A Model Market? Twenty Years of a Floating Australian Dollar
Banking consolidation is a recurring theme in the world’s markets as many wait for what is seen as the inevitable culling of the banking ranks. In Australia this consolidation started more than two decades ago when then-treasurer John Howard authorised a series of domestic mergers aimed at streamlining the local banks ready for foreign bank competition.
These mergers saw the disappearance of several banks – the Commercial Bank of Australia merged with the Bank of New South Wales to become Westpac Banking; National Bank of Australasia got together with the Commercial Banking Company of Sydney and changed its name to National Australia Bank (NAB). This created the so-called four pillars as the two aforementioned institutions joined with ANZ and Commonwealth Bank of Australia (CBA), then government owned, as sacrosanct and unavailable for purchase as far as each other and foreign companies were concerned.
Once the first period of merger activity passed, the banking market entered a brief period of stability as all and sundry took advantage of the volatility of interest rates and the exchange rate. A second period of merger activity took place in the early 1990s which saw several regional banks disappear into larger financial groups, and also the getting together of the big domestic banks and local insurance and fund management groups.
Into this mix, in late 1984/early 1985, were thrown the foreign banks as a finding of the 1981 Campbell Committee, which was founded to recommend changes to the regulatory infrastructure of the financial markets in Australia, was adopted by the government of Bob Hawke. The decision was supported by the Martin Committee established by the Hawke government to report on the first committee’s findings (which were produced under the previous administration), with the caveat that foreign bank ownership be limited to 50%. This led to a number of subsidiaries being established as foreign banks moved quickly into position.
In early 1985, what many now consider to be the seeds of the over-banked conditions were sown when the government suddenly announced that instead of the previously announced four banking licences, 16 were to be issued. All 16 were taken up and 15 banks established operations, but only as subsidiaries – something that limited their ability to compete with the local banks that, as one source notes, “had plenty of time to prepare for the competition”.
So where does this leave the Australian market today? Interestingly, several niches still exist and the banks, both domestic and international, are taking different approaches to their businesses. While this suggests that there is sufficient space for the number of banks, it can also be argued that the diversity of approaches signals some confusion over what it takes to succeed.
For the domestic banks there is still the large retail operation to fall back upon and to help further development, because for all the intentions of the governments of the 1980s and ’90s to promote retail banking competition, this simply has not happened. The impression one gets when speaking to the domestic banks is that they all see themselves in a slightly different light. “We see ourselves as very much a global bank,” explains Gary Dillon, co-global head of FX at NAB in Melbourne. “We look to operate globally and have worked hard to build our regional capabilities within the global matrix that is our management structure.
“We recognise that clients in different regions require different services,” Dillon continues. “In Europe and North America it is very much about the institutional client and in Australia the large corporate. We look to service this broad spread of clients on a local basis – we are the only Australian bank to run a North American trading desk for example. By operating locally we have seen our volumes increase substantially. We provide our clients with global coverage and local colour.”
NAB expanded into Europe by buying four regional UK- and Ireland-based banks, a move that made it the biggest foreign bank in the UK market. ANZ recently further expanded Australia’s interests in New Zealand by buying the National Bank of New Zealand (NBNZ) from LloydsTSB. Rick Sawers, managing director, FX and commodities at ANZ Melbourne, believes the banks are “a good fit”. However, he acknowledges that there are issues over merging those banks positioned at numbers one and two in the NZ dollar market. “Our challenge is to put one and one together and integrate it well enough that we do not end up with 1.2,” he says.
Sawers believes that having restructured its global business around the investment bank under his predecessor, Chris Cooper, ANZ now has to refocus upon its domestic operations. “We have not neglected our domestic business,” he explains. “However, our prime focus was on building our global customer business. We especially want to look at the SME [small and medium enterprises] segment because over the past few years more competitors have moved into this space. We want to win more of this business.”
Aside from those divisions of the other big Australian banks that are focused on the SME sector, ANZ also faces competition from two more recent entrants onto the Australian banking scene. One, St George Bank, converted to a bank from a building society in 1992 and is a natural player in that environment. However, another entrant, Travelex, has come from a somewhat surprising quarter in that it views itself very much as a buy side institution.
