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When Goldman Sachs chief economist Jim O’Neill coined the Bric acronym in 2001, he did investment banking two favours. First, he created a way to describe the world’s fastest-growing economic power centres in a manner that was neat, non-controversial and to the point. Second, by banding Brazil, Russia, India and China into one clearly tagged and non-political grouping, he gave investment bankers a hierarchical world cheat-sheet that could be constructed and reconfigured at will.
The die had been cast. Investment banks suddenly had a way of imagining and depicting the wilder parts of the world – so-called emerging markets – in real economic terms. Overnight, the world’s leading emerging markets had, in banking terms at least, emerged, becoming founder members of a clearly identified group of nations that will drive global economic growth for decades to come.
“Emerging markets’ time has come,” says Philip Lynch, chief executive officer Asia ex-Japan at Nomura, whose career has taken him through New York, London, Dubai and, three times, Hong Kong.
“The reality is that the bulk of world economic growth is going to come from emerging markets, and make up more than 50% of global growth over the next decade. It makes for a very fertile market for investment banks.”
Take Asia. The region, according to listed investment banks’ annual reports, accounted for just 14% of all global investment banking revenues in 2009. Of that total, China comprised a quarter of all Asia generated fees, south-east Asia made up 20%, South Korea 5.5% and India 4.8%.
In other words China and India, home to around one in every three human beings, together contributed barely 4% of the global investment banking profit pool. The potential for growth – and profits – is, from any angle, staggering.
CANDID PICTURE
In the course of researching this story, Emerging Markets spoke to a host of senior representatives at most major investment banks. Not all wanted to be directly quoted, but many senior bankers were, anonymously, prepared to provide candid and often surprising views on the relative importance of emerging markets to leading bulge bracket lenders. Here, painting with a broad brush, are the results.
China, to no one’s surprise, is the emerging market everyone wants to crack. “It’s critical,” says Nomura’s Lynch. “You have to get it right.” Elsewhere in Asia, South Korea, with its chaebol conglomerates, is a key target, as is south-east Asia, particularly highly populated Indonesia.
Slightly surprising is how marginalized India has become in the mind of investment banks. “It’s ranked after south-east Asia
for us, and that’s true for many of our rivals,” said a senior figure at an investment bank that did particularly well coming out of the financial crisis. “It’s over-competitive, inaccessible and protectionist, and it has a merchant class that’s very good at squeezing fees.”
Then there is the Middle East, a region flooded with oil and cash but not for investment banks, it seems, a plethora of prime markets. One senior Dubai-based European banker says: “People think of the Middle East as being full of potential everywhere, but in reality the region is all about three markets – Qatar, the UAE and Saudi Arabia – and how those nations trade and interact, financially and economically, with each other.”
In Latin America, it’s Brazil or bust. “Outside Brazil, there just isn’t enough business to justify being there unless you are a top-three local outfit,” says one New York banker with extensive experience in the region.
Another of the Bric nations, Russia, is a tough nut to crack on a regular basis. Goldman Sachs is on track to post $1 billion in revenues there for the first time this year, and Credit Suisse and Deutsche Bank have been ramping up their presence. But it’s also unpredictable, with an (admittedly slowly fading) reputation as a cowboy market. “Russia is so huge,” says one American financier. “You can make a lot of money there, but you can also get your face ripped off.”
Other key emerging markets are Egypt and Turkey, two traditionally non-aligned entities. And at the heart of central and eastern Europe, a region that has largely disappointed since the fall of Soviet communism, sits Poland. “Warsaw can become a genuine financial hub for the region,” says Ronnie Golan, head of investment banking and global capital markets for Africa, central and eastern Europe and Israel at Morgan Stanley, which recently announced its intention to open an office in the city. “Poland weathered the financial crisis well and can grow into a stock market with very strong and deep capital liquidity.”
Then there is Africa, a continent that has long been serviced out of suitcases, with bankers flying in from London and Paris to collateralize energy and mineral assets for European bourses.
Africa is changing fast. Most nations remain frontier states, too small to justify a representative office, let alone a fully-fledged franchise. But some countries, supported by carbon revenues and friendly-ish governments, are changing the way Africa is seen. Johannesburg has a thriving financial services sector, and is the portal through which the southern wedge of the continent is banked.
Nigeria, troubled and dangerous but boosted by oil revenues, is becoming a major economy in its own right. “The biggest thing you can flatter Nigeria with is that people say it’s the next Brazil – a new Bric country,” says Morgan Stanley’s Golan.
“South Africa is also categorized as an emerging market, but it is a sophisticated, large and well-banked market with a stable economy that has been growing steadily for a long time.”
PROFIT OR ROUNDING ERROR
“The question for any investment bank is: ‘What is the potential of an emerging market, does it have the population and economic growth required to justify a local presence?’” says Fawzi Kyriakos-Saad, chief executive, Europe, Middle East and Africa at Credit Suisse and co-head of the bank’s Global Emerging Markets Council.
“Local financial institutions will always have an advantage when it comes to local connectivity. Foreign organizations can get there [i.e. beat the local players], but it takes time and investment.”
