The U.S. corporation in Europe, to and beyond 1992.
With the integration of Europe's financial services on the horizon, how should U.S. companies react? Are there benefits to be captured and, if so, how fast must CFOs move? Most American financial executives with any involvement in Europe are acutely aware of the fact that monitoring, understanding, and taking advantage of the process of European financial integration will have enormous implications for the profitability of their European operations over the next 10 years. Yet, even after the latest presentation by their investment and commercial bankers on what is happening in Europe, confusion reigns about the conclusions they should draw for their own corporate financing strategies.
Should American multinationals, who have generally taken a pan-European--even global--approach to financial management, be mildly interested in the changes occurring in Europe? Or are the fruits of financial integration entirely for the benefit of small European corporations? Do the key financial services directives, which enable universal banking across Europe, mean that American corporations should assume a "holistic" approach to corporate funding (i.e., equity, bond, and debt markets)? And in light of the continuing spate of mergers, acquisitions, and strategic alliances of all sorts among European financial intermediaries, with which financial intermediaries should companies start building relationships that will appropriately position them in the 1990s?
From fragmentation to integration
Before the current period of European Economic Community-induced change leading to an integrated market beyond "1992," European financial organizations could have been described as being in a complex matrix of fragmentation. In other words, financial institutions were fragmented by country (and consequently by language and corporate culture), by type of product specialization (mortgages, consumer loans, investment advice, equity brokerage, etc.), and by type of customer segment covered (retail, corporate, government, etc.).
Over the last several years, this rather fragmented, but nevertheless highly definable, market organization has been transforming itself into a more fluid structure within each national market. The early roots of this change could be termed international in nature: the fallout from global financial deregulation and the impact of technological applications in financial markets and products have both enabled financial institutions, even in Europe, to build across this matrix of fragmentation and specialization. But perhaps the most vital force of change has been the European Commission's rather revolutionary deregulatory approach since 1985 in the area of financial integration. Instead of painfully harmonizing away the myriad of national regulatory differences, the Commission opted for what has become known as the "dynamic disequilibria" approach.
Two key directives form the guiding philosophy of this new approach: the Second Banking Directive and the Investment Services Directive. After the basic rules in the provision of financial services are harmonized, financial institutions, appropriately registered in one EEC country, can offer their services across Europe and be supervised by their designated home country authorities.
The dynamic disequilibria is, in other words, the expected impact on financial institutions and markets in the 12 EEC countries as players and regulators hustle to define, redefine, and secure their positions in an integrated Europe. The practical effect of this new approach has been to exacerbate the current state of confusion among financial institutions: what should they offer? To whom? And in which markets? And instead of being limited to the various national markets, the confusion has erupted throughout Europe.
As these changes were bombarding the structure of European financial intermediaries, European capital markets also were experiencing significant evolution. Not unlike the matrix of fragmentation among financial intermediaries, until recently the capital markets were equally splintered. Except for blue-chip multinationals from each European country, the vast majority of companies had to content themselves with corporate financing at the national level.
And in most European countries, equity and corporate bond markets lay stagnant and emaciated for several key reasons: the numerous regulations and cumbersome listing, issuance, and trading practices of most continental securities exchanges; the traditional conservatism of retail and institutional investors; and the predominance of the bank debt and government bond markets.
But several factors are combining to change this rather undynamic situation. For instance, the success of privatization programs, increasingly popular with cash-strapped governments in Europe, brought over ECU 35 billion between 1985 and 1987 and revitalized equity markets in the process. And continental stock exchanges, realizing that London was rapidly asserting its capability to serve as the European link in an increasingly global securities business, have begun their own equivalents of "Big Bang" liberalization in terms of listing, new issuance, technology improvements, and trading practices. And many are even allowing intermediaries to position and trade for their own account and engage in market-making activities that should enhance liquidity.
In addition, EEC reforms for universal banking should bring more well-capitalized banking institutions into the securities business as they try to recuperate from the client loss they suffered from the trend toward securitization among prime corporations. Investors, too, are realizing the benefits of portfolio diversification as a means of increasing returns and reducing risks. Many now aim for diversified portfolios in terms of instrument type (not just top-notch government and corporate bonds), industry type, and company-size type across a multiplicity of European countries.
But how do all these positive reforms benefit large corporations?
What's in it for corporations?
Large multinationals often have argued that the prime beneficiaries of European financial integration will be the smaller companies who are now relatively country-bound in their financial relationships. Large corporations feel they already deal across countries in terms of operations, fund themselves in multiple currencies in multiple financial centers, and assume a global approach to cash management. What more could the EEC's efforts in the financial arena bring them?
While small companies will gain, their benefits lie more in the price reductions of financial products within the country and increased efficiency of national intermediaries anxious of protect their client base from foreign players. Large corporations, long used to global shopping, will gain, but for different reasons. There are two interrelated factors, which led to the argument that they, more than their smaller counterparts, may be bigger beneficiaries of European financial integration.
First, as the integration process accelerates to and beyond 1992, financial transactions should become increasingly measurable and comparable across the EEC and become operationally more efficient. In practice, this should imply a gradual harmonization of national regulatory and operational peculiarities, a tendency towards equalization of funding costs, harmonization of transaction taxes and withholding taxes, and an increased likelihood of intermediaries offering unbundled treasury products where costs and benefits are clearly identified.
For CFOs of large companies, who already have significant cross-border cash flows, on both the asset and liability sides, financial integration would mean that they can at last evaluate operating projects and allocate financial resources without the traditional biases they have had to contend with in a splintered Europe.