Travelex is mostly known for its retail business, but after acquiring Thomas Cook Global and Financial Services in 2001, has moved into other areas – including commercial and corporate business. Travelex offers a range of FX products to its client base, including structured options. “We probably have one of the broadest FX businesses in the world,” suggests Roger Bennett, director, dealing operations at Travelex in Sydney. “And we compete with banks in the SME segment, however, because as we have grown, we have continued to look toward larger customer markets, while some of our banking partners are looking further down the value chain than they previously did.”
While Travelex is very much focused upon FX, St George is heavily focused upon interest rate products. Gregg Kenny, general manager, treasury and capital markets at the bank, estimates that over 70% of its receivables is from the interest rate sector – predominantly home loans. “We were very much involved in the banking consolidation in Australia in the 1990s,” he outlines. “Prior to conversion we were an amalgamation of several building societies and cooperatives and were by far the biggest building society in Australia. We continued to grow through the 1990s to the stage that, at the end of the century, we were five organisations rolled into one.
“We use our home loans business as a key building block, this differentiates us from the big four,” he continues. “On top of this, we have seen strong growth in our SME business and built out our geographic spread. We very much think domestically – we have no offshore operations. We run a 24-hour trading desk in Sydney – but we are well established in New South Wales, ACT and South Australia and are growing in Victoria.”
If St George is seen as a thorn in the side of the big banks, the rumour mill has long had a solution to the latter’s problem – buy St George. That it has not happened, according to Kenny, is due to the financial performance of the bank, which was provided with protective articles on conversion in 1992 that effectively made it a highly unlikely takeover target for 10 years. “Once the protective articles matured, there was a lot of speculation that we would be a takeover target,” he explains. “We were seen as an attractive proposition because we constantly topped Australian banking surveys and had grown our business successfully. We took the view that the best defence was strong growth in financial performance and produced very strong results in 2002.”
NAB remains the only Australian bank with open ambitions to sit at the top table. As Ian MacGougan, global head of FX at Westpac, outlined to Profit & Loss last year (March 2003), his ambition for Westpac is not necessarily to be a top 10 global bank, but rather to be the default bank for Australasian currencies. This is an approach also taken by CBA according to Paul Riordan, executive general manager, global markets, who describes the Aud as the bank’s “calling card”. Both Westpac and CBA are keen to stress that they offer a full service provision to clients – however, both see the Aud (and Nzd) as their core offering.
CBA operates a twin-hub model based around trading desks in Sydney and London and sales desks dotted around the globe. “Our approach varies by region,” Riordan explains. “Domestically our reach is across customer segments down to the retail level – all foreign exchange business feeds into our trading hubs in some fashion. Internationally we have a twin focus, supplementing and servicing our domestic client base as well as the needs of the financial institution community.”
Riordan sees a challenging time ahead for the Australian market in that its growth prospects are uncertain given the commoditisation of FX and the fact that several multinational corporations are centralising their treasury functions offshore. “It is not only the corporate world,” he adds. “Asset managers have also gone through a period of rationalisation here and have outsourced management of some asset classes to organisations based in Europe and North America. Consequently, more of the flow tends to be executed offshore.”
This is a point picked up on by Simon Wright, executive director, FX division at Macquarie Bank in Sydney. “Perhaps my overriding memory of the last 14 years is how the nature of ownership of Australian assets has changed. We have gone from a domestically orientated export-led business focused on revenues to predominately internationally owned businesses with Usd balance sheets with a cost base focus.”
Although Macquarie operates in the same market as the big four, it again has a different focus as far as FX is concerned. Wright acknowledges that it has been disadvantaged due to its smaller balance sheet, lower rating and lack of a deep, widespread customer base – however, its very size has presented it with opportunities. It was the first Australian bank to operate 24 hours a day in 1987 and its client base comes from a rather surprising sector – the banking industry.
“We have been able to carve a niche in the markets through our order book,” Wright explains. “The major banks traditionally have never seen us as a competitor because we have been a bank with specialties in the local currencies but one that operates as a price taker in the thirds. Other professional traders and counterparties have always been central to our strategy, especially if they do not operate an Australian operation, because they have effectively treated us like an overnight branch.”
