Emerging markets are having a great year. Suneel Bakshi, global head of Citigroup's emerging market corporate banking business, says: "From our point of view, emerging markets are in a sweet spot at the moment. Volumes are high in every product from M&A to debt products."
Growth in both the size and number of debt, equity and M&A deals has been driven by ideal external conditions. Low US rates and under-performing developed stock markets has meant around $12 billion in western pension fund money has in the last 12 months, according to the IMF, channelled into emerging markets in a global search for yield.
In addition, commodities prices have been at all-time highs. That's led to record pools of corporate liquidity in regions like the CIS and Middle East. A lot of that money has been flowing into local capital markets, or been used for M&A activity.
As a result, both debt and equity emerging markets have been out-performing developed markets. The MSCI emerging market equity index is up 11.5% year-to-date, with stock markets from Moscow to Istanbul hitting all-time highs. The JP Morgan emerging market bond index, meanwhile, has tightened 12 points in the first half of the year.
Investment banks have made good money from these rallies, through their proprietary trading desks. John Davitte, head of emerging market research at consultancy firm IDEAglobal, says: "This year, banks' prop desks have been heavily involved in some fixed income plays, particularly on Brazil and Turkey external debt."
Secondary trading
Secondary trading commissions have been a good source of revenue too, according to John Lomax, chief emerging market strategist at HSBC. He says: "Volume in the secondary market has been almost double what it was in 2004, as emerging markets have been increasingly attracting global and developed market funds, in addition to dedicated emerging market funds."
Banks have also been making good money selling to an increasingly important client – hedge funds. Banks have made money packaging bonds and loans into credit derivative baskets, which have proven very popular with hedge funds.
Alexis Rodzianko, CEO of Deutsche Bank Russia, says: "Banks have been doing a lot of deals through the credit derivative markets. They get less publicity but higher margins. You'd do a straight lending deal, then repackage it through CDS. It's a growing business."
The rallies in debt and equity secondary markets have been tempting many emerging market companies into new debt issues and IPOs.
In debt, bankers complain that fees for regular issuers have compressed to new lows. Fergus Edwards, head of Asia debt syndicate at JP Morgan in Hong Kong, says: "Compression has been fairly severe for regular issuers. The Philippines, for example, paid just 0.03% fees on its $250 million, 10-year bond in May."
However, fees have been better for debut and high-yield issuers, of which there have been many, particularly from Hong Kong and Brazil. Ukraine and South Korea have also been good sources of debut debt issuance.
Banks have been doing well from IPOs this year, in Russia and particularly Asia. Hardly any Russian companies floated stock in 2004, but this year over $4 billion has been raised, including Sistema's $1.56 billion London offering. CSFB and Morgan Stanley have totally dominated the CEE IPO market. Tom Ahearne, head of CEEMEA equity capital markets for CSFB in London, says: "IPO fees have stayed fairly steady over the last 12 months, and the business remains profitable."
The world's biggest IPO, however, came from China – China Shenhua Energy's $2.95 billion IPO in June. It was the first of six Chinese state companies looking to raise $15 billion through IPOs this year, which will make lead managers around $500 million in fees. UBS and Goldman Sachs have done best in this sector in 2005.
M&A thrills
Perhaps the most exciting growth area in emerging markets has been M&A. After a quiet 2004, this year has seen some big deals, particularly in the oil and gas sector as Chinese, Russian and Indian oil companies undertake multi-billion dollar deals. In Russia, Gazprom is raising a $10 billion loan – the biggest ever emerging market loan – to buy Sibneft from Roman Abramovich. The banks in the deal, yet to be mandated, stand to share a total fee-pot of $1 billion on the loan, according to one lawyer working on the deal.
In August, CNPC, advised by Citigroup, bid $4.1 billion for CIS oil company PetroKazakhstan. Another Chinese oil company, CNOOC, was only frustrated in its $18 billion bid for Unocal when US Congress kicked up a fuss. Finlay Thomson, oil and gas analyst at ABN Amro, says: "We'll see more big deals involving Indian and Chinese oil companies, because their appetite for energy is so big. China is using so much oil at the moment, that PetroKazakhstan's total reserves account for just 100 days of China's energy consumption."
While CNOOC may have been unsuccessful in its bid for Unocal, emerging market companies are increasingly acquiring assets abroad, including in developed market companies. Mexican cement company Cemex, for example, bought UK cement company RMC for $5.8 billion at the end of 2004. High corporate liquidity has made Middle Eastern companies important buyers too. Jesse Solomon, EMEA research analyst at HSBC, says: "Gulf investors have announced $8 billion in overseas acquisitions in the past 18 months, with targets ranging from Celtel in the Netherlands, to the Tussauds Group in the UK, to CSX Corp's World Terminals in the US."
Broader trend
Suneel Bakshi of Citigroup says the overseas expansion of emerging market companies is part of a broader trend: "We're seeing emerging market companies really come of age, becoming more sophisticated in their financing, meeting international levels of corporate governance, and expanding beyond their domestic borders. That means banks have to re-think their relationship model, basing it on a strong local knowledge and presence."
Most investment banks have been doing just that – building up local teams and occasionally acquiring local brokers to give them strong local presence. For example, Deutsche Bank recently bought up all of UFG, a Moscow brokerage, for around $150 million. UBS likewise bought 100% of a Moscow brokerage, Brunswick, in 2004.
Banks will be hoping they aren't making the same mistake they did in 1997 – of setting up large local operations, only to see emerging markets collapse. But most bankers and investors feel optimistic that emerging markets are more resilient now than perhaps ever before. One banker in Mexico City says: "Emerging markets have gone through their crazy, unpredictable years. Now, they're increasingly a normal part of the global market, so we can start doing some really sizeable deals."
