INVESTMENT BANKING

SUBMITTED BY:

TANMAY BHADRA
MBA (in Finance), Semester - II Roll No: 32

DECLARATION
I hereby declare that this project on Investment Banking has been prepared by me during the year 2012 for the partial fulfilment of MBA in FINANCE course under UNIVERSITY of CALCUTTA, and this project report has not been submitted in any university or institution for award of degree of diploma so far.

(TANMAY BHADRA) Roll No: 32 . Date: 11th June, 2012-06-06

ACKNOWLEDGMENT
I realise that these words written by the way of gratitude are not sufficient to express my gratefulness to those who supported me with courage, confidence and suggestions. I wish to express my sincere thanks and hearties gratitude to Professor D. R. Dandapat, Co-ordinator, MBA in FINANCE, UNIVERSITY OF CALCUTTA. I also express my deep reverence to Professor R. P. Chowdhury, our semester in charge and all faculty members of MBA in FINANCE for their active cooperation and invaluable support.

TANMAY BHADRA

TABLE OF CONTENTS

1st.

INTRODUCTION A Brief History of Investment Banking and Securities Regulation Role of Investment Banking

2nd 3rd 4th 5th 6th 7th

ORGANISATIONAL STRUCTURE OF AN INVESTMENT BANK SIZE OF INDUSTRY RECENT EVOLUTION OF THE BUSINESS POSSIBLE CONFLICTS OF BUSINESS LIST OF INVESTMENT BANKS CAST STUDY - INVESTMENT BANKING, THE THIRD Introduction External challenges facing the investment baking industry The operational responses Issues for the future Survey participants

MILLENNIUM

8th

CONCLUSION

CHAPTER - 1

INTRODUCTION

Investment banking firms are intermediaries that advice firms, distribute securities, and take principal positions. In the course of these activities, information is produced. Most investment banking firms are vertically integrated organizations that incorporate merger and acquisition (M&A) advisory services, capital raising services, securities trading and brokerage, and research coverage. In Europe, universal banks have been permitted to perform both commercial and investment banking functions. In the USA, the Glass- Steagall Act separated commercial and investment banking functions from the 1930s to the 1990s. Commercial banks were permitted to take deposits from individuals that are guaranteed by the government (up to $100,000 per account-holder, as of 2003). In return for the government deposit guarantee, commercial banks were prohibited from certain activities, including taking equity positions in firms and underwriting corporate securities. The prohibition on underwriting securities was gradually relaxed, first for debt securities and then for equity securities. In 1999, The Glass-Steagall Act was finally replaced, although deposit insurance remains. The key difference between commercial banks and investments banks in the corporate financing function is that commercial banks primarily act as long-term principals, making direct loans to borrowers, whereas investment banks primarily act as short-term principals. Since investment banks are selling to investors the securities that firm issue, the marketing of financial securities is important. This is a topic that has no reason for coverage in a Modigliani-Miller framework, where markets are perfect and there is no role for marketing. An important tool in the marketing of financial securities, especially equities, is research coverage (forecasts and recommendations) by security analysts. Since the investment banking firm providing research reports also underwrites of offerings, this is referred to a self-side coverage. There is a perception that analyst coverage has become more important over time, partly because for many industries (i.e., biotechnology and technology companies), historical accounting information is of limited use in discerning whether new products and services will create economic value added. At the end of 2000, the Securities and Exchange Commissions Regulation FD (fair disclosure) went into effect. This

regulation may affect the role of analysts, for it requires that information that a corporation provides to analysts must be publicly disclosed to others as well. Investment banks help companies and governments raise money by issuing and selling securities in the capital markets (both equity and debt), as well as providing advice on transactions such as mergers and acquisitions. Until the late 1980s, the United States and Canada maintained a separation between investment banking and commercial banks. A majority on investment banks also offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities. Trading securities for cash or securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting research, etc.) is referred to as the sell side. The busy side constitute the pension funds, mutual funds, hedge funds, and the investing public who consume the products and services of the sell-side in order to maximize their return on investment. Many firms have both buy and sell side components.

