CIM Case Study 6 DB 2019 20 vf PDF

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IB3810 Critical Issues in Management 2019/20 Case Study 6: Deutsche Bank: The troubled giant dragging its feet?1

Turning a Conservative Bank into a Wall Street Powerhouse Deutsche Bank was founded in 1870. Its major orientation from the start was foreign trade, only going into retail banking as late as 1959. In the 1970s, it started moving beyond its national boundaries, opening offices in Milan, London and Tokyo. Its growth was steady and largely conservative; its ambitions reasoned. Then came the heyday of 1980s Wall Street. Its steady hand and modesty began to look foolish, even backward. Faced with UK and US rivals posting unprecedented profits based on investment banking expansions, Deutsche soon revisited its ambitions. It not just joined the race – it came to dominate it. As Bloomberg Businessweek recounted2, “Deutsche in 1995 hired one of [the leaders of the new financial products movement] from Merrill Lynch: Edson Mitchell […] Three years later, [it] made an even more emphatic attempt to buy its way into investment banking’s culture and profits, acquiring Bankers Trust – a New York derivatives house notorious for its cowboy culture – for about $10 billion.” By 2000, Deutsche Bank’s London-based investment banking division was responsible for half of its income. In 2001, it was listed on the New York Stock Exchange as one of the world’s ten biggest banks. The following years featured a flurry of acquisitions, all intended to contribute to a target 25% return on equity. It became one of the key players designing and selling collateralised debt obligations (CDOs) and other mortgage-based securities – a new form of financial instruments aimed at providing even more returns to the bank. They did, at least in the short run: in 2008, the bank profited $1.5 billion from its short position related to mortgage-based securities.3 Some of its traders did pretty well also – in 2008, its most profitable derivatives trader took home $130m in bonuses. For a while, Deutsche evidently held a one-way ticket, heading all the way to the top. Dubious Practices Then came the 2008 financial crisis, and revelations into Deutsche’s poor practices. This included manipulating benchmark interest rates (including Libor) 4 , for which

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This case was originally written by Maja Korica and updated by Rene Wiedner and Katharina Dittrich. Silver, V. and Martinuzzi, E. (January 19, 2017). ‘How Deutsche Bank made a $462 million loss disappear’, BloombergBusinessweek, https://www.bloomberg.com/news/features/2017-01-19/howdeutsche-bank-made-367-million-disappear 3 Levin, C. and Coburn, T. (April 13, 2011). Wall Street and the Financial Crisis: Anatomy of a Financial Collapse. Report to the Permanent Subcommittee on Investigations, US Senate. http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf?attempt=2 4 Kasperkevic, J. (May 23, 2016). ‘Lawsuit accusing 16 big banks of Libor manipulation reinstated by US court’, The Guardian, https://www.theguardian.com/business/2016/may/23/libor-manipulationlawsuit-hsbc-barclays-ubs-bank-of-america-deutsche 2

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Deutsche paid $2.5 billion in 2015 to US and UK regulators. It was the largest fine paid by a bank in relation to Libor, and involved Deutsche dismissing seven staff. According to a Financial Times report in April 20155, “Anshu Jain, Deutsche’s co-chief executive, [who] was head of its investment bank [during that time…] was cleared of any wrongdoing [and] told colleagues he had no intention of standing down. However, some legal experts suggested the bank’s top echelons had been tainted by the scandal, [with one arguing that] “it seems hard to imagine a situation today where such wide-scale misconduct could be carried out without the executive management knowing or at least turning a blind eye””. Post-financial crisis revelations also included Deutsche selling investors securities its own traders referred to as “pigs”, i.e., securities with unrealistic future gains. The bank’s losses on its own investments eventually totalled $4.5 billion. In December 2016, Deutsche announced that it agreed a further $7.2 billion deal with the U.S. Department of Justice (DoJ), of which $3.1 billion was a civil penalty, and $4.1 was for consumer relief – a weighty part of the $58 billion total paid by banks to US authorities for mis-selling subprime mortgage securities. But if some hoped these settlements marked the end of Deutsche’s troubles, there was more bad news hidden away, just waiting to be revealed. Deutsche Bank also excelled in “magical accounting”, best reflected in the case of Michele Faissola and Italy’s Banca Monte dei Paschi di Siena – the world’s oldest and Italy’s third largest bank. “On December 1, 2008, most of the world’s banks were still panicking through the financial crisis. […] At the London outpost of Deutsche Bank […] a group of financiers met to consider a proposal from a team led by a trim, 40-year old banker named Michele Faissola”2. This simple meeting would be an inauspicious start to an entangled, protracted web of fantastical accounting, regulatory avoidance, reputational risk, and personal cost. Faissola was then “the head of Deutsche’s global rates unit [… and had] been studying the problems of one of Deutsche’s clients [Paschi], which, as the crisis raged, was down €367 million ($462 million at the time) on a single investment. […] If investors were to find out the extent of its losses in the 2008 credit crisis, the consequences would be unpredictable and grave: a run on the bank, a government takeover, or worse”. Luckily (or unluckily) for Paschi, Deutsche had an idea, and it was a big one. Faissola’s team “described a simple trade in two parts. For one half of the deal, Paschi would make a sure-thing, moneymaking bet with Deutsche Bank and use those winnings to extinguish its 2008 trading losses. Of course, Deutsche doesn’t give away money for free, so for the second half of the deal, the Italians would make a bet that was sure to lose. But while the first transaction was immediate, the second would play out slowly,

