Effectiveness Of The Current Hub And Spoke Model

Published Date: 02 Nov 2017

Historically major international banks operating in the APAC region have evolved their business model in the form of a Hub and Spoke. Hong Kong and Singapore, being the major financial centres of the region, are the Hubs with the spokes spread out in other cities in the region. This model is evident in a number of aspects including headcount distribution, support functions, revenue booking, volume of contracts being signed, etc.

The objective of our project is to analyze the effectiveness of the current Hub and Spoke model and to understand the factors which could potentially call for a re-thinking of the model. These factors include changes in regulatory environment, increased scrutiny by tax authorities, market trends and customer preferences.

Scope

The scope of the analysis is (a) Investment Banking Department (IBD) Front Office organization of (b) major Wall Street banks operating (c) in the APAC region.

Understand the Front Office organization structure of the IBD Department of Credit Suisse and other Wall Street banks in the APAC region.

Confirm that this is following the Hub and Spokes model.

Look for any deviations from a strictly Hub and Spokes model and understand why these deviations exist.

Understand how the economic and political environment is changing in the region and how this might warrant a re-thinking of this model.

Analyze the pros/cons of the current model and those of any alternative model that can be proposed.

The Hub and Spoke Model

The concept of a Hub and Spoke is known and applied by many different industries across the world. Commercial aviation, transportation, technology sectors and large international financial institutions are among those industries that follow the Hub and Spoke model. The Hub and Spoke model can be described as a greatly simplified distribution system in order to improve efficiency and reduce costs between the hub and its various spokes by centralising parts of businesses various activities or support functions.

The model is named after a wagon or a bicycle wheel, Looking at its shape the model refers to a hub, the centre of the wheel, which is connected with a series of spokes. The aim of the hub location is to service and support the various spoke locations.

Hub and Spoke model - Aviation

In the context of the airline industry, the hub is an airport that is used as a transfer point by an airline to get their passenger to their preferred destination that are not served by direct flights. Some airlines uses single hubs, other operate using multiple hubs depending on the size of coverage.

Hub and Spoke model – Investment banking

Over the past two decades, the Investment Banking industry followed a model similar to the Hub and Spoke model used by the aviation industry. New York evolved into the main centre of Investment Banking followed by London evolving into the European hub a few years later. In the early nineties, as the finance industry grew in Asia, Hong Kong became the financial hub within Asia with major banks opening up their investment banking branches there in order to build a presence in the region.

Hub and Spoke model – Credit Suisse

Credit Suisse, like most of the Wall Street banks operating in the Asia Pacific region, has evolved its business model in-line with that of the financial market. Today, Hong Kong and Singapore are the two hubs in Asia from where investment banking operates and runs their business across Indonesia, China, Malaysia, Vietnam, Thailand, Korea and Taiwan. Historically, Japan and Australia have been self-contained due their large autonomous markets, distance and culture. The degree of local presence in each country varies due to various factors such as market size, regulation, taxation, cultural and language aspects.

Figure 1

Current Situation

Credit Suisse

Over the years, Credit Suisse has been building up a strong regional presence in Asia Pacific Region for its Investment Banking business. Credit Suisse, just as most other Wall Street banks, operates its business in the APAC region following the Hub and Spoke model. The bank operates in 13 countries within APAC (Indonesia, Malaysia, Thailand, Philippines, Vietnam, China, Japan, Taiwan, Korea, India, Australia, New Zealand). Hong Kong and Singapore act as the financial Hubs. Depending on various factors such as market size, structure, regulations, cultural and language aspects, the degree of local presence in each

country varies.

Hong Kong

Hong Kong is the most prominent financial centre in Asia. Over the years, this city has established itself as the leading business hub for Asia with many international firms upgrading their Hong Kong operation by adding regional and even global responsibilities. [1] Some of the key factors favourable to Hong Kong as regional business hub are:

Simple tax system and low tax rate

Free flow of information

Absence of exchange controls

Corruption-free government

Communication, transport and other infrastructure etc.

Common Law

Hong Kong is the regional Head Quarter for Credit Suisse in the APAC region and is also the biggest regional Hub for the Investment Banking Department with about 43 percent of bankers on ground. Hong Kong covers not only the large local business, but also acts as the North Asian Hub. It is strategically very important as it is also a gateway to access China business.

