INTRODUCTION TO

INVESTMENT
BANKING :
HISTORICAL
DEVELOPMENT AND
OVERVIEW
(CHAPTER 5)
WHAT IS INVESTMENT BANKING?
Investment banking is concerned with:
Assisting the Capital Market in its function of capital
intermediation

At macro level IB help discharge critical function of pooling and

allocation of capital in the Capital Market

Collin’s ‘The Dictionary of Banking & Finance’ defines IB as a

bank with deals with the underwriting of new issues and advises
corporations on their financial affairs
KEY INVESTMENT BANKING ACTIVITIES

 PROP TRADING & INVESTMENTS

 MARKET MAKING

 M&A ADVISORY

 CORPORATE ADVISORY/ NEW ISSUES / RESTRUCTURING

 UNDERWRITING

 STRUCTURED PRODUCTS

 FUNDRAISING
KEY INVESTMENT BANKING FUNCTIONS

https://www.mergersandinquisitions.com/investment-banking/
MERCHANT BANKING VS INVESTMENT BANKING?

A fine line theoretically separates the functions of these two institutions, even that tends to blur,
as the activities often bleed into one another’s territories. The term “merchant bank” was the
British term used to describe investment banks
Merchant banks lend their services to international finance, business loans for companies, and
underwriting
Investment banking is usually fee- or fund-based, providing a wider variety of services to its clients
Merchant banks help to small- to mid-sized corporations and HNIs access creative equity financing,
bridge financing, mezzanine financing, and a number of highly delineated corporate credit products;
investment banks have a wider range of clients, such as individuals and big companies.
HISTORICAL DEVELOPMENTS - GLOBAL
1. Investment banking initiated in the USA. Investment banking and Merchant
Banking are distinguished by geography, functionality and regulation.
2. Got a boost with the conclusion of World War I. There was a setback due to
the Great Depression of 1929 and the promulgation of the Glass Steagall
legislation that separated commercial banking and investment banking.
3. Traditionally investment banking consisted of intermediation in the
securities market (market for debt and equity securities) and in the M&A
market. Therefore investment banking traditionally had three segments –
Debt Securities Market, Equity Market and M&A Market.
4. To prevent the excessive exposure of commercial banks in the securities
market, the Glass Steagall Act was passed in 1934 preventing universal
banking.
HISTORICAL DEVELOPMENTS - GLOBAL

The 1980s and 1990s saw the growth of this industry to new segments in the US
and Europe with the emergence of global investment banks and universal banks.
After gradual dilution over the decades, on 12th November, 1999 the Glass
Steagall Act was repealed and replaced by the Financial Modernisation Act.

This repeal removed the anti-affiliation restrictions between commercial banks,

investment banks and insurance companies.
Large scale mergers between investment banks (Salomon Brothers and Smith
Barney to form Salomon Smith Barney), Morgan Stanley with Dean Witter (to
form Morgan Stanley Dean Witter), Citibank with Travelers Group (an insurance
company) to form Citigroup are examples.
HISTORICAL DEVELOPMENTS - GLOBAL

1) The global pure investment banks are names such as Merrill Lynch, Goldman Sachs,
Lehmann Brothers and others. Pure investment banks are those that do not have any
commercial banking or insurance affiliations.

1) Global Universal Banks include names such as J.P.Morgan, Citigroup, UBS, Deutsche
Bank (which acquired Bankers Trust), Standard Chartered, Bank of America Merrill
Lynch, HSBC, Barclays, Credit Suisse, Rabo Bank and others.
US INVESTMENT BANKING CRISIS
The year 2008 was unprecedented in the history of investment banking with five top US
investment banks biting the dust.
Lehman Brothers, founded in 1850 and one of the oldest banks is under liquidation. On
Sept. 14, 2008, the investment bank announced that it would file for liquidation after
huge losses in the mortgage market and a loss of investor confidence crippled it and it
was unable to find a buyer.
Bear Sterns was bought by Bank of America under a threat of bankruptcy by J.P. Morgan
Chase. Lehman and Bear Stearns had a number of similarities. Both had relatively small
balance sheets, they were heavily dependent on the mortgage market, and they relied
heavily on the “repo” or repurchase market, most often used as a short-term financing
tool. Bear Sterns was the highest underwriter of MBS.
Merrill Lynch was rescued by Bank of America.
Morgan Stanley and Goldman Sachs were hit by the sub-prime credit crisis.
Citibank also found itself in deep trouble with its stock price trading at less than a dollar
at one time.
US INVESTMENT BANKING CRISIS
US investment banks are held responsible for the origin of the ‘contagion risk’ caused by
the spread of toxic assets in the system through complex securitisation and CDS
derivatives.

