Dear Patrick,

I just started reading your book..and even in the opening pages I saw instantly a very like mind. Given your words, below is an email I sent to Simon Jenkins (UK Sunday Times columnist and now chair of the National Trust) back in October, and below that some of the words from an article I referred to that I wrote 9.5 years ago predicting financial meltdown triggered by investment banking collapse. I look forward to reading the rest of your book.

email to Simon:
Dear Simon,
Interesting times we are in…I couldn’t help digging out an article I prepared for the 1999 Institute of Director’s annual convention (35% of the audience was financial services), in which I suggested that the investment banking industry was ‘long overdue for a cultural revolution’, and posed the question: ‘how long can this go on before there is a worldwide meltdown?’ Well my question has been answered – 9 ½ years to be precise. I’ve attached an extract of this article (2 pages, 5 mins to read…)

Having reflected on what I wrote back then, clearly some things are of more relevance than others, notably the liquidity crisis. Interestingly even the best laid bank contingency funding plans (and I saw the Lehman version back in the early ‘90s), can be overshadowed by poor decision-making and ego.

As a fellow writer (notable Financial Times Pitman Publishing, 1998, Euro: Impact & Reality), happy to chat more about the issues gripping the world we have become.

Importantly, I think governments and economists face 2 serious questions:

Firstly, short-term, what value should the financial services sector extract from the real economy (ie. what is a fair price for the service they provide? – for example, how can a bank justify a corporate finance fee based on the value of a deal, rather than the man-day effort involved in providing advice – the size is irrelevant, complexity and effort is. Consultants and lawyers would have a field day if they could offer services at a price not related to man-days, but the scale of the organisation they were advising.); and

Secondly, medium-term, how long can the world economic model be driven by the concept of growth…more, more, more…when should it be stopped, and reversed, before we drive headlong into the much more important risk: ‘planetary collapse’. Such a collapse is unlikely to risk the planet, which has suffered bigger shocks in the past, but it poses a mega risk to humanity as we know it. Before the human cost, however, we are already seeing the massive deterioration in species diversity in our increasingly fragile environment. We need a fundamental paradigm shift to value our individual and collective contribution to the world we live in. Growth is so 20th century…

All best,
Chris Charlton

Extract from Institute of Directors convention article, 1999:

The Next Generation of Global Investment Bank

What is an investment bank, and what value do they create for their customers?

Investment banks simply act as intermediaries in the exchange of monies (and mitigation of losses like insurance companies) between manufacturing firms, retail firms, governments and each other. However, it is still an exchange between the people that represent each institution.

Hypothesis:

Investment Banks cannot maximise profits, shareholder value or, more importantly, stakeholder value, due to the misapplication of the principle of rewarding stakeholders on the basis of ACTUAL value added throughout the supply chain.

Problem Diagnosis

Few industries share the characteristics of investment banks, notably:

Extremely high ratio of staff cost to total cost – Remuneration packages can be some 50% of investment banks operating revenues (Suzanne Miller, Euromoney, January 1998).

Extremely high ratio of variable to fixed cost – Bonus pools play a high proportion of salary costs which can be upto 50% of total operating revenues.

Extremely high ratio of bonus to total staff compensation – This area is highly subjective, however it is not unusual for bankers to get 3 to 4 times their base salary in bonuses.

Extremely high variations in salary between management layers – Fewer of the investment bankers in the middle and lower strata will be sharing in the wealth of their firms, while top performers of the industry, reckoned to be about 5% of investment banking professionals, will continue to get richer (Suzanne Miller, Euromoney, January 1998).

Extremely high staff turnover rate – With 25%+ base pay rises offered to junior staff and the centralised locations of banking firms staff turnover is very high in comparison to other industries.

Extremely high proportion of customers are also competitors – e.g. inter bank market.

Extremely high revenue for small value added to customers' supply chain - i.e. funds simply provide the means by which a customer adds value to its products.