Singapore

Singapore is another major business centre in APAC region. Over the years, this tiny island nation has emerged as one of the major business hub for regional and global multinationals doing business in Asia. The key advantages of Singapore are its strategic location, extensive connectivity, comprehensive logistical facilities, pro-business environment and robust financial sector.

The Government of Singapore has been making some focussed efforts to develop Singapore as a major hub for commodity trading and risk management. Accounting for more than 50% of Asian volumes, it is already the leading OTC commodity derivatives trading hub.

Credit Suisse has a strong presence in Singapore across business, operations and shared services. For Investment Banking Department, Singapore is the second largest Hub besides Hong Kong with 14 percent of staff. on ground. They provide expertise across all products & sectors and also cover the countries of South-East Asia.

Indonesia

Indonesia [2] is one of the more promising economies in South-East Asia region. The economy has been expanding steadily since mid sixties. First through the rise in oil revenues and resource transfers by government and later through the market based resource transfers. After India and China, Indonesia is the third fastest growing economy among the emerging market countries within G20 group. The rapid industrialisation presents huge opportunity in the investment banking activities.

Credit Suisse has the largest all-Indonesian Investment Banking team among its peers. With a very strong relationship and a high engagement with our unique set of clients in Indonesia, Credit Suisse has retained FinanAsia’s Best Foreign Investment Bank award for past 11 years and claimed numerous other awards. The Indonesia franchise accounts for approximately 25-30% to the IBD revenue in APAC.

Malaysia, Thailand, Vietnam & Philippines

Along with Indonesia, the other Southeast Asian countries have also come out of the Asian Financial Crisis and are now set for very promising growth ahead. Post crisis, the governments across Southeast Asia have been making efforts to strengthen the domestic capital markets by reducing reliance on external financing. This generates a very strong potential for the Investment Bank to participate in debt & equity capital markets.

Credit Suisse has been active in these Southeast Asian markets for last over 10 years and has been winning a number of significant deals on a regular basis over the years. However, due to the overall small deal-flow in Malaysia, Thailand, Vietnam & Philippines, having local presences can not be justified. All countries, taking into consideration their geographic proximity to Singapore, are covered by bankers located at the Singapore Hub. To represent Credit Suisse locally 1-3 coverage bankers are located on ground. Product and Sector experts support the coverage bankers and fly in from Singapore to interact with clients. Deals are executed out of Singapore.

China

During the past three decades of unprecedented growth, China has undergone significant changes in its economy. In 2010 China has become the second largest economy in the world by overtaking Japan and Germany. The transition from an emerging economy to a global powerhouse resulted from continuing industrialization, urbanisation and integration with the world economy. With that, due to its fast-growing market, China is one of the key focus of many financial institutions.

Credit Suisse is one of them. However, the highly stringent legal and regulatory framework makes it a very difficult market to enter and operate in. In order to be able to participate in domestic deals, international financial institutions must have a domestic banking licence, which is according to legal sources very difficult to get if not impossible for the time being.

As legal constraints do not allow Credit Suisse to have execution bankers on ground, the bank’s presence in China is very minimal. Credit Suisse’s local offices are located in Beijing, Guangzhou and Shanghai. Hong Kong bankers have been providing advisory and execution business to client from mainland China for the past 10 years.

Credit Suisse has enhanced its onshore presence in China through the securities joint venture (JV), Credit Suisse Founder Securities. The JV has made notable progress in underwriting domestic capital market offerings. Through collaborative marketing and coverage efforts, the bank has been getting increasing mandates and deepening its relationship with key clients.

Credit Suisse has a strong international Mergers & Acquisitions (M&A) team as well as a Global Market Solution Group coverage based in Hong Kong and is able to take advantage of the strong growth in China. This can be seen in the number of transactions for 2010. In terms of financial advisors to Greater China, Credit Suisse M&A ranking had jumped from ninth places in 2009 to third places for the first three quarters in 2010 as shown in the table below.

