Investment banking pertains to certain activities of a
financial services
Financial services are the Service (economics), economic services provided by the finance industry, which encompasses a broad range of businesses that manage money, including credit unions, banks, credit-card companies, insurance companies, acco ...
company or a
corporate division that consist in advisory-based financial transactions on behalf of individuals, corporations, and governments. Traditionally associated with
corporate finance
Corporate finance is the area of finance that deals with the sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and anal ...
, such a bank might assist in raising
financial capital
Financial capital (also simply known as capital or equity in finance, accounting and economics) is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide ...
by
underwriting
Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabilit ...
or acting as the client's
agent
Agent may refer to:
Espionage, investigation, and law
*, spies or intelligence officers
* Law of agency, laws involving a person authorized to act on behalf of another
** Agent of record, a person with a contractual agreement with an insuranc ...
in the
issuance
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling ...
of debt or equity
securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
. An investment bank may also assist
companies
A company, abbreviated as co., is a legal entity representing an association of people, whether natural, legal or a mixture of both, with a specific objective. Company members share a common purpose and unite to achieve specific, declared go ...
involved in
mergers and acquisitions
Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
(M&A) and provide ancillary services such as
market making, trading of
derivatives
The derivative of a function is the rate of change of the function's output relative to its input value.
Derivative may also refer to:
In mathematics and economics
* Brzozowski derivative in the theory of formal languages
* Formal derivative, an ...
and
equity securities
In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...
, FICC services (
fixed income
Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the prin ...
instruments,
currencies
A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins.
A more general def ...
, and
commodities
In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them.
The price of a comm ...
) or research (macroeconomic, credit or equity research). Most investment banks maintain
prime brokerage
Prime brokerage is the generic name for a bundled package of services offered by investment banks, wealth management firms, and securities dealers to hedge funds which need the ability to borrow securities and cash in order to be able to invest ...
and
asset management
Asset management is a systematic approach to the governance and realization of value from the things that a group or entity is responsible for, over their whole life cycles. It may apply both to tangible assets (physical objects such as buildings ...
departments in conjunction with their
investment research
Securities research is a discipline within the financial services industry. Securities research professionals are known most generally as "analysts", "research analysts", or "securities analysts"; all the foregoing terms are synonymous. Researc ...
businesses. As an industry, it is broken up into the
Bulge Bracket (upper tier),
Middle Market (mid-level businesses), and
boutique market (specialized businesses).
Unlike
commercial bank
A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit.
It can also refer to a bank, or a division of a large bank, which deals with cor ...
s and
retail bank
Retail banking, also known as consumer banking or personal banking, is the provision of services by a bank to the general public, rather than to companies, corporations or other banks, which are often described as wholesale banking. Banking servi ...
s, investment banks do not take
deposits
A deposit account is a bank account maintained by a financial institution in which a customer can deposit and withdraw money. Deposit accounts can be savings accounts, Transaction account#Current accounts, current accounts or any of several othe ...
. From the passage of
Glass–Steagall Act in 1933 until its repeal in 1999 by the
Gramm–Leach–Bliley Act
The Gramm–Leach–Bliley Act (GLBA), also known as the Financial Services Modernization Act of 1999, () is an act of the 106th United States Congress (1999–2001). It repealed part of the Glass–Steagall Act of 1933, removing barriers i ...
, the
United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...
maintained a separation between investment banking and commercial banks. Other industrialized countries, including
G7 countries, have historically not maintained such a separation. As part of the
Dodd–Frank Wall Street Reform and Consumer Protection Act
The Dodd–Frank Wall Street Reform and Consumer Protection Act, commonly referred to as Dodd–Frank, is a United States federal law that was enacted on July 21, 2010. The law overhauled financial regulation in the aftermath of the Great Recessi ...
of 2010 (''Dodd–Frank Act of 2010''), the
Volcker Rule
The Volcker Rule iof the Dodd–Frank Wall Street Reform and Consumer Protection Act (). The rule was originally proposed by American economist and former United States Federal Reserve Chairman Paul Volcker to restrict United States banks from ma ...
asserts some institutional separation of investment banking services from commercial banking.
All investment banking activity is classed as either "sell side" or "buy side". The "
sell side
Sell side is a term used in the financial services industry. The three main markets for this selling are the stock, bond, and foreign exchange market. It is a general term that indicates a firm that sells investment services to asset management fi ...
" involves trading securities for cash or for other securities (e.g. facilitating transactions, market-making), or the promotion of securities (e.g. underwriting, research, etc.). The "
buy side
Buy-side is a term used in investment firms to refer to advising institutions concerned with buying investment services. Private equity funds, mutual funds, life insurance companies, unit trusts, hedge funds, and pension funds are the most comm ...
" involves the provision of advice to institutions that buy investment services.