China, for example, has critical mass, according to most senior bankers, while many developing countries are “just too small” to justify setting up business there, bankers contend. The corollary of that thinking is that some emerging markets are both tiny and, on a total-sum-game, important.
When, from around 2007, Moscow-based Renaissance Capital decided to specialize in sub-Saharan Africa, many scoffed. But it was a clever move: the bank now has six African offices (to Goldman Sachs’s and Morgan Stanley’s one – Johannesburg) in often-overlooked cities such as Accra and Lusaka. Most African markets are simply too small – they might generate $20 million in annual revenues, a small enough total, says RenCap’s head of global equities Nick Andrews, to “fall into the realm of a rounding error” for bulge bracket lenders.
Yet had RenCap not invested heavily in the continent, flooding its cities with analysts, bankers and traders, it would not be in the position it’s in now: helping African companies, increasingly dependent on finance from the world’s great mineral importer, China, capitalize and list shares in Hong Kong.
The Russian house has become something of a specialist in triangulating global capital, African assets and the nation-building drive of the Chinese government. Barring a few holes in its repertoire – notably Latin America – RenCap in many ways has become the archetypal global emerging market bank. Indeed, in June 2010, its chief executive, Stephen Jennings, said his aim was to create the world’s pre-eminent emerging markets investment bank.
As ever, local knowledge creates opportunity, which in turns greases the global wheels of any corporation, investment banks included. The more you know, the more you grow. Credit Suisse’s Kyriakos-Saad says: “For me, today you either have to be embedded in local markets, physically close to your clients, or not there at all.”
Morgan Stanley’s Golan says: “It is always possible to serve clients’ needs from one of the large central offices, but if you need to speak to a group of clients on a regular basis, that’s when you open a local office.”
PROBLEMATIC HEADCOUNTS
Banks are aware of this: most see the logic in boosting headcount and capital reserves within leading emerging markets.
Deutsche Bank is focused on doubling net Asia ex-Japan revenues to $5.4 billion in 2011 from $2.8 billion in 2008, with the region primed to make up 25% of Deutsche’s revenue base by 2017. In 2001, 69% of the bank’s staff were based in leading city hubs such as New York and London. That figure fell to 63% in 2005 and, this year, to 47%.
In some cases, aggressive hiring comes at the expense of leading hubs: Deutsche Bank has seen its staffing levels in Singapore and Hong Kong steadily fall over the past decade as bankers relocate to emerging Asia. Sometimes, it doesn’t. Credit Suisse is still hiring in the US, France and Germany, three archetypal developed markets, as it seeks to build its European presence.
Kyriakos-Saad says: “Investment in human capital has increased in emerging markets, but overall headcount growth in developed countries, such as the UK, Germany and France, is yet to decline.”
Nomura’s Lynch stresses this point, noting that while the Japan-based lender is still building up in Europe and the US, it isn’t yet at the point where it is “reallocating resources away from developed markets and toward emerging markets”.
Some countries, such as China, now the world’s second-largest economy, aren’t really emerging at all, but economic power-bases in their own right. Yet Beijing’s barriers to business, particularly in the banking sector, ultimately justify the developing nation tag. The same is true of Russia, a mineral-rich state with opaque regulations and thin deal flow. “Both are both open and not open, and their barriers make them into developing nations,” says one senior European banker.
Brazil and parts of south-east Asia excepted, it is broadly true that the more power and influence wielded by any emerging market, the more likely it is to impose explicit or implicit restrictions designed to emasculate foreign lenders.
“China is fostering the development of its domestic banks at the expense of global banks,” says the European banker. “India is the same – it’s a pretty closed market. Saudi Arabia is closed more for cultural reasons. In most major emerging markets, the process of liberalization is only happening on a bit-by-bit basis: it’s often very slow.”
Emerging market expansion is tough work for any corporation. You need to be nimble, deft and entrepreneurial, able to work in often hostile, capricious and corrupt environments. Investment banks, hidebound by onerous internal and external restrictions, reactionary shareholders, and a need to project solid corporate governance credentials, are rarely any of these things.
That in turn makes many emerging markets risky business for global bulge bracket lenders. Thus, while local and regional banks might be able to justify opening an office in Harare, Saigon, Abuja or Kiev, for most chief executives in New York, London, Paris or Frankfurt, such an idea is – at least for now – hard to countenance.
Yet that state of affairs has to change. Investment banks need emerging markets, not the other way round. They need them for the profit boost, the spark of new revenues, the ability to tap capital for rising corporations. They need to get to know leading local entrepreneurs and chief executives – the men and women who will drive emerging market corporates and economies for decades to come.
Ultimately, there is no proxy for being there in the flesh. Stephen Roach, Asia chairman and former chief executive at Morgan Stanley: “There is no substitute for local knowledge, local talent and local presence. It doesn’t mean you need to have an office and a team wherever you are, but you do need a regional headquarters.
“That gives you local knowledge, local language skills, and familiarity with customs and regulations.”