Culture and the cross-referral conundrum

Culture – in recent times this single word has come to signify all that is bad and all that should be better in financial services practice. In a summer that threw up the Libor scandal, $6bn (€4.8bn) of proprietary trading losses at JP Morgan, and even Sanford Weill (architect of Citigroup’s universal banking model) turning evangelist for the breakup of large financial institutions, the word “culture” is back on the agenda.

Most people – indeed, most regulators – accept that it is impossible to regulate culture. In fact, culture is widely regarded as the elusive ingredient, the x-factor, that turns a firm full of good people into a good firm.

And yet, one outcome from the proliferation of regulatory activity could well be that firms are forced to re-address their culture – not as a regulatory imperative, but as the simplest and most straightforward solution to enhancing the bottom line.

Historically, even in the boom years, not a single large financial services firm could claim to have cracked fully the problem of cross-referrals. Their investment bankers were far too busy and far too important to focus time and energy on the small transactions introduced from the wealth management teams. Similarly, their wealth management teams wanted their independence to go the market in order to secure the best terms to flatter their own bottom line.

Increased competition

But now, enhanced regulations are driving two fundamental changes in the financial industry. First, enhanced liquidity and funding requirements (for example, through Basel III) mean that regulatory capital will become a key driver for the business. And that means increased competition for deposits and fee-based asset management business.

Second, constraints on investment banking business (for example, through the Volcker rule, through parts of Mifid II and the EU’s short selling rules), mean that financial services groups will need to turn to other sources of business to generate the profits to which they have become accustomed.

All of this brings us back to culture. If firms were unable to get their teams to act like teams in the regulatory environment of the past, it will be imperative in the regulatory environment of the future.

Lesson One from the past was that transfer pricing and service level agreements (SLA) were more often a source of contention than of efficient business introduction. In the new environment, these agreements need to be re-assessed and made fit for purpose for 21st century banking.

Arguably the most successful exception was Credit Suisse with its “One Bank” strategy. As far back as 2006, the Swiss bank had transfer pricing arrangements in place that incentivised its teams to work together. Indeed, according to its 2011 annual report, Credit Suisse is now generating collaboration revenues of SFr4.3bn (€3.6bn). This represents 16.8 per cent of net revenue and the firm hopes to boost this to 18-20 per cent within the short-term future.

Lesson Two, was that regardless how good a firm’s transfer pricing and SLA strategy, these arrangements only work when senior management believe in the capabilities of both units and can press home the benefits of cross-sell to the organisation as a whole.

In this regard, the merger of corporate and investment banking at Bank of America Merrill Lynch (BAML) in April 2011 is an interesting case study. BAML took the view that the best way to convince clients they could gain access to all the banking products and services they needed in one place was to integrate the management teams. Just six months later, the firm was forced to alter the strategy when brokers, dependent on commissions and fees, complained that they had been pressed to push products like credit cards and mortgages.

A year further down the line and BAML’s announcement of the sale of its international wealth management book to Julius Baer could not be a more clear statement from senior personnel that the unit is not integral to the overall offering and provides very little value to the overall business.

Putting the client first

We would add that Lesson Three is there is no point implementing either Lesson One or Lesson Two if the firm does not have a culture of doing what is best for the client. All three parties: the client, the wealth management team and the investment banking team need to have a shared understanding of the value of the transaction for it to be success.

So, while it may not be possible to legislate for culture, going forward regulations may force firms to re-assess what is valuable to them, and by extensions, to focus on internal value and the corporate values that will drive future revenue generation.

Annie Catchpole is senior associate at wealth management think-tank Scorpio Partnership