Private equity
In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a ty ...
funds,
mutual fund
A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV i ...
s,
life insurance
Life insurance (or life assurance, especially in the Commonwealth of Nations) is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death ...
companies,
unit trust
A unit trust is a form of collective investment constituted under a trust deed.
A unit trust pools investors' money into a single fund, which is managed by a fund manager. Unit trusts offer access to a wide range of investments, and depending on ...
s, and
hedge fund
A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...
s are the most common types of buy-side
entities
An entity is something that exists as itself, as a subject or as an object, actually or potentially, concretely or abstractly, physically or not. It need not be of material existence. In particular, abstractions and legal fictions are usually ...
.
An investment bank can also be split into private and public functions with a
screen
Screen or Screens may refer to:
Arts
* Screen printing (also called ''silkscreening''), a method of printing
* Big screen, a nickname associated with the motion picture industry
* Split screen (filmmaking), a film composition paradigm in which mul ...
separating the two to prevent information from crossing. The private areas of the bank deal with private
insider information that may not be publicly disclosed, while the public areas, such as stock analysis, deal with public information. An advisor who provides investment banking services in the United States must be a licensed
broker-dealer
In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and d ...
and subject to
U.S. Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market ...
(SEC) and
Financial Industry Regulatory Authority
The Financial Industry Regulatory Authority (FINRA) is a private American corporation that acts as a self-regulatory organization (SRO) that regulates member brokerage firms and exchange markets. FINRA is the successor to the National Associati ...
(FINRA) regulation.
History
Early history
The
Dutch East India Company
The United East India Company ( nl, Verenigde Oostindische Compagnie, the VOC) was a chartered company established on the 20th March 1602 by the States General of the Netherlands amalgamating existing companies into the first joint-stock ...
was the first company to issue
bonds and
shares
In financial markets, a share is a unit of equity ownership in the capital stock of a corporation, and can refer to units of mutual funds, limited partnerships, and real estate investment trusts. Share capital refers to all of the shares of an ...
of
stock
In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...
to the general public. It was also the first
publicly traded company
A public company is a company whose ownership is organized via shares of stock which are intended to be freely traded on a stock exchange or in over-the-counter markets. A public (publicly traded) company can be listed on a stock exchange (l ...
, being the first company to be
listed
Listed may refer to:
* Listed, Bornholm, a fishing village on the Danish island of Bornholm
* Listed (MMM program), a television show on MuchMoreMusic
* Endangered species in biology
* Listed building, in architecture, designation of a historicall ...
on an official
stock exchange
A stock exchange, securities exchange, or bourse is an exchange where stockbrokers and traders can buy and sell securities, such as shares of stock, bonds and other financial instruments. Stock exchanges may also provide facilities for th ...
.
Further developments
Investment banking has changed over the years, beginning as a partnership firm focused on underwriting security issuance, i.e.
initial public offering
An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically underwritten by one or more investment ...
s (IPOs) and
secondary market offering
A secondary market offering, according to the U.S. Financial Industry Regulatory Authority (FINRA), is a registered offering of a large block of a security that has been previously issued to the public. The blocks being offered may have been held ...
s,
brokerage
A broker is a person or firm who arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither role should be confu ...
, and mergers and acquisitions, and evolving into a "full-service" range including
securities research
Securities research is a discipline within the financial services industry. Securities research professionals are known most generally as "analysts", "research analysts", or "securities analysts"; all the foregoing terms are synonymous. Resea ...
,
proprietary trading
Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) in order to make ...
, and
investment management
Investment management is the professional asset management of various securities, including shareholdings, bonds, and other assets, such as real estate, to meet specified investment goals for the benefit of investors. Investors may be institut ...
. In the 21st century, the SEC filings of the major independent investment banks such as
Goldman Sachs
Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
and
Morgan Stanley
Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
reflect three product segments:
# investment banking (mergers and acquisitions, advisory services, and securities underwriting),
# asset management (sponsored investment funds), and
# trading and principal investments (broker-dealer activities, including proprietary trading ("dealer" transactions) and brokerage trading ("broker" transactions)).
In the United States, commercial banking and investment banking were separated by the Glass–Steagall Act, which was repealed in 1999. The repeal led to more "
universal bank
A universal bank participates in many kinds of banking activities and is both a commercial bank and an investment bank as well as providing other financial services such as insurance.JPMorgan Chase
JPMorgan Chase & Co. is an American multinational investment bank and financial services holding company headquartered in New York City and incorporated in Delaware. As of 2022, JPMorgan Chase is the largest bank in the United States, the ...
,
Bank of America
The Bank of America Corporation (often abbreviated BofA or BoA) is an American multinational investment bank and financial services holding company headquartered at the Bank of America Corporate Center in Charlotte, North Carolina. The bank w ...
