually Brexit started well before the vote. Because as we knew there was a vote coming we started to have contingency planning on what to do and how to position our legal entities in the continent in order to address a potential positive vote on Brexit. And we are now narrowing down the options and we do believe that by the end of the summer, early part of Q4 we will need to further narrow down the options and start to implement some of these moves, which, you know, will indicate maybe the necessity to move people and also to reshape our legal entity construct in order to be able to serve clients.
CR: Do you think Frankfurt will be the location of choice or do you think it will be across Europe?
SE: I think Frankfurt is a location of choice. There are different other locations that could come into into consideration. I think about Amsterdam, I think about Madrid. In different shape or forms, things that at the end of the day, as we speak we are narrowing down really the options. And as I say by the end of the summer, early part of Q4 we're going to make a decision.
CR: Let's change gears, let's talk about the future a little bit. First I want to talk about your future. I recently read a statistic saying that the average shelf life, the average life of a European banking CEO is seven years. You've now been doing this job for six years and you've achieved a lot. I'm not saying that it's the market, it's the analysts who are saying that. You've transformed UBS away from a capital intensive risky bank towards a dedicated wealth manager. What else do you want to achieve?
SE: Well first of all I feel pretty good about what I'm doing today and I do believe that there are still some things to be done. You're right, We put back well its management into the center of what we do, together with our universal bank in Switzerland. We have a very competitive and and profitable investment bank and a strong asset management capabilities. We want to continue to build on all those businesses organically. And for me the real proof going forward will be to show sustainability of what we did and continue to grow. In any case our industry, and particularly in wealth management, we do expect the business to grow twice as much as GDP globally. So there are still a lot of things that we can do in order to capture the growth opportunities and I'm staying very focused on that.
CR: And you don't think your job, your personal job is done yet?
SE: Not. And also, to be honest, I don't think it's you know the average life of a CEO of a European bank in the last 10, 15 years is not a good reference point for how long a person should be in a job. I mean if I look at my peers in the U.S. probably they are a better reference point than Europe.
CR: All right. It seems like you're not going anywhere at this point. Let's also talk about the future of your business. And we know that when it comes to finance overall many of the banks and the financial services providers they've been using, they've been moving towards fintech. And I just wonder you as a wealth manager are dealing with high net worth individuals. Does fintech really work for you? Does it apply to you? Can you use roboadvisors for high net worth individuals?
SE: Very much so, but not in the way people think that it's going to substitute human intervention. Actually, you know we are a big user of tech and technology. You know, we and our peers to be honest, over the last 20, 30 years and as we speak, we are deploying a lot of new technologies to help our client adviser to be more effective and efficient in the way they serve our clients. And we see fintech as a major ally. Only a few of them really want to cannibalize us. Many of them want to work with us to find solutions. And I feel pretty good about what we can do on a client-facing basis. So the real transformation of fintech and technology is going to be on the back-end. That's the battleground for the industry. It's not necessarily the best application or the best way to interact with clients but rather how efficient you are in delivering the services and how economically flexible you are in doing that. That's the battleground.
CR: As you say it might be the survival of the fittest. Does that ultimately mean that we're going to be seeing a lot more consolidation when it comes to the back office?
SE: I do. I do believe it's necessary. I don't think that the financial services industry and that banking in particular are any different than any other part of the economy, any other industry outside banking. If you look at what happened there, across the board every other industry has very competitive, you know, dynamics, but also many areas of collaboration in order to you know stay competitive and stay relevant. But I do believe that consolidation will play a role, a more traditional consolidation will play a role. A less traditional consolidation, like this one of cooperation on the back-end will play a role, and ultimately I do believe that incumbents will be the winners. They're going to be winners and losers. I do see a limited chance for a new entrant to become very effective, particularly in wealth management because it takes decades to build up an expertise. And last but not least, for a new entrant you need to be willing to take on the burden of banking regulation if you want to accept, to be in this business in a meaningful way.
CR: So to be a winner in fintech, do you ultimately have to acquire some of the new technology out there? Are you actively looking at some of the fintech names out there, that you think they could add a lot of value?
SE: Yes but not necessarily we want to acquire them. But two years ago and very recently we started again an initiative in which we ask fintech boutiques and businesses across the world. Last time it was 600 fintechs participated in a challenge, in a competition where we were shown ideas. And we selected the 12 finalists that were, in our point of view bringing the best ideas that we partially utilize and partially we refer to clients or other organizations. So we really believe in working together with fintech, rather than thinking that we necessarily need to acquire them in order to be successful.
CR: Finally, world leaders at the moment are very much at odds over some of the big topics in the world, such as climate, such as protectionism, trade overall. When it comes to sustainability overall UBS has committed to invest $5 billion in impact investing. Last year you launched an oncology fund. Do you feel that this makes sense for the investor?
SE: Well it makes sense yes because they want it. I mean it's not something that we are pushing out to the clients. We are responding to a clear demand that is there and this is, by the way, not only a demand coming from the millennials or the new generations, which of course they have, they want to do something good while doing well. But this is not any longer just something that is particularly a focus of new generations, also older generations want to have a legacy. And as a reference point we have almost a trillion of assets that can be labeled and defined as sustainable investments. Under the category of sustainable investments we manage around 2.7 trillion, actually a little bit north of that. So almost a third of the assets we manage for clients are already under the umbrella of sustainable investment. And this is not because the banks wants to do it; it is because clients want to do it.
CR: Which clients want to do it? You said it's not just the millennials, it's all age groups. But what about some of the regions? Is there a sense that the more developed countries in Europe for example or the United States they're further ahead in this drive to do good? To invest in the social good? Is it also present in Asia?
SE: Yes it's starting. Very much so. I think that in Asia the new billionaires, the people who are coming from, in some cases from poverty themselves, are very keen to give back some things to society, but they are keen to do it in a way that is not charity. I mean charity is part of the equation but the real theme is to say how can I invest while doing good and balancing the returns and sharing some of the risk with, you know, small entrepreneurs and people that wants to develop something. So it's very much accelerating also in emerging markets.
CR: There's always the myth that sustainable investing leads to maybe subpar returns, that returns are never going to be as great as they are in with other causes if you simply look at the profitability of a company. Do you find that over the years that's incorrect?
SE: It's incorrect as a general statement. It may be that in some cases you have an opportunity cost. So I'd rather talk about opportunity cost than subpar investments because the opportunity cost then has to be the financial opportunity cost. It has to be weighted versus the social outcome you get. And that's where people are putting a lot of value. So I think is how somehow limiting to just look at the subpar in terms of financial investments. And it's not even correct in many cases.
CR: Where else do you need to go, do you want to go when it comes to UBS when it comes to social investing? What do your clients want?
SE: Exactly, it's not only trying to think what we think is right, but to stay very close to clients and capture their needs. At the end of the day is not just because it's socially the right thing to do for us as a bank. It's also responding to client needs. I think that if we capture that, we're going to serve both our shareholders, our clients and in general we can serve better society.
CR: Thank you so much. Appreciate it. Thank you.
For more information contact:
Lee Thompson, International Communications, CNBC
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