The sudden collapse of S G Warburg in the mid-1990s was a defining moment in the structure of the UK's financial markets. Until that point it looked as if Britain could retain an indigenous investment banking industry. Afterwards ownership of all the major investment banks by foreigners became inevitable.
The collapse and subsequent rescue of Warburg by the Swiss bank, SBC, was all the more baffling because it seemed to come out of a clear blue sky. Warburg had been the outstanding beneficiary of Big Bang, assembling the most powerful investment bank in Europe by combining a leading corporate finance house, broker and jobber. Approval ratings by clients were astonishing. By the early 1990s earnings were on a steeply rising trend, peaking at £200m in 1993.
The speed of the decline from colossus to pygmy desperately awaiting rescue could not have been more traumatic. Indeed, more than a decade later whenever two or more ex-Warburgers meet, the conversation still inevitably turns to the harrowing months that turned their working lives upside down and the real reasons for the collapse.
I spent last summer double-checking the story with the main participants. I was struck by two things. The first was how many of the developments had been wiped from the memory of those who were involved in them. Occasionally this memory loss was "strategic". The other striking fact was how participants remained unaware of key activity undertaken by others which had a direct impact on their own position. So a decade later and despite all the informal post mortems, I felt I was piecing together the course of events for the first time.
In the summer of 1994 Simon Cairns, the bank's chief executive (and the sixth Earl Cairns), took a decision that Warburg's go-it-alone strategy should be abandoned in favour of a merger with a major US investment bank. The house selected was Morgan Stanley - one of the leading " bulge-bracket" firms on Wall Street - and negotiations began in September. The talks proceeded over the next three months but before agreement could be reached rumours that Warburg was talking to another began to circulate in London and suddenly its share price took off. With the pressure on to make an announcement, the company decided to push ahead with the merger regardless, even though the negotiation would have to be completed through the pages of the financial press.
Great unhappiness developed among the inevitable victims of a combination in both firms, which severely undermined further progress, while Warburg's subsidiary Mercury Asset Management demanded a healthy premium for their external shareholders. Judging that these pressures would not allow sufficient time to complete the transaction, Morgan Stanley's chief executive John Mack pulled out without warning.
The impact of this rejection on Warburg morale was devastating. From the board to the trading floor, employees felt that the group had lost any sense of direction, an impression reinforced by the clumsy partial closure of the fixed interest division. At a time when other financial institutions were circling, looking for key personnel to build their presence, this left Warburg highly vulnerable. First to abandon ship was the equity capital markets team in early February, lured by exciting financial offers from Deutsche Bank. In the end about 200 executives found their way over to this rival. Cairns himself resigned at the end of the week, citing the loss of confidence of his team.
Now David Scholey, the chairman and former chief executive, was forced to find a safe haven. He selected SBC as Warburg's acquirer, rejecting the alternative, domestic, suitor NatWest. "NatWest made an appalling impression, shuffling in with peeping Tom-type mackintoshes," one of the members of the interviewing board recalled. "I couldn't see any credible way to work together with them." On 10 May 1995 the SBC takeover was announced.
While SBC had a balance sheet, its operation in London was relatively modest, so the mere act of combining the two banks cannot explain what happened in the next few years. With fundamentally similar resources at its disposal, the SBC management under Marcel Ospel was able to lever up the Warburg position to create one of the main global investment banks in the shape of UBS. The tantalising question this raises is why could the Warburg management not effect what the Swiss team later succeeded in achieving?
The answer that occurred to me had little to do with the specific mistakes and misadventures of late 1994 and early 1995. The clue was given in a short contemporary conversation I had with the finance director of Warburg in early 1993, Michael Gore. I had written a short paper to the board the previous year recommending that we look at taking over one of the solid middle-ranking US players in the shape of DLJ, which in the depth of the recession looked extremely good value. I had been mildly upset that the board had seemed to brush off the proposal.
Gore had endeavoured to soothe my feelings. "We were concerned that we simply did not have the management expertise to handle a US acquisition like that. We thought the management of the company would take us to the cleaners. "
In retrospect that statement lays bare the Warburg problem. I suspect Warburg had some of the best people in the City working for it, at least to judge by the way many of them went on to senior positions across the range of leading banks in subsequent years. However, the wrong people were in control. Warburg - like the other British houses - had failed to adjust to the revolution in handling risk in scale in the securities markets. If the management team thought they could not control a US subsidiary, why did they think they would be any more successful running a similar business in London?
The over-wieldy board of nearly 30 representatives was dominated by corporate finance specialists only a handful of whom understood the nature of risk instruments, or even the fixed interest environment. As Cairns later observed to me about the decision to scale up fixed interest in early 1994: "I have never been in that business and as the verdict stands we were guessing what to do."
So the corporate finance executives were in effective charge of a rapidly changing securities environment they did not understand. At the same time, ironically, the wrong corporate financiers were in charge of corporate finance. They understood how to craft transactions on a bespoke basis; they were extremely reluctant to allow teams to be built which could operate with clients on a volume basis, turning the activity into the marketing-oriented business it became under the Swiss. The costs of running a business in this bespoke way meant, in turn, that the earnings each expensive executive made were too low to allow competitive bonuses to be paid, so the bank became vulnerable to staff poaching.
The Swiss formula proved remarkably effective. Traders were put on top of the bank and marketing specialists, running sector teams, in effect took over the corporate finance department. It is easy to be wise after the event but it should not have been difficult for Warburg to execute this transformation in the early 1990s; even a relative paucity of capital could presumably have been remedied through some judicious fund-raising.
My hunch is that Cairns had concluded that he would not be able to overcome the internal resistance to the necessary changes and he saw the tight Morgan Stanley management team as the way to make them. "Well, David," he greeted me on the afternoon the proposed merger with Morgan Stanley was announced, "Is that bold enough for you then?" This was the reason that David Scholey and he were so determined to press ahead, despite being caught out by the leaks.
It is possible to take an entirely contrary view of the Warburg collapse and welcome, in particular, the speed with which it took place. This meant that, lurid headlines apart, not much fundamental damage had been done to Warburg's business infrastructure before the Swiss inherited it. They had less to repair and more to leverage. It means that today there is at least one foreign investment bank making a real success of working its way into the tightly controlled US domestic market.
David Freud retired as vice-chairman of investment banking at UBS in 2003, having spent 20 years with the bank and its predecessor, S G Warburg. Freud in the City by David Freud is published by Bene Factum Publishing, May 2006; 390 pages; hardback, £18.
Dressed for the kill
"You're working for SBC Warburg now," the Warburg workforce was told. "We have a casual clothes policy." So on the Monday, three distinct groups of people arrived at work. The first were the SBC traders in their elegant chinos and £100 shirts. The second were the Warburg die-hards who had always worn a suit and were damned if they were going to change now. The third group had searched through their wardrobe for casual gear and selected what they could find, which was their bonfire gear. I suspect the most horrified group in the room were the SBC traders who found themselves surrounded by tramps.
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