A brief history of investment banking and securities regulation

Until the 1970s, almost all investment banking firms were private partnerships, generally with a limited capital base. When underwriting large securities offerings, these partnerships almost always formed underwriting syndicates, in order to meet regulatory capital requirements, distribute the securities, and share risk. Many investment banking firms had relationships with corporations. In the 1970s, the investment banking industry began to change to a more transactional form, where corporations use different investment bankers for different services, on an as-needed basis. Investment banking firms have grown in size and scope, largely through mergers, and most of the larger firms have converted to publicly traded stock companies. A reason for the increase in size of investment banking firms is the increased importance of information technology, with large fixed costs and low marginal costs. With their new-found large capital bases and distribution channels, the historical rationale for forming syndicates to distribute securities has largely disappeared. Consistent with this, the number of investment banking firms participating in a given syndicate has shrunk noticeably over the last few decades. A syndicate is composed of one or more managing underwrites and from zero to over on hundred other syndicate members. The lead manager does most of the work and receives most of the fees. All of the managers usually provide research coverage. Indeed, this is the major reason why syndicates still exist. Frequently, after a deal is completed, a tombstone advertisement listing the syndicate members is published. As a consequence of distributing the shares in an initial public offering, the lead underwriter knows where the shares are placed, which gives a natural advantage for making a market later on, since the underwriter knows whom to call if there is an order imbalance. Advice on acquisitions and follow-on stock

offerings frequently follows as well. The underwriter almost always assigns an analyst to follow the company and provide research coverage. Thus, securities underwriting capabilities are combined with M&A advisory capabilities, as well as sales and trading capabilities. All of these activities are information-intensive activities. Chinese walls, which are supposed to be as impregnable as the Great Wall of China, whereby proprietary information possessed in the M&A advisory function is not disclosed to stock traders, are supposed to exist. In the course of assisting in the issuance of securities, investment bankers perform due diligence investments. In the M&A advisory role, they produce fairness opinions. Investment bankers are this putting their reputations on the line, certifying for investors that the terms of the deal are fair and that material information is reflected in the price. In the USA, federal government regulation of securities markets is based upon a notion of caveat emptor (buyer beware) with full disclosure. The USA Securities and Exchange Commission (SEC) regulates securities markets. In addition, self regulatory organizations such as the New York Stock Exchange and the National Association of Securities Dealers impose requirements on members, and the threat of class action lawsuits on behalf of inventors constrains the actions of issuers and underwriters. Prospectuses are required to contain all material information, with specific requirements for the amount and form of accounting disclosures. In Europe, firms going public and their underwriters are prohibited from disclosing projections that are not in the prospectus during the quiet period, starting before a firm announces its IPO and ending 40 calendar days after the offer. An exception to this is that limited oral disclosures may be made during road show presentations, where attendance is restricted to institutional investors. In 1999, the SEC started permitting certain qualified individual investors to have access to web casts of the road show.

Typically, the managing underwriters issue research reports with buy or strong buy recommendations as soon as the quiet period ends. Michaely and Womack (1999) present evidence that self-side analysts affiliated with managing underwriters face conflicts of interest. The conventional wisdom is that analysts have become cheerleaders. The three reasons for this are
1)

They are dependent upon access to corporate managers for information; 2) Their compensation is tied to whether their investment banking firm is chosen as a managing underwriter on equity or junk-bond offerings, or as an advisor on M&A deals; and 3) The institutional clients that pay attention to a report are likely to be long in the stock. In 2002, new rules were announced in an attempt to limit the conflicts of interest and alert investors to the conflicts.

On the front page of a prospectus, the offer price and underwriting discount (commission) are disclosed. The underwriter is prohibited from distributing any securities at a price above the stated offer price, although if the issue fails to sell out at the offer price, the underwriter may sell at a lower price. Because the underwriter cannot directly gain from any price appreciation above the offer price on unsold securities, while bearing the full downside of any price fall, there is every incentive to fully distribute the securities offered. Based on the logic of the efficient markets hypothesis, beginning in 1982 the SEC began permitting publicly traded firms meeting certain requirements (basically, large firms) to issue securities without distributing a prospectus. Instead, SEC Rule 415 states that by filing a letter with the SEC disclosing the intention of selling additional securities within the next two years, a firm can sell the securities whenever it wants.

Existing disclosures, such as quarterly financial statements, are deemed to be sufficient information to investors. The securities can be taken off the shelf and sold, in what are known as shelf issues. In practice, shelf issues are commonly done for bond offerings. Before selling equity, however, many firms prefer to hire an investment banker and conduct a marketing campaign (the road show), complete with a prospectus. From 1984-1992 there were virtually no shelf equity offerings, but they have enjoyed a resurgence since then. Investment banks help companies and governments raise money by issuing and selling securities in the capital markets (both equity and debt), as well as providing advice on transactions such as mergers and acquisitions. Until the late 1980s, the United States and Canada maintained a separation between investment banking and commercial banks. A majority of investment banks also offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities.

The role of the Investment Bank

Investment banks provide four primary types of services: raising capital, advising in mergers and acquisitions, executing securities sales and trading, and performing general advisory services. Most of the major Wall Street firms are

active in each of these categories. Smaller investment banks may specialize in two or three of these categories.