Fig 3

Taiwan

The critical scale is not big enough to justify the establishment of a local team in Taiwan. Foreign banks such as Credit Suisse are not qualified to advice on domestic listings. There are strict guidelines and restrictions from the local regulators on cross border activities. Offshore entity and its representative are not permitted to "solicit and execute" and it is strongly recommended to avoid offering any investment banking products and services to onshore clients in Taiwan. Any such breach could be subjected to the local licensing and taxation requirements. Exceptions to this are the Direct Sales Scheme which allows certain activities to be taken place outside Taiwan with its residents and treated as "offshore" transaction basis. There is also a specific onshore private placement for qualifying mutual funds in Taiwan by the offshore representatives of the fund to meet the filing and requirements of the Private Placement Regime

Korea

Korea has stringent regulatory requirements that call for a quasi-local presence. The deals are executed by a local team. Product and sector bankers are allowed to fly in from Hong Kong or Singapore.

India

India is a growing financial centre in the region and is of strategic importance to Credit Suisse. The legal and regulatory framework calls for a local presence in order to carry out required amount of due diligence. Credit Suisse re-established its stock brokerage operations and local Investment Banking coverage in India in 2007. Credit Suisse operates a Center of Excellence in Pune and Mumbai and has more than 2000 staff members to deliver important service in areas such as IT, Research, Account, Trade Settlement and many other functions. The Investment Banking activities is benefiting from a growing need for capital on the part of Indian businesses and the Indian government. As per Brady Dougan, Credit Suisse expects Indian economy to grow in double digits during coming years even if with brief pauses. This presents ample opportunity for Investment Banking activities in the areas such as cross-border M&A, specifically in the resource and technology sectors as well as IPO’s and Private/Structured Finance.

Australia

Credit Suisse has a large local presence in Australia with about 22 percent of bankers on ground. IBD team covers Equity Capital Markets, Debt Capital Markets and Mergers and Acquisitions (M&A).

Traditionally, Australia has been operating autonomous mainly due to three reasons: Domestic market size, geographical location and time-zone. In order to meet client expectations local presence is important. It would be rather difficult to service clients in Australia from offshore. Having said that, there are certain parts of IBD business that could be done offshore. For example Industry specialist from Hong Kong or Singapore could provide additional insights on Global investment opportunities for Australian domiciled clients

The requirements of the Australian superannuation funds are a major reason for the large domestic market. Many fund managers and investment banks see a big opportunity to raise client money and increase their revenue inflow by targeting superannuation funds and therefore are eager to play a part in the business by building up local teams.

Growth in Asia Pacific

Clearly the Asia Pacific is the region most likely to drive Credit Suisse in the long term. This has already been recognised by Credit Suisse with resources being allocated from Europe and the Americas to Asia Pacific. The shifting of this focus is justified on two fronts. The first, Gross Domestic Product (GDP) growth in Asia will drive the economies of these countries. As growth increases, market opportunities will increase as well and markets will start to mature. Secondly, with the economy grows in China and India, the middle class (or income) is likely to increase as well and with that consumption – need for goods and services - is likely to pick up

Fig GDP

As this growth continues, Investment Banking can be reasonably expected to grow as well.

The next table and charts shows Asia Pacific M&A volume and value by Industry and region. Although growth is slowing during the latter part of 2010 for China.

China and India are poised to contribute to the huge growth in this area in the coming years.

Credit Suisse Investment Banking

Credit Suisse Investment Banking is divided into Investment Banking Department (IBD), Fixed Income and Equities divisions. Fixed Income and Equities divisions focus on the investment side (investor) and have therefore access to Global Capital Markets information, whereas IBD provides confidential financial advisory service for corporate clients, governments and individuals. Information flow between IBD and Fixed Income/Equities divisions is restricted by a so-called Chinese wall.

The investment Banking Department (IBD) assists clients in achieving their objectives through merger and acquisitions, debt, equity and other capital-raising. IBD consists of industry and product groups as illustrated below:

Credit Suisse Investment Banking

Credit Suisse Investment Banking is divided into Investment Banking Department (IBD), Fixed Income and Equities divisions. Fixed Income and Equities divisions focus on the investment side (investor) and have therefore access to Global Capital Markets information, whereas IBD provides confidential financial advisory service for corporate clients, governments and individuals. Information flow between IBD and Fixed Income/Equities divisions is restricted by a so-called Chinese wall.

The investment Banking Department (IBD) assists clients in achieving their objectives through merger and acquisitions, debt, equity and other capital-raising. IBD consists of industry and product groups as illustrated below:

Strategic Derivatives Group (SGD)

The Strategic Derivatives provides bespoke solutions to clients focusing on capital raising and management: monetization and hedging of equity stakes; equity financing, structured interest hedging; CDS/bond arbitrage strategies: counterparty credit risk management: structured finance: M&A-driven and contingent FX hedging: accounting and fiscal optimized equity solutions.