So while Macquarie was suffering in comparison with the big four in the domestic corporate market due to its lack of product range beyond the financial markets, it went for product in those markets in the form of exotic options and structuring in addition to its core FX activities. It has also extended its offering offshore in the form of joint ventures with organisations in countries such as Japan, South Africa, Korea and Malaysia. “We use technology as an entry to these markets rather than deploy it in the form of a multibank portal which would mean us competing with the global banks – which is not something we want to do,” says Wright.
The development of Internet trading has represented another challenge to Macquarie, as has banking consolidation in the global market and the ensuing rush for market share by the top tier of banks. It has taken the decision to outsource its non-core currency business in the form of white labelling relationships with two top tier banks, something Wright believes the big four are unable to do. “Our model fits the new market paradigm really well,” he observes. “Our cost of liquidity has fallen dramatically through sourcing liquidity elsewhere and we are treated as a customer in every sense of the word – something that the big four Australian banks are unable to do. We have also used technology to gain access to different markets and sectors offshore. By partnering local offshore institutions, providing them the technology and product, we have gained access to their customer base and local franchise pull.”
As far as the big four are concerned, outsourcing liquidity is not on the immediate agenda, however there are those that acknowledge that the threat of the global banks is ever-increasing. “We are developing what I would term an interim strategy to deal with the threat of the global bank,” says Sawers. “We are building our model very much around the personal rather than machine-based relationship. This is a challenging part of our future.”
This is a view echoed by CBA’s Riordan. “We very much operate a relationship model. Australian banks have always been fast followers in the derivative space for example and there is a great focus on that globally at the moment. But in the new regulatory era, companies are likely to be driven away from highly structured products and back towards core relationships and values. This makes the value proposition much tougher for those banks without the necessary depth of relationships and critical mass of clients. Consistency and scale will be a big factor in the future and it will be difficult for new entrants to the market because of that.”
Looking ahead there exists little belief that the domestic banking industry will be reduced in size in the foreseeable future, purely because it remains a political decision. Bill Evans, global head of economics at Westpac Institutional Bank in Sydney, suggests that support for reform has dwindled due to a lack of broad-based support. “In terms of the labour market, goods and financial services, the government seems reluctant to pursue reform because they can never get a majority in the Senate. In the 1980s there was bipartisan support for the Hawke government’s reform plan that simply does not exist today.”
That being the case, the local banks will continue to try to differentiate themselves. As the senior banking source notes, “NAB will continue to build its international institutional business; ANZ will look to strengthen its hand in Asia and Pacific region, Westpac will probably follow a path somewhere in between that, and CBA will continue to rebuild itself as a private bank (less than 10 years ago it was still government-owned).
“All the time they are doing this, they will be fighting a battle on two fronts – from the global banks above and the local banks below,” the source adds. “Ultimately the solution has to lie in the domestic banks being able to strengthen their domestic business to support wider operations in the global market – the alternative is they become satellites of a bigger bank – and the only way that will happen is if the government loosens its four pillars policy.”
As noted in the accompanying feature on the domestic banking industry, allowing the entry of foreign banks was originally aimed at increasing competition in the retail banking industry. This, it summarily failed to do, because typically the foreign banks have declined to oblige. Indeed after the initial rush to enter the Australian market in the 1980s, there has been fairly steady two-way traffic in banks entering and leaving the market (in both financial markets and the wider sense).
Just as the domestic banks seek niches in the market, many of the foreign banks operating there take a different approach to business. Some, such as Citigroup, have included their Australian operations in the reporting line to its global fixed income group, a move made in mid-2003 when it was switched from reporting to the Asian emerging market group. Others, such as HSBC have no trading operations in Australia, preferring instead to price from Hong Kong, while ABN Amro has made Australia its regional hub for G10 trading in Asia.
One of the oldest foreign banks in Australia (behind BNP Paribas which has been there since the 19th century) is SG Australia, which until January 1, 2004 was a wholly owned subsidiary. On that date it reverted to full branch status, something that Stuart Hudson, head of money markets and FX, believes will have a significant impact on its operation. “We will simply find it much easier to source liquidity,” he says.
SG treats Australia as what Bill Mooney, head of spot FX, terms a “centre of excellence” in trading Australasian crosses, especially against the euro. “We are trying to build a niche in this area,” he notes. “We sense that more and more, Australia is looking towards Europe as the US dollar weakens and it loosens its influence in Asia generally.”