,
Citigroup
Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
,
Credit Suisse
Credit Suisse Group AG is a global investment bank and financial services firm founded and based in Switzerland. Headquartered in Zürich, it maintains offices in all major financial centers around the world and is one of the nine global " ...
,
Deutsche Bank
Deutsche Bank AG (), sometimes referred to simply as Deutsche, is a German multinational investment bank and financial services company headquartered in Frankfurt, Germany, and dual-listed on the Frankfurt Stock Exchange and the New York Sto ...
,
UBS
UBS Group AG is a multinational Investment banking, investment bank and financial services company founded and based in Switzerland. Co-headquartered in the cities of Zürich and Basel, it maintains a presence in all major financial centres ...
, and
Barclays
Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services.
Barclays traces ...
.
After the
financial crisis of 2007–08
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
and the subsequent passage of the ''Dodd-Frank Act of 2010'', regulations have limited certain investment banking operations, notably with the Volcker Rule's restrictions on proprietary trading.
The traditional service of underwriting security issues has declined as a percentage of revenue. As far back as 1960, 70% of
Merrill Lynch
Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment bank ...
's revenue was derived from transaction commissions while "traditional investment banking" services accounted for 5%. However, Merrill Lynch was a relatively "retail-focused" firm with a large brokerage network.
Organizational structure
Core investment banking activities
Investment banking is split into
front office
The front office is the part of a company that comes in contact with clients, such as the marketing, sales, and service departments. The term has more specific meaning in different industries.
Types
General offices
The function of front office ...
,
middle office
The middle office is a team of employees working in a financial services institution. Financial services institutions can be divided into three sections: the front, the middle and the back office. The front office is composed of customer-facing emp ...
, and
back office
A back office in most corporations is where work that supports ''front office'' work is done. The front office is the "face" of the company and is all the resources of the company that are used to make sales and interact with customers and client ...
activities. While large service investment banks offer all lines of business, both "sell side" and "buy side", smaller sell-side investment firms such as
boutique investment bank
A boutique investment bank is a investment bank that specializes in at least one aspect of investment banking, generally corporate finance, although some banks strengths are retail in nature, such as Charles Schwab. Of those involved in corporate ...
s and small broker-dealers focus on investment banking and sales/trading/research, respectively.
Investment banks offer services to both corporations issuing securities and investors buying securities. For corporations, investment bankers offer information on when and how to place their securities on the open market, an activity very important to an investment bank's reputation. Therefore, investment bankers play a very important role in issuing new security offerings.
Front office
''Front office'' is generally described as a
revenue
In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business.
Commercial revenue may also be referred to as sales or as turnover. Some companies receive reven ...
-generating role. There are two main areas within front office: investment banking and markets.
* Investment banking involves advising organizations on mergers and acquisitions, as well as a wide array of capital raising strategies.
* Markets is divided into "sales and trading" (including "structuring"), and "research".
=Corporate finance
=
Corporate finance
Corporate finance is the area of finance that deals with the sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and anal ...
is the aspect of investment banks which involves helping customers raise
funds
Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Generally, this word is used when a firm uses ...
in
capital market
A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold. Capital markets channel the wealth of savers t ...
s and giving advice on
mergers and acquisitions
Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
(M&A);
transactions in which capital is raised for the corporation include those listed aside.
[Shaun Beaney, Katerina Joannou and David Petri]
What is Corporate Finance?
Corporate Finance Faculty, ICAEW
The Institute of Chartered Accountants in England and Wales (ICAEW) is a professional membership organisation that promotes, develops and supports chartered accountants and students around the world. As of July 2022, it has over 198,000 members ...
, April 2005 (revised January 2011 and September 2020)
This work may involve, i.a., subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target.
A
pitch book
A pitch book (or pitch deck), also called a Confidential Information Memorandum, is a marketing presentation (information layout) used by investment banks, entrepreneurs, corporate finance firms, business brokers and other Mergers and acquisition ...
of financial information is generated to market the bank to a potential M&A client; if the pitch is successful, the bank arranges the deal for the client.
The investment banking division (IBD) is generally divided into industry coverage and product coverage groups.
Industry coverage groups focus on a specific industry—such as healthcare,
public finance
Public finance is the study of the role of the government in the economy. It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achie ...
(governments), FIG (financial institutions group), industrials, TMT (technology, media, and telecommunications), P&E (power & energy), consumer/retail, food & beverage, corporate defense and governance—and maintain relationships with corporations within the industry to bring in business for the bank.
Product coverage groups focus on financial products—such as
mergers and acquisitions
Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
,
leveraged finance
A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money (leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loan ...
, public finance, asset finance and leasing,
structured finance
Structured finance is a sector of finance - specifically financial law - that manages leverage and risk. Strategies may involve legal and corporate restructuring, off balance sheet accounting, or the use of financial instruments.
