Attempting to assemble a world-class trading operation in the suburbs is tough. That's especially true for a foreign bank. Three years ago, when Swiss bank UBS Warburg built its North American headquarters in Stamford, Conn. – about 40 miles outside of New York City – it soon ran into recruiting problems. Young traders in the New York tri-state area preferred the action and the opportunities in the Big Apple. And they were leery of the here-today, gone-tomorrow reputation of foreign banks.
That's why UBS Warburg executives are now saying Thank you, PaineWebber.'
UBS Warburg bought the U.S. retail brokerage firm in November for its lucrative wealth management business, but got a bonus: PaineWebber's large Nasdaq and listed trading operation. If those traders can be convinced to reroute their commutes from New York City to Stamford – and for now most seem willing – the acquisition will accelerate the bank's plan to become one of the top five U.S. trading houses.
Euro League
In Europe, it is one of the top three, but UBS Warburg is in the middle of the pack in the U.S. The result of a merger in 1998 between UBS Securities and SBC Warburg Dillon Read, UBS Warburg is trying to elevate its stature in the U.S. to become a truly global investment bank. "We need to be bigger," said Bill Schneider, head of North American cash equities trading (stock trading in non-derivative instruments). "You can't be successful globally in the long-term unless you have the biggest piece of the pie – the U.S."
UBS Warburg trades only about 300 Nasdaq stocks. That's nowhere near the "critical mass" considered essential by Nasdaq desk head Jack Francis.
"At some point in time we need to trade over 1,000 stocks to truly help our customers," he said. "Right now, we're helping them with only a small portion of their problem."
Francis offers program trading as an example. "If a customer wants to trade a basket, we're not the first call," he said. "They will go to someone who trades the entire S&P 500."
After the merger, UBS Warburg will trade 700 Nasdaq stocks.
Trading more stocks is a trend among the biggest on Wall Street. Goldman Sachs, Morgan Stanley Dean Witter and Salomon Smith Barney are all pushing the number of stocks they trade into the thousands either through internal growth or acquisitions.
Even with just 300, UBS Warburg's trading operation is at capacity, according to Schneider. "We've been resource-constrained," he said. "It has gotten to the point where a trader handling 25 stocks cannot add any more either profitably or unprofitably. That would crush the rest of the book."
That's why the PaineWebber deal is considered such a boon. More traders will be able to trade more stocks which should boost volume and market share. UBS Warburg's Nasdaq staff of 29 will balloon to about 83 if all of PaineWebber's traders make the move. (Ninety percent have agreed to do so, says Francis.) Listed trading personnel – both on and off the floor – will grow from 44 to 101.
"The U.S. equities business is the unintended beneficiary of the merger," Schneider said. "It will allow us to grow our [U.S. equities] business in the next three years by a couple of hundred percent. If we continue to build it piece by piece as we have been for the last two and-a-half years it would've taken us much longer."
The manpower crisis isn't as acute on the listed desk, according to Schneider. Growth over the last few years in listed volume has not come close to that of Nasdaq nor are the requisite trading skills as involved.
Schneider is still grateful for the PaineWebber staffers. "I think volume will go up enough and, of course, service is key," he said. "If you under-serve the client you won't get the next order."
Trade Volume
The two firms are pretty well matched in volume terms. In the first nine months of this year, UBS Warburg traded 4.2 billion Nasdaq and 7.7 billion listed shares, according to Thomson Financial's AutEx BlockDATA.
PaineWebber traded 5.2 billion Nasdaq and six billion listed shares. At those levels the combined organization would rank among the top 15 Nasdaq market makers and the top five listed traders.
Schneider hopes numbers like those will give the firm a lift in another crucial performance measure – its McLagan ranking. Chicago's McLagan Partners measures market share among brokers serving the institutional community. Schneider won't reveal UBS Warburg's ranking, but acknowledges the firm is not in the top 10. (By contrast, Salomon Smith Barney boasts it is ranked No. 1 by McLagan.) "I expect us to have a rapid ascent as the benefits of PaineWebber come in," Schneider said.
That's not to say UBS Warburg is not a factor now with major buy-side shops. "With the merger they've built a firm that meets our Tier 1 [broker] criteria," said Thomas Bardong, head trader with fund giant Alliance Capital Markets. "They have a large capital base for listed block trading; a large over-the-counter operation; and a large derivatives operation. The industry is migrating towards five or six global mega-firms and it appears they will be one."
UBS Warburg still has its work cut out for it, leveraging the PaineWebber acquisition to reach those heights. PaineWebber is largely a retail firm.
Its traders are not accustomed to bidding on million-share blocks for gargantuan institutions. The broker does cater to smaller money managers, but is not considered a big risk taker. "The reality is we put on much bigger trades with greater risk and get a more market impactful call than PaineWebber," Francis noted.
At the same time, UBS Warburg traders will now be asked to cope with the deluge of retail orders that hit the PaineWebber desk every morning or following the promotion of an analyst's recommendation by its 8,000-plus sales force.
To prepare for these radical changes, each group of traders will attend "boot camps" in the other's trading room. Traders from UBS Warburg will swap seats with traders from PaineWebber in groups of five over the next few months. Each will be licensed to trade at both broker dealers.
"It will be an eye-opener for the PaineWebber guys to make institutional menus – institutional bids and offers – in the seven figures," Francis said. "They've never done that before."
UBS Warburg traders will face culture shock as well. Accustomed to having complete control over their blotters they will now have to share them with PaineWebber brokers. An army of salespeople will have the authority to commit capital automatically for orders up to 2,500 shares.
That makes it easier for the brokers to execute orders, but could wreak havoc with a market maker's position. "One minute you're flat and then you look at your book and find you're short 100,000 shares," Francis said.
