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Transcript of Investment Banking
INDEX Sr. No Topic1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. Executive Summary Introduction Investment Banking and Merchant
Page No.1 2 Banking 4 6 10 12 13 15 19
Distinguished Evolution of American Investment Banks European Investment Banks Global Industry Structure Business Portfolio of Investment Banks The Indian Scenario Characteristics and Structure of Indian Investment Banking Industry Service Portfolio of Indian Investment Banks Interdependence between Different Verticals Investment Banking Regulatory Framework for Investment Banking Regulatory Framework for Merchant Banking Anatomy of Some Leading Indian Investment Banks Recent Trends in Investment Banking The Conflict of Interest Issue Conclusion
23 in 29 31 35 38 51 56 60
IntroductionAt a very macro level, Investment Banking as the term suggests, is concerned with the primary function of assisting the capital market in its functions of capital intermediation, i.e. the movement of financial resources from those who have them (the Investors), to those who need to make us of them for generating GDP (the Issuers). As already discussed banking and financial institutions on the one hand and the capital market on the other are the two broad platforms of institutional intermediation for capital flows in the economy. Therefore, it could be inferred that investment banks are those institutions that are the counterparts of banks in the function of intermediation in resource allocation. Nevertheless, it would be unfair to conclude so, as that would confine investment banking to a very narrow sphere of its activities in the modern world of high finance. Over the decades, backed by evolution and also fuelled by recent technological developments, investment banking has transformed repeatedly to suit the needs of the finance community and thus become one of the most vibrant and exciting segment of financial services. Investment bankers have always enjoyed celebrity status, but at times they have paid the price for excessive flamboyance as well. To continue from the above, in the words of John F. Marshall and M.E. Ellis, investment banking is what investment banks do. This definition can be explained in the context of how investment banks have evolved in their functionality and how history and regulatory intervention have shaped such as evolution. Much of investment banking in its present form thus owes its
origin to the financial market in USA, due to which, American investment banks have been leaders in the American and Euro markets as well. Therefore, the term investment banking can arguably be said to be of American origin. Their counterparts in UK were termed as merchant banks since they had confined themselves to capital market intermediation until the US investment banks entered the UK and European markets and extended the scope of such businesses.
Investment Banking and Merchant Banking DistinguishedAt this stage, it would be relevant therefore, to draw a fine line of distinction between the terms Investment Banking and Merchant Banking as both these terms are extensively used in this project. Merchant Banking as the term suggests, is the function of intermediation in the capital market. It consists of assisting issuers to raise capital by placement of securities issued by them with investors. However, merchant banking is not merely about marketing securities in an agency capacity. The Merchant Banker has an onerous responsibility towards the investors who invest in such securities. The regulatory authorities require the merchant banking firms to promote quality issues, maintain integrity an ensure compliance with the law on own account and on behalf of the issuers as well. Therefore, merchant banking is a fee based service management of public offers; popularly know as issue management and for private placement of securities in the capital market. In India, the Merchant Banker leading a public offer is also called as the Lead Manager. On the other hand, the term, Investment Banking has a much wider connotation and is gradually becoming more of an inclusive term to refer to all types of capital market activity, both fund-based and non-fund based. This development has been driven more by the way the American investment banks have evolved over the past century. Given this situation, investment banking encompasses not merely merchant banking but other related capital market activities such as stock trading, market making, underwriting, broking and asset management as well. Besides the above,
investment banks also provide a host of specialized corporate advisory services in the areas of project advisory, business and financial advisory and mergers and acquisitions. The activity profile of investment banks is discussed in more in detail later in this chapter.
Evolution of American Investment BanksThe earliest events that are relevant for this discussion can be traced to the end of World War I, by which time, commercial banks in the USA were already preparing for an economic recovery and consequently, to the significant demand for corporate finance. It was expected that American companies would shift their dependence from commercial banks to stock and bond markets wherein funds were available at a lower cost and for longer periods of time. In preparation for a boom in the capital markets in the 1920s, commercial banks started to acquire stock broking businesses in a bid to have their presence made in such markets. The first of such acquisitions happened when the National City Bank of New York acquired Halsey Stuart and Company in 1916. As in the past, in the entire 1920s, investment banking meant underwriting and distribution of securities. The stock and bond market boom in 1920s was as opportunity that banks could not miss. But since they could not underwrite and sell securities directly, they owned security affiliates through holding companies. However, they were not maintained like water tight compartments. The affiliates were sparsely capitalized as were financed by the parent banks for their underwriting and other business obligations. While the boom lasted, investment banking affiliates made huge profits as underwriting fees, specially in the segment called Yankee Bonds issued by overseas issuers in US market. In the stock market, the banks mainly conducted broking operations through their subsidiaries and lent margin money to customers. But with the passage of the McFadden Act in 1927, bank subsidiaries began
underwriting stock issues as well. National City Bank, Chase Bank, Morgan and Bank of America were the most aggressive banks present at that time. The stock market got over-heated with investment banks borrowing money from the parent bank in order to speculate in the banks stock, mostly for short selling. Once the general public joined the frenzy, the price-earning ratios reached absurd limits and the bubble eventually burst in October 1929 wiping out millions of dollars of bank depositors funds and bringing down with it banks such as Bank of United States/ In order to restore confidence in the banking and financial system, several legislation measure were proposed, which eventually led to the passing of the Banking Act 1933 (popularly know as Glass-Steagall Act) that restricted commercial banks from engaging in securities underwriting and taking positions or acting as agents for others in securities transactions. These activities were segregated as the exclusive domain of investment banks. On the other hand, investment banks were barred from deposit taking and corporate lending, which were considered the exclusive business of commercial bank. The Act thus provided the water tight compartments that were needed before. Since the passing of this Act, investment banking became narrowly defined as the basket of financial services associated with the floatation of corporate securities, i.e. the creation of primary market for securities. It was also extended to mean at a secondary level, secondary market making through securities dealing. By 1935, investment banking became one of the most heavily regulated industries in USA. The Securities Act, 1933 provided for the first time the7
preparation of offer documents and registration of new securities with the federal government. The Securities Exchange Act, 1934 led to the establishment of the Securities Exchange Commission. The Maloney Act of 1938 led to the formation of the NASDAQ, the Investment Company Act, 1940, which brought mutual funds within the regulatory ambit and the Investment Advisers Act, 1940 which also regulated the business of investment advisers and wealth managers. After the passing of the Glass-Streagall Act of the 1930s, until the beginning of the 21st century, investment banking had been through several phases of transformation which had broken down the water tight compartments to a great extent. Due to the 1973 Arab oil embargo, world economies were under pressure and inflation and interest rate volatility became disturbing. It was at this time that institutional investors madder their advent into securities markets. It was also the time when the industrial and financial service sectors were beginning to expand and globalize. Due to these developments, investment banking and commercial banking once again became constrained by the very legislation that was meant to clean up the system in the 1930s. This led to several relaxations over the years such as the Securities Acts Amendments, 1975 which had permitted commercial banks to have subsidiaries (called section 20 subsidiaries) that were allowed to underwrite and trade in securities. In 1990, J.P. Morgan was the first bank to open a section 20 subsidiary. Since the Glass-Streagall Act did not ap