The US government promulgated the Dodd–Frank Wall Street Reform and Consumer
Protection Act 2010 which inter alia brought OTC derivative contracts under regulation.
It also introduced the ‘Volcker’s Rule’ to regulate financial conglomerates and TBTF
institutions. Volcker’s Rule also brought restrictions on banks indulging in proprietary
trading or in alternative fund management.

Despite systemic risks and regulatory controls, universal banking and financial
conglomerates are the order of the day and most leading global investment banks are
a part of such conglomerates.
 MANY FINANCIAL CONGLOMERATES ARE INTO I-
BANKING
Bank Holding Company / Financial Holding Company
Represents the principal shareholders of the
conglomerate and provides capital/ownership across all
verticals

Commercial Banking Investment Banking Asset Management Insurance

Mortgages and related and Securities and Private Underwriting,
Businesses and Business and related Banking and advisory, risk
Financial Services Financial Services related Financial management and
Services related services
CHINESE WALLS IN I-BANKING
The term Chinese wall, as it is used in the business world, describes a virtual barrier
intended to block the exchange of information between departments if it might result
in business activities that are ethically or legally questionable.
The need for a Chinese wall in the financial industry has become more common since 1999
as Glass Steagall Act was repealed

For example, an IB arm is acting on the behalf of a public company planning a takeover
of a rival company. The talks are highly confidential, not least because of the potential for
illegal insider trading on the information. Yet the same firm has Asset Managers or Traders
in another division who may be actively advising clients to buy or sell stock in the
companies involved. The Chinese wall is supposed to prevent any knowledge of the
takeover talks from reaching the investment advisers.

The need for a Chinese wall policy was strengthened in 2002 by the passage of the
Sarbanes-Oxley Act, which mandated that companies have stricter safeguards against
insider trading.
HISTORICAL DEVELOPMENT OF IB - INDIA
Initially Grindlays and Citibank were active as I-Banks in India in 1960s and 1970s.
In India, investment banking started off in 1972 in a limited way. It gained recognition as an
organised industry only in the eighties with the setting up of SBI Capital Markets Ltd in 1986.
In India the industry is fragmented with different types of investment banks ranging from
universal banks to pure investment banks and advisory firms.
In India we use both the terms – merchant banking and investment banking. Merchant banking
is defined as the activity of management of public offers which is licensed and regulated
under law. Investment banking refers to services in other areas primarily dealing with
corporate finance and advisory, private equity and M&A.

IB industry association in India is AIBI (Association of Investment Bankers of India).

HISTORICAL DEVELOPMENT OF IB - INDIA
• Universal Banks in India presently are SBI, ICICI, Kotak and IDBI (Axis Bank and HDFC group
are also in the race). They are present in all segments of universal banking as understood both in
India and globally. SBI has recently announced setting up of a venture fund.

• Universal banking, the large banks operate extensive network of branches, provide many
different services, hold several claims on firms (including equity and debt) and participate
directly in the Corporate Governance of firms that rely on the banks for funding or as insurance
underwriters.

• Examples of pure play investment banks in India are DSPML (presently owned entirely by
Merrill Lynch (Bank of America) and JM Financial (which broke off with the Morgan Stanley JV).
I-BANKING IN INDIA
 Over-dependence on Issue Management led to perishing of many investment banks

 Due to limited capital market activity only big firms flourish which are backed by
commercial banks

 Inadequate variety in financial products and limited breadth in secondary market,

especially Corporate Debt Market

Big-ticket deals in India have helped big i-banks to take India seriously e.g. Tata-
JLR, Tata-Corus, Hindalco-Novelis
HETEROGENEOUS STRUCTURE OF IB IN INDIA
Full service Investment Banks- SBI, ICICI, IDBI, PNB etc.

