An Interview with Société Générale’s Chris Topple and Christophe Lattuada
Chris Topple and Christophe Lattuada, Co-Heads of Société Générale Prime Services, explain the strategy behind the acquisition of Newedge and Jefferies Bache and their integration into the bank’s Prime Services business.
AS THE CLEARING business continues to consolidate, a handful of firms are staking out a claim for a larger share of the business. Société Générale is one of those firms, having taken full control of Newedge in 2014 and buying most of the Jefferies Bache futures business in 2015. The French bank combined these businesses with several other lines of business within its investment bank and is now focused on offering futures and swaps clearing as a key part of a broader prime services offering. Prime Services sits within the bank’s Global Markets business, which also houses Agency and Principal Execution, Investment and Risk Management Solutions and Research. In this interview, Christophe Lattuada and Chris Topple, the co-heads of Prime Services, talk about the reasons why the bank decided to grow its clearing business and how that business is integrated within the rest of its Prime Services offerings.
What does the combination of Newedge and SG CIB provide in terms of creating a stronger prime services offering than either had on its own?
CL: We initially looked at buying 50% of Newedge back in 2010. But once we finally decided to go ahead it was based on the clear conviction that the market was moving in the right direction and that the top management of the bank strongly believed that being present in the post-trade part of the business was critical: Newedge was the missing piece of the set up. Secondly, we believed that the Newedge business model would be much stronger embedded within our bank’s market activities than as a standalone.
Once we agreed the purchase with Credit Agricole, we put in place an integration team from Newedge and SG CIB to make sure all the synergies were right. We are particularly pleased that we are on track and we’ve managed to do that while maintaining the original foundations of the different business models.
People were initially questioning whether an agency-based business could fit within a bank. Actually, it was not an issue at all. I don’t think any client raised this as a concern. On top of that, if you look at other banks and SG CIB in particular, we have been managing agency and principal side-by-side for decades. We have a cash equity business, which is, in essence, an agency business and we have a principal business that works well. I can tell you, all regulators have scrutinized this and there is no doubt that it works.
CT: We looked at the various models. You have those that bring prime services together with the custodial type of business; those that have prime services almost entirely embedded within equities or even the model where you have it divided up across capital markets. We decided to put all these activities within one business line called Prime Services, which is now one of the four core business lines of Global Markets.
CL: In that respect, the Newedge acquisition was a great opportunity, because we started almost with a blank sheet of paper and we assembled all the different businesses of Newedge and SG CIB, not based on history or legacy but based on the business model that we wanted to create. There was the core FCM part with the clearing and execution and we added the part of equity financing that came from SG CIB market activities. But we also tied in the agency lending from the securities services business and designed this business line based on the type of clients we wanted to service and the type of offering we wanted to deliver.
CT: It is undoubtedly the right structure for the evolving regulatory landscape. We are providing an FCM, OTC clearing, fixed income PB, FX PB, equity PB, synthetic PB and collateral transformation all in a single business so we can aggregate risk, pricing, reporting and margining. We don’t have to deal with legacy battles over who owns what. It seems to work well and resonates well with the clients.
Have you a noticed a change in the client profile or what clients expect from you now?
CT: Most certainly.
CL: Firstly, we should say that the acquisition and integration has had a very positive effect on the client base. For years, some had been questioning the future of Newedge but now there is a clear commitment and there is no doubt they know who the shareholder is and who the counterparty is, so it has clearly helped to stabilize things.
CT: Newedge USA was integrated into our primary dealer, SG America Securities, as of January 1, 2015 and as a result we are now on-boarding some of the largest pension funds and asset managers in the U.S. On the hedge funds side, the prime brokerage business had historically targeted the types of hedge funds that have less of an impact on the balance sheet—those that are more arbitrage, market-neutral, CTAs and managed futures. We serviced equity prime brokerage clients as well, but they were typically the more market-neutral or volatility-arb type funds that were heavy users of derivatives, rather than the ones that were fundamentally equity long/short, simply because we didn’t have the [stock lending] inventory. The size of our stock loan book historically was less than a tenth what it is now. To suddenly have that, off the back of the new infrastructure, was really the missing ingredient to pitch for fundamental long/short business.
If you look at the traditional equities business at SG CIB—it is the global leading equity derivatives house but it had always been weaker on the cash side of the business by not having a prime broker. The amount of synergies we have seen have been huge. In the first year alone we recorded 400 cross introductions, 70% of which have been converted into some sort of positive outcome.
Newedge has fantastic client relationships, but we could only offer them one or two different product suites. All that changed with the acquisition. Now we are able to offer equities research, fixed income research, corporate bonds, new issuances, etc. It has allowed us to expand our breadth of service and has been very complementary to our business. A core differentiator of Newedge and now for Prime Services has always been its market coverage. We cover around 125 exchanges across equities and listed derivatives, so the coverage is very broad and global.
You reached an agreement in April to acquire most of the futures business of Jefferies Bache. What was the main attraction of that deal?
CL: We realized that we could on-board clients and activity onto our existing platform with little capacity constraints. We agreed with Jefferies that we would on-board some of their clients and selected teams. We gained a few hundred clients and had some 40 people joining; a few on the front office side and two thirds on support and services functions. So with only a few additional people we have grown our client base. This is a scale business, so given we had the platform, we were able to deal with all the business and services from Jefferies with our existing platform. It was a win-win deal.
