Capital Markets - News and analysis

Today, UBS announced a massive downsizing of its investment bank. Other banks are in the same process of will follow. This is a logical consequence after various of the investment banks had reached a "bubble stage" prior to the financial crisis. Excesses happened in an environment of governmental regulation of the US real estate market and weak governance of various banks. The current process will not at all be the end of investment banking. In contrary, firms from main street (as opposite to Wall Street) are in urgent need of services which help them to finance projects, to get advice in acquisitions and capital market transactions, to make optimal use of the financial resources etc. Downsized and less risky investment banks can be a more reliable partner in this respect.

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MarketObservation: Nature of investment banks today and in the future, October 11, 2007:

Banks such as UBS have lost billions in the subprime mortgage crisis. This business was done out of the investment banking departments of such banks. It is questioned again whether it could make sense to spin off investment banking from large banking conglomerates as they might have a negative impact on overall risk-adjusted value of such conglomerates.

It is argued that the break up value of a bank such as UBS might be substantially bigger than the current market capitalization of the bank. When thinking about such scenarios it is also important to look at the nature of todays large investment banking operations. They are not homogenous at all within themselves. The investment banking business is a combination of highly computerized, scaleable businesses and businesses where tacit skills are highly important (e.g. M&A deal making). When discussing possible investment banking spin offs from banking conglomerates a differentitated view, looking at the various risk profiles of investment banking businesses, should be taken.

Attached article provides a valuable overview of the current nature of investment banking operations:

Investment Banking: past, present and future, by Alan D. Morrison, Saïd Business School, University of Oxford and William J. Wilhelm, Jr., McIntire School of Commerce, University of Virginia, 2007

Key conclusions are:

• Investment banks emerged as intermediaries in informationally sensitive transactions.
• The banks established long-term profi table relationships with key information providers and used this information, together with a valuable reputation for probity,
  to attract security issuers.
• The traditional investment banker had a largely tacit skill set. He learned his trade during a long on-the-job apprenticeship in a firm that could provide the close relationships, the mentoring, and the peer-group monitoring upon which tacit skills rely.
• Due to the information technology revolution of the late 20th century many traditionally tacit skills were codified, and massive economies of scale became possible.
• Investment bankers jettisoned the partnership form that had fostered their creation and use of tacit skill in favor of joint stock incorporation, which gave them access to the
  capital required to harness the new economies of scale.
• Tacit skill did not become irrelevant but it became more difficult to reconcile it with the formal reporting lines and the increased scale of the older investment banks.
• An industry reorganization was perhaps inevitable. Using new communications
  technologies, investment banks have started to spin off their most human capital-intensive activities into boutique investment houses.
• Settlement, trading, and analysis tasks were retained

Author's guess about the future:

• Further technical advances, coupled with an increasingly strident regulatory state, will likely result in more codification, more systematization, and more consolidation in the largest investment banks.
• This trend will take the biggest players farther from their origins in tacit human capital businesses.
• But tacit skill andinformal contracts based upon reputation will remain central
  features of informationally intensive security market trades.
• The challenge for the large investment banks will be to reconcile their large scale operations with the operations where tacit skills are a key success factor.

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MarketObservation: Daniel A. Kukla about "The Boundary of the Investment Firm ", August 31, 2010:

Kukla, Daniel A., The Boundary of the Investment Firm (August 13, 2010). Available at SSRN: http://ssrn.com/abstract=1658541

Abstract:

"The central concept of an investment firm is fuzzier than might immediately appear. Why do investment firms exist at all? What should be the range of their activities? This exploratory study investigates forces which shape the boundary of the investment firm by analyzing firms in the Private Equity industry. The PE industry offers a rich ground for research, given that substantial parts of the PE universe have been rapidly migrating from traditional single-product PE firms towards multi-business investment firms. Based on interviews with senior investment professionals and executives from leading PE firms and based on case studies, I find that the boundary of the firm is determined by the trade-off between expansion enhancers, in particular ‘deal sourcing advantages’, ‘capital sourcing advantages’, ‘procurement cost advantages’ and ‘information sharing advantages’, and expansion inhibitors, particularly ‘conflicts of interest’, ‘asset allocation authority’, and ‘parenting disadvantages’. Moreover, I speculate that if the new generation of multi-business investment firm models succeeds, they may fill the gap which most recent regulation has created in the commercial and investment banking industry, given that multi-business firms are not scrutinized to the same extent."

Keywords: Private Equity, Multi-Business Investment Firm

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Selected other MarketObservation posts about investment banking in the past:

MarketObservation: Ownership structure of banks matters, March 26, 2011

MarketObservation: Forderung nach einer differenzierten Betrachtung des Investment Bankings, April 26, 2008