Emerging markets: more about marketing than emerging

When I started as a Wall Street lawyer in 1993, emerging markets were all the rage. I worked on big deals in Latin America, shuttling between Mexico City and Buenos Aires on a regular basis.

It was a heady time, and investment banks were pouring resources into the region. In Mexico the neo-liberal presidency of Carlos Salinas de Gortari and the ratification of the North American Free Trade Agreement fuelled investor optimism, while Argentina thrilled investors by taming inflation, thanks to economy minister Domingo Cavallo’s 1991 Convertibility Plan.

But by the mid-1990s, the party had fizzled out and the deal flow had dried up. Currency chaos, political upheaval, and financial crises whacked investor confidence hard.

By the time I moved to Europe, the former Soviet bloc states had emerged as the next frontier. Joining Deutsche Bank in early 1997, I watched bankers flock to Russia and Central and Eastern Europe for big fundraisings. But 18 months later, the Russian rouble lost two thirds of its value in three weeks, and investors soon decided they preferred tech, media and telecoms companies to Hungarian privatisations. Bankers had earned more in airline points than actual fees.

I can’t pinpoint the exact date, but sometime in the late 1990s I went from emerging markets evangelist to (partial) sceptic. I continued to recite the liturgy about EM as a growth engine, but my faith had been shaken. Would emerging markets really offer an outlet for future growth for investment banking? Or would it just be a mirage, benefitting Western-educated coverage officers in those countries but providing no real, sustainable returns through the cycle?

I’m still a Doubting Thomas. Oh, I’m sure emerging market fixed income and currencies can be profitable to trade, and transaction banking and treasury services may offer a seam of attractive earnings if compliance and regulatory risks can be managed.

But the same cannot be said for the bread-and-butter corporate finance activities, such as M&A and capital markets. All these years later, emerging markets are still emerging, and bankers are still bigging up their potential to senior managers and journalists. But the reality is that too many bankers chase too few deals at too tight a fee spread in the name of supposedly building a franchise and against a backdrop of political and economic instability, as well as reputational risk.

In short, it’s a slog for slim pickings.

Emerging markets investment banking has no shortage of internal champions within the banks. First, there are the local coverage officers: they are paid handsomely; have grandiose titles like president of country X, or chief executive of country Y; and can get a meeting with almost anyone by deploying their bank’s business card. They are often alumni of global financial institutions, and brand-name US or UK universities, as well as scions of well-known families. So, the country coverage job has a profile and prestige commensurate with their social status.

Second, it’s sometimes fun for bankers in developed markets to visit EM countries. You often stay in the finest hotels, eat in the best restaurants, and have access to the most senior echelons of business and society.

Some of my most enjoyable business trips were to the emerging markets. I dined at incredible venues, saw some amazing sights and met fascinating people. One of my favourite memories was attending a barbecue at a colleague’s breathtaking horse farm. The setting was spectacular, and I felt like a king. You don’t get that in Dusseldorf or Detroit.

Third, a presence in emerging markets allows senior management to boast of their firm’s ‘global reach’.

The more grounded argument is that you can be credible with multinational corporations only if you have a footprint all over the world.

This claim is asserted more than it is substantiated, especially since multinationals are quite adept at divvying banking mandates according to particular expertise, or more to the point, capital commitment. Anyhow, emerging markets investment banking can smack of an expensive exercise in marketing and bragging rights.

After so many years of promise, you have to wonder whether EM investment banking has earned anything like an acceptable return. It has so far been mostly for show, and the hit-or-miss results have been more miss than hit.

There are nuances and exceptions, but a few generalisations hold for much of it.

For one thing, it’s clear that small markets are scarcely worthwhile for the global banks. When I started at Deutsche Bank, there were two senior investment bankers to cover Czech clients, and we were racing to pitch IPOs on the Prague Stock Exchange. Fast forward 27 years and that seems ridiculous. There might be the odd deal but, other than the big emerging markets, most countries are lucky to have a major transaction once every few years.

This means banks have gradually focused on the big markets, such as the BRIC countries. But they have not been unproblematic places in which to do business. Brazil blows hot and cold (right now, it’s frigid); Russia is off limits following its invasion into Ukraine and has long been a difficult place for investment banking; India has exciting growth companies but severe fee compression, not to mention governance challenges; and China, unquestionably the ‘best’ emerging market, has boomed and busted in recent years amid a crackdown on key sectors and new rules to limit overseas listings.

Other larger markets such as Mexico, Turkey and Indonesia still haven’t come through with consistent dealflow, either, even if they have been hyped up repeatedly over the years.

Meanwhile, investment banking talent in these countries is scarce, with skilled personnel demanding big rewards during the good times. When things slow down… well, the banks have a lot of overhead costs to bear: rent on prime office space, trained staff in the front and back offices, licences, systems, technology, the list goes on.

The great hope today rests in the Gulf region. Investment banks are ramping up their efforts, buoyed by a surge in IPOs. “The Middle East’s ECM transformation has further to run,” wrote Global Capital two weeks ago. And it’s true: offerings have been well oversubscribed and traded up in the aftermarket. Is this the Age of Aquarius for Gulf investment banking?

Maybe this time is different, maybe the sheer weight of capital in Abu Dhabi and Riyadh and their tax and regulatory appeal mean that investment banking takes off on a sustainable basis, as fund managers build out their local presence and expats pour into the region. But I have a few words of caution.

For one thing, international banks aren’t earning all that much from these deals. Fee spreads are tighter even than in stingy Europe, and the lion’s share tend to end up with well-connected, and sometimes state-affiliated, domestic institutions. The offerings tend to consist of privatisations of crown jewel companies, and they will remain in friendly hands even after listing. What happens when those are exhausted?

The reality is that the biggest fee events for Middle East investment banking arise from margin lending and M&A linked with investments into Europe or the US, such as Morgan Stanley’s work to finance STC Group’s stake-building in Spanish telecoms giant Telefónica. In this context, big fees come from funnelling Gulf money into developed markets, not supporting home market growth. Moreover, it turns the local coverage bankers into concierges and not advisors, as they host colleagues flying in from London or New York.

The product range for emerging markets remains limited. Equity underwriting grabs more headlines than fees, and margin lending and M&A revenues are primarily tied to developed markets. Leveraged finance is virtually non-existent, and debt underwriting is confined to the low-margin business of sovereign and blue chip company issuance in major currencies. For the big banks this business will rarely move the needle.

EM investment banking still looks more like a vanity project than a profitable prospect. It seems more about image than income. FOMO-ridden banks keep pouring in resources, chasing the dragon of untapped riches and nurturing the pretension of a global presence. The shimmering promise of a deep fee pool feels just a few short years away — just as it did 30 years ago.