London's Big Bang at 25, origin of today's financial universe

By Ethan Bilby

London Stock Exchange

Banks with long histories but small balance sheets were bought up by foreign firms, creating investment banking as it is today: giants that advise on mergers and takeovers and raise capital, as well as making trades and markets.

The deregulation, championed by Prime Minister Margaret Thatcher and going further than anything world banking had seen, has been hailed as a brilliant innovation that cemented London's role as a global financial powerhouse.

Protestors from the "Occupy the London Stock Exchange" movement marked the anniversary with a demonstration on Thursday in Canary Wharf, the British capital's new financial district.

"We're here because it's the silver jubilee of Thatcher's shock deregulation," one protestor told Reuters.

"The deregulation of the banking system in a way led to the financial crisis we have today. Creating wealth in itself is not a bad thing, but the distribution is out of whack," said another protestor, Allan MacDonald.

The Big Bang heralded the end for the liveried doormen and the financial gentry - stockbrokers who executed trades in wood-paneled rooms and whose bowler hats and umbrellas were a trademark of London's traditional financial center, the City.

Controversially, it allowed firms to advise clients how to make deals, but also to profit and trade on those deals as well.

"Big Bang was clearly the origin of the universe of the modern stock market and all financial transactions in Europe since then," said Roy C. Smith, professor of entrepreneurship and finance at New York University's Stern School of Business.

The colorful "open outcry" pit of LSE traders was replaced by banks of computers and trading floors migrated to the banks.

While Thursday's protestors may get little sympathy in financial circles, the global credit crisis has led many people to wonder whether vast conglomerate banks really are better than the old-style partnerships they killed off.


Deregulating the City and its merchant banks was a priority for the Conservative government to satisfy an anti-competition claim made against the LSE in 1983 and to free up the markets.

Finance minister Nigel Lawson decided that a series of changes should all occur on a single day - October 27, 1986.

The changes let London catch up with New York, which had eliminated minimum commissions on stock trades in 1975, but also made it the world's capital of unfettered finance, breaking down the divisions between market-makers and order-takers.

The Big Bang was more of a whimper at first. Computer servers were so overwhelmed with orders for the opening of electronic trading that the system broke down under the strain and traders went back into the pit.

After its wobbly start, Big Bang brought swift changes to the City, both good and bad.

But on the way out were the liquid lunches, the distinctive offices and collegiality that had been a hallmark of the City.

"It was a very civilized place to work," Hollingworth reminisced.

The motto of the LSE was "dictum meum pactum" - my word is my bond. The loss of the old-boy City network resulted in a lowering of trust and signaled an end to self-regulation.

London became a 24-hour market connected electronically with the entire world, and that meant a change in lifestyle as well.

Traders at JP Morgan now come in at 6:15 a.m., whereas in the 1980's offices weren't even open for a couple of hours after that.


Many firms couldn't compete with the tough competition the changes brought and iconic City firms met an ignominious end as they were quickly snapped up by bigger, mainly American, rivals.

"Nineteen of the twenty largest brokerage firms disappeared right at the time of Big Bang," said Professor Smith.

A few firms like Cazenove, with its reputation as broker to the queen, decided to remain as an old-fashioned partnership - but they too succumbed some two decades later.

"There was a strong sense of heritage and purpose at Cazenove and that was why they decided not to sell," said Hollingworth.

Even for his Cazenove, the risks of remaining alone as a partnership began to be outweighed by the benefits of finding a home within a larger bank.

"Partnership carried unlimited liability. As the world got bigger, the risks got was something that you had to think really carefully about."

Joining a big exchange-listed bank meant limited liability, as well as an ability to finance deals far beyond the scope of the balance sheet of a partnership.


Not all the subsequent behemoths have fared well.

"It's very difficult to build a great investment bank through acquisitions. The industry is littered with failed acquisitions," said Scott Bok, chief executive of Greenhill & Co. <GHL.N>.

Broker Phillips & Drew, at one time the leading dealer in UK sterling bonds, was bought in 1986 by UBS <UBSN.VX> to gain entry into investment banking.

The Swiss bank later also scooped up Warburg along with Rowe & Pitman through its merger with Swiss Banking Corporation.

UBS has received strong criticism for this acquisition strategy and now faces investor pressure to break up over poor performance.

"Without having bought those things they probably couldn't have been in the business they were in," said Smith.

"You only have one reputation in our business, and if you damage that reputation it's very difficult to repair," said Hollingworth.

"We were very careful about what we did (at Cazenove). We tended not to do things we didn't understand," he said.

Critics say many of today's global financial dealings are dangerous because they are so complex that few people, even of those involved, fully understand them.

Established merchant banks like Morgan Grenfell & Co, bought in 1990, were thought to be potential windfalls, but buyer Deutsche Bank <DBKGn.DE> failed to see any great return on its $1.48 billion investment.


Since the 2008 credit crisis, with large banks like Lehman and Bear Stearns disappearing, many boutique banks have gained ground because of their partnership models, which has meant they have less capital exposure and greater perceived independence.

"I've always thought of us as heirs to the classic client-focused British merchant banks," said Bok, whose Greenhill firm perpetuates the partnership model.

Does this mean that partnerships are set to reign supreme in banking again?

"I doubt it, because the real value of a boutique tends to be the personal connections between some banking star and some of their clients" said Professor Smith.

The capacity to do "bought deals," where the bank takes ownership of a deal and sells it on, is beyond the realm of the boutique banks, he pointed out, and that was important in the modern market.

But Bok says the ability to provide specialized knowledge is more valuable in the 21st century.

"Small firms start as a collection of individuals with their own client lists. The next level is for them to evolve into coordinated teams of bankers who have broad geographic presence and deep industry expertise," Bok said.

A Goldman Sachs report in March said Greenhill and similar firms could benefit on global mergers and acquisitions as they could pursue top bankers with less regulatory pressure.

"We can provide everything but the big balance sheet which is fine because our clients would rather have unconflicted independent advice," said Bok.

(Reporting By Ethan Bilby; Edited by Richard Meares)