October 27, 2014

UBS Adds $2 Billion to Its Litigation Warchest as Regulators Sharpen Their Sabres

The Top 10 banks are building sizeable capital reserves to mitigate a looming regulatory backlash specifically aimed at FX-rate manipulation. Regardless of the penalties, "litigation and regulatory matters will remain elevated for the foreseeable future".

The largest investment bank in Switzerland, and one of the largest in the world, UBS, published its quarterly financial results earlier today.

According to its Q3 2014 report UBS has set aside 1.8 billion Swiss francs ($1.9 billion) in “legal provisions for litigation, regulatory and similar matters.” A substantial part of the allocated funds are expected to address the looming fines to be imposed by a queue of regulators, including FINMA, FCA, BaFIN and others. Legal reserves at UBS, which had already raised its provisions for future litigation to 2 billion francs earlier this year, now stand at 3.5 billion francs ($3.7 billion).

Overall, UBS beat forecasts with a 32% rise in net profit from a year earlier, largely due to a gain of 1.3 billion francs from slightly adjusting how it accounts for deferred tax assets. However, on a reporting basis the bank suffered a 554 million francs ($585 million) loss in Q3 2014.

In September 2013, UBS provided the U.S. Department of Justice with information about practices related to foreign exchange fixings. Since then, the FCA (in tandem with other agencies) has begun talks with UBS and five other banks – Barclays, HSBC, Royal Bank of Scotland, JP Morgan and Citigroup – about a possible settlement that could result in heavy fines being imposed on each bank confirmed to have been involved in manipulative behaviour. The resulting fines are rumoured to be in the £300 million – £500 million range for each bank. The banks are expected to be fined different amounts depending on the gravity of the alleged misconduct.

Justice Renegotiated

With over $3bn now allocated for litigation and regulatory fines, UBS foresees stormy waters ahead. In the Q3 report, UBS states, “No agreement has been reached on the form of a resolution with the Antitrust or Criminal Divisions of the DOJ. It is possible that other investigating authorities may seek to commence discussions of potential resolutions in the near future.” The door is open for more regulators to step forward and lay claims against the bank.

In a clear admission of a sour state of compliance within the banking industry as a whole, UBS says, “We expect charges associated with litigation, regulatory and similar matters to remain at elevated levels through 2014. At this point in time, we believe that the industry continues to operate in an environment where charges associated with litigation, regulatory and similar matters will remain elevated for the foreseeable future.”

The bank said Q3 net profit was 762 million francs although the bank suffered a 554 million francs net loss – the disparity emanating from a convoluted method used by UBS in its financial reporting whereby each figure is given three shades of true in the form of ‘underlying’, ‘adjusted’ and ‘actual’.

Most of the bank’s financial underperformance came from its Investment Bank and Corporate Center units amid widespread downsizing and “restructuring costs.”

The UBS report estimates “restructuring costs of approximately 700 million for 2014 and 1.4 billion for 2015. For 2016, restructuring costs of 900 million and 400 million in 2017.”

Meanwhile, French prosecutors are close to finalising a €5 billion fine to be imposed on UBS for allegedly helping wealthy French individuals avoid/evade taxes, according to Reuters.

Avoiding Media Scrutiny, Evading a Quagmire

Last week, Deutsche Bank was reported to be setting aside litigation costs of €894 million for a number of items for when the banks reports its quarterly results tomorrow. According to Reuters, Deutsche (among other top FX banks) is expecting to be cut down with billions in fines by UK and US authorities, if and when banks and regulators “settle” on a figure.

In addition, Reuters reported that Deutsche was bracing to pay almost €1 billion for LIBOR-related fines as it nears a deal with U.S. and UK authorities to settle allegations that it had attempted to manipulate the benchmark interest rate.

Given UBS’s and Deutsche’s contingency plans related to FX penalties, it seems the world’s top ten banks are bracing for the regulatory crunch as if it was a chore rather than a crusade.