A new direction for UBS

A rush to break up UBS in today's banking environment isn't a good idea but Olivant Advisors' call for the Swiss bank to overhaul its corporate governance is spot on.

The clean-up at UBS cannot begin unless there are executives in place who can take a dispassionate look at all corners of the bank, with an equal on eye on UBS' debt and equity investors.

That's why the replacement of Marcel Ospel as chairman with general counsel Peter Kurer makes little sense other than as a desperate stop gap.

There's more than one way to protect the core of UBS from the implosion of the investment bank. To isolate the investment bank from the more robust private banking and wealth management operations, UBS could issue class-B shares or a tracker stock, giving the investment bank a separate New York listing.

Once the investment banking environment stabilises, UBS could separate itself from the bank permanently or buy back those class-B or tracker stock by issuing new UBS shares.

Despite the possibility UBS might need more capital, it would be wrong to sell the investment bank or its Brazilian business just yet, the latter being one Olivant suggestion. With few willing buyers around long on cash, the assets would be bought only at distressed prices. Selling a promising emerging-market business such as Brazil's Banco Pactual would be short-sighted.

Olivant isn't suggesting a break-up right away. But the firm's activism might encourage other investors, notably some late hedge-fund entrants to UBS' shareholder register, to push for an immediate break-up to make a quick buck.

What UBS needs first is an orderly clean-up. Investment banking is replete with examples of banks trapped in aggressive trading methods and wrong asset classes.

It happened to Goldman Sachs with its ponzi scheme at the turn of the 20th century before legendary banker Sidney Weinberg came in, taking years to restore its reputation. More recently Morgan Stanley's attempt to profit from aircraft ownership failed.

Now we are seeing the same happening with the sub-prime mortgage sector, with UBS paying the price after its massive bet that US house prices wouldn't fall. For every Swiss franc of its Tier 1 capital, UBS invested CHF1.25 in US housing in 2007.

On the other hand, UBS' investment banking business has earned good returns at less risk in the past, and it's not all bad today. Back in early 2005 it earned a 36 per cent return on its regulatory capital when it's daily average value at risk was just over CHF400 million compared with CHF667 million at the end of 2007. Gross capital market and corporate finance fees in the fourth quarter 2007 stood at CHF2.1 billion, the second highest quarterly figure in three years.

So to improve returns, UBS has to wind down its exposure to the US home loan securities market fast. Plans to create a new vehicle to hold the distressed assets is an important first step.

But equally vital is to get fresh talent in at the top for the board to rebuild the confidence of employees, clients and investors in the future of UBS.