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When the barons of Crédit Agricole were debating whether to bid for rival French bank Crédit Lyonnais three years ago, one of the more vocal critics of the proposed deal was Edouard Esparbès. As head of Agricole's largest division, Paris-based Crédit Agricole d'Ile de France, Esparbès was the biggest of the barons, or regional chiefs, and enjoyed tremendous independence under the cooperative bank's federal structure. He worried that a merger with the centralized Lyonnais, where investment bankers rather than regional bosses controlled relationships with key corporate clients, would threaten his autonomy, costing him customers and revenues.

Esparbès failed to stop the E16 billion ($18.6 billion) acquisition, but he has prevailed nonetheless. He won a hard-fought internal power struggle to become chief executive of the combined group's investment bank, named Calyon, and deputy CEO of Crédit Agricole to boot.

Now Esparbès has embarked on a major expansion designed to make Calyon a European powerhouse. But he is doing so in an unusual way. Instead of leveraging the parent bank's strengths by focusing on the French corporate market, which could create conflicts with the regional chiefs, Esparbès has chosen to target the lucrative but highly competitive market for equity derivatives, a business dominated by French rivals Société Générale and BNP Paribas. He aims to triple Calyon's modest derivatives business by 2007 and use those revenues to finance expansion in fixed income, asset management and other areas.

"Our ultimate desire is to be a bank of reference in the international markets," the 61-year-old banker says in an interview at Calyon's offices along the Seine in the La Défense district just west of Paris. "Current initiatives like our goals in equity derivatives are just the first steps in that direction."

To lead the derivatives drive, Esparbès has lured out of retirement Marc Litzler, a flamboyant banker who helped build Société Générale's world-leading equity derivatives business in the 1990s. During his two-year break from banking, Litzler used his considerable wealth to buy a Paris restaurant, open an art gallery and collect modern art. What attracted him back to the business was the chance to create the kind of dynamo he had forged at Société Générale.

"An opportunity to build a new investment banking operation at one of the world's top-ranked banks in terms of balance-sheet strength comes around only about once in a decade," says Litzler, who joined Calyon as deputy CEO in December.

The ambition of Esparbès and Litzler is laudable, but rivals and analysts question their prospects of succeeding. Calyon starts far behind its rivals, and it is expanding at a time when other bulge-bracket investment banks, including Goldman, Sachs & Co. and UBS, with deeper pockets and more lustrous pedigrees are also beefing up their equity derivatives businesses.

Even more significant, the two investment bankers must overcome a legacy of failure stemming from the stultifying dominance of the caisses régionales, the regional banking divisions that control Agricole. These units forced cutbacks in Agricole's successful Asian equities and European fixed-income operations over the past decade and prompted the departure of a number of talented bankers, including Dominique Ferrero, the former head of Crédit Lyonnais's investment bank. Rather than challenge the regionals, Esparbès is bowing to them by setting a strategy that largely ignores Agricole's powerful position in the French corporate market. The bank is the euro area's second largest by assets, with E913 billion, and is the leading lender to small and medium-size businesses in France.

"In the past the influence of the regional bank heads has led to the destruction of valuable businesses," says Jean-Pierre Lambert, a banking analyst at Keefe, Bruyette & Woods in London. "Today it is diverting Calyon from building up a domestically focused corporate and investment banking business that leverages off the corporate connections of the regional banks."

Esparbès insists that his expansion strategy makes sense, however. As a former baron himself, he refuses to compete with the regional banks for corporate lending and investment banking business. By focusing on derivatives, he hopes to avoid internal conflicts, penetrate new markets, such as selling structured products to hedge funds, and build up the bank's trading capacity.

"We did not want a strategy that would have put the caisses régionales in an uncomfortable competitive position," Esparbès says. "Today, Crédit Lyonnais has its own business clients, while on the other side, the caisses régionales have theirs. Calyon is at the service of the two networks for capital markets products, rather than competing with them."

