On paper, the Warburg Group has everything it needs. In corporate finance, it has the combination of the Warburg Bank with Rowe and Pitman. In equity distribution, it has Akroyd and Smithers, one of the big three London jobbing firms which also has a history of Eurobond trading. So far, it has been able to find enough capital to stay abreast of even its largest competitors, while some of Warburg's traditional rivals have suffered because of a lack of it. Underpinning Warburg, too, is a corporate culture that combines an image of success and superiority with a clockwork efficiency.
But if Warburg aspires to reach the top rank of international securities houses, to become a truly global player, to develop the footholds it has in the Tokyo and New York markets, has it got enough to take on growing risks? Should it seek an alliance, or enter into yet another merger?
Or perhaps the challenge of the next few years is one that a London-based house of Warburg's size is best able to meet: to develop core markets at its own back door and concentrate on the role of what Sir David Scholey, Warburg's co-chairman, described as "the leading edge in the middle". He meant that it should neither cover all possible securities markets, nor remain dependent on a blue chip client list for lucrative fee-earning business.
In that case, comparisons with its competitors on the basis, say, of market capitalisation become largely irrelevant. The strengths it has now are the important ones.
In July 1983, Cecil Parkinson, then Secretary of State for Trade and Industry, and Sir Nicholas Goodison, chairman of the London Stock Exchange, announced plans to abolish dual capacity and fixed commissions. The countdown to Big Bang had begun.
Within days of that announcement, David Scholey, co-chairman of SG Warburg, was lunching at Akroyd and Smithers with Brian Peppiat and Timothy Jones, co-chairmen of the jobbing firm. As well as enjoying what Scholey himself admitted was a better kitchen than Warburg's, he was discussing plans for a new conglomerate.
By autumn, plans had been laid for an alliance. By November, Warburg's 29% stake in Akroyd was announced. "Scholey wanted a market-maker and an agency broker. There was a tremendous amount of understanding right from the beginning," explained someone close to the deal.
At the time Scholey was breaking bread with Akroyd, the jobber was already planning a joint venture with Rowe and Pitman, a blue-chip broker which even today retains a client list that ranks second only to that of Cazenove. The venture was an international broker/dealership to trade non-UK securities. That became ROWAK, although not until the spring of 1984. The delay was due largely to Rowe and Pitman's desire to maintain ties with other merchant banks. October 1986 still seemed a long way off, and indeed it was not until April 1986 that Akroyd and Rowe were formally and fully merged with Warburg.
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The fit between Rowe and Pitman's client list and Warburg's was a good one. And with attention at the time focused on the bond markets, the acquisition by Warburg of Mullen's – which last year celebrated its bicentennial as the government bond broker – was also a natural development, further eased by the presence of Robin Peppiat, Brian Peppiat's brother, on the Mullen's board. (Mullen's, despite its silk-hat image, has an interactive computer system for its bond trading operation superior to those of its rivals.) "It all happened extraordinarily rapidly," Scholey recalled.
The new group was at first called Mercury International, but at the end of July 1987 it was renamed the SG Warburg Group.
"We found that all four of us held the view that the initial strategic objective was the development of the market-making area," Scholey said. "Market-makers were in shortest supply, and that was the most secretive area of the market. Akroyd felt that they were at the core of the revolution, and Rowe and ourselves agreed that they were."
Akroyd, like Warburg, was a corporate entity rather than a partnership. Such was the compatibility of the two firms that Scholey said: "If we hadn't been able to do it with Akroyd, I think we might have gone a totally different route."
At a meeting of 55 senior executives from the four firms in the Warburg board room in the spring of 1984, Scholey realised that the merger would work.
"Within an hour and a half I remember feeling excited and relieved," he said. "I thought to myself that if someone had come in through the door then, they would have believed they were seeing a group of people from one firm."
A steering group was formed, with its members working late into evenings and weekends to establish the precise structure of the new group, to get people to work together and to evolve a consensus among the staff. (Scholey used the Japanese word nemawashi, literally: "From the roots".) There were up to 300 people involved in working parties, or preparing reports.
There were plenty of rivals ready to criticise Warburg's strategy at the time. The £41 million paid for Akroyd was an investment in goodwill that might easily have been vaporised by over-heating within the new machine.
The task of ensuring that the risk paid off fell first and foremost on the shoulders of Scholey, a man who, some have claimed, rose to the co-chairmanship of Warburg as a "compromise candidate".
"Scholey attended all the meetings and put his personal stamp on the whole process, but he never forced his will on people. We were all pre-eminent in our own fields, and the beauty of it was that there were no disagreements on anything of substance," claimed a member of the steering committee.
