By Taimur Ahmad
It's not been the easiest of times for global investment banks. Press them, and most investment bankers will grudgingly admit that increased competition has led to pressure on their margins, and resulting fee compression over the last couple of years across all markets, developed and emerging.
There's also a growing sense in certain regions that the real money is not always going to be made in traditional investment banking territory, namely, debt and equity underwriting and M&A advisory. So, many banks are looking to their proprietary businesses (for example, pre-IPOs, private equity and non-performing loan businesses) for the big returns. This is especially the case in Asia.
Asia
The standard agency business is not as profitable as you might wish, says one Hong Kong-based banker at an international bank. Competition is harder so fees have dropped. At the same time, deal size has grown. So now these proprietary businesses are the typical businesses where many investment banks are focusing.
Last year Asia witnessed equity and equity-linked deals in the order of $70 billion. Taken as a whole, the Asian market offers more scope for investment banks than possibly any other emerging region in the world. The market is already quite large, but foreign banks are piling in because of the region's growth potential.
Still, the shift towards propriety business requires a very aggressive risk appetite and has tended to be the domain of players like Goldman Sachs. But most bankers argue that if a bank's business isn't fundamentally client-driven, it won't last. Many suggest there are at least three big banks that will be forced out of the Asian market by year-end.
I think [Asian] clients are looking for increased diversity of funding, says Ken Borda, chief executive, Deutsche Bank Asia.
But others shrug off the increased competition. Competition is not new in this business, says KL Wong, head of Asia-Pacific (excluding Japan) investment banking at Merrill Lynch, who is bullish on his bank's prospects in the region.
All eyes are on India and China. Yet foreign investors' concerns are growing over the large investments required of them, to buy small stakes in Chinese banks that rarely give them significant influence over the operations.
Goldman Sachs recently became the first foreign firm with a joint venture it effectively controls, while others such as Credit Suisse First Boston, Deutsche Bank, Merrill Lynch and JP Morgan look on with envy.
Richard Gnodde, president of Goldman Sachs Asia, says: Our Asia strategy is obviously integrated into our global strategy: we want to be the leading underwriter and adviser in the world.
On the whole, market leaders like Goldman Sachs have weathered the intense competition for such mandates well.
Latin America
In Latin America, investment banks have experienced some of the most acute pressure on margins in emerging markets worldwide, mostly in fixed income, although to some extent in advisory as well.
One banker, who heads a Latin American debt capital markets desk at a US bank, says: Underwriting fees have been crushed. Fees in emerging markets are generally lower than in US high grade but the risks are greater. It doesn't make sense.
For example, last month, Citigroup won the race to arrange El Salvador's $286.5 million 30 put, 15-year bond, with a bid of 0.95bp for fees on a 10-year bond, the lowest ever fee on an emerging market bond. The fee would rise to 10-year fees plus 15bp if the issuer could do a 30-year bond. The 15.95bp fees for the 30 put, 15-year bond compares with 30bp fees on recent Brazilian deals, and levels of about 50bp for sovereign deals a few years ago.
Citigroup, who denies it is cheap, is not alone in winning some mandates for low fees. Nearly all banks are dropping their fees as the pressure to win primary market business intensifies.
As a result, many banks are rethinking their commitment to the region. The challenge of increased competition and fee compression means that to survive, banks must demonstrate relevance to their clients. This means seeking out new products. One area that has shown great promise is the restructuring business, which has drawn the likes of Morgan Stanley and JP Morgan among others. Some M&A skills and resources are transferable to meet the increasing quality of restructuring work, says Steve Cunningham, head of investment banking for Morgan Stanley's Latin America division.
Given that debt issuance is patchy (though volumes are beginning to pick up again) and equity deals are infrequent, with very few IPOs, banks with a strong advisory capacity have a natural advantage. We are a bit uncommon, says Brian O'Neill, chairman of JP Morgan's Latin American business. A number of our competitors on the fixed income side don't have an advisory capacity, whereas M&A is the quintessence of what we do.
There is room for and a need for both large and well capitalized multi-product offering investment banks, and the small niche players, says O'Neill.
Throughout the region, there is also a growing emphasis on local capital markets financings, both in debt and equity. Product offerings are likely to focus on the debt restructuring and advisory business going forward.
Emerging Europe
In Central and Eastern Europe, debt markets are rebounding, especially with Russian borrowers returning after the banking crisis this year. Citigroup leads the pack in the debt capital markets, followed by Deutsche Bank and CSFB.
More generally, across the former Soviet Union many corporates are considering international issues, which means a lot of upcoming mandates for international investment banks operating in the region. Some bankers think that, in light of strong liquidity levels in the region, issuance volumes in Europe, Middle East and Africa in 2004 could turn out to be better than last year when a record $40 billion was issued in the region.
The trend, though, is likely to be the same as for emerging markets worldwide: increased competition and shrinking fees. One investment banker sums up the situation: You will have to offer a lot of extra services to win business.
Bank by bank profiles
ABN Amro
ABN Amro has reorganized changing its global country approach to one that is now more client led. This means product groups work with and through the client groups to offer a better service. Asia is one key region for the bank. ABN has a significant presence in every major country in the area, with particular emphasis on Greater China and India. It is also making selective advances in Latin America. In June, the bank co-arranged Venezuela's buy-back of $1 billion of six-month dollar denominated bonds. Critics, though, argue the bank fails to pull its weight in emerging markets.
Barclays Capital
Across emerging markets, Barclays Capital's business focuses on financing and risk management. Financing encompasses debt products from bond issuance to syndicated lending. Risk management goes all the way from foreign exchange to funding all Treasury activities and includes strategic capital structure related activities and liability management.
The bank is making inroads fast. In Asia, for example, it is aiming to become one of the top three bond arrangers over the next three to five years. It has had a particularly strong year in Korea, for example.
