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Chapter 2
Investment Banking Industry
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I. Investment Banking in the U.S.
A. Investment Banking Regulationsa. 1933 The Securities Act and 1934
The Securities Exchange Acta) The Securities Act of 1933
Regulation before public offering Full disclosure in Prospectus(Due-diligence)
b) The Securities Exchange Act of 1934 Securities Exchange Commissions (SEC) Securities Exchange Systems Securities Settlement Rules Registration Requirements
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I. Investment Banking in the U.S.
Illegal trades Registration statement (S-1)
Financial statements Pricing Underwriter commission Contracts, documents
Securities Exchange Commission (SEC) Regulations Implementation Corporate Finance Market Regulation Investment Management
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I. Investment Banking in the U.S.
b. The Glass-Steagall Act of 1933 Separate the deposit-taking and loan-m
aking banker form the underwriter or dealer banker; create firewall between the commercial bankers and investment bankers
The commercial banker was prohibited from participating in risk taking with regard to all corporate securities and governmental securities. e.g. J.P. Morgan, Morgan Stanley
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I. Investment Banking in the U.S.
c. Gramm-Leach-Bliley Act of 1999 Glass-Steagall Act repeals
Section 20 repealed Section 32 repealed
Financial holding company or Financial affiliation
Financial activities Insurance Securities underwriting Merchant banking
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I. Investment Banking in the U.S.
B. Investment Bankersa. The New Inter-firm Competition
Specialization Individual investors – Merrill Lynch Institutional investors – Salomon Smith Barney
Deregulation Shelf-registration
M&A and Junk bonds (LBOs)
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I. Investment Banking in the U.S.
b. Leading Investment Bankersa) Securities Underwriting
Conventional Negotiated Debt (Salomon Smith Barney, Morgan Stanley) High-yield Corporate Debt (Drexel Burnham Larnbert) Asset-Backed Debt (Salomon Smith Barney, CS First Boston) Municipal Debt (Merrill Lynch, Goldman Sachs) U.S. Government Securities (Merrill Lynch, Goldman Sachs) Corporate Equity Securities (Merrill Lynch, Lehman)
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I. Investment Banking in the U.S.
b) Secondary Market Business Commissions Trading profit Research Service (Merrill Lynch, Goldman
Sachs) Money management (Merrill Lynch, Lehman)
c) Corporate Financing Activities Traditional Corporate Finance M&A (Goldman Sachs, Morgan Stanley) Venture Capital ( Donaldson Lufkin and
Jenrette, DLJ) Real Estate (Morgan Stanley, Goldman
Sachs)
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I. Investment Banking in the U.S.
C. Investment Banking Activitiesa. Investment banking
Securities underwriting Merger and acquisition Financial consulting Venture capitalist Securities (derivatives) dealer and broker Bonds (derivatives) dealer and broker Futures Forex trading Investment Management Real estate investment
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I. Investment Banking in the U.S.
b. Underwriting typesa) Negotiation Underwriting (Full
Underwriting) Syndicate (Syndicate Manager) Proportional distribution Price stabilization Gross spread (1%-10%, Mostly 7%)
• Hot issue?• Risk? (Market, idiosyncratic)• Distribution channel
Components of revenue• Syndicate manager expenditures• Investment bankers return• Selling commission
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I. Investment Banking in the U.S.
Hot issues• Overallotment ( short 15%)• Overallotment Option (Green Shoe, x<p)
Pricing• Price negotiation• Underpricing (10% -20%)
b) Stand-by Underwriting Absorb by investment bankers
c) Best-efforts Underwriting Commission only
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II. Investment Banking in the U.K.
A. Investment Banking Regulationsa. 1986 Financial Services Act
Department of Trade and Industry Securities and Investment Board
Limited Minister of DTI Governor of the Bank of England
The Securities and Futures Authority, SFA (The Securities and Investment Board, SIB)
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b. The Financial Services and Markets Act, 2000 Financial Services Authority
Market confidence Public awareness Protection of consumers Reduction of financial crime
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II. Investment Banking in the U.K.
