1 Chapter 2 Investment Banking Industry. 2 I. Investment Banking in the U.S. A. Investment Banking...

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Chapter 2

Investment Banking Industry

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I. Investment Banking in the U.S.

A. Investment Banking Regulationsa. 1933 The Securities Act and 1934

The Securities Exchange Acta) The Securities Act of 1933

Regulation before public offering Full disclosure in Prospectus(Due-diligence)

b) The Securities Exchange Act of 1934 Securities Exchange Commissions (SEC) Securities Exchange Systems Securities Settlement Rules Registration Requirements

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Illegal trades Registration statement (S-1)

Financial statements Pricing Underwriter commission Contracts, documents

Securities Exchange Commission (SEC) Regulations Implementation Corporate Finance Market Regulation Investment Management

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b. The Glass-Steagall Act of 1933 Separate the deposit-taking and loan-m

aking banker form the underwriter or dealer banker; create firewall between the commercial bankers and investment bankers

The commercial banker was prohibited from participating in risk taking with regard to all corporate securities and governmental securities. e.g. J.P. Morgan, Morgan Stanley

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c. Gramm-Leach-Bliley Act of 1999 Glass-Steagall Act repeals

Section 20 repealed Section 32 repealed

Financial holding company or Financial affiliation

Financial activities Insurance Securities underwriting Merchant banking

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B. Investment Bankersa. The New Inter-firm Competition

Specialization Individual investors – Merrill Lynch Institutional investors – Salomon Smith Barney

Deregulation Shelf-registration

M&A and Junk bonds (LBOs)

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b. Leading Investment Bankersa) Securities Underwriting

Conventional Negotiated Debt (Salomon Smith Barney, Morgan Stanley) High-yield Corporate Debt (Drexel Burnham Larnbert) Asset-Backed Debt (Salomon Smith Barney, CS First Boston) Municipal Debt (Merrill Lynch, Goldman Sachs) U.S. Government Securities (Merrill Lynch, Goldman Sachs) Corporate Equity Securities (Merrill Lynch, Lehman)

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b) Secondary Market Business Commissions Trading profit Research Service (Merrill Lynch, Goldman

Sachs) Money management (Merrill Lynch, Lehman)

c) Corporate Financing Activities Traditional Corporate Finance M&A (Goldman Sachs, Morgan Stanley) Venture Capital ( Donaldson Lufkin and

Jenrette, DLJ) Real Estate (Morgan Stanley, Goldman

Sachs)

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C. Investment Banking Activitiesa. Investment banking

Securities underwriting Merger and acquisition Financial consulting Venture capitalist Securities (derivatives) dealer and broker Bonds (derivatives) dealer and broker Futures Forex trading Investment Management Real estate investment

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b. Underwriting typesa) Negotiation Underwriting (Full

Underwriting) Syndicate (Syndicate Manager) Proportional distribution Price stabilization Gross spread (1%-10%, Mostly 7%)

• Hot issue?• Risk? (Market, idiosyncratic)• Distribution channel

Components of revenue• Syndicate manager expenditures• Investment bankers return• Selling commission

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Hot issues• Overallotment ( short 15%)• Overallotment Option (Green Shoe, x<p)

Pricing• Price negotiation• Underpricing (10% -20%)

b) Stand-by Underwriting Absorb by investment bankers

c) Best-efforts Underwriting Commission only

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II. Investment Banking in the U.K.

A. Investment Banking Regulationsa. 1986 Financial Services Act

Department of Trade and Industry Securities and Investment Board

Limited Minister of DTI Governor of the Bank of England

The Securities and Futures Authority, SFA (The Securities and Investment Board, SIB)

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b. The Financial Services and Markets Act, 2000 Financial Services Authority

Market confidence Public awareness Protection of consumers Reduction of financial crime

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Lord Chancellor

FinancialService tribunal

Secretary of stateFor Trade and Industry

Financial Services Authority

Self-regulatoryorganizations

Recognized Investmentexchanges

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II. Investment Banking in the U.K

Characteristics The U.K. Structure is fundamentally

pyramidal The secretary of state for Trade and

Industry is vested with the full oversight authority and power of the system

FSA has power to regulate the functioning of a broadly defined financial and investment business in the U.K.

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II. Investment Banking in the U.K

SROs are responsible for regulating the relationships between their members and customers

The International Stock Exchange determines listing requirement (LSE)

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B. Investment Bankersa. Financial System in the U.K.

Clearing banks (Commercial Banks) Merchant banks (Investment Banks) Stock brokers Jobbers

b. Investment bankersa) Merchant bank (S.G. Warburg, N.M. Rothschild,

J. Henry, Schroder Wagg) Financial advisory services ( James Capel, B

arclays, Warburg)

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M&A Underwriting securities (Samuel Montagu, G

oldman Sachs)

b) Stock brokers Fixed commission agent for individual or ins

titutional investors ( Zoete & Bevan, Strauss Turnbull, etc. )

c) Jobbers Market makers (Specialist) (Akroyd & Smithers, Wedd Durlacher)

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C. Investment Banking Activitiesa. Securities Underwriting

a) Corporate Equity Underwriting Merchant banks Underwriting syndicates Right offerings

b) Debt underwriting Debentures (secured) Loan stocks (unsecured)

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b. U.K. Government Securities Trading Short (up to five years) Medium (5-15 years) Long (over 15 years) Undated (perpetual)

c. Other Securities Tradinga) * Eurobonds

*Domestic equities*International equities

b) The Stock Exchange Automated Quotation System (SEAQ)