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Financial Times (April 23, 2015). ‘Deutsche Bank pays record fine for Libor manipulation’, https://www.ft.com/content/ccf7af08-e904-11e4-a71a-00144feab7de

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over many years. No sign of the €367 million sinkhole would need to show up when Paschi compiled its year-end financial reports”. Of course, Faissola couldn’t just run with this. The proposal was presented to Deutsche’s global market risks assessment committee, “a top-level panel that reviews transactions with legal, regulatory, and reputational considerations. [… This panel asks]: Is a given trade within the law? Is it within the looser framework of industry rules and standards? And even if so, can Deutsche pull it off without [damaging] its brand?” Jeremy Bailey, Deutsche’s European chairman of global banking, was particularly enthusiastic. He said “this is fantastic. You can book a [profit] in front and spread losses over time? We should do it”. The deal was also beneficial for Deutsche Bank as the downfall of Paschi would also have negatively affected Deutsche. Another example of Deutsche’s magic was mirror trading, helping clients buy and sell to themselves. “At first glance, the trades appeared banal, even pointless. Deutsche Bank earned a small commission for executing the buy and sell orders, but in financial terms the clients finished roughly where they began. [However,] these transactions had nothing to do with pursuing profit. They were a way to expatriate money.” 6 Almost every weekday between autumn 2011 and early 2015, a Russian Broker, Igor Volkov, called the equities desk of Deutsche Bank Moscow to execute such a deal, transferring money to a company in an offshore territory. The eventual amount shifted out of Russia? Some $10 billion in total. Even though mirror trading is not inherently illegal, repeated trades indicate dubious practices of shifting and hiding money. Financial regulators in the US, UK and Germany all launched investigations into the Russian deals and three Deutsche Bank employees were quickly suspended. There is no end to Deutsche’s troubles. More recently, US authorities sued Deutsche Bank for violating the Foreign Corrupt Practices Act: allegedly Deutsche Bank had “hired unqualified relatives of powerful Russian and Chinese government officials to win business.” 7 Despite efforts to clean up its internal control systems, Deutsche Bank still has deficiencies in its anti-money laundering practices8 and if all of this were not yet enough, it is now also under closer scrutiny by US regulators due to its relationship with President Trump: “Deutsche Bank continued to lend to the Trump Organization long after other lenders concluded that the risk was too great.”9 6

Caesar, E. (August 29, 2016). ‘Deutsche Bank’s $10-billion scandal’, The New Yorker, http://www.newyorker.com/magazine/2016/08/29/deutsche-banks-10-billion-scandal 7 Hickey, S. (August 23rd 2019) ‘Deutsche Bank to pay $16m to settle US ‘princelings’ case’ The Guardian, https://www.theguardian.com/business/2019/aug/23/deutsche-bank-to-pay-16m-usprincelings-case 8 Ewing, J. (June 10th 2019) ‘Deutsche Bank Acknowledges Lapse in Checks on Money Laundering’, The New York Times, https://www.nytimes.com/2019/06/10/business/deutsche-bank-moneylaundering.html 9 Ewing, J. (July 7th 2019) ‘Deutsche Bank Scales Back Ambitions, Announcing Job Cuts and Reorganization’ The New York Times, https://www.nytimes.com/2019/07/07/business/deutschebank-jobs-overhaul.html

