GAC Berlin 2000: The Role of Global Financial Firms

By Kenneth Liss, Editor, HBS Working Knowledge

For evidence that the walls are coming down in international business, one need look no further than the financial services industry.

The past few years, said HBS Professor Dwight Crane, introducing a discussion on "The Role of Global Financial Firms," have seen all of the following: rapid growth in cross border investments; unparalleled corporate financing in international markets; and increasing examples of financial services crossing national boundaries.

In cross-border flows, said Crane, there has been a record increase in direct foreign investment. In international financing, we saw an astounding $1.3 trillion in international bonds in 1999. ("More than half of those were denominated in a currency [the Euro] that did not exist a year ago.") And in just one example of how geographic barriers are coming down in services, he noted that more than 10% of all stock trades in Germany, the U.K. and the U.S. are now done online. "I can do this anywhere in the world."

"The world of finance is very, very different," Crane continued in his introduction. "What's driving and causing these changes? What does it mean for the financial markets and the firms that play in those markets? How well do financial service companies serve the needs of their customers and society?"

Helping Crane to answer these questions were the heads of three top financial services firms: Count Maurice Lippens, Chairman of Fortis (HBS MBA '72); Henry Paulson, Chairman and CEO of Goldman Sachs (HBS MBA '70); and Rolf Breuer, CEO of Deutsche Bank.

An Old-Fashioned Emphasis on Shareholder Value

Count Lippens, whose Benelux-based company is the result of the first cross-border merger of financial services firms, warned the audience that he might be starting out on the wrong foot.

"At the risk of sounding old economy, I have chosen to put this short presentation in the framework of how large, diversified financial institutions continue to create shareholder value in a globalizing world," said Lippens. "Creating shareholder value seems a little old fashioned, but chairmen and CEOs are paid to create shareholder value."

Both shareholders and the capital markets, he said, are giving strong signals of the direction the industry should take. "No matter how successful you are in your home market, the financial markets and our shareholders expect us to make credible steps in other markets so that we are less vulnerable at home.

"It's not a question of whether we should play a role in globalization; it's a question of how."

From Fortis's point of view, said Lippens, there are two options. The first is to continue along the path they've pursued for the last 10 years: mergers of equals, with other financial institutions of similar size, position and values.

This approach, he said, takes patience. ("It's mostly dependent on opportunities and situations. You have to give time to time.") But is also takes flexibility. ("We have to be ready to strike forcefully and energetically when the time is right.")

The second option is specialization in specific businesses through a blend of owning and alliances. This is still a very small market, said Lippens, "but growth and unit profit are very high, and, as you know, this is what drives shareholder value."

Pursuing specialized strategies across borders has far-reaching implications, he said. "Leveraging cross-border specialized activities will require that we ruthlessly focus our business on the best performing areas...pruning down those activities that might have been considered core but are no longer expected to deliver shareholder value.

"History goes out; specialization comes in."

A second consequence, he said, is that alliances will play critical roles, as it's unlikely that any one player will have the resources to go it alone.

This presents a dilemma: "Should we go on a deal-by-deal approach, selecting the right partner for each opportunity? Or rather attempt to stick to logical partners that are bound to have more than one opportunity?

"These are very exciting times," concluded Lippens. "We're in a revolution, and like all revolutions it's going to be messy for the next few years. What will distinguish the winners from the losers will be the ability to create a long-term vision—the right vision—with impeccable implementation."

A Diverse, But Increasingly Linked, World

Goldman Sachs' Paulson started off his talk with a caution: "We all start with the assumption that globalization, economic reform, and free trade are going to continue, but we can't take that for granted. I'm an optimist, and I believe we're going to continue to see globalization. I think it's likely, but it's not inevitable."

But assuming that the current economic environment will continue, said Paulson, there are a number of things that we can expect to see, especially in Europe. That includes acceleration in corporate restructuring and consolidation and, most dramatically and significantly, continued growth in the equity markets outside the U.S.

Driving these changes are a number of factors, including technology, tax and pension reform, an aging population and, especially, the Euro. "Monetary union is shifting investors from single country portfolios to Pan-European and global portfolios," said Paulson.

"This doesn't mean that we're going to have one big homogenous market," he said. "The world is a very diverse place and it will continue to be so for some time." But the growing linkage between international markets means it's increasingly necessary to tap individuals and institutions in markets around the world.

"What does this mean for our industry in terms of the business model," asked Paulson.

It means, he said, "that to do well we need a global reach and a perspective and we need local knowledge, presence and relationship. That doesn't mean we have to put pins in every nook and cranny. We need to be big and real in the important markets.

"It's a very complex business model to execute. We specialize by product, by geography, by industry. To link all that together, to do it on an integrated basis and a global basis is very difficult to do."

Adding to the challenge, said Paulson, is technology and the Internet, a new way of doing business that needs to be integrated into all of the industry's business models.

"We believe we are still in the relatively early days in terms of the growth of the securities markets outside the U.S., in terms of corporate restructuring and consolidation," said Paulson. "It's going to be an exciting time to be a banker and an investment banker. We're not just at the center of change; we're helping drive change."

Building on Home Market Strength

The third speaker, Deutsche Bank CEO Breuer, began with a question: "What is the importance of strength in the home market for global firms? Does it play a role, or could you see a global firm being practically homeless?"

Looking at the success of U.S. firms in the global financial arena, said Breuer, it's clear that one of the keys is their strength in "the biggest, the strongest, the most transparent market in the world. It was a good basis for such firms to make inroads into Europe and into Asia.

"The wisdom with regard to the U.S. is that home strength is very important. It provides a sound basis for expansion into other parts of the world."

The story is the same in Japan, he said, where financial institutions had success abroad when they were strong at home, but when they had trouble at home they withdrew from realms they had conquered before.

But in Europe, said Breuer, the story is somewhat different. "If you are strong in only one of the home countries in Europe, this is not enough. It needs much more in the context of increasing globalization than being number one in Germany or France or Spain.

"You need continental European strength or you have no chance to compete with the Goldmans of this world, with others in Asia and so forth. If you need home strength for expansion abroad, in this case you need European strength."

That doesn't mean there's no role left for domestic institutions, Breuer said. "I'm not arguing against a continuing role for regional and local players. Distribution is the name of the game, and none of those global firms can establish a local distribution network on its own. They have to have local partners.

"Distribution is the thing to invest in. If you invest in distribution, you get more interest from big global players" and are integrated into the global system.

The Internet, he said, will play an important and decisive role on the distribution side. "Since distribution is so important, the global players have to rely more and more on Internet distribution channels as well. It is a strategic question for global players if they want to invest in their own Internet distribution network to get access to the retail customer."

Breuer also looked at the role of global financial firms in international crises, lamenting how much falls on these firms every time a crisis, like the 1998 crisis in Asia, occurs. It's obvious, he said, that the financial sector and international organizations do not learn their lessons. "All the talk about financial restructuring and new architecture is in vain," he said.

"There's still a lack of transparency, still a lack of cooperation between public and private sectors, still a lack of information about conditions in the usual suspect countries.

"I think that is disastrous. I'm so disappointed that all that has been said, and even done to some extent, did not lead to anything that could give us reason to hope to avoid, or at least mitigate, the next financial crisis, and that the global players will again by victimized by that.

"We should not tolerate that. We should not accept that as a given."