Equity Corporate Finance

Equity Corporate Finance Department helps lead the execution of the Firm’s more complicated equity and equity-linked offerings and assists other GMSG Departments in creating solutions such as pre-underwritings to provide certain equity to fund M&A bids.

Corporate & Emerging Markets Debt Capital Markets

Corporate & Emerging Markets Debt Capital Markets works primarily with investment grade and corporate clients to raise and underwrite new issues debt offerings in amounts from USD 50mm to USD 10bn+.

Debt Advisory and Restructuring (DA&R)

Debt Advisory and Restructuring is responsible for the origination, structuring and execution of new debt capital raisings and debt advisory activities on behalf of IBD clients in the EMEA region. The product includes the coverage from the raising of new senior and subordinated debt capital through to liability

management solutions and full balanced sheet restructurings.

Competitors

The major Wall Street competitors (e.g. Goldman Sachs, UBS, Morgan Stanley, etc.) appear to have similar Hubs and Spoke model franchises with Hong Kong and Singapore as the countries of choice to base operations. This is most likely because of:

The rule of law being similar to that of western countries

These being mature markets

Hong Kong’s proximity to mainland China.

However, each of these peers have varying degree of local presence in different spoke locations depending on their market penetration, deal share and strategic focus.

Goldman Sachs do not have a representative office in Indonesia, however are expanding exposure into China with offices in Hong Kong, Beijing and Shanghai. Goldman Sachs established its presence in China since 1992 and is very much ahead of its peers. It has built a strong relationship over the years with the local regulatory agencies and the Chinese government. Goldman Sachs was granted a licence to operate in China in 2004 and is ranked number one in performance and presence in the 2008 Price Waterhouse Coopers survey. Other regional offices include India and Singapore. Goldman Sachs also has strong office presence in Australia due to their 55% ownership by JBWere.

Morgan Stanley does not have representative offices in Hong Kong, Singapore, India and Korea.

Deutsche Bank has a similar model to Credit Suisse with offices in Hong Kong, Singapore, India, China (Beijing, Guangzhou, Shanghai and Tianjin).

UBS, follows a similar model as Credit Suisse with Hong Kong and Singapore as hub location. Further the bank runs offices in China, India, Indonesia, Japan, Malaysia, Philippines, Korea, Taiwan, Thailand and Australia with Brisbane, Melbourne, Perth and Sydney.

Below chart illustrates the ranking during first half of 2010 in Global Mergers and Acquisitions among Credit Suisse and its peers

Fig 10

Analysis of the model

From a historical perspective offered previously in Section 1, one can say that the Hub and Spokes Model is not the result of a blue-print driven architecture. Rather, it is the result of gradual evolution shaped by natural forces of economic growth in the Asia Pacific region. Thus, the greatest strength of the model is that it evolved to accommodate the unique opportunities and challenges of the region, through practical approaches such as trial-and-error and natural selection. Given the striking diversity in the region, it would not have been practical to come up with an operating model based on theoretical rigor rather than such a practical approach. Nevertheless, this is not saying it would not be possible in today’s society. The model has evolved rather slowly over time in APAC for Credit Suisse who initially had the presence via its First Boston franchise.

This section describes the advantages and disadvantages of the model. It analyzes the readiness of the model to step up to the opportunities and challenges of the current environment.

Opportunities

Economies of Scale

Although the typical IBD operations cannot be categorized as mass-production (for example, contrast with Prime Services Electronic Trading), the centralization of resources and processes nevertheless brings out significant economies of scale. This translates into several advantages such as cost efficiencies and the ability to hire specialists with a narrow focus area.

Cost Efficiency

The deal flows in most of the spoke regions tends to be thin and unpredictable. In many cases, the amount of deal flow cannot justify a full scale local team to execute the deals. The centralization of the deal execution allows the hub to best utilise its resources and systems across a diverse pool of deals, thus providing enormous cost efficiencies. Having the ability to have centres of excellence removes the cost associated with hiring costs (include hiring white collar professionals such as Bankers, Lawyers and Accountants) and floor space in the smaller Spoke locations.