Securitization ...
,
restructuring
Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons ...
, equity, and debt issuance.
Recent legal and regulatory developments in the U.S. will likely alter the makeup of the group of arrangers and financiers willing to arrange and provide financing for certain highly leveraged transactions.
=Sales and trading
=
On behalf of the bank and its clients, a large investment bank's primary function is buying and selling products.
''Sales'' is the term for the investment bank's sales force, whose primary job is to call on institutional and high-net-worth investors to suggest trading ideas (on a
caveat emptor
''Caveat emptor'' (; from ''caveat'', "may he/she beware", a subjunctive form of ''cavēre'', "to beware" + ''ēmptor'', "buyer") is Latin for "Let the buyer beware". It has become a proverb in English. Generally, ''caveat emptor'' is the contrac ...
basis) and take orders. Sales desks then communicate their clients' orders to the appropriate
trading room
A trading room gathers traders operating on financial markets. The trading room is also often called the front office. The terms "dealing room" and "trading floor" are also used, the latter being inspired from that of an open outcry stock ex ...
s, which can price and execute trades, or structure new products that fit a specific need.
Sales make deals tailored to their corporate customers' needs, that is, their terms are often specific. Focusing on their customer relationship, they may deal on the whole range of asset types.
(In distinction, trades negotiated by market-makers usually bear standard terms; in
market making, traders will buy and sell financial products with the goal of making money on each trade.
See under
trading desk
Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system or network that allows trade as a market.
An early form of trade, barter, saw the direct excha ...
.)
''Structuring'' has been a relatively recent activity as derivatives have come into play, with
highly technical and numerate employees working on creating complex
structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single Security (finance), security, a basket of securities, Option (finance), options, Index (economics), indices, ...
s which typically offer much greater margins and returns than underlying cash securities, so-called "yield enhancement". In 2010, investment banks came under pressure as a result of selling complex derivatives contracts to local municipalities in Europe and the US.
''Strategists'' advise external as well as internal clients on the strategies that can be adopted in various markets. Ranging from derivatives to specific industries, strategists place companies and industries in a quantitative framework with full consideration of the macroeconomic scene. This strategy often affects the way the firm will operate in the market, the direction it would like to take in terms of its proprietary and flow positions, the suggestions salespersons give to clients, as well as the way
structurer
In investment banking, a structurer
Joris Luyendijk (2012)Interview: Head of Structuring equity-derivatives ''theguardian.com''
is the finance professional responsible for designing structured products.
Their solution will typically deliver ...
s create new products.
Banks also undertake risk through
proprietary trading
Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) in order to make ...
, performed by a special set of traders who do not interface with clients and through "principal risk"—risk undertaken by a trader after he buys or sells a product to a client and does not hedge his total exposure.
Here, and in general, banks seek to maximize profitability for a given amount of risk on their balance sheet.
Note here that the
FRTB
The Fundamental Review of the Trading Book (FRTB), is a set of proposals by the Basel Committee on Banking Supervision for a new market risk-related capital requirement for banks.
Background
The reform, which is part of Basel III, is one of th ...
framework has underscored the distinction between the "
Trading book
The Fundamental Review of the Trading Book (FRTB), is a set of proposals by the Basel Committee on Banking Supervision for a new market risk-related capital requirement for banks.
Background
The reform, which is part of Basel III, is one of th ...
" and the "
Banking book
The Fundamental Review of the Trading Book (FRTB), is a set of proposals by the Basel Committee on Banking Supervision for a new market risk-related capital requirement for banks.
Background
The reform, which is part of Basel III, is one of th ...
"
- i.e. assets intended for active trading, as opposed to assets expected to be held to maturity -
and market risk
capital requirements
A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital ad ...
will differ accordingly.
The necessity for numerical ability in sales and trading has created jobs for
physics
Physics is the natural science that studies matter, its fundamental constituents, its motion and behavior through space and time, and the related entities of energy and force. "Physical science is that department of knowledge which r ...
,
computer science
Computer science is the study of computation, automation, and information. Computer science spans theoretical disciplines (such as algorithms, theory of computation, information theory, and automation) to Applied science, practical discipli ...
,
mathematics
Mathematics is an area of knowledge that includes the topics of numbers, formulas and related structures, shapes and the spaces in which they are contained, and quantities and their changes. These topics are represented in modern mathematics ...
, and
engineering
Engineering is the use of scientific method, scientific principles to design and build machines, structures, and other items, including bridges, tunnels, roads, vehicles, and buildings. The discipline of engineering encompasses a broad rang ...
PhDs who act as
"front office" quantitative analysts.
