the financial services industry. Have these linkages changed over time? If so, how have they changed? Give appropriate examples.
The financial services industry can be divided into the four broad sectors. See Smith and Walter, Global Banking (2003). 鐦 𡃶 的四㷻
1. Commercial banking which involves traditional banking activities of
BANK3014 INVESTMENT AND PRIVATE BANKING
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WEEK 2 TUTORIAL SUGGESTED SOLUTIONS WEEK 1 MATERIAL
Concept Review Questions
1. Briefly explain the possible linkages amongst the various segments of
移而改变?如果是 deposit taking and borrowing and lending and investment. These FI’s 的话，他们是如何 typically operate at both the retail and wholesale (corporate) levels.
2 2. Securities businesses (Investment banks). 改变的?给予适当 证券业务
3. Asset management. These businesses provide bespoke wealth 例子 3资产管理management services to individuals, corporations etc. and includes private banking and pooled or collective investment vehicles. These activities could be delivered by stand-alone asset management firms,
or as part of a commercial or investment banking operation.
4. Insurance. Insurance whilst often not thought of as part of 4雠 mainstream financial intermediation receives premiums from customers and invests surplus funds to build reserves for claims. In this sense insurance companies mobilise small funds into larger investments. Insurance can be general (e.g. property insurance) or
life insurance.
The predominant trend has seen these segments merge into single organisations referred to as universal banks. This model as long existed in Europe and has been the most common FI model there. By comparison, the development of universal banks in the US, Australia and the UK is a much newer phenomenon. The process in these countries has taken many forms but to a large extent it has occurred via the acquisition or establishment of new operations by commercial banks.
2. What are the key factors behind the current and emerging trends in the
linkages between the commercial and the investment banking segments of the financial services industry?
There are many reasons behind the increasing linkages between the sectors noted in Q1, and in particular commercial banking and investment banking, and thus this is to an extent an open question.
But one of the principal factors is that changes in the environment, in terms of both regulatory and market conditions, have allowed commercial banks to take advantage of their ability to service their clients in terms of financing their operations and business investments and to leverage this in the provision
“pure play”投资银 行的崛起和衰落， 无论是在国际上还 是在澳大利亚
investment banks, both internationally and in Australia. 藏司
“Pure play” represent investment banks who exclusively provide investment
of investment banking related services. These advantages principally arise from the existence of economies of scale and scope which arise from the combination of the two types of services and arise because of the existence of fixed costs.
Economies of scale, for example, in financial intermediation amongst other things a FI needs physical assets such as branch networks and intangible assets such as risk assessment and management skills. Due to the considerable costs in developing both types of assets the breakeven point is considerably higher. That is, significant volumes of deposits and loans are needed to be profitable.
Economies of scope exist across two types of financial services that share a common fixed cost. For example, both commercial banks and investment banks need to develop skills in analysing current future prospects of companies with a view to either extending a loan or providing a capital market related services (e.g. IPO, M&A, etc.). Under the specialist system commercial banks and investment banks need to develop this skill independently incurring relevant costs. However, since a common skill is required in this risk assessment on companies, there is a potential cost saving if one institution is providing both types of financial services as the fixed cost is incurred only once.
3. Explain the extent to which changing regulatory environments and
market factors have led to both the rise and the decline of the “Pure Play”
banking services and who do not also provide other traditional commercial banking services.
The regulatory environment 监管环境
In the US by virtue of the Glass Stegal regulation and in Australia the Banking Act prevented NBFI’s (including investment banks) from accepting deposits from the public. These organisations therefore have their genesis in legal and regulatory regimes. They were also able to develop due to regulatory factors, for example in the US commercial banks were prevented from providing these services or from owning a business with a substantial presence in these markets.
In Australia the regulatory environment particularly, the application of reserve requirements on banks, created an environment in which pure play investment (merchant)banks were able to flourish at the expense of commercial banks.
Perhaps unsurprisingly the removal of many of these regulatory restrictions in both the US ( Bliley- GLB) and Australia (following the Campbell Committee recommendations) led to the decline of the pure play investment banks to a large extent through via acquisition by commercial banks.
The period of the 1980’s can to a large extent be characterised as a period of banking deregulation. In most jurisdictions this led to rapid growth in lending activities and credit. This also led to the rapid growth of financial markets and in turn to the growth of investment banking businesses. This
The market environment
period of rapid growth came to an end in the early 1990’s with a recession in most developed economies.
In Australia the recession of the early 1990’s coupled with the regulatory reforms initiated by the Campbell Committee led to the decline of pure paly investment bank operations. These tended to be merged into the operations of parent commercial banks. The exception is Macquarie Bank who took its merchant banking businesses into a licensed banking structure in 1985.
In the US the 2008 Sub-prime debt crisis and the resultant GFC caused enormous losses to US pure play investment banks. Those forms that survived the rationalization that followed GLB that were acquired by commercial banks, became bank holding companies or folded (such as ).