Few details were left unconsidered. Salaries were to be above average, but there were to be no prima donnas. It was a fine balance. There were unhappy memories at Warburg of the firm's involvement with Becker, the US investment bank, where there had been 35 separate bonus pools to confuse motivation and self-interest; the alliance was dissolved in 1983. Employees down to middle-tier traders and salesmen were to have share options to help to instil a sense of belonging to the new conglomerate.
There was also a long debate over settlements systems. This paid off. Today, while its major rivals are plagued with settlements problems, Warburg has far fewer. "No one reckoned that volumes would increase three times over in the nine months since Big Bang, but we did recognise it as a potential problem," Scholey said.
It was even decided that Warburg's twositting lunches, at 12.30 and 1.30, would not be imposed on its new partners.
An overriding concern was the maintenance of the Warburg ethos, and this is still manifest in the group's headquarters at 33 King William Street, at the end of London Bridge. It is best summed up as classroom efficiency, with no room for the kitsch trappings of the parvenu investment bank, such as fake panelling and over-large lamps. Ordered politeness has survived the explosive growth in staffing that has made a visit to so many of Warburg's London rivals an assault course through a petty bureaucracy. Warburg people like to call the atmosphere "dignified austerity". There are worthy professionals in the London capital markets who would shy away from a job at the firm because of that.
Flashiness – including the use of the first person singular – is discouraged. No more than a dozen executives in the Warburg Group overall have their own offices. The visiting president of a Japanese securities house noted something he had thought unique to Japan: Warburg executives either had lunch with clients in dining rooms, or they ate in the staff canteen with everyone else.
Scholey expressed a distaste for the excesses of free-market capitalism, the worst of which have "nauseated" him. The late founder, Siegmund Warburg, also felt this distaste. He once compared financial greed to necrophilia. The distinction between hunger and greed, confidence and arrogance, is at the core of Scholey's definition of his managerial philosophy.
"One of David's great assets was that he knew everyone by name," reported a ROWAK hand. "He'd come around and say hello. We felt that we had a stake in the future, without having cut the umbilical cords with our parent firms so that we didn't have a shoulder to cry on if something went wrong."
By autumn 1984, the blueprint for Mercury International was substantially ready. ROWAK, meanwhile, began dealing; the only international broker/dealership to be formed well in advance of the introduction of Seaq International in June 1985, it proved a successful union of different cultures, which has lasted while other Big Bang marriages have proved unstable. Fall-out from ROWAK and from Mercury has been small. The most senior man to leave was Stephen Raven, a director of Akroyd, who left this year to join County NatWest.
"The old divisions were abandoned at ROWAK a year before Big Bang. Salesmen sat next to traders and they were both within reach of the analysts. We got on well," commented a ROWAK source. In April 1986, Mercury International was born, although the names of its four constituent parts, and indeed their boardrooms, were retained within the group.
Scholey was modest about the achievement of the merger: "We don't regard ourselves as having succeeded yet. What we have sought to do – and so far succeeded in doing – is compile a group that is relevant to the current outlook of the London-based securities market. One that is not only capable but that is trading profitably."
Warburg's Japanese and US arms "both make useful profits", Scholey said. The difficult world bond markets make it unlikely that all areas of Warburg's business are consistently profitable.
In the lucrative Euro-equity market, Warburg ranks second in the Euromoney lead and co-lead management league tables to the end of June this year – up from 17th place for 1986 as a whole – with an involvement in 19 deals to a value of $594 million. Its lead management of $446 million of Euro-equity issues gave it a 6% market share.
In Eurobond lead managements, Warburg ranks ninth; it is the top UK house, with $2,917 million of deals brought to the market, again an improvement on last year's performance.
That improvement may be due in part to sterling's popularity against the dollar with investors. But Warburg is also the top nonJapanese Euro-yen lead manager and has been prominent in the Euro-Australian dollar sector. In Euro-commercial paper, Warburg has ranked third behind CSFB and County NatWest in terms of dealerships this year. The 1987 annual report for the group reveals an interest rate and currency swap arrangement business of $5 billion last year.
The business of the Warburg group now has two main streams, the asset management side and investment banking, and that is how the group's balance sheet is presented; in the style of a US investment bank. That in itself reflects a change over the past year. Previously, Warburg Securities was distinguished from SG Warburg, the merchant bank, although the 40-year history of the latter has been based more on the London acceptances markets (or, to use a modern generic term, securitised debt markets) than on merchant banking per se.
