London Set for Financial Revolution : Stock Exchange to Ease Requirements for Membership

To some, it is the Big Bang. Others call it the Revolution. In a country given to understatement, neither is an exaggeration.

Changes about to sweep through London’s financial district will be revolutionary indeed, affecting securities markets and firms worldwide. Membership in the London Stock Exchange is to be liberalized, and centuries-old restrictions are to be eliminated, providing new opportunities for foreign as well as British financial institutions.

“The changes are vast,” Richard Lloyd, chief executive of the merchant bank Hill Samuel & Co., said. “Customs, many of them restrictive, are being swept away that have been with us for a long time.”

Among the most significant developments:

- On March 3, the London Stock Exchange will remove a restriction that since the 18th Century has limited membership to individuals. The acceptance of corporate members will effectively open Europe’s largest, most important securities market to international banks and brokerage houses.

The move is expected to lure some blue chip equity trading away from other financial centers and intensify competitive pressure in the British securities markets.

- On Oct. 27, the exchange will abandon the minimum broker’s commission of 1.65% on all equity transactions, a move considered certain to increase trading volume but one that could trigger a commission war and shakeout similar to that which followed the May Day, 1975, deregulation of commissions on the New York Stock Exchange.

To further stimulate trading volume, the exchange is pressing the government to remove a 1% duty on all transactions. An exchange survey indicates that such a move would increase volume by about 70% over a four-year period.

- Also on Oct. 27, barriers will fall that have compartmentalized London financial services since the early 17th Century, when securities were traded in the coffee houses around Throgmorton Street.

Division Will Disappear

The age-old division separating London’s brokers and jobbers will disappear. Brokers, who deal with investors but are forbidden from market making, and jobbers, who make markets but cannot deal directly with the public, will be permitted to enter each other’s preserves.

Restrictions that have prevented commercial banks from operating in securities markets and securities houses from offering banking facilities will also be dismantled. In a parallel development, the exchange is implementing a computerized information system for quoting and dealing. Exchange officials said it will be the most modern anywhere.

“By October, we will be the only stock exchange in the world that can move off its trading floor,” exchange spokesman Luke Glass said.

Collectively, all these measures will convert London into an international free-for-all, giving major banks and financial houses the chance to test a complete range of services for the first time.

Already a quarter of the world’s international bank lending takes place in London--there are more U.S. banks in London than in New York. And London serves as the epicenter of the $45-billion-a-week Eurolending market. The changes have global ramifications.

Critical Point

“What is happening here will make London the most critical point of development for our global strategy,” said Stanislas Yassukovich, chairman and chief executive officer of Merrill Lynch Europe Ltd.

Robert H. Smith, vice chairman of Security Pacific Corp., the Los Angeles-based banking firm, said: “It’s a unique opportunity for our merchant banking strategy. We can offer to lend, deal in capital products, underwrite securities, and broker.”

The rapid advances in communications technology that have turned London, New York and Tokyo into 24-hour global markets for securities mean that London’s liberalization will draw additional business from other major markets. Much as changes in other markets have helped bring liberalization to London, it is widely thought that London’s Big Bang will accelerate the pace of change in New York and Tokyo.

To police the new free-wheeling London system, a Securities and Investments Board will license institutions and exercise other forms of control--indirectly, through a series of self-regulating organizations. Its presence marks the first legally backed regulatory body in the fiercely independent square mile that is London’s financial district, better known as “the City.” Until now, the City has run itself as a group of “old-boy” clubs that make their own rules.

Legal Challenge

The changes in London began as the price for ending a prolonged legal challenge to tight exchange rules on grounds that they constitute restrictive practices. The threat to the system, coupled with the prospect of no immediate alternative, led to an agreement to drop the challenge in return for liberalization moves.

The anticipation of the powerful competitive pressures associated with the changes has brought a wave of mergers, takeovers and expansions as institutions large and small add expertise in preparation for a battle considered virtually certain to follow deregulation.

Security Pacific, which sees the revamped London market as the launch pad for its corporate strategy of de-emphasizing its commercial loan portfolio and building expertise in investment banking and securities, began the merger-mania prematurely nearly four years ago by taking a 29.9% stake in Hoare Govett Ltd., one of the three largest London brokers. In April, it plans to increase its stake to between 80% and 85%.

Since early 1984, when it became apparent that the London market would be heavily deregulated, most of the City’s leading brokering and jobbing firms have been either snapped up by large banks or merged into larger units to boost their financial strength.