Specialists

  The economies of scale at the Hub allow the financial institutions to hire various specialists such as product and sector specialists. These specialists form a centralized resource pool that can be leveraged by the coverage bankers in the spokes. There is a wide spectrum of specialists that are required in a successful Investment Bank such as product coverage and sector coverage bankers, legal and tax specialists and operational efficiency experts to name a few.

Sophisticated Systems and Processes

The high deal volumes at the Hub can justify the development of a more integrated systems and processes to handle all the operational aspects and to incorporate efficient tools for risk management and reporting. This involves carrying out in depth analysis of the operational aspects, engaging operational experts to design the required solutions, deploying the required Information Technology solutions and maintaining the required operational staff to run the systems and processes. All of this involves significant investment of capital, time and effort which is not viable in a typical Spoke location with very thin deal volumes.

Talent Pool

The Hub locations such as Hong Kong and Singapore, being the centres of financial activity in the region, have naturally evolved into fertile grounds for attracting and retaining financial professionals from around the world. The availability of this talent pool is a huge advantage to Financial Institutions and makes it much easier to find the right candidate in the Hub locations than in the Spokes. With a critical mass in the Hub, it provides the opportunity for the Bank to be able to re-deploy its talent pool to expanding growth areas and also provides employees with career opportunities and exposure to other business areas within the Bank.

Operational Risk

The deal execution phase has substantial operational risk factors, most importantly legal, regulatory & reputational aspects. These risks can be mitigated by building processes to carry out due diligence at every stage and also making sure the system has built in checks and balances. In addition to building the right systems and processes, operational staff also needs to be well trained to handle these risk factors. The Hub and Spokes model allows for centralization of most of the operational aspects which in turn ensures that sufficient attention can be paid to all the operational risk factors at the Hub. In contrast, if a deal is executed in a local branch whose annual deal flow is very thin (for example, 3-4 deals an year), it is much more difficult to keep the staff well trained enough to handle all the risk factors.

Only alternative due to Legal restrictions

In certain cases such as China, the Hub and Spoke model is the only available alternative. Due to legal restrictions in the region it is not possible for a foreign financial institution like Credit Suisse to provide domestic service unless a licence is granted. According to a source from legal department, receiving this licence seems to be very difficult, if not impossible for the time being.

Another reason on why foreign financial institutions are finding it very difficult to establish a foothold for a local presence is due to the fact that China’s strict regulatory framework, which is not based on the English rule of law, can be rather complicated

Platform for Information Exchange

The centralized model offers certain advantages for better Information Exchange among the various regions, sectors and products because of (a) the necessity to report the details of all the deals into the Hub (b) the common pool of specialists in the Hub who are involved with deals across the board and (c) standardization of information reporting practices at the Hub.

Leverage on strong Trading Hubs

The securities and brokerage business presence in Asia is typically concentrated in the major financial centres like Hong Kong and Singapore. All the regional trading activities of global investment banks are managed through the regional offices in these hubs with the minimum local presence for IBD trade executions. Investment banking departments can effectively leverage on the firms brokerage business to run large IPO’s and private placements.

Challenges

Diverse Legal and Regulatory Environment

The Asia Pacific region has a highly diverse legal and regulatory landscape with very little common denominator. For example, Korea's regulators require a high proportion of on-shore presence whereas China does not allow any on-shore presence [3] . Given that much of the region is dominated by developing countries, another key feature of the legal and regulatory environment of the region is ambiguity. Many regulatory aspects are open to interpretation and are only clarified through dispute resolution. Often, financial institutions have to take calculated risks in interpreting new regulations. This diversity and ambiguity make it an extremely challenging environment to operate in. In order for the operations at the Hub to be successful, sufficient due diligence has to be applied to ensure that all the local idiosyncrasies are kept in perspective. This makes it difficult to make generalizing assumptions while streamlining processes. For example, the Transfer Pricing policy of the region is a tricky issue due to the many differences in individual countries.

Local Presence helps strengthen client relationships

Having strong client relationships is important in the wholesale banking business in general and more importantly for the advisory business. In general, having a bigger local presence allows us to have stronger relationships with clients by providing them a one-stop-shop for all their needs. Being on the ground and being closely in touch with the client allows the bank to understand and anticipate the client's needs better. New clients would have a certain amount of bias towards banks with a bigger local presence due to the confidence that they will be able to provide better coverage after the deal.