In Latin America, highlights include co-arranging Mexico's 20-year sterling offer earlier in the year as well as Venezuela's buyback. In emerging Europe, Russia is a key market.
Citigroup
Citigroup is the world's leading bond market underwriter and the second ranked arranger of global syndicated loans. Combined, these strengths give it a huge advantage over pure investment banks. Its emerging markets strategy? A geographic spread and capability across a range of products that overshadow its rivals and allow it to ride out market uncertainties with relative ease. The bank's ability to be aggressive on the balance sheet gives comfort to clients who tend to demand hard underwriting as part of its commitment.
The two big criticisms are (1) it is highly leveraged so difficult to grow, and (2) it sometimes charges low fees to win business an allegation the bank denies.
CSFB
The sudden departure of John Mack as chief executive hasn't altered CSFB's push for greater visibility. Nor
has the lateral shift of Adebayo Ogunlesi, until recently global head of investment banking. In M&A, CSFB has tended to go after the sole adviser or lead adviser role, where it believes it can provide real value and get
the fees.
The once-profligate bank has cut costs, especially in investment banking, to restore profitability. The question remains, though, whether CSFB can win back its big-cap clients. In fixed-income, under the watchful eye of Paul Tregidgo, the bank specializes in high yield and is a solid performer across all emerging markets.
Deutsche Bank
Deutsche Bank has made a formidable effort in debt capital markets over the last three years, powering
up the league tables and at the same time courting criticism of undercutting competitors, an allegation
it denies.
But Deutsche Bank can now claim to be a leading player in fixed income markets on a global basis. Its Global Markets Division has helped the bank become a leading player in a range of products. The danger is that Deutsche becomes even more reliant on an investment banking business that already accounts for 70% of pre-tax profits but is inherently volatile. If the performance of the whole bank is to be stabilized, the contribution of the private client and asset management division has to increase dramatically.
Dresdner Kleinwort Wasserstein
In debt capital markets DrKW has made big strides in Central and Eastern Europe. It is a consistent top five player in the region and has worked on some of the best deals to emerge in the past couple of years. Last year, for example, it co-lead managed Gazprom's $1.75 billion deal. Elsewhere the bank doesn't really feature in the top half of
the league tables although, in Latin America, DrKW co-lead managed Brazil's recent euro-denominated deal.
Goldman Sachs
The global rise in M&A volumes in the past 12 months can be largely attributed to the re-emergence of a few multi-billion dollar, complex, industry-defining transactions. Goldman Sachs has once again asserted its dominance in this market, advising on seven of the world's largest M&A deals over this period. The trend is no different in emerging markets, where Goldman remains a selective player, pouncing on the biggest deals in the most lucrative markets.
As is the trend among global investment banks, Goldman Sachs is moving to merge its fixed income and equities groups.
HSBC
Stuart Gulliver and John Studzinski, co-heads of HSBC's investment banking division, are setting out to improve the bank's position as strategic adviser on mergers and acquisitions and fundraising for corporations with which it already has strong lending and transaction services relationships.
Asia remains its obvious strength, but the bank has begun to make some selective gains, for example, in Latin America's debt capital markets. In particular, HSBC is beginning to make a name for itself in Mexico. Even so, the bank has yet to fulfil its potential in the emerging markets. HSBC is likely to invest at least $400 million over the next few years. Will it sit with Citigroup, Deutsche Bank and JP Morgan at the top table? Only time will tell.
JP Morgan
JP Morgan's debt capital markets business is facing stiff competition, not only from Citigroup but from Deutsche Bank this year the bank sits third in the league tables for all emerging regions.
The bank has lost a lot of talented individuals over the past few years, particularly those that used to work for the pre-merger JP Morgan.
The bank admits that its M&A advisory businesses is what differentiates it from the competition, especially in Latin America. There, the focus is on its strategic M&A advisory, and with it, a dedication to sales, trading and research. Off the back of these capabilities, it has built its capital raising businesses. A number of our competitors on the fixed income side don't have an advisory capacity, whereas M&A is the quintessence of what we do, says Brian O'Neill, chairman of JP Morgan Latin America.
Merrill Lynch
After two years of belt tightening and severe cost cutting, Merrill Lynch looks set to reap the rewards of its conservatism. In its emerging markets investment banking business, it's focusing a lot on Asia. Key markets include China, India, Taiwan and Korea. Elsewhere, in Latin America for example, Merrill Lynch is especially strong in structured finance. As with many of its peers, the bank combines its debt and equities businesses, which makes it easier to offer seamless solutions to clients.
Morgan Stanley
Morgan Stanley has rallied up the equities and M&A league tables over the past year and has been aggressively growing its businesses. Aggressive cost-cutting in recent years has allowed the bank to remain reasonably profitable, despite the industry-wide downturn.
In Asia, the bank is pushing heavily to develop its presence in order to compete for business – across all its investment banking businesses. In Latin America, Morgan Stanley is arguably less visible in fixed income than in the past, although it expects its equities business to bounce back. It is also leveraging its M&A business to move into corporate debt restructurings.
UBS
An often underestimated bank, UBS is a top five player in all aspects of emerging markets investment banking. Perhaps its biggest strength lies in equities, where it is number two to Goldman Sachs. In fixed-income, too, the firm is making its presence felt and now sits behind the big three of Citigroup, Deutsche Bank and JP Morgan. One of its most recent deals was Brazil's E750 million – the sovereign's first in euros for two years.
In Asia, UBS's private banking business is dominant, so it's very easy for the investment bank to come in and piggyback off that. In Central and Eastern Europe, the bank has a strong presence in Russia. In August, UBS agreed to buy out Brunswick Capital's share of their joint venture Brunswick UBS, an equities brokerage.