=Research
=
The
securities research
Securities research is a discipline within the financial services industry. Securities research professionals are known most generally as "analysts", "research analysts", or "securities analysts"; all the foregoing terms are synonymous. Resea ...
division reviews companies and
writes reports about their prospects, often with "buy", "hold", or "sell" ratings. Investment banks typically have
sell-side analyst
A sell-side analyst works for a brokerage firm and evaluates companies for future earnings growth and other investment criteria. They sometimes place recommendations on stocks or other securities, typically phrased as "buy", "sell", or "hold." T ...
s which cover various industries. Their sponsored funds or proprietary trading offices will also have buy-side research.
Research also covers
credit risk
A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
,
fixed income
Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year and repay the prin ...
,
macroeconomic
Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole.
For example, using interest rates, taxes, and ...
s, and
quantitative analysis, all of which are used internally and externally to advise clients; alongside "Equity", these may be separate "groups".
The research group(s) typically provide a key service in terms of advisory and strategy.
While the research division may or may not generate revenue (based on policies at different banks), its resources are used to assist traders in trading, the sales force in suggesting ideas to customers, and investment bankers by covering their clients. Research also serves outside clients with investment advice (such as institutional investors and high-net-worth individuals) in the hopes that these clients will execute suggested
trade idea Trade ideas (or trading ideas, or "Electronic Alpha-Capture") are investment ideas, typically equity related, ("long" i.e. buy, or "short" i.e. sell) which are sent by institutional stockbrokers to their institutional clients (i.e. this is not a s ...
s through the sales and trading division of the bank, and thereby generate revenue for the firm.
With
MiFID II
Markets in Financial Instruments Directive 20142014/65/EU commonly known as MiFID 2 (Markets in financial instruments directive 2), is a legal act of the European Union. Together with Regulation (EU) No 600/2014 it provides a legal framework fo ...
requiring sell-side research teams in banks to charge for research, the business model for research is increasingly becoming revenue-generating. External rankings of researchers are becoming increasingly important, and banks have started the process of monetizing research publications, client interaction times, meetings with clients etc.
There is a potential conflict of interest between the investment bank and its analysis, in that published analysis can impact the performance of a security (in the secondary markets or an initial public offering) or influence the relationship between the banker and its corporate clients, and vice versa regarding
material non-public information (MNPI), thereby affecting the bank's profitability.
Middle office
This area of the bank includes
treasury management
Treasury management (or treasury operations) includes management of an enterprise's holdings, with the ultimate goal of managing the firm's liquidity and mitigating its operational, financial and reputational risk. Treasury Management includes a fi ...
, internal controls (such as Risk), and internal corporate strategy.
Corporate treasury
Treasury management (or treasury operations) includes management of an enterprise's holdings, with the ultimate goal of managing the firm's liquidity and mitigating its operational, financial and reputational risk. Treasury Management includes a fi ...
is responsible for an investment bank's funding, capital structure management, and
liquidity risk
Liquidity risk is a financial risk that for a certain period of time a given financial asset, security or commodity cannot be traded quickly enough in the market without impacting the market price.
Types
Market liquidity – An asset cannot be so ...
monitoring; it is (co)responsible for the bank's
funds transfer pricing
The Fund Transfer Pricing (FTP) measures the contribution by each source of funding to the overall profitability in a financial institution. Funds that go toward lending products are charged to asset-generating businesses whereas funds generated by ...
(FTP) framework.
Internal control Internal control, as defined by accounting and auditing, is a process for assuring of an organization's objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. A broad ...
tracks and analyzes the capital flows of the firm, the finance division is the principal adviser to senior management on essential areas such as controlling the firm's global risk exposure and the profitability and structure of the firm's various businesses via dedicated trading desk product control teams. In the United States and United Kingdom, a comptroller (or financial controller) is a senior position, often reporting to the chief financial officer.
=Risk management
=
Risk management involves analyzing the market risk, market and
credit risk
A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
that an investment bank or its clients take onto their balance sheet during transactions or trades.
Middle office "Credit Risk" focuses around capital markets activities, such as syndicated loans, bond issuance,
restructuring
Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons ...
, and leveraged finance.
These are not considered "front office" as they tend not to be client-facing and rather 'control' banking functions from taking too much risk.
"Market Risk" is the control function for the Markets' business and conducts review of sales and trading activities utilizing the value at risk, VaR model.
Other Middle office "Risk Groups" include country risk, operational risk, and counterparty risks which may or may not exist on a bank to bank basis.
Front office risk teams, on the other hand, engage in revenue-generating activities involving debt structuring, restructuring, syndicated loans, and securitization for clients such as corporates, governments, and hedge funds.
Here "Credit Risk Solutions", are a key part of capital market transactions, involving debt structuring, exit financing, loan amendment, project finance, leveraged buy-outs, and sometimes portfolio hedging.
The "Market Risk Team" provides services to investors via derivative solutions, Portfolio manager, portfolio management, portfolio consulting, and risk advisory.