Foreign Universal Banks- Citibank, J.P.Morgan, HSBC, Deutsche, Barclays, CS, UBS etc

IB structures as NBFC- Tata capital, Reliance Capital, L&T Finance, Mahindra Finance,
IL&FS etc.

Home grown pure IB- DSP, JM Financial, Edelweiss, Religare Capital, Avendus Capital

Boutique I banks- MAPE Advisory

STRUCTURE OF INDIAN IB INDUSTRY
As per Indian Regulations, it is not allowed for one legal entity to perform
all investment banking functions.
Bankruptcy remoteness is a key feature while structuring the business lines
of an investment bank
Indian Investment banks follow a conglomerate structure by keeping their
business segments in different corporate entities to meet regulatory norms
For acting as merchant banker, certificate of registration is issued by SEBI
SERVICE PORTFOLIO OF INDIAN IB
Core IB
Merchant Banking, Underwriting & Book Running (free pricing of securities by SEBI)
M&A Advisory (institutionalization of corporate acquisitions by SEBI by Takeover Code 2011)
Corporate Finance Advisory (related to project finance, corporate restructuring, capital
restructuring through equity repurchases, raising VC/PE funding, structuring JVs

Allied Business
Asset Management Services (Mutual Funds, Hedge Funds, Realty funds, PE/VC funds)
Securities Business (broking, trading, sales & research, investment advisory, PMS, Wealth
management)
 BUSINESS PORTFOLIO
CORE INVESTMENT BANKING
 Public Offers in Equities and Bonds –
Domestic Offers, Foreign listings on
domestic markets such as Wall Street,
Sponsored ADR/GDR programs,
Underwriting, Sales and Distribution.
 Private Placements – Bond and Equity
institutional placements, global bond
underwriting and placements.
 M&A transaction advisory, tender
offers, M&A financing, co-investing,
buy-outs and LBOs, High Yield M&A
Bond placements.

ALLIED BUSINESSES
 Asset Management – Mutual Funds,
hedge Funds, Private Equity and
Venture Capital, Buyout Funds
 Securities Business – Stock Broking,
Investment Advisory, Proprietary
Trading and Investments, Derivatives,
Structured Products
 Forex and Commodity products
 Risk advisory and management.
 Custodial Services
 Other Capital Market services.
BUY SIDE & SELL SIDE IN I-BANKING

Source: CFI
SELL SIDE BUY SIDE : MORE EXPERIENCE

Source: CFI
ALLIED BUSINESSES – MUTUAL FUNDS
Regulated in India by SEBI.
A tripartite structure is followed for domestic mutual funds.
The sponsor, trustee and AMC comprise the parties around the mutual
fund which is incorporated as a trust.
Investment criteria formulation and fund management are conducted
by the AMC.
ALLIED BUSINESSES – PE AND HEDGE FUNDS
Hedge funds originated in the US as unregistered funds. Their floatations are strictly
private offerings not regulated by the SEC. They are now regulated under the Frank-
Dodd Act. They are similarly regulated in UK, EU and other countries

 Venture capital is a part of private equity. In India these are regulated by SEBI.
Foreign funds are regulated under separate guidelines.
ALLIED BUSINESSES – SECURITIES BUSINESS
Usually structured in a separate subsidiary for conducting securities business regulated
under SEBI regulations.

Business includes stock broking, sales and distribution of financial products (equity, debt,
MFs), proprietary trading, Equity, Fixed Income and Quantitative Research and
investment advisory services or portfolio management.