1. Raising Capital
An investment bank can assist a firm in raising funds to achieve a variety of objectives, such as to acquire another company, reduce its debt load, expand existing operations, or for specific project financing. Capital can include some combination of debt, common equity, preferred equity, and hybrid securities such as convertible debt or debt with warrants. Although many people associate raising capital with public stock offerings, a great deal of capital is actually raised through private placements with institutions, specialized investment funds, and private individuals. The investment bank will work with the client to structure the transaction to meet specific objectives while being attractive to investors.

2. Mergers and Acquisitions

Investment banks often represent firms in mergers, acquisitions, and divestitures. Example projects include the acquisition on a specific firm, then sale of a company or a subsidiary of the company, and assistance in identifying, structuring, and executing a merger or joint venture. In each case, the investment bank should provide a thorough analysis of the entity bought or sold, as well as a valuation range and recommended structure.

3. Sales and Trading

These services are primarily relevant only to publicly traded firms, or firms which plan to go public in the near future. Specific functions include making a market in a stock, placing new offerings, and publishing research reports.

4. General Advisory Services

Advisory services include assignments such as strategic planning, business valuations, assisting in financial restructurings, and providing and opinion as to the fairness of a proposed transaction.

Who needs an Investment Bank?

Any firm contemplating a significant transaction can benefit from the advice of an investment bank. Although large corporations often have sophisticated finance and corporate development departments, an investment

bank provides objectivity, a valuable contact network, allows for efficient use of client personnel, and is vitally interested in seeing the transaction close. Most small to medium sized companies do not have a large in-house staff, and in a financial transaction may be at a disadvantage versus larger competitors. A quality investment banking firm can provide the services required to initiate and execute a major transaction, thereby empowering small to medium sized companies with financial and transaction experience without the addition of permanent overhead.

What to look for in an Investment Bank?

Investment banking is a service business, and the client should expect topnotch service from the investment banking firm. Generally only large client firms will get this type of service from the major Wall Street investment banks; companies with less than about $100 million in revenues are better served by small investment banks. Some criteria to consider include:

1. Services Offered
For all functions except sales and trading, the services should go well beyond simply making introductions, or brokering a transaction. For example, most projects will include detailed industry and financial analysis, preparation of relevant documentation such as an offering memorandum or presentation to the Board of Directors, assistance with the due diligence, negotiating the terms of the transaction, coordinating legal, accounting, and other advisors, and generally assisting in all phases of the project to ensure successful completion.

2. Experience
It extremely important to make sure that experienced, senior members of the investment banking firm will be active in the project on a day-to-day basis. Depending on the type of transaction, it may be preferable to work with an investment bank that has some background in your specific industry segment. The investment bank should have a wide network of relevant contacts, such as potential investors or companies that could be approached for acquisition.

3. Record of Success
Although no reputable investment bank will guarantee success, the firm must have a demonstrated record of closing transactions.

4. Ability to Work Quickly

Often, investment banking projects have very specific deadlines, for example when bidding on a company that is for sale. The investment bank must be willing and able to put the right people on the project and work diligently to meet critical deadlines.

5. Fee Structure
Generally, an investment bank will charge an initial retainer fee, which may be one-time or monthly, with the majority of the fee contingent upon successful completion of the transaction. It is important to utilize a fee structure that aligns the investment banks incentive with your own.

6. Ongoing Support
Having worked on a transaction for your company, the investment bank will be intimately familiar with your business. After the transaction, a good investment bank should become a trusted business advisor that can be called upon informally for advice and support on an ongoing basis. Because investment banks are intermediaries, and generally not providers of capital, some executives elect to execute transactions without an investment bank in order to avoid the fees. However, an experienced, quality investment bank adds significant cant value to a transaction and can pay for its fee many times over. The investment banker has a vested interested in making sure the transaction closes, that the project is completed in an efficient time frame, and with terms that provide maximum value to the client. At the same time, the client is able to focus on running the business, rather than on the day-to-day details of the transaction, knowing that the transaction is being handled by individuals with experience in executing similar projects.

CHAPTER - 2

ORGANIZATION STRUCTURE OF AN INVESTMENT BANK

The main activities and units

The primary function of an investment bank is a buying and selling product both on behalf of the banks clients and also for the bank itself. Banks undertake risk trough proprietary trading, done 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 client and does not hedge his total exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet. An investment bank is split into the so-called Front Office Middle Office Back Office.