Although it has a global institutional sales group, SG operates independently in terms of its FX operations, wherein each centre is responsible for its profitability and positions. It also conducts proprietary trading from each dealing centre predominantly in FX and interest rate markets. As such, it does not operate a regional hub system per se, rather it has a network of operations.
While SG has previously operated independently, ABN has stationed its G10 Asia hub in Sydney to sit alongside its emerging markets hub in Singapore. Col McKeith, managing director and head of financial markets, Australia and New Zealand, suggests that because only a few truly global organisations have their Asian hub in Australia, ABN can offer the all-important differentiator to its local clients.
To sit alongside this however, the bank has sought to link with local partners to access business across a wide range of products. “We have developed partnerships that provide synergies in areas such as retail, equities and mortgages,” McKeith explains. “These areas have provided quite substantial business for us that feeds through into what we are doing in the wholesale markets. We also see great opportunities in financing the country’s infrastructure such as the PPP [public/private partnership] initiative.
“Our operation is currently a combination of what ABN offers globally and what we are trying to do locally,” he adds. “I would estimate that 75% of what we do in Australia is locally focused, however we are seeing a growing influence of the international fund management sector as it takes a closer look at this market. At the end of the day, we are a long way from head office in geographical terms, therefore we have to ensure that we are consistent with their strategy and stay focused upon this market’s needs.”
As is to be expected, Citigroup operates a full range of FX products in Australia and is currently moving more of its Stir [short term interest rate] products group to Sydney. In terms of its focus on the client, Citi operates three desks within the overall sales team, one dealing with internal and external e-commerce business, another on investor clients and the third on corporate clients. It also operates a night desk to service local customer needs in the European market.
“We are interacting much less with our clients over where the market is going and more on their strategic needs,” explains James Kalaf, head of FX sales, Australia and New Zealand at Citi. “Our relationship is more about building a risk profile for them so that they can position themselves according to their exposures and hedging needs.
“We have to focus on advice because it is a real strength for Citigroup and an area where we can differentiate ourselves,” he continues. “We will always be competitive on pricing but we can also leverage the huge knowledge base that comes with a global footprint such as ours. We feel that we can add a lot more value than the domestic banks in this area and as such, our move to the Global Fixed Income Group was a critical factor in our ability to offer this.”
Citigroup realigned its FX capabilities in Australia from the treasury group within the bank to the fixed income securities group reporting to London in the early part of 2003.
HSBC takes the opposite approach in terms of its trading to the aforementioned banks, preferring instead to station all of its FX trading activities in one location in Hong Kong. “There were times when we would have had 10 dollar/mark traders around Asia,” suggests Graeme Bricknell, treasurer, Australasia at HSBC Australia. “But our ability to leverage technology now means that we do not need to have as many traders on the ground.
“We prefer to have sales desks in different locations feeding into one trading hub – because you get a much better picture of the overall flow than if you have a segmented operation,” he continues. “In terms of delivery to the client it is seamless. We structure products here, and while many components of the price can come from different locations we are firmly of the belief that if you want to know what is going on in Korea for example, you ask somebody based there.”
It is unusual that a country with a relatively small economy should not only be such an active financial market centre but also have the sixth most actively traded currency in the world. A knock-on effect of this has been the development of a technical structure capable of supporting these activities, but what is interesting is how the local market seems reluctant to fully embrace these tools.
Australian banks are enthusiastic advocates of the benefits of e-commerce and have deployed their proprietary systems to achieve the efficiencies therein. However, in general they have also maintained a relatively healthy broking market. One source suggests this is merely a question of caution; having experienced the wild swings that the Aud has had in its 20-year float and the equally volatile interest rate environment before that, bank management is reluctant to put all of its eggs in one basket.
“We still run a spot desk because the banks believe there is still a role for the spot broker,” says Keith Sedergreen, managing director at Prebon Yamane in Sydney. “It is much reduced from the heyday of the broker market, but banks want to ensure that if the technology fails, there is an alternative execution mechanism.”