Language and Cultural barriers

The Asia Pacific region is also highly diversified in the Cultural and Linguistic aspects. In some countries, these differences are so high that it is not practical to operate in a Hub and Spokes model. The prime example for this scenario would be Japan where both cultural and language barriers are very high.

Prioritization Conflicts of Centralized resources

The centralized model opens up chances of prioritization conflicts of the centralized resource pool. This might result in smaller deals to be pushed down the priority order and thus not getting the timely response they need. In certain cases, a relatively large deal in a smaller country may not be large enough when compared to the other deals that the hub is dealing with.

Risk of one-way communication lines

A standard problem that a centralized model brings is the hazard of one-way communication lines. This refers to the issue where people are the spokes location feel an obligation to promptly pass on any information they have to the hub location but the people at the hub are not able to promptly identify which pieces of information are relevant to which spoke and might delay or ignore dispatching such information in time.

Increased focus from local Tax Authorities

The high rates of economic growth in the region have opened up new streams of tax revenue for many countries in the region and the local Tax Authorities are increasingly focusing on further potential opportunities. The role of wholesale banking is increasing at a rapid rate in the region; hence this is a prime area of focus for the Tax Authorities. The trend suggests that centralized execution of deals will be closely scrutinized by the Tax Authorities in order to question how much of taxable income has to be booked to the local entity. Traditionally, this problem has been solved by booking revenues to the local entity on a Cost Plus basis as per the Transfer Pricing policy. This policy determines what percentage of the profit should be booked to the local entity in order to generate taxable income for that entity.

Changes in regulatory environment

Post financial crisis, regulatory bodies in the region have increased their scrutiny of the banking activities in their jurisdictions, with a particular focus on activities of foreign banks. A number of new regulations or amendments to existing regulations have come out in order to tighten the screws around previously lax policies. Some of these regulatory changes call for an increased local presence particularly because of restrictions on foreign bankers flying in to execute local deals.

Looking ahead

The model currently adopted by Credit Suisse in the APAC is more than likely the most efficient in the current environment. However, as Asia starts to become the global driver for growth in the world economy – and as a side effect, the tax and regulatory authorities become more actively involved – the model is likely to evolve in a way that accommodates these changes. In this section, we attempt to visualize some of these potential changes.

Over the past 3 years following the financial crisis, Credit Suisse has evolved its strategic investment by ensuring an industry tier 1 capital ratio and by reducing the risk averse proprietary trading. Further, its capital-efficiency model helped Credit Suisse to keep agile for any regulatory initiatives and to implement a number of regulatory requirements before its competitors did. While its peers were in the process of re-aligning their strategies, Credit Suisse could continue to focus on its clients.

The strategic will include metrics to track revenues, Client votes, market shares and industry ranking.

IBD have also focused on their strategic plan to include ‘Regionally Tailored Strategies" to sharpen their focus in the large account and mid-cap fee pool, product capabilities and local competitive landscape in order to maximise opportunities.

Client relationship focus have been also significantly refined to focus on the list of Priorities and Key Accounts and to align our senior Bankers across the 3 regions (EMEA, US and Asia) to work towards a common ‘pitch’.

Hong Kong to remain a major Hub

We see the Hub of Hong Kong remaining for something into future on the basis that it will be servicing the needs of China and providing Investment Banks access to a growing market that may take 10+ years to become a jurisdiction with a predictable rule of law, which countries like Hong Kong already have.

Singapore to continue to service South East Asia

Singapore will also remain a hub with its easy access to growing markets like Indonesia & Malaysia.

India to develop into an autonomous centre

We see the model changing slightly with India and Korea starting to become drivers in the Asian economy. These economies will start to support full teams of bankers servicing an ever growing market. The model will more than likely be similar to that of Australia where clients are looking to meet and discuss possible transactions face to face quickly and efficiently. By having teams in these major markets predominately based offshore the ability to service and gain market share is reduced.

Credit Suisse has a licence in India and is also a centre of excellence (CoE). With a lower cost centre and the readily available talent pool, it will not be difficult for a large scale presence in India.

Credit Suisse re-entry into India with a stock broking operations in Mumbai in 2007 and has enhanced its positions to serve both Indian and International clients.

