In the last decade or so, almost all functions of investment banking have seen major disruption. An investment bank from pre dot com bust era is almost unrecognizable in the present scheme of things. Almost all banks are struggling to keep in tune with the historical profits that the industry is quite used to. It’s an era where factors like Technology, Outsourcing and Innovation are relaying the rules of the game for Investment Banks
Here are the major trends that are being observed in the industry:
Changes in the IPO business
Traditionally assisting corporates in accessing the public markets has been a major source of revenue for investment banks. Banks have typically charged around 3% to 7% of the money raised as their fees. Bigger and simple IPOs commanded less percentage while smaller IPOs and complex deals commanded higher fees percentage. The number of IPOs has gone down significantly, and the average size of the fund raised has increased. Also, most bigger IPOs have been from tech firms like Facebook, Uber, and Softbank. As the tech firms are already a household brand name even before the IPO, it does not necessitate a reputed Investment Bank underwriting its shares. That gives more bargaining power in the hands of these tech firms as compared to Investment Banks and hence the fees commanded by Investment Banks are under stress.
Apart from the major trend of lesser IPOs and more bargaining power to tech clients, here is what that is further making the industry more challenging:
The trend of staying Private
The last decade also saw the emergence of multiple Private Equity and Venture Capital firms, which formed an alternative to raising funds by going public for the companies. Firms like Softbank have mega-funds which have raised hundreds of billions of dollars to be invested in companies. Raising money from private investors is faster and attracts lesser scrutiny from regulatory authorities. Companies can also function independently in a much efficient way without the pressure of retorting to QoQ profits that public companies are subjected to. This has led to even fewer companies using the services of Investment Banks to go public.
Direct Public Offerings
This concept was first shown in practice by Spotify which went public without underwriting its equity. As tech firms have previous acceptability and brand established, It is easier for them to access money due to its own brand name, rather than a Goldman Sachs or a Morgan Stanley backing it up. Spotify has shown the way to other tech firms, who probably will use this route of public listing more and more in the future.
Alternative Exchanges
There have been multiple substitutes for traditional stock exchanges like NYSE that have cropped up. These exchanges like Investor Exchange or Long term Stock Exchange (LTSE) provide an alternative to list without many complications. All of this leads to a further reduction in the fees commanded by Investment Banks. There have also been multiple platforms that bring together investors and companies using technology. One such platform, Axial Network is now known to be the Tinder of M&A.
Initial Coin Offerings
Still at its infancy but ICO is expected to be used more and more in the future. Here a company offers its equity or right to equity in a blockchain or crypto-based coin. It is still facing too much suspicion from regulatory authorities to become mainstream anytime soon.
Changes in the M&A landscape
M&A activity saw a major boom in the 80s and 90s on the back of public companies looking to improve their EPS and hence improving their valuations. Investment Banks had a bigger role to play as M&A activity was driven more from a financial angle. Presently most of the M&A activity is on the back of the strategic vision of the management, rather than looking for a quick bump in the EPS. This has led to more active role play by the Management and less importance to the value that Investment Banks bring to the table.
Apart from these following are the underlying trends that are rewriting the rules of M&A
Boutique banks and Specialization
There are multiple boutique banks that have shown spectacular growth in their business on the back of specialization. Banks specializing in tech space have shown bigger increases when compared to bigger and more generalist banks. This is because boutique banks understand the industry well and are in a position to recommend vision, strategy, and synergy-based M&A targets.
Technology
There are multiple platforms that are aiding to DIY M&A. Axial network, which is known as Tinder of M&A, connects start-ups with investors, is showing tremendous growth regarding the transactions on its platform.
Changes in Asset Management landscape
Asset Management which still forms the major chunk of revenues for bigger Investment Banks is also going through multiple changes.
Although the major chunk of revenues of bigger investment banks comes from Asset Management, it seems Banks are losing to specialized asset management firms when it comes to traction and growth.
After Lehman brothers collapse, regulatory changes led to bigger investment banks to hold bigger percentage of funds as liquid. This took away the advantage that the banks had in terms of their scale. Specialized Asset Management firms turned out to be agile and relatively less susceptible to regulatory constrictions. Specialized ETFs have given better returns than the funds managed by Investment Banks.
Changes in Equity Research
Equity research for investment banks has been commoditized to a great extent. A huge chunk of information is available that is researched sometimes manually and sometimes using automated programs, but there is very little that is being absorbed. It meant less for the Banks and Clients and probably was not even being used in the way envisaged. Banks did not care much as the cost of the research was bundled along with the cost of a trade.
A recent European Commission’s directive called MiFIID II is set to change all this. Under this Banks are expected to bill the cost of research separately. This has led to banks across the globe, taking notice of their Equity Research operations. Now that the research would be paid separately, it makes sense to evaluate the value addition it brings to the table. Investors also are now more alert in consuming these reports given that they will be paying separately for this. All of this will lead to the elimination of useless repetitive and non-insightful equity research.
Changes in Sales and Trading
Of late after the Lehman Brothers episode, there have been multiple curbs on how much a Bank can trade in the market with its own and client’s money. This has led to curbs on the capital available for trading and thus killing another lucrative source of revenue for Investment Banks
How are banks countering all this?
Large banks have taken different strategies to counter the challenges I mentioned earlier. Here are the major types of strategies followed by them:
Offloading the loss-making verticals: Banks like Morgan Stanley are letting go business divisions that are not profitable and at the same time investing more and more in verticals like Asset Management, that is turning out to be increasingly profitable.
Investing in technology: Others like Goldman Sachs are investing heavily in Technology and Platforms. They are also outsourcing a lot of operations to Low-Cost countries like India. JP Morgan is coming up with Blockchain-based crypto called JPM coin.
Still in the world of Finance, the prestige of investment banks holds significant sway. Changes have arrived but still, the pace of change is expected to be slower as compared to other industries.
The Author Prabhash Choudhary. is the CEO of Magistral Consulting (www.magistralconsulting.com), a firm that helps Investment Banks in outsourcing their operations. He can be reached at prabhash.choudhary@magistralconsulting.com for any queries.
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