Investment banks have to maintain firewalls (Chinese Walls) between core investment
banking and allied businesses.
REGULATION IN USA
Dodd–Frank Wall Street Reform and Consumer Protection Act 2010
Oversight of Rating Agencies
Consent for prop trading
Registration & Regulation of private fund advisors
Regulatory regime for Derivatives Markets-Central Clearing Mechanism
rather than bilateral clearing
Mortgage Lending Reforms: curbs on sub-prime lending
Regulation of TBTF (Too Big To Fail) financial conglomerates
REGULATION IN INDIA
 Indian I-banks follow a conglomerate structure by keeping their business segments in
different corporate entities to meet regulatory norms
 So SEBI regulates merchant banking arms, while RBI will regulate banking operations
and IRDAI will regulate insurance
 SEBI issues merchant banking license
 Asset Management Business is also SEBI regulated
 All IB companies are incorporated and governed by Companies Act
 Universal banks regulated by RBI Act and Banking Regulations Act (which puts restrictions
on capital mkt exposures to be taken by banks)
 IBs constituted as NBFCs are regulated by RBI (in area of resource mobilization, accounts &
admin control)
REGULATORY FRAMEWORK FOR IB BUSINESSES IN INDIA

Different Aspects of IBs regulated by SEBI

Merchant banking business SEBI (Merchant Bank) rules 1992
Underwriting business regulated by SEBI (Underwriting) rules 1993
Secondary mkt ops SEBI (Stock brokers & Sub-brokers rule 1992, Prohibition of Insider
Trading rules 1992, Prohibition of Fraudulent & Unfair Trade Practices relating to
Securities mkt 1993)
Asset Management as Mutual Funds regulated under SEBI (MF) rules 1996
Portfolio Management regulated under SEBI (Portfolio Managers) rules 1993
VC business by funds incorporated in India under SEBI (Alternative Investment Fund)
rules 2012 and those incorporated outside India under SEBI (Foreign VC Fund) rules
2006
SEBI 2012 GUIDELINES FOR AIF
 Category I AIF – those AIFs with positive spillover effects on the economy, for which certain incentives
or concessions might be considered by SEBI or Government of India or other regulators in India; and
which shall include Venture Capital Funds, SME Funds, Social Venture Funds, Infrastructure Funds and such
other Alternative Investment Funds as may be specified. These funds shall be close ended, shall not
engage in leverage and shall follow investment restrictions as prescribed for each category.

 Category II AIF – those AIFs for which no specific incentives or concessions are given by the government
or any other Regulator; which shall not undertake leverage other than to meet day-to-day
operational requirements as permitted in these Regulations; and which shall include Private Equity
Funds, Debt Funds, Fund of Funds and such other funds that are not classified as category I or III. These
funds shall be close ended, shall not engage in leverage and have no other investment restrictions.

 Category III AIF – those AIFs including hedge funds which trade with a view to make short term
returns; which employs diverse or complex trading strategies and may employ leverage including
through investment in listed or unlisted derivatives. These funds can be open ended or close ended.
DARK SIDE OF I-BANKING
Overleveraged
Speculative
Manipulative: Barclays, Deutsche
Misleading Investors: Goldman Sachs, Citicorp
Too much Pay & Bonuses: All I-Banks
Money laundering: HSBC, Standard Chartered
Insider trading: Goldman Sachs
COMPLIANCE FRAMEWORK FOR IB
BUSINESS
Dodd-Frank Act
Volcker’s Rule
Basel III Banking Accord
Foreign Account Tax Compliance Act (FATCA), 2010
Financial Action Task Force

India:
Prevention of Money laundering Act
MAJOR INVESTMENT BANKS
GLOBALLY INDIA
J.P. Morgan Kotak Mahindra Capital
Goldman Sachs Citigroup Global Markets India
BoA Merrill Lynch SBI Capital Markets
Morgan Stanley Standard Chartered India
Citigroup IDBI Capital Markets
Barclays Capital Axis Bank (acquired Enam)
Credit Suisse JM Financial
Deutsche Bank Edelweiss Financial Services
Wells Fargo ICICI Securities
HSBC PNB Investment Services
BNP Paribas BOB Capital Markets
UBS HSBC India
Societe Generale IDFC Bank