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Schwab Expands Global Horizons

TORONTO - Charles Schwab's recent expansion into Canada is only one of a series of moves the brokerage giant will be making to further diversify its business globally. With the opening of the new Toronto-based operation, Schwab now has a physical presence in four locations outside the U.S. The others are London, Hong Kong and the Cayman Islands.

"We're looking at the possibility of strategic alliances, joint ventures and doing it ourselves," said Luis (Ed) Valencia, president of Charles Schwab International and an executive vice president of the parent firm based in San Francisco. "We don't rule anything out."

Acquisitions expedited Schwab's entry into both Britain and Canada and they are likely to be used to speed Schwab's international expansion elsewhere. Though Schwab's fledgling foreign operations represent only a negligible amount of its total 1998 profit of $348 million on revenue of $2.7 billion, the firm expects the portion to grow, said Valencia.

Europe is receiving special attention right now because of the launch of the Euro on Jan. 1, and the continent's deregulation drive.

"We are looking at several European countries to see where we have opportunities," said Valencia in an interview from San Francisco. Though Valencia would not name countries, Germany, France and Italy are logical candidates. Valencia did confirm that expansion into Japan is being actively considered.

Schwab will avoid price wars with the bank-owned firms that dominate discount trading in Canada. Instead, it is pitching itself to consumers as Canada's first "full-choice" brokerage.

Paul Bates, the seasoned Toronto discount brokerage executive who is president and ceo of the new Canadian operation, said it will offer a "suite of services." They will range from on-line order execution, the cheapest alternative for Schwab Canada customers, to full service advisory accounts.

The new twist for Canadians is that clients will be able to have both advice and no-advice order execution from the same provider, said Bates.

"More and more they're seeking both," said Bates, who is a former president of Toronto Dominion Bank's Green Line Investor Services, the country's largest discounter.

Bates said he expects that 40 percent to 45 percent of his business will be from advice seekers, with the balance being discount customers. He added that one-half to two thirds of customers are likely to have both self-directed and advisory accounts.

The concept of different levels of service under one roof is a familiar one to Bates. He was a co-owner of the small independent discounter Priority Brokerage and the full service Porthmeor Securities, both based in Toronto, both of which Schwab bought in order to establish its Canadian beachhead. Bates and his management team, who are continuing with Schwab, gives the Canadian operation "the nucleus of a solid enterprise," said David Pottruck, the U.S. parent firm's president and co-ceo.

Schwab executives declined to provide dollar estimates of how much business it expects from Canada. However, it is clear that the head office is willing to make substantial investments to make a marketing breakthrough. As of late February, Schwab Canada had only 30 employees.

"A year from now it will be a multiple of that number," said Bates.

Pottruck does not expect Canada to be an instant money maker. He said Schwab will probably incur losses in the "single digit" millions of dollars over the next couple of years on its new operation. But he predicts that the investment will pay off in terms of "staggering growth" as Canadians become more aware of Schwab's package of automated trading, research and advisory services.

On a company-wide basis, Schwab's client assets surpassed the $500 billion milestone in January and ended the month at $521 billion, up more than 40 percent from a year earlier. Though on-line capacity has been strained recently, resulting in widely-publicized trading delays, Schwab executives credit much of its success to its investments in electronic trading.

"The Internet is creating a revolution in financial services, particularly in the world of investing," says Pottruck. "The opportunity for us (in Canada) is the same as in the U.S. Technology becomes the engine to keep prices low."

Schwab Canada is setting itself apart from other full-service Canadian brokers by eliminating all transaction-based commissions. Instead, the firm's compensation package to advisors will be a combination of a base salary, a bonus based on growth in client assets, and a "qualitative component" giving management some discretion in awarding merit pay.

Schwab advisors will not earn "one nickel" in commissions so Schwab customers, "won't have to decide who is really benefiting from a transaction," said Bates. Schwab's pay scheme will not attract top producing brokers from competing firms, he conceded.

On the discount side, Schwab has no plans to compete with bank-owned discounters which are offering commission rebates of 2.5 percent or more on purchases of deferred-load funds. He dismissed the value of rebates because investors may be liable for heavy redemption fees if they change their minds about staying in a fund.

"Why they chose this particular avenue to compete is beyond me," said Bates, who believes discounted front-end funds are a better alternative for clients.

However, Schwab will not be a price leader on sales of front- end funds either. Its basic commission for a front-end purchaser who trades electronically and requires no advice is one percent. The cheapest discounters, including independent E*Trade Canada and bank-owned Scotia Discount Brokerage, waive front-end charges and receive their entire revenue from trailer commissions.