How has the integration of these new businesses – Newedge and Jefferies Bache – impacted your systems?
CT: The biggest challenge has been around some of the processes like on-boarding. This was not just a question of legacy Newedge platforms or systems, the business had to be fully integrated into the investment bank across risk, legal and client service. That has been a little bit challenging but at the same time we are now targeting larger and more sophisticated accounts than perhaps we have historically. That increases the complexity of the process.
CL: From a systems perspective what made the integration easier compared to other integrations was the fact that there was no similar activity to Newedge in SG CIB. So we didn’t have to make a decision between two clearing systems, for example. We just picked up the Newedge systems and clearly had to make some changes to make sure they were well connected to the SG CIB systems and environment and transferred them over.
CT: As a rule SG didn’t have a prime broker, it didn’t have an FCM business, it didn’t have FX PB or fixed income PB. It had an equity swap platform and that was the only piece of core infrastructure that we actually integrated into the legacy Newedge platform.
CL: Today, from a systems point of view, front office to back office, the integration is complete. From a firm perspective—an operations, IT and legal perspective—we are halfway through the process and although there is still a lot of work to be done it is progressing well.
Many banks see a negative outlook for the clearing business in terms of profitability. SG CIB seems to have a contrarian view, doubling your investment in Newedge and acquiring selected assets from Jefferies Bache. Why are you bullish on derivatives clearing?
CL: I think we are more positive because we have taken a long-term view. Clearly, if we have taken the decision to invest in this business, it is because in the end, we consider that this business can be as profitable as the other ones on a standalone basis.
CT: SG CIB has always been phenomenally good at creating and selling products, but it didn’t have a concept of delivering suites of services and the resulting deep relationships you get from a services-based relationship. The way I think prime services is now viewed is as the platform through which you position yourselves as a core counterparty to your client, structured through ISDA and PB agreements and through which you sell your capital market product suite. We are under no illusion—Prime Services has to be profitable on a standalone basis and has to meet the targets of the investment bank. But in addition, it must also provide synergies to the rest of the Global Markets business.
A core differentiator of Newedge and now for Prime Services has always been its market coverage. We cover around 125 exchanges across equities and listed derivatives, so the coverage is very broad and global.
Chris Topple
Société Générale Prime Service
CL: If you look at the prime brokerage model there are two things to keep in mind to make it profitable. Firstly, balance sheet commitment is a scarce resource. Here it is a matter of being disciplined and having the right pricing, evaluating the profitability of the client on a holistic basis and not just providing financing on one side and the bank not making sure the revenues are tied elsewhere. We have to have good discipline in the way we allocate and mobilize our resources. Secondly, in a business where two-thirds of the costs are operations and IT, scale matters. Newedge is one of the leading FCMs and integrating it into a global bank provided further economies of scale in areas like IT and ops and other efficiencies like off shoring and STP.
CT: SG CIB has a sizable equity finance book but that has largely been financing other prime brokers. It has almost been a prime broker to prime brokers. So we have the ability to pull that inventory back and give it to the end-user clients thereby materially changing the profitability yet not requiring us to go out and increase our balance sheet. That’s the rationale behind it.
SG CIB bought equity stakes in Eris and GMEX. Why did you think that was a good investment and how does it fit into your overall vision for the evolution of swaps and futures markets?
CL: These are two different platforms, which are U.S.-centric and Europe-centric respectively, but in both cases it shows the commitment of the bank. The futurization of the market will take some time. There will always be OTC products and they will remain the core market of SG CIB. The first requests for these platforms came from clients and it made good business sense as we were willing to get access to those markets.
CT: A core differentiator of Newedge and now for Prime Services has always been its market coverage. We cover around 125 exchanges across equities and listed derivatives, so the coverage is very broad and global. We like to be seen as one of the firms that is progressive in terms of being involved in new market initiatives and being the driver of change. We have a very solid platform and a senior management structure that supports expanding this business.
Looking at the listed market, what are the other areas of development along these lines. Where do you see a gap in the market for other similar initiatives?
CT: One area we focus on is the area of fixed income. This is the one remaining OTC market that would lend itself to some sort of ECN or exchange-type structure. We are monitoring that area very carefully.
You are clearly optimistic about the business at the moment. What areas of the business are you concerned about?
CT: The leverage ratio causes concern. The regulators’ desire to push more products onto exchange but at the same penalize the providers of the services who are doing it by forcing them to place client collateral on their balance sheet does raise issues. There is plenty of lobbying going on to try and convince them to rectify this, but the industry doesn’t see any material change in the near future. There is now at least recognition that there is an issue here. It doesn’t make sense to take client collateral and place it in a segregated account at the exchange yet it sits on your balance sheet. The Basel Committee is considering the issue but the timeframes for resolving this are long. So that will remain one of the biggest challenges for all of us.
Overall, volumes have stabilized for the industry, but they are still too heavily skewed to the lower margin and high frequency volumes. Ironically those are the volumes you quite like now because you don’t have large initial margins that sit on your balance sheet and that you have to post capital against.
Repricing is happening, but has not been aggressively done yet. The OTC clearing space was priced far too low for a long time so the pricing is beginning to be normalized.