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The Fall-out: Fines, Loss of Confidence and Continuous Struggles to Bring the Bank Back on Track These cases of alleged deceit and illegal transactions contributed to Deutsche Bank’s involvement in over 7,000 legal disputes10 and $17bn fines between 2008 and 201811. Over the years, multiple traders, employees and managers were disciplined or dismissed for their involvement in dubious practices. However, managers’ prevailing attitude when new issues were uncovered was “how much are we going to get fined?” Unless the sum was astronomical, they appeared to be willing to take the risk.12 In addition to coping with litigation and fines, Deutsche also faced significant financial pressures in the aftermath of the 2008 financial crisis. According to the Financial Times12, “borrowing costs [for Deutsche] spiralled following credit rating downgrades. Under pressure from regulators, the bank has had to raise €33bn of fresh equity since 2008, more than any non-nationalised rival.” The resulting lack of investor confidence was reflected in Deutsche Bank’s falling market valuation. “By September 2017, Deutsche Bank’s share price had dropped [from more than €100 before the financial crisis] to just €13,”13 indicating that many thought the bank was “beyond repair.”13 The mood among Deutsche’s employees was also bleak: In 2016, a “survey found that less than half of Deutsche Bank employees are proud to work there.”14 Attempts to save the bank have been numerous, but the dwindling share price suggests that not much had been achieved since the onset of the financial crisis. In June 2015, following increasing pressure from shareholders, the two co-CEOs of Deutsche Bank, Anshu Jain and Jürgen Fitschen, announced their resignations. John Cryan, a former CFO at UBS with a reputation for being serious and tough15 , was subsequently hired to “clean up” and enforce controls at the bank. In April 2018, after three turnaround plans, he also had to leave due to increasing tensions with the chairman of the supervisory board, Paul Achleitner. The board’s directors then turned to a Deutsche Bank veteran, Christian Sewing, to take on the leadership. “Mr Sewing wants to return Deutsche to its roots as a bank for large corporates in Germany and 10

Boerse.ard.de (May 24, 2016). ‘Deutsche Bank: Zwischen Ramsch und Skandalen’, https://boerse.ard.de/aktien/deutsche-bank-zwischen-ramsch-und-skandalen100.html 11 Bloomberg (April 9th 2018) ‘Why Deutsche Bank Replaced CEO John Cryan After Less Than 3 Years’ Fortune, https://fortune.com/2018/04/09/deutsche-bank-ceo-john-cryan-christian-sewing/ 12 Jenkins, P. and Noonan, L. (November 9, 2017). ‘How Deutsche Bank’s high-stakes gamble went wrong’, Financial Times, https://www.ft.com/content/60fa7da6-c414-11e7-a1d2-6786f39ef675 13 Morris, S. and Arons, S. (September 19, 2017), ‘Deutsche Bank ‘Beyond Repair’ as Trading Drops, Autonomous Says’, Bloomberg, https://www.bloomberg.com/news/articles/2017-09-19/deutschebank-beyond-repair-as-trading-drops-autonomous-says 14 Shotter, J. (May 19, 2016). ‘Deutsche Bank investors vote against executive pay packages’, Financial Times, https://www.ft.com/content/d1c65e1e-1d95-11e6-a7bc-ee846770ec15 15 Butcher, S. (May 16, 2016) ‘The incredible truth about Deutsche Bank’s John Cryan’, eFinancialCareers, https://news.efinancialcareers.com/uk-en/244582/truth-about-deutsche-banksjohn-cryan/

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beyond.” 16 In July 2019, Sewing finally outlined his plan, which he describes as “radical” in an attempt to break decisively from Deutsche’s past, including scaling back its involvement in Wall Street9. As the New York Times writes17 , “one of the mysteries of modern banking is why Deutsche Bank ’s retreat from Wall Street […] took so long. Since the financial crisis a decade ago, the German institution’s giant investment banking operations have lagged well behind those of its rivals. Switzerland’s Credit Suisse and UBS made hard decisions several years ago that helped them adapt to new realities. But Deutsche Bank wavered and delayed.” The last chance to reverse a decade of decline The new CEO Christian Sewing is less emotionally attached to investment banking as his predecessors. He joined Deutsche in 1989 “as an apprentice at a branch in the Westphalian town of Bielefeld. Friends and colleagues describe Mr Sewing as a demanding, methodical manager who obsesses over punctuality and has little time for small talk. “If you have a time slot you stick to it, and you get straight to the point,” says one former executive. Unlike many of his counterparts at rival banks, Mr Sewing has little direct experience of the trading floor.”16 He held a number of positions in risk management, working in Deutsche Bank’s offices in Frankfurt, London, Singapore, Tokyo and Toronto, before he took over Deutsche Bank’s retail division in January 2016. There “Sewing earned a reputation as an unapologetic cost-cutter who closed hundreds of branches, reduced staff by 7 percent—3,100 positions—over two years, and sold operations in Poland and Portugal. [… He is not seen] “as a visionary […but] a rational, adaptable CEO” […] His aim is to restore credibility and a sense of pride to an institution that’s become a symbol of failed expectations.”18 The turnaround plan announced by Sewing in July is ambitious. As the Financial Times writes, it “puts Deutsche’s challenges in a category all of their own. The plan requires Mr Sewing to strip out €1.3bn in costs by the end of the year, cull 18,000 jobs and remove €281bn of assets from its balance sheet without haemorrhaging revenue and talent from its investment bank.”19 To dispose of risky assets and restore investor’s 16

