Faculdade de Economia da Universidade do Porto

Master in Finance

Financial Institutions
[5]

Carlos Francisco Alves

2023-2024

Investment
Banking

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Faculdade de Economia da Universidade do Porto

Role of Investment
Banks in Financial
Markets

[Roles and
Functions
(varies per
country and
– Securities Underwriting (IPO and seasoned offerings) bank)]
(best efforts underwriting vs firm commitment)
– Advising
(M&A, Financial Restructuring, IPO, etc.)
– Market Making
– Securities Trading (“Proprietary trading”) and Brokering
– Research
– Risk Management Services
– Private Banking and Asset Management

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Main differences
between
Investment and
Commercial
Banking

– Commercial banks receive deposits from clients (individuals or firms) and lend
funds to borrowers

– Investment Banks raise funds for corporations by selling securities

[Accordingly, commercial banks are mainly regulated by prudential regulators

(e.g., Banco de Portugal and European Central Bank), and investment banks are
mainly regulated by the securities markets regulators (e.g., SEC in the Unit
States and CMVM in Portugal).

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Separation
between
Commercial and
Investment
Banking

- The Glass-Steagall Act (1933), imposed the complete separation of

commercial and investment banking activities, which lasted until its repeal in
1999 by the Gramm-Leach-Bliley Act.
- Some believe that the engagement in both types of banking under one roof,
contributed to the burst of some bubbles and for the beginning of the global
recession in 2008 following the 2007 sup-prime crisis. This happens because
some risks originated in the investment banking side are assumed in the
commercial bank balance sheet.
- For example, acting as an investment bank, an institution can help a company
sell an IPO, then use its commercial division to extend a generous line of credit
to the new corporation. The generous loan allows the new company to finance
rapid growth and boost its stock price. However, the decision on the credit line
was not independent of the investment banking interests.
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Equity Offerings

Concept of IPO [Initial Public Offering]

First public offering of shares of an unlisted company
Issuance of New Shares [Primary Market] [The seller is the company]
Public Offering Sale of Shares Previously Issued [Secondary Market]
[The seller is a shareholder or a group of shareholders]
A mix of Primary and Secondary Market Operation

Concept of SEO [Seasoned Equity Offerings]

Offering shares of an already listed company in the primary and/or
secondary market.
The sale of the securities to investors
is made indirectly through
authorised financial intermediaries
[underwriters].

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Financial
Institutions
Commitments

Levels of Responsibility of Financial Intermediaries:

Firm-commitment - the underwriters purchase for their own portfolio, at a

predetermined price, that part of the issue which, after a certain period of
time, has not been placed with the end-investors.

Best-efforts - the financial intermediaries only commit to develop their best

efforts with the placement of the issue.

Syndicates - Consortia formed by investment

banks to share the legal process risks (including
underwriting) and reach a greater number of
investors.

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Syndicate Roles

Different roles in a syndicate:

Global Coordinator - is the coordinator of the operation. Only highly
prestigious investment banks aspire to this role.
Bookrunner - the bank that centralises in a book the purchase orders
channelled by the other banks. In general, the global coordinator is a
bookrunner, although it may not be the only one.
Joint Lead Manager and Joint Bookrunners - are the second lines.
Lead Managers and Managers - third and fourth lines.

Fees are different for different roles (management

fee, underwriting fee and selling fee). The bookrunner
has the advantage of playing a relevant role in the
allocation of shares.

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Syndicate Roles

EDP Renováveis’ IPO

Coordenadores Globais e Gestores do Livro de Ordens
(Bookrunners )
1) Banco Espirito Santo de Investimento
2) Banco Millenium BCP Investimento
3) Caixa – Banco de Investimento
4) Citigroup Global Markets Limited
5) Morgan Stanley & Co. International
6) UBS Limited

Co-Managers
7) Deutsche Bank AG, London
8) JP Morgan Securities Limited
9) Merril Lynch International
10) Santander Investment
11) Societe Generale
Source: Prospecto da Oferta.

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Syndicate Roles

EDP
Joint Global Coordinators
ABN AMRO Rothschild - Goldman Sachs - BPI

United States United Kingdom Continental Europe&ROW Portuguese Institutional

Joint Lead Managers Joint Lead Managers Joint Lead Managers Lead Manager
Goldman Sachs [*] Goldman Sachs [*] ABN AMRO Rothschild [*] BPI [*]
ABN AMRO Rothschild ABN AMRO Rothschild [*] Goldman Sachs ESSI
CISF
Co-Managers Co-Lead Managers Co-Lead Managers
Lehman Brothers SBC Warburg Dresdner KB Co-Lead Managers
Merril Lynch BPI UBS CGD
BPI BPSM
Underwriters Junior Co-Lead Managers
12 others NatWest Senior Co-Managers Co-Managers
Schroders Crédit Lyonnais B. Mello
Santander
Co-Managers
Barclays de Zoete Co-Managers
Cazenove 5 Other

[*] Bookrunners
Source: Prospecto da Oferta.

