LOSING TO GERMANY AT HOME
They've bought Rolls-Royce. They've sold Rover And now, calling the shots in the City
AT the time of writing, the result of Satur- day's football match between England and Germany is known only to the soothsayer Eileen Drewery; but the precedents are not encouraging. It is now 34 years of hurt since the English beat the Germans at foot- ball, and in those days the team took on only the western half of the country. We look back at a string of humiliations.
As a prediction, this looks more accurate now than it did at the time. In those days, with Einheit still three months away, Europe remained a German carthorse rid- den by a French jockey. Today, at least in rapidity of advance, it looks more like a Panzer driven by a willing Dutchman. The main axis of advance, as Ridley predicted, is economics. The euro has given German manufacturing the weak currency it needs to counter high labour costs, and has creat- ed a single capital market across 11 coun- tries, in which the German banks are ideally placed to thrive. The European Central Bank is based in Frankfurt, switching the attention of bond dealers to Germany. Beneath the public confidence that the City can thrive outside the euro lurks an uneasy feeling that the position of London as the leading financial centre in Europe is as exposed to German persistence, stamina and efficiency as the English football team.
Nothing illustrates this better than the precipitate decline and fall of the London International Financial Futures Exchange (Liffe). Just three years ago, Liffe was the second largest futures and options exchange in the world. The Germans had set up a competitor — the Deutsche Ter- minborse, or DTB — as long ago as 1989.
But it was an electronic trading system in an industry where prices at all the major exchanges were set by open outcry — in which young men and women in striped jackets shouted and gesticulated at each other. By the spring of 1997, after eight years of trying, the DTB had a market share of barely a third, even in the Bund, the key German government-bond futures contract. Just as Edwardian cotton manu- facturers thought foreign Johnnies could never weave like Lancashire lads and lass- es, and English farmers still argue that Cox's Orange Pippins are the finest apples in the world, Liffe chief executive Daniel Hodson persuaded himself that 'no elec- tronic trading system will be able to repli- cate the advantages of open outcry'. But on 22 October 1997, a month after the DTB had merged with the Swiss Options and Financial Futures Exchange (Soffex) to create Eurex, more Bunds were traded on Swiss-German screens than in the pits at Liffe. In the year that followed, Liffe lost nearly half its business. Today Eurex is the largest derivatives exchange in the world, having overtaken the one market (the Chicago Board of Trade) Liffe never sur- passed even in its glory days. In July 1998 Hodson resigned, haunted by his advice to Liffe members only a year ear- lier ('Always remember that technology is far from an opponent to open outcry, rather it is a friend of open out- cry'). The chairman and deputy chairman went too.
After boardroom upheavals, mass sackings, the transformation of the Exchange from a members' club into a profit-seeking business, the closure of the trading pits and the cre- ation of an electronic trad- ing system called Connect, Liffe is glad to have sur- vived at all.
The reason Eurex suc- ceeded and Liffe failed is, as Nick Ridley glumly fore- saw, economics: a pit full of Nick Leesons is better at establishing prices, but electronic trading is much cheaper because it employs fewer people. No wonder the merger plans of the London Stock Exchange and the Deutsche Borse (creating ix), announced in May, have caused such alarm among those who share Ridley's belief that the Germans are 'trying to take over everything'. Even as he spoke, the big German banks were putting their trust in technology as the fastest route to global domination. With the German stock market split between eight regional exchanges, screen-based technology was the only way to concentrate activity. Since its formation in 1993, the Deutsche BOrse has pursued this technology-driven strategY relentlessly. One bonus is that screens can be placed anywhere, allowing Deutsche BOrse to recruit members all over the world. When it came to the merger with London, the Germans were in a strong position. Although Sets — the electronic order- matching system built by the London Stock Exchange — is just three years old, iX will use German technology. There are plenty of other reasons to believe that the iX merger is actually a German takeover. Werner Seifert, the Pipe-puffing Swiss-German McKinsey alumnus who runs the Deutsche BOrse, will also be chief executive of iX. Although trading in blue-chip shares will be based in London, there is no guarantee that iX can retain such business against competition from New York and elsewhere. The Deutsche Borse has astutely ensured that a Joint venture with Nasdaq to trade high- growth stocks, which are much less likely to be lost to competitors, will be based in Frankfurt. Clearing and settlement — the back-office functions of swapping cash for shares and bonds — may be lost to Luxem- bourg, where the Deutsche Borse has a Joint venture with an international bond- clearing house. On closer examination, the notional 'par- ity' looks generous to London. The mem- bers of the German half of the partnership are fewer in number, and more likely to adopt a common approach than the dis- parate membership of the London Stock Exchange. The big German banks will be the largest shareholders in iX, while the London Stock Exchange is now dominated by European and American investment banks whose loyalties cannot be predicted. What is certain is that the interests of large international financial conglomerates such as Merrill Lynch and UBS Warburg Dillon Read rarely coincide with the interests of the hundreds of private client brokers who make up the bulk of Exchange membership or the hundreds of middle-sized companies that make up the majority of its listings. Their clients being wholly domestic, small- er firms are understandably disturbed by the idea that Sets will be replaced by Xetra and that all stocks on iX will eventually be quoted and traded in euros.
