Withstanding the whirlwind
By Roger Hogan
The global financial crisis promises to be an important
milestone for the major investment banks which, for the
last 10 years or so, have undergone radical change in
their attempts to keep up with a world in which capital no
longer recognises national boundaries.
Australia has felt the effect of this process particularly
keenly during the past year, when the landscape of the
local investment banking industry altered yet again as a
result of mergers and rationalisations among the parents
of the many foreign-owned players here.
BZW Australia, the investment bank once owned by
Britain's Barclays Bank plc, disappeared (in name, if not
in substance) as it became absorbed into the local
operation of giant Dutch bank ABN AMRO.
County NatWest was swallowed by US-based Salomon
Smith Barney. Weeks later, the deal paled into
insignificance as Salomon's parent, Travelers Group,
merged with Citigroup in a $US135 billion deal to form
the world's biggest provider of financial services.
The move involved integrating Salomon's and Citibank's
operations in Australia.
Another mega-merger consummated during the year was
that between the major Swiss banks, Swiss Bank Corp
and Union Bank of Switzerland, to form UBS AG. The
respective subsidiaries merged locally to create
investment bank Warburg Dillon Read.
Wall Steet giant Merrill Lynch developed a strong,
mid-sized organisation based largely on the acquisition of
local broker McIntosh and mergers and acquisitions
advisory boutique Centaurus. Germany's Dresdner Bank
relaunched itself here as Dresdner Kleinwort Benson.
These changes were simply the latest phase in a pattern
of development, in which major European banks and
large Wall Street securities firms have competed to
establish global finance houses capable of delivering
virtually any kind of product anywhere in the world.
There are differences in degree to which the European
and US houses have pursued their objectives through
mergers and acquisitions. Broadly speaking, the
European banks favour the takeover route, while the US
firms place more emphasis on organic growth.
More striking, however, is the extent to which they share
common assumptions about the desirability and necessity
of becoming global financial powerhouses – assumptions
that date back to bullish views about world economic
growth and the free movement of capital.
Recent events have called these views into question.
The mobilisation of capital – which has underpinned the
investment banks' growth during the last decade, and led
many inside and outside the industry to take globalisation
for granted – has shown its dark side and now threatens
a global recession.
In reality, the dark side of global capital is no different
from that of local capital: the possibility that aggressive
lenders and speculators will increase the level of risk for
everybody else. The consequences of such behaviour on
a global scale are simply more serious.
Banks and other investors are now seen to have moved
aggressively into the opaque and relatively unregulated
markets of South-East Asia, and into Russia – arguably
the world's most politically high-risk environment.
For all its sophistication, Long Term Capital Management
– the US hedge fund saved from collapse by a $US3.5
billion bank rescue package – came undone simply
because it took highly leveraged and highly concentrated
positions on the wrong side of the market.
The consequences proved devastating for the third
quarter results announced earlier this month by the
world's biggest banks and investment banks.
They included Japan's Nomura Securities which reported
a $US1.9 billion net loss as a result of exposure to Russia
and the fall in the Nikkei; a $US1.4 billion loss for
BankAmerica through derivatives and bond trading.
UBS lost its chairman and $US800 million over its
exposures to LTCM; Salomon Smith Barney took a
$US700 million hit in respect of Russia and arbitrage
business; Bankers Trust lost $US500 million to Russia
and high-yield bonds; Chase Manhattan, $US300 million
to LTCM.
Merrill Lynch lost $US164 million in the third quarter and
retrenched 3,400 people worldwide, or 5 per cent of its
staff, including 37 in Australia; JP Morgan announced a
70 per cent plunge in quarterly earnings to $US122
million from $US396 million a year ago.
The most likely short-term effect of these results will be
yet another round of industry rationalisation. Deutsche
Bank, for example, is said to be looking at BT, Lehman
Brothers and JP Morgan as possible acquisitions.
There is also likely to be some tightening of the regulatory
environment, although not to the extreme of reintroducing
capital controls, as has happened in Malaysia. Some
central bankers have advocated raising bank capital
adequacy ratios from 8 to 10 or even 12 per cent.
Commercial bankers have argued that such a move
would inevitably lead to higher costs for users of bank
debt, and could create further impetus for corporates to
raise debt in the capital markets rather than borrow from
banks.
Investment banks, which underwrite capital markets
issues, would naturally welcome such a development.
For the next few years, investment banks' main challenge
– assuming they do not become bogged down by
worldwide recession – will be to reassess their global
strategies in the light of their recent painful experiences,
and the new risks and opportunities opening before them.
Chief among the new risks and opportunities is next
January's introduction of a single European currency,
which is expected to help create a debt and equity capital
market capable of rivalling – indeed, surpassing – that of
the United States.
US investment banks, with their unique inroads into the
domestic investor base, claim that it is impossible for an
investment bank to be truly global unless it has a US
distribution capability. Generally speaking, European
banks have yet to crack the US market.
Equally, European banks see the emerging
euro-denominated market as a globally important sector
in which they have a naturally commanding lead. There is
a stunning but logical corollary to all this, that investment
bankers even now are considering very seriously.
That is, that the scale of mergers between investment
banks will simply carry on increasing until they reach the
right critical mass to operate on a truly global basis with
competitive operations in both the euro-denominated
markets and the US.
Quite how this will play itself out in practice is an
interesting question, given the traditional nature of, and
the emerging dynamics in, the euro-denominated
markets. Traditionally, the euromarkets have catered to a
predominantly retail investor base. This is because the
product available has consisted mainly of government or
supranational bonds, or bonds issued by companies that
are household names. In this environment, the European
banks have been the natural marketers to retail investors,
via their branch networks.
As the euro becomes established, however, institutional
investors will no longer be able to diversify their risks
through currencies and will seek to do so through credit
instead. This will give rise to increased demand for
corporate bonds.
The trend will be supported by the growth of
superannuation, as European governments move from
pay-as-you-go to self-funded pension models. The US
investment banks, which already have a major foothold in
Europe, see themselves as natural marketers to
institutional investors.
Although investment bankers face many uncertainties,
they appear to agree on one thing: the day is coming
when the Citicorp/Travelers Group merger may not seem
such a big deal after all.
Roger Hogan is Capital Markets Editor for The
Australian Financial Review.
afr.com.au
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