Understandably, that approach has the firm support of Agricole's regional bosses. "Putting an emphasis on derivatives and not on expanding in the domestic corporate market may seem like a tough strategy to deliver on, but it makes sense given the structure of our group," reasons Nicolas Renaudin, CEO of Crédit Agricole Brie Picardie, which is based in Meaux, 40 kilometers east of Paris. "We don't want Calyon aggressively expanding its corporate business in France since it would lead to competitive overlap with our own growing corporate loan businesses, but we do want to improve its relatively poor profitability and its ability to expand overseas so that it can serve us better."

Though Calyon is a substantial entity, boasting nearly 11,000 employees and offices in 60 countries, the firm's performance has been second-rate. It ranked tenth among European investment banks last year, according to its own estimates, with revenues of E3.9 billion. That was far behind top-ranked Deutsche Bank's E13.3 billion and trailed domestic rivals BNP Paribas and Société Générale, which had investment banking revenues of E5.7 billion and E4.7 billion, respectively. Calyon also relies more heavily on low-margin, capital-intensive lending than do its domestic rivals, who generate higher returns on capital markets activities like derivatives. The firm devoted E6.9 billion in capital to its investment banking activities last year, virtually double SocGen's E3.5 billion, even though Calyon lagged its rival in revenues by 19 percent.

As a result, the gap in profitability between Calyon and its would-be rivals is wide. The investment bank reported that cost-cutting boosted operating profits to E355 million in the first quarter, the latest figures available, a gain of 24.5 percent from a year earlier. Revenues rose a modest 4.9 percent to E1 billion. Return on equity was 16.9 percent. By contrast, BNP Paribas posted a 21.2 percent increase in operating profits, to E700 million, on a 5 percent gain in revenues, to E1.6 billion. Its ROE was a robust 34 percent. Société Générale rode a blowout performance in derivatives to post a 44.7 percent rise in operating profits, to E754 million, on a 31.6 percent jump in revenues, to E1.6 billion. ROE was an astonishing 54 percent. BNP Paribas's operating profits rose 18 percent in the second quarter from a year earlier, to E714 million, and SocGen's profits edged up just 3.1 percent, to E471 million.

Calyon ranks outside the top 20 in most main investment banking product lines, including debt issuance and merger and acquisition advice, and trails well behind BNP Paribas and Société Générale. The bank's main strengths largely reflect balance-sheet power rather than capital markets expertise. Calyon was the second-largest lender globally in project finance in the first seven months of this year, according to London-based Dealogic, and ranked tenth in syndicated loans.

The bank's equities franchise got a major boost when the French Treasury named Calyon sole book runner on its E4 billion initial public offering of a 22 percent stake in Gaz de France in July. That single deal vaulted Calyon to 12th place in global equity issuance from a position outside the top 40, according to Dealogic. The bank is also joining with Morgan Stanley to handle the expected E11 billion sale of a 30 percent stake in Electricité de France this autumn. Calyon boasts a well-regarded domestic equities sales and research arm, Cheuvreux, which ranked first in France on Institutional Investor's 2005 All-Europe Research Team, but on a pan-European basis, Cheuvreux is small compared with the equities operations of bulge-bracket firms like Merrill Lynch & Co., Goldman Sachs and UBS. Elsewhere, Calyon's only notable business outside of Europe is Asian equity sales and research house CLSA, the third-largest brokerage in Hong Kong by turnover.

Analysts estimate that Calyon generated about E1.1 billion in revenues last year from fixed-income trading and origination (the firm doesn't provide a breakdown). Equity brokerage chipped in an additional E475 million or so. The equity derivatives operations that Esparbès wants to build account for 5 percent of the group's revenues, or slightly less than E200 million -- one of the few figures Calyon has publicly confirmed. Even if Esparbès and Litzler succeed in tripling derivatives revenues, the business would still be less than one third the size of Société Générale's, which is likely to generate more than E2 billion in revenues this year, according to Jacques-Henri Gaulard, an analyst at Merrill Lynch. Esparbès' growth plan aims to increase overall revenues in corporate and investment banking by E1 billion by 2007.

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