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Money for nothing: passive bookrunners are the least-bad solution

Investment banking is rich in situations that seem ridiculous. The existence of passive bookrunners — banks paid fees for doing no work — is a prime example, but it’s the least-bad compromise in a difficult balancing act.

Defending the existence of the passive bookrunner seems impossible. Banks mandated in this august role are paid in line with their active counterparts, but have no work to do on the new issue at hand.

Work without pay might seem the dream — retailers would not be struggling if they were paid without selling products — but investment banks aren’t like other firms, and the absurdity of the passive bookrunner is part of a carefully balanced equilibrium.

The problem is this: bond mandates are, in part, payment for previous services rendered, and not always reflections of market competence. Every bank in the top 10 can execute a new bond issue for a well-known corporate with roughly equal skill. The ones mandated to do so, however, are the ones which also lend.

Since the crisis though, more and more of the banks that lend to corporates are clamouring for capital markets business. Bank capital requirements have increased, and banks must squeeze every ounce of profit from their corporate relationships. While top corporates borrow more cheaply than banks, capital markets fees must make up the difference.

Corporates have some sympathy for banks, but few good options. They want to keep their relationship banks, but won’t pay more for backstop credit they don’t use, and don’t want to screw up their bond deals by mandating 15 squabbling banks every time they issue.

Hence the passive bookrunner. It’s a freakish, but elegant solution to a thorny problem.

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