Lord Chancellor
FinancialService tribunal
Secretary of stateFor Trade and Industry
Financial Services Authority
Self-regulatoryorganizations
Recognized Investmentexchanges
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II. Investment Banking in the U.K
Characteristics The U.K. Structure is fundamentally
pyramidal The secretary of state for Trade and
Industry is vested with the full oversight authority and power of the system
FSA has power to regulate the functioning of a broadly defined financial and investment business in the U.K.
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II. Investment Banking in the U.K
SROs are responsible for regulating the relationships between their members and customers
The International Stock Exchange determines listing requirement (LSE)
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II. Investment Banking in the U.K.
B. Investment Bankersa. Financial System in the U.K.
Clearing banks (Commercial Banks) Merchant banks (Investment Banks) Stock brokers Jobbers
b. Investment bankersa) Merchant bank (S.G. Warburg, N.M. Rothschild,
J. Henry, Schroder Wagg) Financial advisory services ( James Capel, B
arclays, Warburg)
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II. Investment Banking in the U.K.
M&A Underwriting securities (Samuel Montagu, G
oldman Sachs)
b) Stock brokers Fixed commission agent for individual or ins
titutional investors ( Zoete & Bevan, Strauss Turnbull, etc. )
c) Jobbers Market makers (Specialist) (Akroyd & Smithers, Wedd Durlacher)
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II. Investment Banking in the U.K.
C. Investment Banking Activitiesa. Securities Underwriting
a) Corporate Equity Underwriting Merchant banks Underwriting syndicates Right offerings
b) Debt underwriting Debentures (secured) Loan stocks (unsecured)
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II. Investment Banking in the U.K.
b. U.K. Government Securities Trading Short (up to five years) Medium (5-15 years) Long (over 15 years) Undated (perpetual)
c. Other Securities Tradinga) * Eurobonds
*Domestic equities*International equities
b) The Stock Exchange Automated Quotation System (SEAQ)
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II. Investment Banking in the U.K.
c) * Alpha stocks – most active* Beta stocks – second rank in volume* Gamma stocks – less active* Delta stocks – least liquid
d. Research activitiese. Money Managementf. Mergers and Acquisitions
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b. Underwriting Typesa) Full Underwriting
Merchant banks Syndicates (Syndicates Manager) * Merchant banks
* British institutional investors
* Foreign securities firms
Offering for sale ( proportional distribution)
Shares may be privately placed directly to institutions
II. Investment Banking in the U.K.
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II. Investment Banking in the U.K.
b) Best-efforts Underwriting Moral underwriting
No legal obligation
c) Rights offering Existing shareholders
Purchase price 15-30% below current market price
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III. Investment Banking in Japan
A. Investment Banking Regulations
Characteristics of Japanese Business Environment
A pervasive national concern with external perils
Society’s acceptance of a major role for government in the financial markets
Openness to adapting the practices of Western financial institutions to its own needs
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The particularly Japanese structure of Industrial organization – the “zaibatsu”• Meiji era• Giant Conglomerates• Holding company with a
major private bank• The bank nourished the
companies in its zaibatsu with the necessary financing
III. Investment Banking in Japan
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a. The early Meiji Restoration Perioda) The Stock Exchange Regulations, 1878
London Stock Exchange style Tokyo Stock Exchange, etc. Government bond issues ( Warriors of samurai family) Two sessions’ trade ( 10 a.m. and 2 p.m.)
b) Bourse Regulations,1887 German legal advisor, Hermann Roesler Public securities trading
III. Investment Banking in Japan
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b. WWI to the Great Depression 1922, the Law of Trust Companies
c. The postwar recovery to internationalizationa) 1947, Securities and Exchange Law
Article 65:
A bank, trust company or such other financial institution as may be designated by a Securities and Exchange Commission Regulation shall not engage in any of the acts enumerated in Paragraph 8 of Article 2.