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Syndicate Roles

Price Fixing Mechanisms in Offers of Shares Fixed Price - a fixed price is

agreed.
Indexed Price - a fixed price is agreed based on a given date and this price
is indexed to a market benchmark in order to remain up-to-date.

Auction - a competitive price auction is held [applicable to blocks of

shares].

Bookbuilding - a process of registering and noting purchase intentions,

following presentations by the company and an investor engagement
process by the placing syndicate. During the bookbuilding period,
investors' purchase intentions are mere designs and do not constitute
firm intentions.
[SEO discount to current share price (<2%)]

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Syndicate Roles

In the allocation (bookbuilding) process, as a rule, preference is given to

(i) the orders of investors of higher quality;

(ii) the orders of investors that show less price sensitivity;

(iii) the orders carried earlier to the book and kept unchanged;

(iv) the orders in which the amounts requested are genuine or the orders
that are inflated for positioning for allocation, trying to foresee which
amount is really desired for long-term investment.

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Underpricing

IPO Underpricing
País Período Média
Alemanha 1994-2000 39%
There is abundant and Reino Unido 1994-2000 22%
significant evidence of Portugal 1994-2000 21%
Suécia 1994-2000 18%
underpricing. [IPO price Espanha 1994-2000 14%
< secondary market Suíça 1994-2000 14%
opening price]. França 1994-2000 13%
Itália 1994-2000 12%
EUA 1996-2000 37%
Fonte: Levy e Post (2005)

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Underperformance

In addition to underpricing, the literature documents two other anomalies:

- Concentration of issues at certain times (hot issue);
- Underperformance in the long run;
Ritter (JF, 1991): Using a sample of 1526 IPOs carried out in the USA between 1975
and 1984, the author showed that after three years the performance of these
companies was significantly lower than that of other companies of the same size
and in the same industries [34.47% vs 61.86%]. [Note: Using the price of the first day
of the stock exchange as the starting price]

[«(…) it is consistent with a scenario of firms going public when

investors are irrationally over optimistic about the future potencial
of certain industries. (p. 4)]

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Primary Market
Offerings of Listed
Firms

Rights entitle existing shareholders to buy new shares. Usually, such

shares are issued at discounted price (“preemptive right”).

Standby agreements: investment banks commit to take up any

unexercised rights and exercise them paying the subscription price in
exchange for the new shares.

Rights are usually temporarily traded after their distribution to

shareholders.

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Primary Market
Offerings of Listed
Firms

Example:
A certain company had an equity capital of EUR 1 000 000, represented by
1 000 000 shares with a nominal value of EUR 1 each. Their share price
was EUR 2 per share at the time (zero date) when the company decided to
increase its capital to 1 500 000 shares by issuing 500 000 shares by public
subscription at a unit price of EUR 1.5 per share.

How much is the subscription right for the new shares worth?

[(1 000 000x2 + 500 000x1.5)/1 500 000 = 1.83(3) = Expected Ex-Rights
Price]
[2-1.83(3)= 0.16(6). (value of the right implied by the share price).]
[1.83(3) – 1.5 = 0.3(3). But given that I need 2 old shares to be able to buy
a new one, 0.3(3)/2 = 0.16(6)]

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Primary Market
Offerings of Listed
Firms

Expected Ex-Rights Price

𝑃0 𝑁0 + 𝑃𝑆 𝑁1 where:
𝑃0∗ = N0 = number of shares before the capital increase;
𝑁0 + 𝑁1 + 𝑁2 N1 = number of shares for subscription at the price Ps;
N2 = number of shares issued by incorporation of
reserves.

Assumption: There is no other issue affecting the price.

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Primary Market
Offerings of Listed
Firms

Right Value

where:
P*0 = ex-right price;
𝑃0∗ − 𝑃𝑆 Ps = price for subscription the new shares;
𝑅= M = Number of rights needed to buy one new share.
𝑀

[(1.83(3) – 1.5)/2 = 0.16(6)]]

Assumption: There is no other issue affecting the price.

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Primary Market
Offerings of Listed
Firms

𝑃0∗ − 𝑃𝑆
𝑅=
𝑀

Alternatively, since P*0 = P0-R:

𝑃0 − 𝑅 − 𝑃𝑆 𝑃0 − 𝑃𝑆
𝑅= «=» 𝑅=
𝑀 𝑀+1

In the Example: (2-1.5)/3=0.16(6).

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Master in Finance

Financial Institutions
[5]

END

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