Extremely low ratio of fee based revenue versus interest or dividend based revenue.

Management reward schemes based upon revenue rather than contribution to fixed costs (nb. arbitrary allocation of fixed costs)

Massive share option schemes forcing directors to have potential conflicts of interest relative to other stakeholders.

Largely poor cross product selling conversion ratios (max 40%)

Jargon that baffles even the regulators and senior managers of the banks.

Pure investment banks that have no retail franchise have to rely mostly upon their competitors for liquidity, notably in the intraday, overnight and CP markets. Long term funding is minimal relative to the total size of the balance sheet.

Key Drivers of Change

The world of investment banking is overdue for a cultural revolution; and this will not be news to the majority. However, changes in the current market place may now drive investment banks to change if they are to remain competitive. In my mind the key drivers for change are:

1. The Euro
2. Globalisation
3. Intensifying competition e.g. non banks
4. New internet based technologies
5. More exacting customer requirements
6. Year 2000
7. Consolidation

Risk management, both by the regulators, and by individual firms, focuses on market risk and credit risk which are statistically calculable, though rarely achieved at a firm wide level. More serious risks, notably in law and in operations or IT meltdown, have yet to be addressed thoroughly.

As such, these firms rely on the quality of their integrated operations, back office and IT PEOPLE to ensure their long term viability and survival. It is these people that add true value to the bottom line of investment banks, but they are not remunerated according to this true value. Instead they are, at best, just ignored by the front office.

The experience of the Euro conversion weekend threw this fact into sharp light when senior front office managers realised that if the Ops and IT staff failed, they would have no business to run on 4 January 1999. But even then, when bonuses came round the same old mistake was made again through unfair and misallocated bonuses, many Ops or IT staff will leave by being devalued and demotivated, and the firms will lose all the accumulated knowledge and experience, unique to each firm.

On the other hand, banks pay the front office a fortune to stop them leaving, as there is very little motivation for such individuals to stay when they can easily up and leave and get more cash elsewhere, particularly if an entire team is willing to move. Little knowledge is lost as any bank can provide the capital for the front office to use to make more revenue.

This fact simply reinforces the fact that the world of investment banking is nothing more than a world of people with contacts. That is the nature of this short term business, where all firms want the same scarce resource talented people with good customer relationships.

Fear of building new long term relationships force banks looking for short term growth to poach personnel from its competitors (who are also providing it liquidity and customers). No wonder then that competition is fierce and margins are exceptionally thin.

How long can this go on before there is a worldwide meltdown? We have seen it in Japan and Russia already, and now Malaysia and Latin America. Will the Euro remain stable under these pressures? George Soros, in his book, “The Crisis of Global Capitalism” has begun to analyse these issues.

So, how do we change?

Alternative Treatments

Do nothing
Maximize cross selling opportunities
Build new and existing long term relationships
Restructure remuneration across all functions
Growth through acquisition- or other forms of forward and reverse combination
Increase margins through reduced cost

Optimum Solution

1. Overcoming investment banking dysfunction

2. Reward staff according to added value to contribution, not revenue

3. Create cross product / function / regional communication channels that are easy and quick to use

4. Focus on long term relationships rather than cost or short term gain

5. Tie staff's reward to success of company overall e.g. pay bonus in shares

6. Even out rewards throughout the supply chain e.g. pay suppliers on time

7. Emphasise delivery of exceptional, honest and value added service to customers

8. Create cross functional management teams that encompass more than one product per team i.e. create manager / product overlap

9. Assign project managers, with multi product / multi functional responsibility to deliver long term strategic objectives.

10. Assign line managers with front to back responsibility and authority, including contribution to fixed costs and profit. Rotate managers around functions to enhance cross functional / product experience.

11. Automate all manual, repetitive tasks through global STP. Reduce reliance upon individual members of the integrated teams. Use people for development projects e.g. winning new clients or upgrading in house technology.

12. The above changes should change on a global scale and be overseen by the regulators.

hello