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c) * Alpha stocks – most active* Beta stocks – second rank in volume* Gamma stocks – less active* Delta stocks – least liquid

d. Research activitiese. Money Managementf. Mergers and Acquisitions

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b. Underwriting Typesa) Full Underwriting

Merchant banks Syndicates (Syndicates Manager) * Merchant banks

* British institutional investors

* Foreign securities firms

Offering for sale ( proportional distribution)

Shares may be privately placed directly to institutions


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b) Best-efforts Underwriting Moral underwriting

No legal obligation

c) Rights offering Existing shareholders

Purchase price 15-30% below current market price

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III. Investment Banking in Japan

A. Investment Banking Regulations

Characteristics of Japanese Business Environment

A pervasive national concern with external perils

Society’s acceptance of a major role for government in the financial markets

Openness to adapting the practices of Western financial institutions to its own needs

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The particularly Japanese structure of Industrial organization – the “zaibatsu”• Meiji era• Giant Conglomerates• Holding company with a

major private bank• The bank nourished the

companies in its zaibatsu with the necessary financing


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a. The early Meiji Restoration Perioda) The Stock Exchange Regulations, 1878

London Stock Exchange style Tokyo Stock Exchange, etc. Government bond issues ( Warriors of samurai family) Two sessions’ trade ( 10 a.m. and 2 p.m.)

b) Bourse Regulations,1887 German legal advisor, Hermann Roesler Public securities trading


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b. WWI to the Great Depression 1922, the Law of Trust Companies

c. The postwar recovery to internationalizationa) 1947, Securities and Exchange Law

Article 65:

A bank, trust company or such other financial institution as may be designated by a Securities and Exchange Commission Regulation shall not engage in any of the acts enumerated in Paragraph 8 of Article 2.


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Article 2 :” Securities business” To buy and sell securities To act as broker, agent or proxy with

respect to buying and selling of securities

To act as broker, agent or proxy with respect to the entrustment of transaction on a securities market

To underwrite securities To sell securities by public offering To handle the issuance or sale of

securities by public offering


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b) 1952, Long-term Credit Bank Law

Authorize banks to borrow 20-30 times of their capital to accommodate corporate borrowers

c) 1971, Law Concerning Foreign Securities Firms Non-Japanese firms for branch-office

license Merrill Lynch (1972)


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B. Investment Bankersa. The Early Meiji Restoration Period

1893, Standard Securities Underwriting Managed by one or two national banks National banks issue stock for public

subscription Other banks act as selling agents1902, Industrial Bank of Japan (IBJ) Government created Financing the longer-term capital needs of

Japanese industry Corporate debentures underwriters

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b. WW I to the Great Depression Emergence of leading securities firms

• Koike Company (Yamaichi Securities)• Fujimote Bank(Daiwa Securities)• National City Co.(Nikko Securities)

Emergence of leading Trusts • Mitsui Trust (1924)• Mutual Trust (Yasuda Trust,1925)• Sumitomo Trust (1925)• Mitsubishi Trust (1927)• Issuance of new corporate debentures• Underwriting new securities offerings of their group affili

ated companies• 1927,”Big Five” (Daiichi+Big Four)

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c. The postwar recovery to internationalizationa) Japanese securities firms

the Big Four (Nomura, Daiwa, Nikko, and Yamaichi) 21 other large firms directly supervised by the Tokyo off

ice of MOF Small Local firms supervised by the branch offices of M

OFb) International investment bankers

Merrill Lynch, 1972 1986 TSE members

• Merrill Lynch• Morgan Stanley• Goldman Sachs• Vickers da Costa• Jardine Flemming• S.G. Warburg

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C. Investment banking activitiesa. Investment banking activities

a) Brokerage activities Brokerage commission (60% of revenue) Secondary market trading

b) Future market 1985, Japanese government bond futures 1987, Nikkei stock index futures 1989, TSE futures

Interest rate futures on Euroyen and Eurodollars Currency futures

c) Japanese government bond underwriting 40%--- Competitive bids from members of underwritin

g syndicates 60%--- Syndicates members under fixed allocation

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d) Corporate Underwriting Euromarkets and TSE

Government subsides rationing insistence of collateral in banks

“BIG Four” dominance Equity-linked securities offering

e) Offshore Corporate Underwriting Securities Firms, commercial banks Commercial banks established subsidiaries in the

major offshore markets MOF “three bureaus agreement”

Banking Securities International finance

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f) Corporate Finance Activities Minor The leading securities firms

Financial engineering skills Long-term financial planning Valuation and financing skill in M＆ A)

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b. Securities Underwritinga) Securities underwriting procedures

Financial plan consulting Capital structure adjustments IPO

Pricing Time table Review of corporate charter Review of directors meeting Review of management Compliance Registration(MOF) Underwriting Syndicates (The Big Four


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• Proposal Method (MOF) Electric utilities and Telephones Compete for syndicate managers

• Shelf Registration (Oct. 1. 1988) Qualified issuers can preregister securities and hold them ready for an offe

ring on short notice if market conditions become favorableb) Public bidding System (April, 1989)

• Fixed proportion for public bidding• Price floor, Price ceiling (Comparison,EPS,BPS)• Exclusive restriction (Major shareholders)• Top-down bidding

c) After market support• Application for price stabilization (MOF)• Restrictions of initiators, period, price limit, etc.

1 Chapter 2 Investment Banking Industry. 2 I. Investment Banking in the U.S. A. Investment Banking...

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