In the City

Is the party over?

David Freud

Alittle more than a year ago the City stockbroking community was suffer- ing from a bad attack of the jitters. Business was slack and with summer coming on talk of cost-cutting was in the air. A favourite topic of speculation for those of gloomy bent was how the Square Mile could remain immune from the car- nage in the ranks of industrial executives. Underlying the worries was the spectre of the restrictive practices court case, in which battle over the Stock Exchange's rule book would be joined from January 1984. In the late spring of 1982 a majority of brokers seemed resigned to seeing the rules shredded, along with their comfortable ex- istence.

Since then the mood has been transform- ed. Stockbrokers have enjoyed the best year of their lives. Easy pre-election money allowed the market to set more records than this year's weather. The FT 30-share index topped 700; volume of business jumped a quarter; and unparalleled numbers of new companies were floated; a spate of takeovers and rights issues topped up the excitement. All this action has been ex- tremely lucrative. A couple of senior part- ners are rumoured to have picked up seven- figure sums.

The year was crowned last week when Mrs Thatcher confirmed that the Govern- ment was prepared to call off the restrictive practices investigation. But the initial euphoria was brief, as the market realised that, so far as the pressure for change is concerned, nothing has really changed. In his heart of hearts nearly every broker I know believes that the present cosy trading arrangements are too good to last.

At lunch, a forthright equity analyst in a large firm of stockbrokers confided: 'It's obscene, what we all earn, bloody obscene. No other word for it. Me, I'm on a good screw, much better than what's on offer in industry. But it's pretty modest by City standards and at least I work my rocks off to get it.' He does, too.

'What really gets my goat is the gin brigade handling gilts. Couple of phone calls in the morning, half-sozzled by 11 o'clock and then off to a boozy lunch. For that they pick up thirty grand. We're all liv- ing in a fool's paradise. Some day we're go- ing to have to compete properly for our business, and when we do the drones will find themselves out on their necks.'

Ironically, the decision to drop the restrictive practices case is likely to mean that change will emerge more rapidly than before. Mr Hattersley's strictures have more to do with the Labour leadership elec- tion than the outside world, but the Stock Exchange Council is being forced to offer some significant concessions to a more po- tent adversary, the government, in return for dropping the case. At the time of writing those concessions have not emerg- ed. But their exact extent is not critical. Almost any imaginable new rules and guidelines are likely to start unravelling a system that keeps foreign rivals out and, for the brokers (who simply execute client orders to buy and sell stock to and from the jobbers), cosily bans price competition and eliminates dealing risk.

One thing the stock exchange rules have succeeded in maintaining up to now is employment levels. In spite of the nasty shake-out in the mid-1970s, the number of broking members has risen by about 40 per cent to 3,500 over the last 25 years. Yet in that period the switch of private capital from individual into institutional hands means that the number of important clients has shrunk sharply.

The lion's share of business is now con- ducted on behalf of fewer than fifty large institutions. These are growing increasingly resentful about the cost of doing business. A good individual gilt broker can handle six to twelve institutional clients, each of whom, in sharing out its largesse, might put £20,000 commission into his hands. That's five or six deals a year to switch an average £2 million from one stock to another. So the broker generates between £120,000 and £240,000 annual corhmission. As a rule of thumb he may pick up a fifth or a quarter of this as his personal reward — equivalent to anything between £25,000 and £60,000. As one gilt investor in an insurance com- pany said to me the other day: 'We seem to be tucking an awful lot of money into those guys' back pockets. I simply think it's too much.'

Of course, the commission does not all go straight into the broking fraternity's back pocket. Some comes back in the form of plentiful lunches. But mainly the brokers compete on more conventional financial services, which means expensive back-up.

`Go and make a decent job of hanging yourself.' Each broker is likely to have a series of screens on his desk — a Reuters monitor, Telerate, Topic, Datastream, all bringing him — at a cost — information on market movements past and present. At the same time the broking houses are spraying the institutions with analysts' research. Much of that is regarded by the recipients as a complete waste of time. While the top three of four analysts in each sector of the market are producing valuable work, the next fifteen are also-rans in a different race.

An executive in an industrial company re- counts in disbelief: 'You've no idea how off-beam the analysts can be. One broker — our own, as a matter of fact — produced a geographical breakdown of our profits that had no relation at all to reality. I asked him the name of our subsidiary that was meant to have produced £2 million of profit in North America. He couldn't. Not sur- prisingly really, since we don't have a com- pany in North America.' Keynes would have been amused to see that in the 1980s the new by-product of his casino has become the proliferation of services that nobody wants.

The optimists see unlimited opportunities for the London market if it opens itself up to competition. It could become a major centre for trading securities from all over the world. Commissions might be lower, but the cake could grow immeasurably larger. That vision is all very well, but how many of the present participants in the Lon- don market would retain a place at the table?

The-run-of-the-mill broking house has capital of a couple of million pounds, along, with recourse to the personal wealth of its partners, in theory. A giant in UK terms is Hoare Govett, with net resources in the region of £15 million. The jobbers tend to be bigger still, and Ackroyd and Smithers, one of the two really big firms, shows £37 million in its balance sheet.

That pales into insignificance alongside the fire-power of the potential international competition. The US firm Merrill Lynch - the self-dubbed 'thundering herd' — has net worth little short of £1 billion at the last count, while the Japanese house of Nomuru can lay its hands on a cool £1.2 billion. Moreover, most of the world's major securities houses are already represented in London and could move onto the attack as soon as the starter's pistol fires.

In private, stock exchange officials con- cede that there is probably no way of keep- ing out the big boys for ever. And once they come in they would be able to gobble up the local talent with ease. The only defence will be for the brokers to grow fast, through

mergers — possibly with the merchant banks — and by raising fresh capital. While

the Government should hot go out of its way to defend the life-style of the drones, it will have to give the stock exchange time to adjust unless it wants the UK securities business to pass into foreign hands.

Jock Bruce-Gardyne returns next week. David Freud is a Lex columnist on the Financial Times.