4. What are the differences and similarities between the way in which commercial banks and investment banks undertake financial intermediation. To what extent do you consider that these factors have contributed to the trends that you have noted in Question 2 above?
The core role of financial institutions is to intermediate the flow of funds in the financial system. FI’s mobilise savings and investible funds from lenders for use by borrowers. A traditional FI (commercial bank) does so via traditional intermediation involving accepting deposits and borrowings and making loans and investments. These transactions involve the FI as principal to the transactions. An investment bank facilitates the issuance of financial assets or securities by the borrowers and the placement of these assets with investors via financial markets. The investment bank is an agent in these transactions rather than a principal. It should be noted that investment banks may acquire assets from time to time for example as a result of an underwing commitment or because the investment bank wishes to hold the assets as an investment or more recently as part of a securitisation arrangement. These assets will however commonly be held in the form of marketable securities.
5. Briefly describe the key operating divisions or activity segments of investment banks. How do each of these contribute to the financial intermediation role undertaken by investment banks?
A typical investment bank operates the following divisions:
1. The investment banking division which typically includes the following activities; equity capital markets, debt capital markets and mergers and
acquisitions.
2. The Trading and Sales division which typically covers activities in fixed
income, currencies and commodities and equities.
3. The Asset management division which typically includes collective
investment schemes, investment advisory services and private banking.
Extension Question; an Open Question
1. Having regard to the developments that you identified above, what future changes in the structure and operations of investment banks do you consider are likely to occur? Give reasons.
2. Read article “
The Muscle Flexed in the $74 Billion
Bristol-Myers Deal
” on Canvas and discuss the advantage and disadvantages
of universal bank.
Open question no suggested solution provided.
BANK3014 INVESTMENT AND PRIVATE BANKING
WEEK 3 TUTORIAL QUESTIONS BASED ON WEEK 2
(Note: Some questions adopted from CFA)
Concept Review Questions
1. Identify the key factors that an issuer of equity will consider in selecting an investment bank to be the lead manager of its equity issue. What attributes must an investment bank be able to demonstrate to indicate its credentials in relation to these key factors and what types of metrics do you consider would be useful to do this?
It should be noted that in practice investment banks (IB) will need to pitch an IPO to potential issuers. This could be a “pre-emptive” proposal where the IB has identified the potential of an IPO and delivers a proposal to a client or it could be via a competitive bid, where the potential issuer has decided that it wishes to undertake and IPO (or indeed a follow-on issue) and has called for proposals. The following factors are identified by Liaw on page 121, together with some additional factors that might be considered:
(a) Reputation. This factor will highlight the IB’s history of IPO’s and their success. This will include details of league tables and other performance metrics such as the proportion of securities placed, the returns on issues managed by the IB.
(b) Experience. This factor will consider the IB’s experience in a particular market or industry segment. This would include for example details of successful IPO’s in the same industry in which the potential issuer operates, or with particular instruments such as preference shares or convertibles in a follow-on issue.
(c) Distribution and marketing capabilities. This will examine the IB’s positioning in the industry segment of the potential issuer including any market making activities. It will also detail the extent of the IB’s relationship with potential classes (no names) of institutional investors who are likely to have an interest in the issue. This will assist in giving the potential issuer confidence that the size of the issue proposed can be sold/placed by the IB.
(d) Fees. The range of fees that would be proposed. These would include the management fees, underwriting fee and selling concessions that are envisaged.
(e) Research. The extent of research that the IB undertakes of the potential issuer itself or the industry segment. The quality of this research would also need to be highlighted and this may include details of the relevant research team/s and their expertise and experience.
(f) Underwriting terms. As well as fees the details of the underwriting arrangement that is proposed should be presented. Will the issue be a bought deal/ firm placement or best efforts? How will the terms of the placement be agreed and when and how will the underwriting commitment be firmed up?
(g) After-market services. What aftermarket services will be provided? How will the IB ensure that the share price is supported in the market and that sufficient liquidity exists post listing? Are any special arrangements such as a “greenshoe” process or other over-allotment processes and how will these operate?
2. What are the key functions that the lead manager in an initial public offering performs. What are the risks associated with these functions and how can the investment bank who acts as the lead manager mitigate these risks?
(a) Preliminary analysis involves initial due diligence including an assessment of:
(i) the company’s business plan and in particular ensuring that this is adequately documented and formulated.
(ii) assessing the existing capital structure to determine how the IPO is likely to impact on the existing shareholders but also on the current leverage ratio of the company.
(iii) reviewing the governance structures in particular the structure and composition of the company’s board and board sub-committees, such as audit committee, nominations committee and HR and remuneration committees.
(iv) the initial structure of the offer in particular considering it in the context of the existing shareholding structure, for example should the IPO include a sell down of the existing shareholdings or the creation of new shares or class of shares.
(v) reviewing the company’s operations to ensure that it complies with the ASX requirements for listing around performance, asset size and expected spread of shareholdings.
(b) Regulatory research involving:
(i) initial discussion with ASX about the potential IPO.