Well-known "Risk Groups" are at JPMorgan Chase, Morgan Stanley, Goldman Sachs and Barclays.
J.P. Morgan IB Risk works with investment banking to execute transactions and advise investors, although its Finance & Operation risk groups focus on middle office functions involving internal, non-revenue generating, operational risk controls. The credit default swap, for instance, is a famous credit risk hedging solution for clients invented by J.P. Morgan's Blythe Masters during the 1990s.
The Loan Risk Solutions group within Barclays' investment banking division and Risk Management and Financing group housed in Goldman Sach's securities division are client-driven franchises.
Note, however, that risk management groups such as credit risk, operational risk, internal risk control, and legal risk are restrained to internal business functions — including firm balance-sheet risk analysis and assigning the trading cap — that are independent of client needs, even though these groups may be responsible for deal approval that directly affects capital market activities.
Similarly, the ''Internal corporate strategy'' group, tackling firm management and profit strategy, unlike corporate strategy groups that advise clients, is non-revenue regenerating yet a key functional role within investment banks.
This list is not a comprehensive summary of all middle-office functions within an investment bank, as specific desks within front and back offices may participate in internal functions.
Back office
The back office data-checks trades that have been conducted, ensuring that they are not wrong, and transacts the required transfers. Many banks have outsourced operations. It is, however, a critical part of the bank.
=Technology
=
Every major investment bank has considerable amounts of in-house software, created by the technology team, who are also responsible for technical support. Technology has changed considerably in the last few years as more sales and trading desks are using electronic trading. Some trades are initiated by complex algorithms for Hedge (finance), hedging purposes.
Firms are responsible for compliance with local and foreign government regulations and internal regulations.
Other businesses
*Global transaction banking is the division that provides cash management, Securities Services, securities services (including custody and securities lending etc.) to institutions. Prime brokerage with hedge funds has been an especially profitable business, as well as risky, as seen in the bank run with Bear Stearns in 2008.
*Investment management is the professional management of various securities (
stock
In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...
s,
bonds, etc.) and other assets (e.g., real estate), to meet specified investment goals for the benefit of investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private investors (both directly via investment contracts and more commonly via investment funds e.g.,
mutual fund
A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV i ...
s). The investment management division of an investment bank is generally divided into separate groups, often known as wealth management, private wealth management and Private_banking, private client services.
*Merchant banking can be called "very personal banking"; merchant banks offer capital in exchange for share ownership rather than loans, and offer advice on management and strategy. Merchant banking is also a name used to describe the private equity side of a firm. Current examples include Defoe Fournier & Cie. and JPMorgan Chase's One Equity Partners. The original J.P. Morgan & Co., Rothschilds, Barings and Warburgs were all merchant banks. Originally, "merchant bank" was the British English term for an investment bank.
Industry profile
As an industry, it is broken up into the
Bulge Bracket (upper tier),
Middle Market (mid-level businesses), and
boutique market (specialized businesses). There are various trade associations throughout the world which represent the industry in lobbying, facilitate industry standards, and publish statistics. The International Council of Securities Associations (ICSA) is a global group of trade associations.
In the United States, the Securities Industry and Financial Markets Association (SIFMA) is likely the most significant; however, several of the large investment banks are members of the American Bankers Association Securities Association (ABASA), while small investment banks are members of the National Investment Banking Association (NIBA).
In Europe, the European Forum of Securities Associations was formed in 2007 by various European trade associations. Several European trade associations (principally the London Investment Banking Association and the European SIFMA affiliate) combined in November 2009 to form the Association for Financial Markets in Europe (AFME).
In the securities industry in China, the Securities Association of China is a self-regulatory organization whose members are largely investment banks.
Global size and revenue mix
Global investment banking revenue increased for the fifth year running in 2007, to a record US$84 billion, which was up 22% on the previous year and more than double the level in 2003.
[International Financial Services London. (2010)]
BANKING City Business Series
/ref> Subsequent to their exposure to United States Subprime lending, sub-prime securities investments, many investment banks have experienced losses. As of late 2012, global revenues for investment banks were estimated at $240 billion, down about a third from 2009, as companies pursued less deals and traded less. Differences in total revenue are likely due to different ways of classifying investment banking revenue, such as subtracting proprietary trading revenue.
In terms of total revenue, SEC filings of the major independent investment banks in the United States show that investment banking (defined as M&A advisory services and security underwriting) made up only about 15–20% of total revenue for these banks from 1996 to 2006, with the majority of revenue (60+% in some years) brought in by "trading" which includes brokerage commissions and proprietary trading; the proprietary trading is estimated to provide a significant portion of this revenue.[
The United States generated 46% of global revenue in 2009, down from 56% in 1999. Europe (with Middle East and Africa) generated about a third while Asian countries generated the remaining 21%.][ The industry is heavily concentrated in a small number of major financial centers, including New York City, City of London, Frankfurt#Economy and business, Frankfurt, Hong Kong, Singapore, and Tokyo. The majority of the world's largest Bulge Bracket investment banks and their investment management, investment managers are headquartered in New York and are also important participants in other financial centers.] The city of London has historically served as a hub of European M&A activity, often facilitating the most capital movement and Corporate finance, corporate restructuring in the area. Meanwhile, Asian cities are receiving a growing share of M&A activity.