Sedergreen’s comment is supported by Clive Bennett, managing director at Tullett Liberty in Sydney. “There is still a role for the spot broker to play, however it is unlikely to grow,” he suggests. “The key for the broking market is to develop its hybrid products further – offering banks a blend of voice execution and straight-through processing (STP) – this offers an alternative.”
The impending Financial Services Reform Act regulations would at least appear to have one positive knock-on effect for the brokers – the reduced need to name switch. Graham Turnbull Ince, then managing director of Astley & Pearce in Australia recalls that having the merchant banks only partly owned or as subsidiaries used to create huge problems for the broking market. “On a busy day you could end up with more than 60 switches because some banks supporting the market were unacceptable to the big players,” he explains. “This meant you spent the last few hours of the day trying to get new names and again you were in competition, because all the brokers had similar problems.”
The forward FX market, as Sedergreen notes, reflects the wider world in that up to one week it is dominated by Reuters Matching but beyond there the brokers hold their own, “The tickets are getting more irregular further out,” he says. “But they are increasing in size.”
Both Sedergreen and Bennett are also heartened by what they discern as a trend towards bringing more short term interest rate (Stir) trading desks to Australia, a move currently being made by Citigroup, which is shifting its Australasian currency Stir operation from Singapore.
The biggest market for the brokers remains the interest rate swaps (IRS) segment, as is the case elsewhere. Bennett points out that Australia has typically been an early adopter of derivative products and as such good niches exist throughout the financial markets.
It is not only derivative products. Australia is an enthusiastic adopter of technology and support tools. Communication system and technology solutions provider Syntegra has a large operation in the country. “We are very committed to Australia and New Zealand,” stresses Tom Fortunik, general manager. “Banks here appreciate that they can integrate their data systems to their phone systems to provide additional details to support the sales relationship – this is especially important if you are servicing offshore clients. Communication is vitally important in areas that are geographically removed.”
Syntegra’s experience is reflected in the data provision industry. Both Moneyline Telerate and Reuters have stationed a lot of their activities for Asia in Australia, the former has its “Active8” – global desktop development team and marketing team in Sydney, according to Mark Benfield, director, business development – Asia, at Moneyline, and uses the local market as its “testing” ground for many new products and distribution technologies. “We see the Australian market as being a good representation of the demographics associated with the wider regional and global market,” he says. “The local participants have very good quality control mechanisms from the trading environment to IT and market data groups – it is a very professional market.”
Diccon Close, senior company officer, Pacific, at Reuters, agrees, “Australian banks tend to provide a higher level of scrutiny to new products, so if a product is adopted it normally works well in the global market. Uptake of new products is probably higher in Australia than anywhere else.”
As well as its data services, Reuters has the distinct advantage of a dominant position in Aud matching. Local traders suggest this is simply an extension of the market’s desire to offer choice, on this occasion from EBS, however the latter, as discussed elsewhere, is planning to make a move in Australia.
Close acknowledges Reuters’ position, but stresses it has only been achieved through persistent hard work. “We have to ensure that we maintain the necessary quality of service and enhance the product wherever necessary if we are to maintain our position,” he argues. “Alongside this sits our challenge to continue the drive toward e-enablement and extend the efficiencies this brings to the back and middle office.”
An area in which the banks have been reluctant to support an alternative execution platform is the Aud contract on the Sydney Futures Exchange (SFE). Maurice Farhart, senior manager, interest rate and currency products, notes that the Chicago Mercantile Exchange does reasonably well in this market, but domestically market participants remain on the sidelines monitoring the situation. “However, we are constantly open to discussions with any market player regarding future direction and development,” he observes.
Whilst FX remains a small part of the SFE’s business, it “owns” the interest space according to Farhart, and has a very good presence in equities, commodities and energy products. “Our growth is driven by a broadening cross section of the market from the traditional fund manager and bank base to the increasing speculative community which does not have access to the limits or repo trading facilities,” explains Farhart. “We have focused on our distribution mechanism globally, we bring the FCMs [Futures Commission Merchants] in, as well as their clients.
“A big factor in our volume growth has been the increasing use of e-trading. Dealers like that they can access prices from multiple exchanges on one terminal, this also makes them more efficient,” he adds, explaining that the SFE went totally ‘e’ in 1999. “It is a question of milliseconds to trade now – the playing field is much more level.”
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