Bank by bank profiles
ABN Amro
The Dutch bank has been forced to cut costs and re-focus on its core business. In emerging markets retail, the bank seems unsure what it wants to be – a niche player or a universal bank. In investment banking, it has done better. It has been bold in both Latin American and east European debt, particularly in Kazakhstan, where it's a market leader. In Latin America, it was the first bank to bring a Venezuelan corporate to the loan market for 48 years. In Asia, though, it has yet to make a real impact.
Barclays Capital
Barclays Capital has done a good job at building up its investment banking business fast, but it still has some way to go if it wants to catch up with the top emerging market banks. It has a decent presence in Africa, which it recently strengthened through the acquisition of a South African bank, Absa. Barclays Group CEO John Varley says he wants the bank to be strong in Asian investment banking. So far, the bank is strong in Hong Kong dollar bonds, but not much else. And it is surprisingly weak in CEE fixed income, considering its chairman, Hans-Joerg Rudloff, helped create the market in the 1990s.
Citigroup
Citi has an awesome investment banking debt business. It dominates Middle East debt, Latin American debt and Asian debt. The one area where it doesn't dominate is Russian debt, which has been quite a lucrative market. No one is making a bigger bet on emerging markets' continuing success than Citigroup – its lending to Brazil rose 11% in 2004, for example. That means, if the bottom should fall out of emerging markets, Citi would be worst hit. The bank is also one of the best placed to capitalize on the upswing in the M&A business – it advised on $90 billion-worth of deals in Asia (excluding Japan and Australia) in the last 12 months.
CSFB
Credit Suisse has clipped the wings of its investment banking division, but it doesn't seem to have affected its emerging market business too badly. Its strength is in the equity business – it is a leader in eastern European and Latin American IPOs. It's advising on two enormous Kazakh IPOs in the next eight months. It's also done some good privatization deals, such as the PKO privatization in Poland. And it's right up among the leaders in Latin American and eastern European fixed income. But if it really wanted to compete globally, it would have to get a firmer foothold in the lucrative Asian M&A market.
Deutsche Bank
Deutsche has, with JP Morgan, one of the strongest credit derivatives businesses around. It's been leveraging that strength to increase its exposure to emerging market credits, then repackaging the loans into CDS. That means it can take on more debt, and make good margins selling the debt on to hedge funds. As a result, Deutsche is happily taking on EM risk. One hopes the hedge funds can correctly assess the risk they are taking on. The bank is strong across emerging market debt, but not such a big player in equity. Local brokerage acquisitions like UFG in Russia might improve that.
Goldman Sachs
Goldman doesn't make an effort to be a universal emerging market bank, concentrating instead on what it does best – IPO and M&A advisory. It is the world leader in IPOs this year, claiming back the top spot from Morgan Stanley. It's been helped to that position partly through some big Asian IPOs. It advised on the Bank of Communications' successful $2.2 billion IPO in June, and is rumoured to have recently won the mandate for Bank of China's $5 billion IPO early next year. It's also advised on over $80 billion in Asian M&A deals, and has worked on some of the biggest Latin American deals, such as Mexican cement company Cemex' $5.8 billion acquisition of RMC in the UK. It is curiously absent from the eastern European IPO and M&A market, however.
HSBC
HSBC has said it wants to compete with the biggest banks in emerging markets. It is not doing too bad a job in Asia, where it is strong in the growing local currency bond markets as well as the loan markets. In Latin America, it puts in a good showing for loans, but is less strong in fixed income. It needs to shape up in eastern Europe, though – it's done a few Polish IPOs, and won some restructuring advisory mandates, but has yet to win significant Russian debt or equity deals. "The world's local bank" could probably do with more local presence in key markets.
JP Morgan
Whether intentionally or not, JP Morgan seems to be scaling back its presence in emerging market debt. In Latin America, it has handed over its crown as the biggest debt provider to Citigroup. In eastern Europe, it has lost its head of fixed income, and is struggling to stay in the top three. In Asian debt, it's 11th. It's IPO business is similarly on the skids – in Latin American IPOs, it's ranked just 14th. Perhaps president Jamie Diamond doesn't think emerging markets are an important business?
The bank is, however, as strong as ever in advisory work, doing the most M&A deals in eastern Europe, and putting in a top five position in Asia. It's done some of the biggest deals in Latin America, but has yet to establish dominance in Brazil.
Merrill Lynch
Merrill has a good Asian business, where it's done around $55 billion in Chinese IPOs. It is not quite among the biggest M&A houses in Asia, but is snapping on their heels. It also has a decent Latin American business, advising on IPOs such as the issue for Brazilian electricity company CPFL Energia. But again, it doesn't have much of a showing in eastern European IPOs and M&A, where it has lost some senior bankers to local brokerages.
Morgan Stanley
John Mack recently appointed Walid Chammah head of investment banking at Morgan Stanley. Chammah, like Mack, comes from a fixed income background, so perhaps the bank will shape up its emerging market fixed-income business, where it is not strong. It has a good showing, at least, in Chinese high-yield debt. The bank is stronger in IPOs – it has done most of the big Russian IPOs and is in the top five for Asian IPOs. But it's really making money in M&A, particularly in the huge Asian market. It has been helped in the Asian market by its 34% stake in China International Capital. It is also building up its presence in Moscow.
UBS
UBS is, together with Deutsche Bank, probably the strongest European bank in emerging markets. However, its presence is a bit patchy. Where it's good, it's very good – in Russian debt, the bank has brushed aside Citigroup and JP Morgan to establish dominance. It's also a top three player in Latin American, Russian and Asian IPOs, and has one of the best research teams in emerging market equity. The bank has done well to position itself as one of the hedge funds' favourites for prime brokerage and other services. But its presence is weaker in Latin American and Asian debt.