According to estimates published by the International Financial Services London, for the decade prior to the financial crisis in 2008, M&A was a primary source of investment banking revenue, often accounting for 40% of such revenue, but dropped during and after the financial crisis.[ Equity underwriting revenue ranged from 30% to 38%, and fixed-income underwriting accounted for the remaining revenue.][
Revenues have been affected by the introduction of new products with higher margin (finance), margins; however, these innovations are often copied quickly by competing banks, pushing down trading margins. For example, brokerages commissions for bond and equity trading is a commodity business, but structuring and trading derivatives have higher margins because each Over-the-counter (finance), over-the-counter contract has to be uniquely structured and could involve complex pay-off and risk profiles. One growth area is private investment in public equity (PIPEs, otherwise known as Regulation D or Regulation S). Such transactions are privately negotiated between companies and accredited investors.
Banks also earned revenue by securitizing debt, particularly mortgage debt prior to the financial crisis. Investment banks have become concerned that lenders are securitizing in-house, driving the investment banks to pursue vertical integration by becoming lenders, which is allowed in the United States since the repeal of the Glass–Steagall Act in 1999.
]
Top 10 banks
According to ''The Wall Street Journal'', in terms of total M&A advisory fees for the whole of 2020, the top ten investment banks were as listed in the table below. Many of these firms belong either to the Bulge Bracket (upper tier), Middle Market (mid-level businesses), or are elite boutique investment bank
A boutique investment bank is a investment bank that specializes in at least one aspect of investment banking, generally corporate finance, although some banks strengths are retail in nature, such as Charles Schwab. Of those involved in corporate ...
s (independent investment banks).
The above list is just a ranking of the advisory arm (M&A advisory, syndicated loans, Equity (finance), equity capital markets, and debt capital markets) of each bank and does not include the generally much larger portion of revenues from sales and trading and asset management
Asset management is a systematic approach to the governance and realization of value from the things that a group or entity is responsible for, over their whole life cycles. It may apply both to tangible assets (physical objects such as buildings ...
. Mergers and acquisitions and capital markets are also often covered by ''The Wall Street Journal'' and Bloomberg L.P., Bloomberg.
Financial crisis of 2007–2008
The financial crisis of 2007–2008 led to the collapse of several notable investment banks, such as the bankruptcy of Lehman Brothers (one of the largest investment banks in the world) and the hurried sale of Merrill Lynch
Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment bank ...
and the much smaller Bear Stearns to much larger banks, which effectively rescued them from bankruptcy. The entire financial services industry, including numerous investment banks, was bailed out by government taxpayer funded loans through the Troubled Asset Relief Program (TARP). Surviving U.S. investment banks such as Goldman Sachs and Morgan Stanley converted to traditional bank holding companies to accept TARP relief. Similar situations occurred across the globe with countries rescuing their banking industry. Initially, banks received part of a $700 billion TARP intended to stabilize the economy and thaw the frozen credit markets. Eventually, taxpayer assistance to banks reached nearly $13 trillion—most without much scrutiny— lending did not increase, and credit markets remained frozen.
The crisis led to questioning of the business model of the investment bank without the regulation imposed on it by Glass–Steagall. Once Robert Rubin, a former co-chairman of Goldman Sachs, became part of the Clinton administration and deregulated banks, the previous conservatism of underwriting established companies and seeking long-term gains was replaced by lower standards and short-term profit.[Matt Taibbi]
"The Great American Bubble Machine"
''Rolling Stone'' magazine (5 April 2010). Retrieved 7 March 2011 Formerly, the guidelines said that in order to take a company public, it had to be in business for a minimum of five years and it had to show profitability for three consecutive years. After deregulation, those standards were gone, but small investors did not grasp the full impact of the change.
A number of former Goldman Sachs top executives, such as Henry Paulson and Ed Liddy, were in high-level positions in government and oversaw the controversial taxpayer-funded bank bailout. The TARP Oversight Report released by the Congressional Oversight Panel found that the bailout tended to encourage risky behavior and "corrupt[ed] the fundamental tenets of a market economy".
Under threat of a subpoena, Goldman Sachs revealed that it received $12.9 billion in taxpayer aid, $4.3 billion of which was then paid out to 32 entities, including many overseas banks, hedge funds, and pensions. The same year it received $10 billion in aid from the government, it also paid out multimillion-dollar bonuses; the total paid in bonuses was $4.82 billion. Similarly, Morgan Stanley received $10 billion in TARP funds and paid out $4.475 billion in bonuses.