Even the smallest private client brokers recognise that liberalisation, Internet tech- nology and the euro have exposed the Lon- don Stock Exchange to competition for the first time. In the long run, their clients will benefit from competition for their business. But the iX alliance is a sad finale for the Stock Exchange, for centuries a landmark of British culture, in whose orbit has grown an entire suburban way of life. If absorption Into a German-led alliance is the only way it can stay in business, that is a stern indict- ment of the leadership of the London Stock Exchange. Over the last ten years, its two blue-blooded chairmen — Sir Andrew Hugh Smith and Sir John Kemp-Welch — failed repeatedly to find the right chief executive. Peter Rawlins from Lloyds (1990-93) left after the 1993 debacle, when the Stock Exchange lost responsibility for settlement to the Bank of England, and Michael Lawrence from the Prudential (1994-96) was forced to resign. The tenure of Gavin Casey, the chartered accountant who has held the job since 1996, will be best remembered for the extended but ultimate- ly fruitless negotiations to create an alliance of eight European stock exchanges.
Worse, the dithering at the Stock Exchange may be symptomatic of a want of leadership in the City as a whole. London is well ahead of Germany in a string of other businesses: foreign exchange, syndi- cated international loans, interest rate and currency swaps, fund management and bond trading. (This last may explain the German enthusiasm for a withholding tax designed to export the Euro-markets to Switzerland.) But margins in the markets where the City dominates are thin, and get- ting thinner. The high-margin businesses are the ones where the right advice and the right people to give it are as important as effective technology and capital strength: corporate mergers and acquisitions, com- pany flotations, fancy debt financings and fund management. Werner Seifert under- stands this logic so well that he has pub- lished a book about it. Although its title is far from exciting (European Capital Mar- kets) and its author disclaims any hostility to London (`Talk of Frankfurt "overtaking" London is the result of wishful thinking, not hard-headed analysis'), the book makes a persuasive case that British dominance of international financial services is going the way of British dominance of textiles and motor cars.
Deutsche Bank (which owns Morgan Grenfell), Dresdner Bank (which bought Kleinwort Benson), Commerzbank (which owns Jupiter) and Hypo Vereinsbank (which controls Foreign & Colonial) have learnt much about mergers and acquisi- tions, corporate flotations, bond issuance and fund management from the English merchant banks and fund managers they have bought. That knowledge is now allied to a natural advantage. In the past, few German companies borrowed internation- ally or went public. Now, with a stream of private and family-owned companies going public in Germany, the big banks are guar- anteed a steady diet of lucrative underwrit- ing work. The corporate restructuring occasioned by the euro, and amplified in Germany by a relaxation of the tax penal- ties on the disposal of large shareholdings by the banks, will produce merger and acquisition work for them as well. Even in 'Let me through, I'm a butcher.' fund management, where the absence of separately funded pension schemes and the traditional hostility of German savers to buying shares has handicapped the banks, the asset-management arms of the German banks are growing faster than their British competitors.
So far, as Werner Seifert concedes, Lon- don is holding on to the high-margin busi- ness. But it has continued to succeed only because it continues to attract clever and ambitious people from all over the world — the investment bankers who drive inno- vation in financial markets. Today, the City is home to five times as many investment bankers as Frankfurt. There are many rea- sons for this. London is conveniently placed between New York and Tokyo, the natives speak English, the law is flexible, the restaurants are good, and the taxes and regulations are relatively light. But the most important reason is money. Modern investment bankers of all nationalities can work almost anywhere. Their only ties to time or place are those of money, and Lon- don provides them with money by the bucketful. The City, like the Premier League, is a cosmopolitan place because it is a honeypot as well as an entrepot. Keeping this concentration of talent happy, rich and here is now the best guaran- tee of the continued success of London as a financial centre. If there is one aspect of modern international finance to which the German preference for disciplined team- work over individual brilliance is singularly ill-adapted, it is the successful management of investment bankers. Unfortunately, in the 'real' economy the cosmopolitanism and greed of City fat cats is a source of suspi- cion. It fuels the idea that the City is some- how unpatriotic, lending money to foreign companies and countries rather than invest- ing it here, and over-eager to sell strategi- cally important industries (such as motor cars) to foreigners. This may encourage the New Labour government, as it scours the country for useful enemies, to make Lon- don less congenial for country-hopping investment bankers.
What would kill London as a financial centre is not the Germanisation of the Stock Exchange, but the Germanisation of the tax system. Only three years ago, an under-sec- retary at the German ministry of finance crit- icised Britain for luring talented investment bankers to London with 'unfair' tax advan- tages. His reward was the withdrawal in the 1998 Budget of the foreign-earnings deduc- tion, which allowed any investment banker working in the City to escape being resident in Britain for tax purposes altogether, if he planned his travelling schedule carefully. This, too, was foreseen by Nicholas Ridley in 1990, when he warned that Europe would give the Germans the right to rewrite the British tax code. They may not have to take it up. If Gordon Brown scores any more own-goals, the battle between the City and finanzplatz Deutschland will not need to be settled by penalties.
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