Alternatives

In this section, we present the possible and theoretical alternatives to the Hub and Spoke model and discuss the advantages and disadvantages they might bring. The most likely alternative to the current would be to establish a third hub in China. Being local would give Credit Suisse the opportunity to participate in China’s fast growing market and increase market shares. The other two alternative models described in the following section are rather based on a theoretical approach and realizations are unlikely.

China Bank Branch

China’s attractiveness to foreign investors is first and foremost due to its size. The Chinese population is expected to reach 1.35 billion people during the course of 2010. More importantly, in terms of purchasing power, the growth rate is increasing very rapidly. The per capita GDP is expected to have increased from 2300 dollars in 2007 to 34’500 US dollar in 2010. It’s high saving rate amounts to 55% of China’s Gross Domestic Product (GDP).

As more and more people are getting rich, good private banking services are becoming more important.

China’s booming economy offers a lot of opportunities for investment banks in terms of equity and debt issuance and advisory services such as mergers and acquisitions and research.

To capture market shares in China and position itself to grow in the competitive but fast growing market, it would be best for Credit Suisse to establish local presence by setting up a domestic banking branch with international equities and capital market banking capabilities. Being "local" would allow the bank to participate in the domestic IBD deals including local Mergers and Acquisitions, A-share IPOs, Corporate Finance, etc.

Unfortunately, Chinese regulations restrict foreign investment banks from directly accessing the Chinese markets. Only a handful of investment banks have been granted QFII status, (Qualified Foreign Institutional Investor), though the requirements to be able to operate as a Qualified Foreign Institutional Investor in China are high as illustrated in following example in regards of requirements for Securities Companies and Commercial Banks:

Securities companies

At least 30 years of experience in securities operation

No less than USD1 billion of paid-in capital

Managed a minimum USD10 billion of securities assets in the most recent accounting year

Commercial banks

By total assets, ranked among Top 100 in the world in the most recent accounting year; managing no less than USD10 billion of assets.

The QFII applicant must also have a strong financial position and not had any material regulatory findings or sanctions against it. Importantly, the home regulator of the QFII must also have signed a memorandum of understanding with the Chinese Securities and Regulatory Commission.

Once the QFII is granted they can only trade publicly listed shares on the Shanghai and Shenzhen Exchanges. Furthermore the QFII can only invest 10% in any of the listed entity. Within the listed entity Chinese regulations allow that only a total of 20% of shares can be sold to QFII.

Applications for very few QFII’s are granted, many large banks choose to enter joint ventures with local Chinese banks which is a slightly easier path but also generally restricted to a certain local. One of the benefit of a foreign institution entering into a joint venture is the already existing client base of the local entity. Furthermore the foreign institution can leverage on the knowledge and the know-how of the local joint venture partner in terms of local regulatory landscape.

Since Credit Suisse does not have a licence to operate a domestic branch in China, the bank has been establishing strategic relationships with a number of Chinese companies over the past few years. It has entered into a couple of joint ventures. In December 2007 it expanded its investment banking business in the world’s fastest-growing major equities and capital markets with China’s Founder Securities. In August 2010, Credit Suisse set up a joint venture with ICBC to form ICBC Credit Suisse Asset Management Company. With these strategic alliances, it allows Credit Suisse to have a role in underwriting securities such as domestic-A shares as well as government and corporate bonds and engaging other financial services.

With the help of China Coverage bankers in Hong Kong, Credit Suisse is tapping into

the international deals as illustrated in below chart.

M&A tables

Figure 1: China IBD share of wallet rankings from 2005 until YTD [4] 

Credit Suisse has two representative offices in China – Credit Suisse Guangzhou and Credit Suisse AG, Beijing that offers mainly Research and Development services. It also has a bank branch namely Credit Suisse AG, Shanghai Branch that has limited product offerings in the form of Interest Rate Swaps, Domestic Bonds and with FX Options on G7 currencies in the pipeline to mainly Peoples Republic of china (PRC) Corporate clients. It is regulated by its licensing requirement and any interest in new investment vehicles or products will need to be applied and registered with the local regulators for their approvals.