What is to be the Warburg strategy now that Big Bang has been weathered? "The challenge is to keep a balance between moving forward to new areas and markets without losing touch with existing sources of business and relationships," Scholey said. He compared the firm's progress to that of a cross-country skier: always keeping one foot on the ground rather than leaping through the air. Cross-country skiing is one of Scholey's many interests; it may suit his natural caution in planning the next step.
According to one school of thought, Warburg is approaching another crossroads. With its shareholders' capital of £675 million, it cannot compete internationally with the leading American and Japanese securities houses. There are those who argue that Warburg would need some $3 billion to assure it of a place in the world's top 10 securities firms as it moves into the 1990s.
It was rumoured at the outset of the Mercury master plan that Warburg had rejected overtures of a bid from Lloyds, the smallest of the big four UK clearing banks, and it would seem highly unlikely that either Lloyds or Midland – the other clearer that has had the most obvious lack of success in creating a competitive securities business – would be considered viable new parents, even if the group were searching for fresh capital. Most observers agree that the Bank of England would refuse to allow Warburg to seek, or be sought by, a foreign buyer.
Another possibility, adoption by a corporate parent like GEC or BP, also seems unlikely.
The biggest fright Warburg has had was the acquisition by the US financier Saul Steinberg of a 15% stake in Mercury, announced last December. In January, it was announced that Steinberg had sold out to the Canadian National Railways Pension Fund – far friendlier hands – giving Steinberg's company, Reliance, a $47 million profit. The friendliness of the new holders' intentions can be gauged by the $26 million book loss it took on the shares, now largely recouped.
The only other Warburg shareholder with a 5% or more stake is the Norwich Union insurance company; it has 5.48%. On paper, Warburg is still vulnerable to an aggressive bidder. Its best defence is its continuing profitability. Warburg shares were trading at 475 pence in mid-August. They had fallen to 371 pence following news of Steinberg's sale to CNRPF.
Last June, Mercury International announced pre-tax profits for the year to March of £98 million, up by 6.8 %. Earnings per share were 42.7 pence, up from 34.3 pence the previous year. Of that, £22.7 million was accounted for by Mercury Asset Management, which has under management some £21.5 billion, of which about £15.7 billion comes from UK pension funds. The balance was not publicly split between the merchant banking group (SG Warburg and Co) and Warburg Securities.
Banking analysts agree that the current year's results will show a significant improvement, generated largely on the securities side. Profitability last year was hindered by the costs of gearing up for Big Bang, besides the disadvantages the business faced before October 26 and the difficult markets of the first quarter of this year; £12 million development expenditure was charged to inner reserves in the annual report.
At Messel, the bank analyst, Christopher Davis, forecast pre-tax profits of £127.5 million for 1988 for the Warburg Group: "Warburg has a clear strategy, in the sense that it has gone for a securities operation in a big way and cast aside commercial banking," commented David Poutney, merchant banking analyst for BZW. "Morgan Grenfell and Kleinwort Benson still have relatively large loan books."
Mercury Asset Management had a particularly good year in 1986-87. Funds under management increased by 62%, as it added 40 new pension funds to its client list. Analysts forecast that MAM's profits might clear £30 million for the current financial year. But in the longer term, MAM's weakness lies in the predominance in its business of UK pension funds. Scholey foresaw slower growth for these in the future. Breaking further into the profitable US fund business would be tougher still, although that must be a target for MAM, which so far has around £1.5 billion of ERISA funds (freed under the US Employee Retirement Income Security Act) under management. A development on the private client side of the asset management business was also a target.
There was some criticism of the flotation of 25% of MAM earlier this year. The shares opened at a £1 premium to the 225 pence issue price. As the sale required the winding up of directors' accrued share benefits, more than £3 million had to be charged against profits for the year.
The MAM flotation did, however, raise some £37.9 million. Immediately after its annual results, Warburg launched a £131 million rights issue. As well as protecting Warburg against new capital adequacy requirements, it has put the group in a better position to take advantage of markets. Much of the house's development costs came from reserves, but that cannot go on forever. In London, perhaps, people, organisation and skill are more important than capital.
"We brought the rights issue because it was opportune," Scholey said. "We have adequate capital now for the expansion potential we see now, although there might be opportunities overseas that could have a new equity requirement over the next year or two. But don't forget that the most dynamic source of capital is retained earnings."
Scholey also pointed out scope for expansion in the domestic UK markets, in bonds and in corporate finance. "We don't cover as much as we necessarily should do," he said. "We're far from saturation point."