Second, changes in the organizational structure and operations patterns of key financial intermediaries should enable corporations to take an efficient corporate finance approach throughout Europe. In a nutshell, as key intermediaries themselves aim to capture the advantages of a unified financial market, they will undoubtedly attempt to build upon, on a European scale, what they consider to be their competitive advantages in their home market. In terms of activity, this may range from product or client segment specialization to full-scale universal banking.
For CFOs of multinationals, this would be a pleasant departure from the days when they had to piece together a pan-European corporate finance strategy for one liability tranche--say, bonds or equity--without the assistance of a truly integrated European intermediary. Hence, in practice, the benefits of these changes among financial intermediaries will result in more support from truly "Euro-bankers," who, instead of touting the number of offices they have in each country, will now be emphasizing their ability to put together an all-European client team that takes a holistic attitude to a given category of financing. But CFOs should be prudent in dealing with a new breed of one-stop, universal Euro-bankers, who will push a version of "financial advisor for all your problems."
So what other organizational and operational structures may develop among financial intermediaries, and with which ones should large U.S. corporations emphasize relationships?
Finding the relationship that fits
As we discussed above, European financial intermediaries are entering into a period of healthy and competitive chaos as they jostle to carve out successful positions in a financially integrated Europe. Global deregulatory trends and the impetus for change given by the EEC is pushing some players to specialize and others to diversify, both in terms of product and client segments.
In other words, in the post-1992 period, it is likely that both universal and specialist intermediaries will co-exist, and the fears that three or four gigantic universal banking monsters will dominate most European commercial and investment banking activity should prove unfounded. But an interesting phenomenon will manifest itself in the coming years, to and beyond 1992.
While a handful of big banks serving all of Europe will try to provide all things for all people, a group of innovative key financial players in each major EEC country will first define and limit their product or client segments and then increasingly attempt to extend their volume across European markets. However, recognizing the dangers of recuperating limited scope with added scale (as various studies indicate low, or even negative, economies of scale in traditional banking activities typically after $100 million in assets), these asture banks may opt for a "partnership" organizational and operational structure. And these are the players that corporate CFOs looking to build innovative financial relationships should start identifying, monitoring, and nurturing.
Essentially, these financial intermediaries will aim not to expand across Europe through outright acquisition or de novo routes but prefer to build intricate webs of strategic alliances in key financial markets. This approach, which requires less in financial resources but more in managerial energy, is especially useful in avoiding the costly mistakes of outright acquisitions and is valuable in Europe with its wide economic and linguistic differences. These arrangements, which run the gamut of legal frameworks, can range from simple distributorships to complex agreements to jointly develop entire markets, and they can involve some or all parts of the financial business system. In the case of financial intermediaries, the approach forces each player to carefully identify and foster its competitive advantages vis-a-vis its partner. But why may CFOs of large corporations favor these intermediaries?
In the early 1990s, it is likely that CFOs will be deluged with calls from "one-stop advisor teams" from those universal banks that have spent most of the late 1980s undertaking outright acquisitions and building upon outdated and operationally heavy matrix organizations. The quality of such all-encompassing services may be questionable, however. As their top management expends immense effort coping with post-acquisition issues, it is unlikely that enough effort will be spent on identifying corporate client needs, which by then will have further evolved technological and financially.
These giant universal banks may continue to follow the conventional wisdom in Europe that the largest banks, with the international networks, are better equipped to cope with all the needs of large multinational corporations. Many do not want to realize that the balance sheet and P&L management at large corporations involves a group of financial officers who are frequently far more skilled than even a top commercial or investment banker. Hence, what large European or American corporations will need is more focused advice on tranches of financing that take a total European--or, better yet, global--approach. And the CFO of the corporation will keep the job of evaluating the whole evolution of his financial structure. Ironically, then, the approach of universal banks may in the end be better suited to medium and small companies, which may need overall financial advice in addition to the actual financing itself.
In other words, a pan-European intermediary that focuses on several key areas of corporate finance (whether it be funding, M&A advice, or securities research, issuance, market-making, and trading) and does so across the EEC using key "Euro-partners" in the major markets with which it maintains strategic alliances for certain aspects of a product has a plus. It is better positioned to bid for a particular tranche of financing than is a pan-European universal bank with a strong presence in one EEC country but dabbling in every financial product in every European country using its wholly-owned subsidiaries, which may be of second-tier importance in the local markets. Interestingly, many of the major U.S. commercial and investment banks in Europe, some after long and painful experiences in "do-all" banking, are following the advisable approach. The external difference may seem subtle, but the effect for CFOs of using one or the other certainly is not.
Time to watch
The ongoing process of European financial integration is indeed complex due to the multiplicity of factors affecting both users and providers of financial services. The very nature of the process defies generalizations, and gleening trends and making predictions frequently pushes one into the realm of soothsaying. Yet now more than ever before it has become imperative that corporate financial officers carefully follow the legislation emanating from the EEC in Brussels, monitor the developments in the financial markets, and understand that the organizational and operational restructurings made by certain innovative financial intermediaries may better suit their corporate finance needs in the 1990s.
The payoff of these efforts? The ability to stay one step ahead of competitors in Europe's rapidly evolving state of corporate planning, control, and finance.
PHOTO : Dutch Still Life with Primroses, Paul Wonner, 1979, acrylic on canvas
PHOTO : Santa Rosa, CA Fred Parker, 1983, painted photograph
Eric J. Rajendra Engagement Manager McKinsey & Company-Brussels
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|Title Annotation:||single European market|
|Author:||Rajendra, Eric J.|
|Date:||May 1, 1990|
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