Credit Suisse (Hong Kong) Ltd is licensed by the China Securities Regulatory Commission (CSRC) as a Qualified Foreign Institutional Investor (QFII) and trades in China equities markets via Direct Market Access through its joint venture Founders Securities on Shenzhen A shares and with CITIC (Shanghai A) and Shenyin Wanguo (Shanghai B) shares. Clearance of Settlement is through ICBC. The daily investment quota is RMB18m for Shanghai and RMB4m for Shenzhen market.

In order to tap into the vast and fast growing internal market in China, we need a domestic banking branch in China. This will allow us to participate in the domestic IBD deals including local Mergers and Acquisitions, A-share IPOs, Corporate Finance, etc. Emerging markets have for the first time this year attracted more deals than Europe as international investors target fast-growing economies like China. Overall M&A activities in emerging markets has surpass Europe with China as the most attractive for acquirers followed by Brazil, India and Russia. The 4 BRIC nations have been responsible for more than 50% of emerging market deal making this year with Credit Suisse advised the highest volume in 2010 followed by MS and BoA Merrill Lynch and is also ranked number 2 in M&A in China for Jan - Sep 10.

Challenges

The challenge with this approach is that Credit Suisse does not have a license to engage in trading and advisory business in the local domestic bank branch in China. This alternative has been explored and found not feasible by our Legal department.

Fully Local Presence in each location

This is the extreme opposite to the Hub and Spokes model, with every location being a fully independent centre in itself, servicing the clients within the region. Each location will have a full-blown team consisting of coverage, product and sector bankers, their own execution team, legal and taxation experts and operational experts.

Advantages

Operating locally, the branch is fully self-reliant and can act upon its own discretion without asking the head office. Further, due to its strong presence locally the distance between the bank and its clients become closer which supports to strengthen client relationship.

Disadvantages

The two main disadvantages when building up branches locally are the significant cost increase and the negative impact on the operational risk due to fragmented processes and involved. Further, it could be difficult to maintain a pool of specialists on ground.

Recommendation

Despite some of the advantages this model brings, the cost of setting it up and running it is so high that it cannot be of practical relevance.

Collaborative Decentralized Model

The main disadvantage of the Fully Local Presence was the high cost and lack of cross-regional leverage of resources. In order to address this, we could make a few modifications to come up with what we call a Collaborative Decentralized Model.

In this, we would require roughly the same resources that the Hub and Spokes Model has, including generalists and specialists. However, there is no central location where most of the critical mass is located. The bankers are distributed more of less evenly across all the regional sites. Virtual teams are formed on-demand to work on deals as they come up.

Advantages

This affords us a lot of flexibility in managing our deploying the resources across the region and the distribution of resources can be changed in real-time as the business opportunities arise. It also allows us to attract talent who have a high affinity to their home location and are not willing to relocate.

Disadvantages

Although the flexibility that this model gives us looks attractive, it also increases the complexity for management. It can be very tricky to optimize it for best results. The operational risk is very high due to fragmented processes and systems. Communication issues could be very prevalent unless rigorous communication rules are put in place (which would also be counterproductive as it amounts to more red-tape). Further due to its fragmented processes the operational risk could improve significantly.

Recommendation

The complexity of the model is too high and it would be hard to make it work.

Conclusion

The global economy is undergoing tremendous change with the proverbial see-saw tilting in favour of emerging economies. In particular, the Asian economies such as China and India are experiencing phenomenal growth rates and also gradually liberalizing their economies. In order to remain a successful player, Credit Suisse would definitely have to proactively adapt its business and operating model to best leverage the future global economic landscape. It is imminent that China and India will figure as heavyweights in the Asian operating model.

In the meantime, Credit Suisse should gradually increase its present in the region, based on revenue forecast and its strategy. Over all, from a client relationship perspective, country coverage is important.

Looking at cross border issues, the bank should continue to improve the awareness at all levels and further ensure that cross boarder rules and regulations requirements are met and followed.

Another important strategic aspect is having the ability to accommodate strategic regulatory changes by remaining agile.

A particular focus should be given to Public Policy. In order to maintain the reputation of Credit Suisse and to promote the bank’s interest with policy stakeholders, the Public Policy department is monitoring, assessing and engaging in relevant political, social and environmental issues in cooperation with the bank’s management, line departments and experts. Its mission is to establish a solid, long-term relationship with public and private stakeholders and to ensure one voice in regards of Public Policy matters.

Last but not least, concentrating on a comprehensive product suite offering helps to attract more and more clients.