Britain’s largest commercial bank, Barclay’s, bought out the respected jobbing firm of Wedd Durlacker Mordaunt & Co. in a deal estimated at $225 million or more. New York-based Chase Manhattan Bank bought two smaller brokerage houses. One, Simon & Coates, is strong in equities and unlisted securities; the other, Laurie, Milbank & Co., is active in the market for British Treasury bonds, called gilts.

Integrate Individuals

Other large multinational companies, such as Merrill Lynch and Salomon Bros., have chosen to integrate individuals into their existing structures.

In the belief that bright people, not massive capital, will eventually decide who survives the shakeout, the recent spate of takeovers has been accompanied by huge payments to the partners of the important brokering and jobbing houses. The payments, usually spread over a period of years to ensure that the partners stay on, are called “golden handcuffs.”

But even golden handcuffs have not prevented widespread raiding of key personnel. In some instances, entire research teams have been lured away intact. In others, bright young gilt brokers in their early 20s, who began a few years ago at a salary of 25,000 pounds a year (about $36,000), have been lured away with offers of 90,000 pounds (about $130,000).

“It’s all been a huge bonanza for head-hunters and go-betweens,” said William Kay, a British business journalist who is writing a book on the revolution in the City.

One of the more interesting sidelights to these linkups has been the difficulties encountered by large Japanese securities houses. Despite their size and capital strength, these houses, including Nomura Securities, Daiwa Securities and Nikko Securities, have been effectively blocked by the British government from preparing for the deregulation because of Japanese refusal to open the Tokyo exchanges to British firms.

Recruit Talent

Attempts by Japanese firms to recruit top talent have also been hurt by a reluctance of the most sought-after people to join organizations where language is a significant problem and where promotion prospects and professional independence are reputed to be far more limited than with American or European companies.

“The Japanese corporate culture stands out against (young) age,” said Terry Smith, a banking analyst for W. Greewell & Co., a London stockbroker.

As London prepares for the Big Bang, there is a sense of apprehension and uncertainty about the impact of such sweeping change on life in the City. Trading volume is bound to rise with deregulation, but there is concern as to whether it will rise enough to sustain more than the hardiest participants. London equity trading last year totaled about $140 billion, roughly a third of what is believed to be needed to sustain a healthy market after the Big Bang.

The big question concerns the severity of the shakeout that will follow. Conditions in the market for British Treasury bonds reflect the intensity of the competition. The market is shared by six market makers, but no fewer than 29 have been authorized to fight for a share of business after Oct. 27, among them such names as Bank of America, Citicorp and Merrill Lynch.

By comparison, the U.S. Treasury bond market, with a turnover roughly 10 times that in London, is handled by 36 market makers.

“Twenty-nine is too many,” said Lloyd of Hill Samuel & Co., one of the institutions that will be scrambling for a slice of the market. “It will be interesting to see who makes a go of it and who is too proud to give in.”

Prolonged Shakeout

Lloyd said the desire for British financial institutions to maintain a place in their own gilt market will make the shakeout a prolonged, costly one for the losers. Foreign participants will be reluctant to quit, since many view access to gilts as an integral part of a larger plan.

“Debt markets are global, so we need a presence in all government markets as part of our global strategy,” Merrill Lynch’s Yassukovich said.

The presence of a statutory regulatory body, the Securities and Investment Board, in a part of London that has always looked after itself is also unsettling to a community with such a strong tradition of self-regulation.

And there is uncertainty about how the smaller British houses will stand up to the might of large Anglo-American conglomerates formed for the new market. Quality British houses are counting on customer loyalty as a key factor in their battle with the larger institutions. This loyalty is believed to be a powerful force.

“We see much more relationship banking than in the U.S.,” Smith said. “People don’t shop around as much for the best possible deal.”

Lloyd said: “Loyalty will count. The Americans have a lot of capital, but it won’t take them all the way.”

Strengthen Ties

Hill Samuel, a well-known British investment banking group with assets of $12 billion, has devoted much of its preparation to strengthening ties with its traditional customers and integrating its brokering firm into a single management operation with the capacity to issue, distribute and make markets.

But even the big groups know that the next few years will be not be easy.

“From the very beginning we knew it was going to be tough,” said Lord Redesdale, spokesman for Chase Manhattan here. “We’re prepared for a shakeout, but we’re in this for the long run.”