As for the UK corporate finance business, Warburg has been ranked third behind Morgan Grenfell and Schroder Wagg in M&A, advising 17 bids to a value of £2,047 billion. But the M&A business may be changing, bringing more risk for intermediaries. Recent jumbo share issues for the UK companies WPP and Blue Arrow to finance US acquisitions have illustrated the underwriting capability of Warburg's rivals.
A Warburg Group logo depicts the globe encircled by pastel rings representing the banking, securities and investment management strands of its business. Such imagery hardly tells the whole story. Scholey defended himself against critics who suggested that Warburg's commitment to US Treasury bond dealing confronted US houses head-on in a game in which the latter have obvious advantages. He said: "They don't appreciate that the US Treasury bond business is an integral part of our global fixed-income division." However, he has indicated that there are specific roles for a UK merchant bank, which ensure that London remains a natural focus.
The historic role of London as a hub for global trading was being enhanced by the growing cohesion of Europe, Scholey maintained in a speech he delivered last April. The City's heritage of skills might ensure that London developed as the financial outlet of a European hinterland. The connection between the fortunes of London and Warburg is obvious; but Warburg's European connections are also well established.
In Switzerland, Warburg merged its interest last January by forming SG Warburg Soditic Holdings, which acquired the whole of SG Warburg Bank SA (previously 80%-owned) and Soditic, in which it had a 45% stake. The Warburg group owns 50% of the merged group; important to its distribution network and the envy of its rivals.
Few outside, or even inside, the group know just how much of Siegmund Warburg's other European connections, many purely personal, were maintained after his death in 1982, or to what extent the concentration of resources in London during the run-up to Big Bang affected them.
In Australia, Warburg owns 50% of Potter Partners, and in Hong Kong it has a joint venture with the Bank of Far East Asia. The New York operation employs 200 people in equity, ADR, Eurobond and US Treasury bond sales and trading; the Tokyo office 150 in equity sales and research. None the less, Scholey conceded: "We are not as significant in international investment banking as we are capable of being, but although we emphasise the importance of other financial centres, we don't see them as Everests – to be climbed just because they are there. We see ourselves as functionally driven and regionally coordinated."
In Tokyo, SG Warburg Securities has been trading on the stock exchange since April 1986 – the first UK house to get a licence there. It now has a Japanese president, Kyoshi Tsugawa, formerly with Bank of Tokyo. Other firms are still scrapping for ancillary licences in the face of stiff opposition from the smaller and more parochial of the TSE's 93 members. The firm has longstanding links in Japan; Siegmund Warburg first visited Tokyo with a group of bankers from the City in 1962 and was deeply impressed. The old Warburg Bank in Hamburg had links with Japan dating back to the beginning of the century, when it helped finance the war with Russia.
Senior executives at Nomura speak warmly of their relationships, dating back to the early 1960s, with Warburg's great diplomats, like Lord Roll. Such contacts were useful to Nomura when it was setting up in London, just as they were when Warburg applied for TSE membership.
In New York, it is a different case. "Warburg may be competing internationally with the Americans, but their view of what constitutes international business may be different," said John Tyce, bank analyst with Alexander Laing and Cruickshank. "They may concentrate on the bits that are an afterthought for the likes of Salomon. In America, that means doing business for foreign institutions before the Americans get to them."
Scholey has gone on record as saying that he wants a Treasury bond primary dealership. That would require a turnover of roughly $10 billion annually (0.75 % of the market), and Warburg at present does only about half that.
The New York office of SG Warburg has been criticised as lacking direction, and Scholey admitted that New York has been a difficult area for Warburg. This is perhaps especially so with its mainstream business, in which Warburg has so far been unable to compete on equal terms with domestic houses.
David Russell, formerly head of Rowe and Pitman's US operations, was put in charge of US equity sales but returned to London last spring. He was replaced by Cher Blake.
"I don't think anyone believes that Warburg can compete head-on with the likes of Salomon and Goldman Sachs for domestic business in the US," said Rod Barrett, an analyst with Hoare Govett. "They can compete, not on a capital basis, but in terms of contacts and expertise." That primarily means getting to European clients who want to do business in North America before its US competitors.
There are those close to the SG Warburg Group who believe that another major restructuring is inevitable within the next few years; that the survival of any large-scale securities business will be determined by a capital strength that matches all competition in the same league.
But the strategy of the Warburg Group is not based on such simplicities, and the logic of capital is not quite so remorseless. Warburg's strengths outnumber its weaknesses, and its greatest strength, its leaders know, is its name.
Scholey, despite rumours that he has been earmarked as a future governor of the Bank of England, intends to remain at Warburg "as long as the shareholders and the board want me to".