The French Flex Their Muscles

They're poised to shake up European finance

During a working dinner at the end of January, Daniel Bouton had a clever idea. The chief executive of French retail bank Societe Generale was deep in merger negotiations with executives from investment bank Paribas. On the wine list, he noticed a bottle from a vineyard in which a Paribas board member owned a stake. The selection went over well, recalls Bouton. The two banks tied the knot on Feb. 2, announcing a $17.2 billion merger and the creation of a new European banking goliath.

The very same day, a captain of French finance, AXA Chairman Claude Bebear, announced that his insurance empire would launch a friendly, $5.59 billion bid for Britain's Guardian Royal Exchange PLC. If the deal is consummated, AXA will rival Germany's Allianz as Europe's No. 1 insurer.

SECRET WEAPONS. Just two years ago, many bank analysts wrote off France's financial institutions as mere takeover bait for bigger, savvier foreign banks. So far, the French have been mostly absent from the merger free-for-all among European financial institutions. Now they are making their move. As the single-currency financial market begins to take shape, France is sizing up the competition and preparing to deploy its unique resources.

The creation of the euro zone robs the French of a great advantage: protected financial markets that channeled capital into domestic institutions and instruments. But French banks bring special expertise to the euro zone battlefield. France has long excelled in finance, with an elite cadre of technicians trained to manage money for the dirigiste state. That's one reason the French have vaulted ahead of the rest of Europe in such sophisticated financial products as derivatives and asset-backed securities. Transferring these skills to the new marketplace could give French banks an edge in money management.

France has another secret weapon that's potentially more lethal. Its banks and insurers are sitting on centuries' worth of wealth, now locked up in real estate, savings accounts, and low-yielding investment funds. French insurers alone control more than $714 billion. If these assets are unleashed from their national borders and poured into stocks and corporate debt, France could wield enormous financial clout in Europe. The French will have "a pivotal position in the euro zone's financial sphere," says Svenja Nehls-Obegi, senior economist at Deutsche Bank's Paris office.

SHEER FIREPOWER. Insurance contracts and mutual-fund products are still regulated across Europe by a panoply of national laws. But these rules are gradually being dismantled as the European Commission and enlightened finance ministers confront the realities of a single market. Historically, too, French institutions have favored bonds and other fixed-income investments over equities. Now, French investors are beginning to demand higher returns. When the French begin diversifying their accumulated wealth out of domestic bonds into equities across the Continent, they could wind up with a sizable piece of Europe Inc.

For sheer asset firepower, French institutions have most of their European counterparts beaten by a mile. They rank No. 1 in Europe in asset management, with 25% of a market total of more than $5 trillion. French mutual funds alone have more than $625 billion under management, and the French market ranks second-largest in the world behind the U.S. Meanwhile, French insurers, with $714 billion in assets, rake in 27% of all European life-insurance premiums, and the French life-insurance market overall is the global No. 3.

But for French institutions to make the most of their wealth and market share, they will not only need more strategic mergers domestically. They will need to build management strength, streamline operations, and forge cross-border ties. That means taking a cutthroat approach to winning market share that doesn't come easily in France. "The French financial-services sector can only become as strong as French capitalism, which is a concept that still has some distance to go before being totally accepted," says Felix Rohatyn, U.S. ambassador to France.

A FEW VISIONARIES. There's no question that French banks are weaklings in the lucrative global mergers-and-acquisitions business. They also underperform rivals in return on equity. French banks' ROEs are expected to average 11% to 12% over the next three years, compared with 18% to 20% for British and Irish banks and 15% to 20% for Swedish and Iberian banks.

The issue now is how the French can compete once their markets are open. Their insurance industry has benefited enormously from tax-exempt life-insurance contracts introduced in 1983. Then, in 1992, the government created a new tax-advantaged savings plan in order to spur investment in French mutual funds. That was meant to counterbalance British and U.S. pension funds, which now control some 40% of the equity in quoted French companies. So far, the plan has attracted some $54.6 billion.

Artificial barriers to foreign competition already are coming down. Brussels-based EASDAQ, the Europe-wide exchange for small-cap stocks, has challenged the legality of special tax treatment for French mutual funds that invest in French stocks. And European Union officials are likely to force the French to eliminate any treatment that favors French stocks over others in the euro zone.

A few French visionaries can already see the potential of wider markets. AXA's Bebear is racing to extend his empire from a strong French base. With assets under management of $550 billion, AXA reaches into every corner of the world. It was Bebear, as the lead shareholder of Paribas, who pressured Paribas to seek a partner. Now, he has the largest stake in France's megabank--just ahead of his fiercest rival, German insurer Allianz.

Now, Bebear must push growth to AXA's bottom line. With more than twice the revenues of American International Group, Bebear's company shows earnings of $1.4 billion to AIG's $3.3 billion. This earnings lag results in part from Bebear's steady acquisitions--most of which eventually make money. His U.S. portfolio, for example, pulled down earnings initially but now contributes $600 million, or 30%, to the bottom line. In fact, AXA officials expect Equitable Cos., which is 60% owned by AXA, to pursue more acquisitions in the U.S. before the ink dries on the Guardian Royal deal.

"SITTING DUCK." The next two most obvious targets for bank mergers in France are Banque National de Paris, which considered a tie-up with Paribas and rejected it, and Credit Commercial de France. "BNP is a sitting duck," says Paris-based consultant Christian Saint-Etienne. Among the possible partners could be Germany's Dresdner Bank. BNP favors a link with Credit Lyonnais in the upcoming privatization, but the merger of two French retail banks in the overbanked French market would lead to major layoffs and prompt union protests.

That kind of thinking could hobble France's strides into Europe's financial future. The country needs more players like Bebear, who think in terms of the global stage. And like the corporate sector, financial institutions must learn to live without the coddling of a paternalistic government. But France has many of the raw materials it needs to become a heavyweight in the new euro zone. With a few more strategic deals, it could live up to its unrealized potential.

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