Crow, D., and Storbeck, O. (July 5th 2019) ‘Christian Sewing, a company man going back to basics;’ https://www.ft.com/content/f10e40b2-9efb-11e9-b8ce-8b459ed04726 17

Eavis, P. (April 26th 2018) ‘Three Reasons Deutsche Bank Didn’t Exit Wall Street Earlier: DealBook Briefing’ The New York Times, https://www.nytimes.com/2018/04/26/business/dealbook/facebook-privacy-scandalsearnings.html 18 Arons, S. and Comfort, N. (September 24th, 2018) ‘A Plan to Mend Deutsche Bank’, Bloomberg Businessweek, https://www.bloomberg.com/news/articles/2018-09-20/a-newceo-plans-big-cuts-to-mend-deutsche-bank 19 Storbeck, O. and Morris, S. (October 31st 2019) ‘Deutsche Bank’s results reveal scale of challenge for Sewing, Financial Times, https://www.ft.com/content/978e7ade-fb35-11e9a354-36acbbb0d9b6

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confidence, Sewing wants to create a bad bank, a tactic used by many banks after the 2008 crisis20. The restructuring involves the creation of a new Corporate Bank, a more focused Investment bank and $4bn investment in internal controls and computer systems. As part of the transformation efforts, Sewing also announced changes to the leadership structure, including letting go of one-third of the management board and adding a new Group Management Committee that will connect the Management Board better with the heads of the businesses. Even though the plan can certainly be seen as “radical”, some think that it comes too late and others “fear that Mr Sewing’s cuts will not go deep enough. One former executive says Mr Sewing should shut the bank’s Wall Street operation altogether and pull out of most types of trading.”16 “The plan is also a big gamble, carrying significant immediate costs with no guarantee they will revive the bank. Severance payments and other expenses will total 7.4 billion euros, or $8.3 billion, through 2022, Deutsche Bank said. At the same time, revenue is certain to fall as the bank shrinks, creating the risk of a vicious circle of declining income and profits. [The big] question that’s now on the table is whether DB can shrink itself to heightened competitiveness and sustainable profitability without a merger of some sort.”9 Investors are sceptical whether Sewing’s 2022 revenue target of €25bn is realistic19. It is unclear where revenues should come from without a profitable business with the potential for growth. Looming troubles Given that Deutsche Bank’s difficulties sit deep, it is no surprise that despite Sewing’s ongoing efforts, there are still troubles looming. An example of its deep-rooted challenges is the recent Russian deal that was reported to US federal authorities by Deutsche Bank executives in the US. Deutsche Bank sold a stake in a Californian office complex to a company linked to the son of a former Kremlin official. “Against the backdrop [of multiple money laundering investigations], bank executives in the United States raised objections about the proposed transaction, warning that while not illegal, it could further damage the bank’s reputation. Executives in the bank’s Frankfurt headquarters decided to go forward with it anyway. After the sale went through, Deutsche Bank officials in the United States took the rare step of contacting the federal watchdog that polices financial crimes to report the bank’s own transaction as suspicious.”21 Decisions about the way in which Sewing is cutting costs are also being questioned. Recently, Sewing axed “a much-loved tradition of hosting 20

Farrer, M. (June 17th, 2019) ‘Deutsche Bank plans radical overhaul with €50bn hived off to 'bad bank' – reports’, The Guardian, https://www.theguardian.com/business/2019/jun/17/deutsche-bank-plans-radicaloverhaul-with-50bn-hived-off-to-bad-bank-reports 21 Savage, C., and Enrich, D. (October 31st, 2019) ‘Deutsche Bank Reported Its Own Russian Deal as Suspicious’, The New York Times, https://www.nytimes.com/2019/10/31/business/deutsche-bank-russia-real-estatedeal.html

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Christmas parties for retired employees,” a move that was seen by many as “embarrassing and petty.”19 Other cost-cutting initiatives, such as eliminating firstclass train tickets for bankers and daily office fruit bowls, were equally unpopular. There are also persisting questions about Deutsche Bank’s leadership. For example, Mr Sewing’s dual role as CEO and the head of the Investment Bank, that he took over in summer 2019, is criticized. “The European Central Bank and German regulator BaFin want the positions to be separated [… due to] a potential conflict of interest between the two roles”22. Investors also fear that Mr Sewing “is spread too thin”22 and that there is lack of expertise in investment banking on the management board. The most recent change in Deutsche Bank’s leadership is Fabrizio Campelli – he was appointed to the management board in November 2019 as the Chief Transformation Officer. Previously, the turnaround plan was “overseen by a committee that consisted of Mr Sewing, Mr von Rohr [the Deputy Chairm...