WealthBriefing’s most recent poll asked readers how they believed private banking clients prefer to see bank losses covered. The result shows that more than a quarter (26 per cent) think that clients would prefer to see losses covered by investment from sovereign wealth funds and 42 per cent through direct access to capital markets. Perhaps most interesting, though, the poll revealed that just 32 per cent of responding wealth managers think that their clients are not interested in banks’ capital structures. Ray Soudah, founder of Millennium Associates says that whilst the client advisors who responded to the survey are a reasonable proxy for their clients, many clients are not in a position to understand the complexities of banks’ capital structure: “With the exception of cash deposits, clients’ assets are held in custody and are not on banks’ balance sheets so even if the custodian went bankrupt, assets would be protected. The amounts of capital required for custody risk management are very small when compared to assets on balance sheets. Therefore, the impact of capital structures on clients is purely psychological and reputational.” Mr Soudah makes the point that if UBS, for example, needs $20 billion, it needs it for its own business activities and that, from a client viewpoint, the private banking business can continue to operate without more capital. Client perception is hugely important, though, according to Ted Wilson consultant at Scorpio Partnership who calls capital structure “mood music” for clients: "They are clearly interested in capital structure in so far as they want an impression of solidity and security," he says. "The perfect storm will be created when client funds are stuffed into in-house structure, which the bank has made a good fee on and which then blow up." Ian Woodhouse director at Ernst & Young says that as the private banking industry is so fragmented, there are many perspectives. He believes that bank losses will have particular resonance for clients of those private banks linked to bigger groups which are either subsidiaries of investment banks or retail banks: “There are those which are with smaller institutions and private banks and high-end IFAs which remain unaffected.” Mr Wilson is not surprised to see that bank clients would like to see losses covered through direct access to capital markets rather than sovereign wealth funds: "Direct access to capital markets will often provide the best value for equity. Sovereign wealth funds will tend to come in where there are distressed positions and, due to the large size of the position, obtain equity at a discount." Speculation in the industry is that a bank would sell tier one equity to a sovereign wealth fund at significantly less than it would in capital markets. Mr Woodhouse says that rebuilding the capital base through a sovereign wealth fund takes less time and is easier to arrange and that when the issue is to rebuild capital and investor confidence, speed is key: “Sovereign wealth funds provide the speed and access to restore the capital structure quickly. There are difficulties in going to capital markets as this takes time and the share price will be affected. It could still be difficult to raise capital in these markets. Investors are unsure and the markets are anticipating more shocks in the banking sector. We have seen at least one in the last couple of weeks.” Mr Soudah says that whilst the survey implies that banks have options as to which route they adopt, in reality, although in some instances existing shareholders were unhappy at being bypassed, some banks have had no choice but to go down the sovereign wealth fund route: “Banks that want to salvage their reputation in a matter of days, with regulators desperate to announce capital raising plans, had little or no choice but to turn to sovereign wealth funds. Capital markets had dried up and raising capital in this way with due process would have been lengthy.” Mr Soudah says that whilst the sovereign funds have been able to get in at a low cost, the banks can present to the market that it is a privilege that these funds have invested in their bank: “Others have gone down the capital market route because although their ongoing business is good, the reason for their loss was more specific, and more embarrassing. It would have been difficult to present it as such an opportunity to a sovereign wealth fund,” he says. He believes that there are different consequences to each approach and whilst sovereign wealth funds tend to come in at times of difficulty, clients and advisors might prefer that there was no dominant shareholder to exert influence over strategy: “I can see why they’d be more comfortable with a broader capital allocation. Ideally, they might like to see their private bank or wealth management arm separately capitalised and ring-fenced from the risks of the banking business,” Mr Soudah concludes.