Block Trader
Not that being short 100,000 shares is unusual for UBS Warburg. Because the broker works strictly with institutions, it routinely executes million-share blocks, often in crosses, according to Francis. Data supplied by consultants Plexus Group shows the average trade size at UBS Warburg is comparable with other institutions-only brokers such as SG Cowen and ING Barings.
Trading at UBS Warburg is run as a profitable business in its own right. It is not a completely stand-alone entity, but in contrast with other investment banks, it does not exist solely to support research and investment banking either. Traders are paid a salary plus a performance-based bonus.
"That doesn't mean they are encouraged to swing for the fences everyday," Schneider noted.
But it does mean risk is an important part of the culture. Much of UBS Warburg's approach to equity trading is guided by the risk management principles set out by O'Connor & Associates, a derivatives outfit and industry leader acquired by Swiss Bank in 1994.
"Cash equities and derivative equities sit next to each other and share information freely," Schneider said. "We use some derivatives analysis in looking at our cash business. That makes us different from our competitors who largely run separate operations."
As an example of the synergies between the two desks Schneider cites the case of a "broken stock." If a stock has fallen on bad news the options desk may want to cover a short position while a customer of the cash equities desk may want to sell. The cash desk can take the stock off the hands of the customer with the assurance they have a short position on the derivatives desk to offset their risk. Both desks report into the same internal profit and loss statement.
"When a stock is trading down our options volatility book may need to do some hedging and therefore become a natural buyer of the distressed stock," Schneider explained. "On our floor, unconventional supply meets unconventional demand. In Stamford, I am cheek-to-cheek with the derivatives desk."
Francis added: "That would never happen at another firm. They're sitting on different sides of the room or on different floors."
Explosive Growth
O'Connor's derivatives expertise is credited with the explosion in both listed and Nasdaq trading that took place in the year following the merger.
UBS Warburg doubled its Nasdaq volume from 1.9 billion shares in 1998 to 3.8 billion in 1999, according to BlockDATA figures. Listed trading nearly doubled from 3.9 billion shares to 7.6 billion.
"Integrating the business – cash and derivatives – is what catapulted us from Point A which was zero to Point B," Francis said.
The trader adds that it was a hard sell at first because neither Dillon Read nor UBS Securities was known for aggressive trading. "People didn't really want to trade with us," he said. "We had to dispel any notions they had of Dillon Read or UBS Securities. We had to get people comfortable with a new firm with a much higher risk profile."
Schneider adds they also had to overcome the stigma of a foreign bank. "We had to dispel the notion we were just a foreign firm that wasn't going to be here a long time," he said. "A lot of U.S. clients see foreign banks as buying market share and then whittling it away. We're here to stay."
Mergers and Acquisitions
PaineWebber is the latest addition in an organization pieced together as a result of several mergers and acquisitions in the last six years.
UBS Warburg was created two years ago by the merger of UBS Securities, the American broker dealer unit of Switzerland's UBS AG, and SBC Warburg Dillon Read, the investment banking subsidiary of Swiss Bank.
At the time, UBS was reeling from losses incurred by its investment in Long-Term Capital Management, a hedge fund which made one bet too many.
With the merger, UBS got its name on the door, but Swiss Bank was clearly calling the shots.
At the core of UBS Warburg in the U.S. are bankers from Dillon Read and risk managers from O'Connor & Associates, a derivatives firm formerly part of SBC Warburg Dillon Read.
According to UBS Warburg trading bosses Bill Schneider and Jack Francis, there is little left of the equities group of UBS Securities. "For the most part, the guys from O'Connor run the investment bank," Francis said.
The Nasdaq Chieftain
UBS Warburg's Nasdaq chieftain Jack Francis, 39, ironically got his start in the trading world as a Nasdaq market maker at Dillon Read in 1985. Dillon Read would later become a key building block in the house that is now UBS Warburg. By the time he left in 1991, Francis was running the desk.
Francis then went to Prudential Securities for one year where he learned retail trading, a skill he will need as he integrates PaineWebber's traders into the UBS Warburg desk.
"I got really good at it," he said. Francis' next stop was CS First Boston, where he spent three years trading technology stocks on Nasdaq. First Boston memories aren't so fond. "The place kind of imploded in 96," he said. Then it was on to UBS Securities which evolved into UBS Warburg.
The Top Boss
The head of all cash trading for UBS Warburg in North America, William (Bill) Schneider, 46, began his career trading convertible securities at the now-defunct Kidder Peabody in the 1980s.
Schneider then moved on to Salomon Brothers where he spent six years as a senior block trader. He stayed four months into the Smith Barney takeover in 1998 before moving to the newly-formed UBS Warburg to run the listed desk.
His recent promotion, giving him oversight of both listed and Nasdaq trading, clears the way for PaineWebber's Robert Harrington to take over the listed desk.
Thank You,
PaineWebber and Adios
On February 1, PaineWebber's Nasdaq desk will be history.
That's the day its traders and their technology are scheduled to merge with those of UBS Warburg. Running the desk for the last three years Pat Davis is an industry veteran with 23 years of experience. On February 1, he will join Jack Francis, head of Nasdaq trading, and James Denonna, the head of Nasdaq sales trading, to run UBS Warburg's Nasdaq group.
Davis will be a "product manager" which, he says, will involve integrating the two firms' operations. That means integrating personnel and coordinating the desk in areas such as retail brokerage, corporate finance and research sales. It also means making sure the unit is trading the correct names and for the right customers.
Davis will deal with big picture issues while Jack Francis will run day-to-day trading. The three report to Bill Schneider, the head of cash trading at UBS Warburg.
Davis joined PaineWebber in December 1997 after running the Nasdaq desk at Salomon Brothers for six years. As co-head of Nasdaq trading at PaineWebber with William Heenan, Davis took over from Richard Bruno.
