BNPP finds solution to equities woes

UNLESS YOU TRADE French equities or derivatives you could be forgiven for never having heard of Exane.

It is a highly-regarded independent equities boutique based in Paris, that offers services in research, sales, sales trading and execution in cash equities and derivatives. Although it is renowned in France it has not been able establish the same profile outside its home market.

But in April this year, it will become a much more important part of the European equities landscape, by effectively assuming control of BNP Paribas' cash equity operations through a joint venture.

BNP Paribas is transferring control of its European cash equities business to Exane's partners in return for a 50% stake in the holding company that controls the partnership. Exane's partners will hold a majority of the voting rights and hence effective control over the joint venture, marking a stunning admission on the part of the much larger BNP Paribas of its own failure to build a successful brokerage business.

BNP Paribas would, naturally, argue with that assessment, but as the joint venture has not yet officially been launched, it is unwilling to comment extensively on it.

The cash equities business has been a headache for BNP Paribas for years, in stark contrast to its success in equity derivatives. The bank has had to rethink its strategy several times. In May 2002 it announced that it would invest an additional e300 million in the business over three years in an attempt to break into the ranks of the top 10 European equity houses.

This came on top of the hundreds of millions poured in to rebuild the business after the merger with Paribas. Barely three months later, the bank changed its mind and put the plan on hold as market conditions continued to deteriorate.

Then, in February 2003, it announced that it would seek cost cuts of 5% to 10% in its cash equities division through streamlining research and back-office functions. This proved to be merely a stop-gap measure as the bank was ready to unveil its plans with Exane in December 2003.

In the short term, the deal makes unambiguously good financial sense for BNP Paribas as it removes what analysts estimate to be e100 million of recurrent annual losses from the business, equivalent to 10% of the advisory and capital markets division's 2003 projected net profit. According to Lehman Brothers this corresponds to e1.1 billion of value creation or e1.33 a share.

However, the real significance of the move is more strategic than financial. "The importance of the deal goes beyond improving financial performance and is essentially a question of models," says Kinner Lakhani, a senior European banks analyst at ABN Amro. "Cash equities may be important in helping to understand the equity derivatives market although lacking control of the cash equities or distribution platform remains uncharted territory in terms of the impact on the bank's ability to win equity underwriting transactions."

Whether or not BNP Paribas' equity capital markets business will be affected by the bank's decision to place its brokerage activities in the joint venture will depend on how the two cooperate on deals. Exane BNP Paribas will be the exclusive distribution channel for BNP Paribas' equity capital markets business but, because management control of the division remains with Exane, it will ultimately decide whether or not to push a deal. So if Exane BNP Paribas' sales force does not like a deal that BNP Paribas has originated, BNP Paribas' equity capital markets bankers will be unable to force the joint venture's salesmen to really push it.

It is certainly a unique position to be in. In most investment banks, sales traders have no such choices. Although, for example, ABN Amro has a joint venture with Rothschild to originate ECM deals, the sales force responsible for distributing the deals remains firmly in ABN Amro's corporate and investment banking division.

Crucially, it is a problem only if Exane BNP Paribas' salesmen do not like a particular deal. As the independent source of BNP Paribas' equities research and its cash trading conduit, the joint venture would naturally be consulted throughout the process, so there should be no reason why they should not like the deal.

In theory, investors buying into BNP Paribas' ECM deals should therefore be encouraged by the clear independence of the investment bank's brokerage activities. This should in turn also benefit clients, as long as they are satisfied that the Exane BNP Paribas' sales force is on board with their particular transaction. Any hint otherwise could seriously damage the bank's ability to win mandates.

The two groups have already shown their ability to work together. On March 4, BNP Paribas led a e161 million accelerated bookbuild for 1.5 million shares in French construction company Eiffage. The shares were being sold by private-equity firm PAI Partners and were distributed through Exane. The deal priced at a tight 3.1% discount to the previous day's closing price.

The information flow from a brokerage business is invaluable to ECM desks and equity derivatives businesses, which is another reason why investment banks tend to prefer to keep their brokerages in house. But there is no reason why the same level of communication cannot be maintained with a joint venture. "It's not that it can't be done," says the head of syndicate at a European investment bank. "It's just that it creates additional hurdles, which could create an unnecessary problem."

For BNP Paribas, however, there is a different angle. "I've never had such a good information flow as I get from the Exane people," confesses a syndicate official at the bank. "They are even more in the market than our own equities people and the information I get from them is even better."

Indeed for BNP Paribas the main strategic benefit of the joint venture is precisely that Exane, a leaner and better broker by most measures, will be managing the business. Unlike BNP Paribas Exane can credibly claim to have maintained solid financial ratios every year since it was started in 1990 and even last year had a balanced P&L. It has a stronger reputation in research and although BNP Paribas appears to have a strong market share of trading in French stocks, analysts estimate that if only client business were included it would not rank in the top 10.