‘Switzerland has spoken’. Will UBS leave?

Last month, the bank was dealt a crushing blow when the Swiss Senate backed a proposal that would force it to hold an extra $16 billion of capital. Keystone / Til Buergy

New regulations will leave lender with options ranging from retaining billions of dollars of additional capital to shrinking international operations.

Three-and-a-half years after UBS acquired its stricken rival Credit Suisse in a state-orchestrated rescue, Switzerland’s biggest bank is once again confronting fundamental questions about its future.

Last month, the bank was dealt a crushing blow when the Swiss parliament’s upper house backed a proposal that would force it to hold an extra $16 billion of capital.

The final proposals, designed to prevent a repeat of the 2023 crisis, still have to pass through the legislature’s lower chamber. But UBS executives are resigned to losing the political battle. “Switzerland has spoken,” said one person close to the bank’s leadership.

The defeat has left UBS with few good options, ranging from retaining billions of dollars of additional capital to shrinking its international operations. Or the nuclear choice: leaving the country altogether.

Leave Switzerland

Chair Colm Kelleher acknowledged publicly for the first time last month that UBS could reconsider its Swiss base if the regulatory tightening proved too onerous.

Two of UBS’s largest investors have already urged the bank to shift its headquarters out of Switzerland if the planned reforms are rubber-stamped by the parliament’s more left-leaning lower house.

Artisan Partners, a top-10 shareholder, wrote to the bank’s board last week saying Switzerland was “no longer an attractive or desirable location” for the country’s largest lender — whose balance sheet significantly exceeds the size of the country’s economy. Cevian Capital, which owns about 1.5%, issued a similar warning last year.

Some investors have pointed to the US as a potential destination for relocation because of its less stringent capital framework, while others say a large Eurozone economy closer to UBS’s traditional home, such as Germany, could house the group. The UK is considered less viable because its capital requirements are more similar to those in Switzerland.

Several governments have raised relocation with UBS over the past few years, according to a person familiar with the matter.

But leaving would carry significant costs. Morgan Stanley analysts estimate that the government could impose an exit tax as high as $10 billion on UBS.

Swiss finance minister Karin Keller-Sutter, who has spearheaded the government’s reforms, said last month that if UBS left the country it would be “much more expensive and legally very complex” than if it stomachs the new capital rules.

Do a deal

Rather than relocating on its own, UBS could pursue a deal with a foreign rival, allowing it to escape Switzerland’s capital regime. One person familiar with the bank’s thinking said that UBS would have more options once the integration of Credit Suisse was complete.

By then, the bank will have absorbed most of the costs of integrating its former rival and expects to be generating significantly higher profits, giving it greater financial flexibility to pursue a deal. It could then consider a transaction that “provided regulatory capital relief”, the person said.

One way of achieving this could be through a reverse takeover in which a smaller foreign bank — potentially in the US — acquires UBS in an all-share deal but UBS shareholders emerge with a majority stake in the combined group.

Giulia Aurora Miotto, an analyst at Morgan Stanley, said such a structure could avoid the exit tax, although it would require a smaller bank to merge with UBS and potentially cede control of the combined group.

There is also the possibility of a mega-merger with a Wall Street or European bank as a route out of Switzerland.

Some UBS insiders see Morgan Stanley — where Kelleher spent much of his career — as a potential partner with obvious synergies. “You would be combining the largest US wealth manager with the largest international one,” said a person familiar with the matter. There is no indication that any side is pursuing a transaction currently.

Split in two

Another option would be to split UBS in two, allowing its prized and highly profitable domestic business to remain Swiss while shifting its sprawling international operations outside the country’s regulatory purview.

A senior executive at a rival European bank said this would be their preferred option if they were in UBS’s position.

Under such a structure, a “Swiss UBS” containing the domestic retail and corporate bank could remain headquartered and regulated in Zurich. Meanwhile, its investment bank and overseas wealth businesses could sit under a separate foreign-domiciled parent, potentially in the US, UK or Eurozone.

However, analysts point out that much of UBS’s overseas business — particularly its Asian wealth-management operations — is already booked directly through UBS’s Swiss parent bank via foreign branches rather than subsidiaries, complicating a clean separation and limiting the capital benefit it might provide.

There appears to be little appetite within UBS for such an overhaul. A senior UBS employee told the Financial Times that any alternative to remaining in Switzerland was more likely to “involve a radical move” rather than a restructuring.

Shrink in America

If implemented, the new capital rules would fall particularly heavily on UBS’s US operations, by far its largest foreign subsidiary, with some industry observers saying the bank could consider offloading some or all of the business.

Under the current proposals, the bank would have to cover 90% of the value of its foreign units with common equity tier one capital at the parent bank, up from about 60% currently. At present, UBS is also allowed to use cheaper additional tier one (AT1) debt to cover some of the requirement.

Morgan Stanley analysts pointed to the US unit’s weak profitability in recent years, with margins below those of other parts of the group. “Holding significantly more capital because of [the reforms] could make the case for selling the [US business],” they said.

Johann Scholtz, an analyst at Morningstar, said UBS would probably regard maintaining a meaningful US investment banking presence as “strategically important”, leaving US wealth management as the business with “the clearest economic rationale for separation” or a spin-off.

He added that UBS’s US wealth business was largely a domestic adviser-led franchise that had relatively limited overlap with the group’s international wealth operations, which are built around entrepreneurs, family offices and ultra-high-net-worth clients with global financial needs.

But such a move would run directly against UBS’s global ambitions. Goldman Sachs analysts describe the US, alongside Asia, as a key pillar of UBS’s growth strategy in global wealth management.

Chief executive Sergio Ermotti said this week that the bank needed a presence in the US “to be successful”, suggesting that shrinking substantially in the country was not currently under consideration.

Stay put and pay up

The simplest — if costly — option for UBS would be to accept the higher capital requirements and continue running the group under its current structure from Switzerland.

Although UBS has estimated the additional required capital to be $16 billion, analysts believe the shortfall would be closer to $6 billion-$8 billion once excess capital already held at the parent bank is taken into account.

The senior UBS employee said the bank was most likely to stay in Switzerland and adapt to the new rules, which would be phased in over several years.

Scholtz at Morningstar said his “base case” was that UBS would meet the higher demands by retaining a higher proportion of earnings. “The requirement appears manageable and should not require an equity raise,” he added.

But that could have significant consequences. Morgan Stanley analysts said the 90% requirement would represent “a significant constraint on UBS’s current and future strategy”, potentially limiting its ability to grow internationally.

Kian Abouhossein, an analyst at JPMorgan Chase, estimates the proposal would knock half a percentage point off UBS’s return on tangible equity — a key measure of bank profitability — in 2028, while leaving it operating under “the most stringent regulatory environment globally”.

For now, UBS has said its goal is “to continue operating successfully as a global bank from Switzerland” as it weighs its options.

As it does so, some rivals are allowing themselves a degree of schadenfreude. “If UBS wants to be Swiss, these are the consequences it has to live with,” said the rival executive. “A competitor that has to hold more capital is good for us.”

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