III. Investment Banking in Japan
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Article 2 :” Securities business” To buy and sell securities To act as broker, agent or proxy with
respect to buying and selling of securities
To act as broker, agent or proxy with respect to the entrustment of transaction on a securities market
To underwrite securities To sell securities by public offering To handle the issuance or sale of
securities by public offering
III. Investment Banking in Japan
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b) 1952, Long-term Credit Bank Law
Authorize banks to borrow 20-30 times of their capital to accommodate corporate borrowers
c) 1971, Law Concerning Foreign Securities Firms Non-Japanese firms for branch-office
license Merrill Lynch (1972)
III. Investment Banking in Japan
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III. Investment Banking in Japan
B. Investment Bankersa. The Early Meiji Restoration Period
1893, Standard Securities Underwriting Managed by one or two national banks National banks issue stock for public
subscription Other banks act as selling agents1902, Industrial Bank of Japan (IBJ) Government created Financing the longer-term capital needs of
Japanese industry Corporate debentures underwriters
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III. Investment Banking in Japan
b. WW I to the Great Depression Emergence of leading securities firms
• Koike Company (Yamaichi Securities)• Fujimote Bank(Daiwa Securities)• National City Co.(Nikko Securities)
Emergence of leading Trusts • Mitsui Trust (1924)• Mutual Trust (Yasuda Trust,1925)• Sumitomo Trust (1925)• Mitsubishi Trust (1927)• Issuance of new corporate debentures• Underwriting new securities offerings of their group affili
ated companies• 1927,”Big Five” (Daiichi+Big Four)
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III. Investment Banking in Japan
c. The postwar recovery to internationalizationa) Japanese securities firms
the Big Four (Nomura, Daiwa, Nikko, and Yamaichi) 21 other large firms directly supervised by the Tokyo off
ice of MOF Small Local firms supervised by the branch offices of M
OFb) International investment bankers
Merrill Lynch, 1972 1986 TSE members
• Merrill Lynch• Morgan Stanley• Goldman Sachs• Vickers da Costa• Jardine Flemming• S.G. Warburg
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III. Investment Banking in Japan
C. Investment banking activitiesa. Investment banking activities
a) Brokerage activities Brokerage commission (60% of revenue) Secondary market trading
b) Future market 1985, Japanese government bond futures 1987, Nikkei stock index futures 1989, TSE futures
Interest rate futures on Euroyen and Eurodollars Currency futures
c) Japanese government bond underwriting 40%--- Competitive bids from members of underwritin
g syndicates 60%--- Syndicates members under fixed allocation
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III. Investment Banking in Japan
d) Corporate Underwriting Euromarkets and TSE
Government subsides rationing insistence of collateral in banks
“BIG Four” dominance Equity-linked securities offering
e) Offshore Corporate Underwriting Securities Firms, commercial banks Commercial banks established subsidiaries in the
major offshore markets MOF “three bureaus agreement”
Banking Securities International finance
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III. Investment Banking in Japan
f) Corporate Finance Activities Minor The leading securities firms
Financial engineering skills Long-term financial planning Valuation and financing skill in M& A)
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b. Securities Underwritinga) Securities underwriting procedures
Financial plan consulting Capital structure adjustments IPO
Pricing Time table Review of corporate charter Review of directors meeting Review of management Compliance Registration(MOF) Underwriting Syndicates (The Big Four
III. Investment Banking in Japan
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III. Investment Banking in Japan
• Proposal Method (MOF) Electric utilities and Telephones Compete for syndicate managers
• Shelf Registration (Oct. 1. 1988) Qualified issuers can preregister securities and hold them ready for an offe
ring on short notice if market conditions become favorableb) Public bidding System (April, 1989)
• Fixed proportion for public bidding• Price floor, Price ceiling (Comparison,EPS,BPS)• Exclusive restriction (Major shareholders)• Top-down bidding
c) After market support• Application for price stabilization (MOF)• Restrictions of initiators, period, price limit, etc.