(ii) the commissioning of research reports from experts for example mining engineers if the listing involves resources or scientists if the listing involves medical
or other scientific developments or activities.
(iii) the preparation of the prospectus. This will involve
coordination with the other members of the IPO team.
(iv) the lodgment of the prospectus with ASIC and dealing
with any comments by ASIC.
(c) Structuring the offer involving determining:
(i) the timing of the offer, the valuation, size and structure of the offer.
(ii) establishing the terms of and executing the underwriting agreement. This will include a consideration of any co-managers or sub-underwriters in the issue.
(d) Execution of the IPO involving:
(i) the marketing of the offer including the roadshow, presentations to and issuing prospectuses to clients of the IB.
(ii) finalising pricing of the issue.
(iii) the book-build involving accepting and recording
applications.
(iv) the allocation of shares.
(v) aftermarket support for the issue. This involves
operating in the secondary market to support the price and the liquidity of the issue once trading commences.
3. Towhatextentdoyouthinkthatunderwritingisanimportantactivity undertaken by investment banks in the issuance of new equity? What are the two principal types of underwriting arrangements? How can an investment bank manage the risks that it is exposed to in each of these two types of underwriting arrangement?
Underwriting is a key value add that IB’s provide in an IPO as well as follow-on issues. The underwriting (depending on its structure) guarantees the issuer the full amount of the proceeds from the issue which issuers see as being highly valuable to them. Liaw ,for example, notes that underwriting requires the underwriter to have a strong balance sheet and access to funding to be able to fund any shortfall from the underwriting and to carry the associated risk. This has enabled large commercial banks such as Citibank and Bank of America to leverage their financial strength to become significant underwriters of new issues and hence capture a large market share of the IPO market. This indicates the importance of underwriting in securing IPO mandates.
There are two types of underwriting arrangements:
(a) Bought Deals/ Firm commitment. Under this arrangement the underwriter commits to purchase the entire issue at the agreed price. The risk associated with the issue is transferred from the client to the underwriter.
The risk associated with the can be managed by the underwriter by:
(i) Charging a fee designed to cover this assessed risk.
(ii) Pricing the deal so that the price is attractive to
potential investors. This runs the risk of the issue being
“under-priced”.
(iii) Using its expertise in the market and relationships with
its clients to gauge the likely interest in the issue. Note the underwriter cannot promote the issue prior to the lodgement of the prospectus and the conclusion of the ASIC review period, so this must be general in nature.
(iv) Engaging sub-underwriters to assume part of the risk. The sub-underwriting arrangement with particular sun- underwriters could cover various market segments based on, for example, the types of investors (e.g. retail vs institutional or types of institutional investor) or region or even country. This will however reduce the underwriters return because fees will have to be paid the sub-underwriters.
(v) Obtain a discount on the shares compared to the offer price. This too is in effect a form of fee to compensate for the risk.
the underwriter commits to use its best efforts to place the shares at the agreed price. The issue however will carry the risk for any shortfall. In this underwriting the underwriter will receive a smaller fee which will compensate it for its effort in placing and marketing the issue to investors. It should be noted that even in this form of underwriting, the underwriter continues to carry reputation risk. If the issue is not fully subscribed this will reflect poorly on the underwriter and this will in turn affect its ability to bid for future deals (see Q1 above).
4. What would motivate a Company consider the issuance of a secondary equity issue? What role does and investment play in secondary market issues and in particular what factors do you consider an investment bank should consider in arriving at a recommendation to its client on the most appropriate instrument/s to be issued?
An important factor to consider in follow-on or secondary market offerings is the impact on existing shareholders. In particular a new issue will dilute the earnings per share of the existing shareholders as well as potentially dilute control. These factors need to be carefully considered in any follow-on issue.
efforts underwriting. In this underwriting arrangement
(a) Strong stock performance or supportive equity research
This would potentially enable the company to issue additional equity at an attractive price. This will however depend on the structure of the issue, dilute the earnings per share of the existing shareholders. This may be less of an issue of the forecasted increase in performance occurs because this will reduce the future dilutive effect on earnings. This could be ameliorated by the use of a rights issue. A convertible bond might also be attractive instrument in this case because the option to convert will be very valuable and hence the cost (interest rate) on the bond might be low.
(b) Large insider holdings or small float / illiquid trading.
The issue of new shares will, all things being equal, enhance liquidity of the shares in the market. This will however require the new shares to be places with investors other than the existing shareholders otherwise the objective may not be achieved. It is also important that if the new issue is placed with institutional investors that these are active traders rather than “buy and hold’ style of investors. A rights issue may not be a desirable strategy in this case, a private placement may be more effective because the investors can be identified based on their presence in the secondary market.
(c) Overly leveraged capital structure.
The issue of new shares will improve the capital structure of the company (typically its debt to equity ratio). In doing so it will reduce the company’s risk profile and improve it borrowing costs. It should be noted however that ordinary shares carry the largest risk in the “risk stack” hence the related cost of capital is highest. This may result in an increase in the company’
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