Criticisms
The investment banking industry, and many individual investment banks, have come under criticism for a variety of reasons, including perceived conflicts of interest, overly large pay packages, cartel-like or oligopolistic behavior, taking both sides in transactions, and more. Investment banking has also been criticised for its opacity.[William D. Cohan, author of ''House of Cards: How Wall St. Bankers Broke Capitalism'', speaking on BBC Radio 5 Live, Up All Night (radio show), ''Up All Night'', 13 April 2011]
Conflicts of interest
Conflicts of interest may arise between different parts of a bank, creating the potential for market manipulation, according to critics. Authorities that regulate investment banking, such as the Financial Conduct Authority (FCA) in the United Kingdom and the U.S. Securities and Exchange Commission, SEC in the United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...
, require that banks impose a "Chinese wall" to prevent communication between investment banking on one side and equity research and trading on the other. However, critics say such a barrier does not always exist in practice. Independent advisory firms that exclusively provide corporate finance advice argue that their advice is not conflicted, unlike bulge bracket banks.
Conflicts of interest often arise in relation to investment banks' equity research units, which have long been part of the industry. A common practice is for equity analysts to initiate coverage of a company in order to develop relationships that lead to highly profitable investment banking business. In the 1990s, many equity researchers allegedly traded positive stock ratings for investment banking business. Alternatively, companies may threaten to divert investment banking business to competitors unless their stock was rated favorably. Laws were passed to criminalize such acts, and increased pressure from regulators and a series of lawsuits, settlements, and prosecutions curbed this business to a large extent following the 2001 stock market tumble after the dot-com bubble.
Philip Augar, author of ''The Greed Merchants'', said in an interview that, "You cannot simultaneously serve the interest of issuer clients and investing clients. And it’s not just underwriting and sales; investment banks run proprietary trading operations that are also making a profit out of these securities."
Many investment banks also own retail brokerages. During the 1990s, some retail brokerages sold consumers securities which did not meet their stated risk profile. This behavior may have led to investment banking business or even sales of surplus shares during a public offering to keep public perception of the stock favorable.
Since investment banks engage heavily in trading for their own account, there is always the temptation for them to engage in some form of front running—the illegal practice whereby a broker executes orders for their own account before filling orders previously submitted by their customers, thereby benefiting from any changes in prices induced by those orders.
Documents under seal in a decade-long lawsuit concerning eToys.com's IPO but obtained by ''New York Times Wall Street Business columnist Joe Nocera alleged that IPOs managed by Goldman Sachs and other investment bankers involved asking for kickback (bribery), kickbacks from their institutional clients who made large profits flipping IPOs which Goldman had intentionally undervalued. Depositions in the lawsuit alleged that clients willingly complied with these demands because they understood it was necessary in order to participate in future hot issues. ''Reuters'' Wall Street correspondent Felix Salmon retracted his earlier, more conciliatory statements on the subject and said he believed that the depositions show that companies going public and their initial consumer stockholders are both defrauded by this practice, which may be widespread throughout the IPO finance industry. The case is ongoing, and the allegations remain unproven.
Compensation
Investment banking is often criticized for the enormous pay packages awarded to those who work in the industry. According to Bloomberg Wall Street's five biggest firms paid over $3 billion to their executives from 2003 to 2008, "while they presided over the packaging and sale of loans that helped bring down the investment-banking system".[Tom Randall and Jamie McGee]
"Wall Street Executives Made $3 Billion Before Crisis (Update1)"
Bloomberg, 26 September 2008.
The highly generous pay packages include $172 million for Merrill Lynch CEO Stanley O'Neal from 2003 to 2007, before it was bought by Bank of America in 2008, and $161 million for Bear Stearns' James Cayne before the bank collapsed and was sold to JPMorgan Chase in June 2008.
Such pay arrangements have attracted the ire of Democratic Party (United States), Democrats and Republican Party (United States), Republicans in the United States Congress, who demanded limits on executive pay in 2008 when the U.S. government was bailing out the industry with a $700 billion financial rescue package.[
Writing in the Global Association of Risk Professionals journal, Aaron Brown, a vice president at Morgan Stanley, says "By any standard of human fairness, of course, investment bankers make obscene amounts of money."]
See also
* Alternative investment
* Boutique investment bank
* Devolvement
* Independent advisory firm
* Investment Banking Exam
* List of investment banks
* Traditional investments
References
Further reading
*Fleuriet Michel Investment Banking Explained: An Insider's Guide to the Industry McGraw-Hill Education, McGraw-Hill New York NY 2008 .
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Investment banking,
Banking terms