Front Office
Investment Banking is the traditional aspect of investment banks which involves helping customers to raise funds in the Capital Markets and advising on mergers and acquisitions. Investment banking may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target. Other terms for the Investment Banking Division include Mergers & Acquisitions (M&A) and Corporate Finance. The Investment Banking Division (commonly referred to as IBD) is generally divided into industry coverage and product coverage groups. Industry coverage groups focus on a specific industry such as Healthcare or Technology, 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 & Acquisitions, Financial Sponsors, and Leveraged Finance. Investing management is the professional management of various securities (shares, bonds, etc.) and other assets (e.g. real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporation etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds). The Investment management division of investment banking is generally divided into separate, often known as Private Wealth Management and Private Client Services. Private Wealth Management deals with institutional investors, while Private Client Services manages the funds of high net-worth individuals. Sales & Trading is often the most profitable area of an investment bank, responsible for the majority of revenue generated by most investment banks. In the process of market making traders will buy and sell financial products with the goal of making an incremental amount of money on each trade. Sales is the term for the investment banks sales force, whose primary job is to call on institutional and high-net-worth investors to suggest trading ideas (on caveat emptor basis) and take orders. Sales desks then communicate their clients orders to the appropriate trading desks, which can price and execute trades, or structure new products that fir a specific need.

Structuring has been a relatively recent division as derivatives have come into play, with highly technical and numerate employees working on creating complex structured products which typically offer much greater margins and returns than underlying cash securities. The necessity for numerical ability has created jobs for physics and math Ph.D.s who act as quant. Merchant banking is a private equity activity of investment banks. Examples include Goldman Sachs Capital Partners, JPMorgan Partners, etc. Sometimes, merchant banking is a part of Alternative Investment division. Research is the division which reviews companies and writes reports about their prospectus, often with buy or sell ratings. While the research division generates no revenue, its resources are used to assist traders in trading, the sales force in suggesting ideas to customers, and investment bankers by covering their clients. There is a potential conflict of interest between the investment bank and its analysis in that published analysis can affect the profits of the bank. Therefore in recent years the relationship between investment banking and research has become highly regulated requiring a Chinese wall between public and private functions. Strategy is the division which advices 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 structures create new products.

Middle Office
Risk Management involves analyzing the market and credit risk that traders are taking onto the balance sheet in conducting their daily trades, and setting limits on the amount of capital that they are able to trade in order to prevent bad trades having a detrimental effect to a desk overall. Another key Middle Office role is to ensure that the above mentioned economic risks are captured accurately (as per agreement of commercial terms with the counterparty), correctly (as per standardized booking models in the most appropriate systems) and on time (typically within 30 minutes of trade execution). In recent years the risk of errors has become known as operational risk, and the assurance Middle Offices provide now includes measures to address this risk. When this assurance is not in place, market and credit risk analysis can be unreliable and open to deliberate manipulations. Finance areas are responsible for an investment banks capital management and risk monitoring. By trading and analyzing the capital flows of the firm, the Finance division is the principal adviser to senior management on

essential areas such as controlling the firms global risk exposure and the profitability and structure of the firms various businesses. In the United States and United Kingdom, a Financial Controller is a senior position, often reporting to the Chief Financial Officer. Compliance areas are responsible for an investment banks daily operations compliance with FSA regulations and internal regulations. Often compliance areas are also considered as a back-office division.

Back Office
Operations involve data-checking trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers. While some believe it provides the greatest job security with the bleakest career prospectus of the divisions within and investment bank, many have outsourced operations. It is however a critical part of the bank that involves managing the financial information of the banks and ensures efficient capital markets through the financial reporting functions. In recent years due to increased competition in finance related careers, college degrees are now mandatory at most Tier 1 investment banks. A finance degree has proved significant in understanding the depth of the deals and transactions that occur across all the divisions of the bank. Technology refers to the IT department. Every major investment bank has considerable amounts of in-house software, created by they Technology team, who are also responsible for Computer and Telecommunications-based support. Technology has changed considerably in the last few years as more sales and trading desks are using electronic trading platforms. These platforms can serve as auto-executed hedging to complex model driven algorithms. An investment bank can also be split into private and public functions with a Chinese wall which separates 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.

CHAPTER - 3

SIZE OF INDUSTRY

Size of Industry
Global investment banking revenue increased for the third year running in 2005, to $52.8 billion. This was up by 14% on the previous year, but 7% below the 2000 peak. The recovery in the global economy and capital markets resulted in an increase in M&A activity, which has been the primary source of investment

banking revenue in recent years. Credit spreads are tightening and intense competition within the field has ensured that the banking industry is on its toes. The US was the primary source of investment banking income in 2005, with 51% of the total, a proportion which has fallen somewhat during the past decade. Europe (with Middle East and Africa) generated 31% of the total, slightly up on its 30% share a decade ago. Asian counties generated the remaining 18%. Between 2002 and 2005, fee income from Asia increased by 98%. This compares with a 55% increase in Europe, and a 46% increase in the US, during this time period.

CHAPTER - 4 RECENT EVOLUTION OF THE BUSINESS

Recent Evolution of the Business

New products
Investment banking is one of the most global industries and is hence continuously challenged to respond to new developments and innovation in the global financial markets. Throughout the history of investment banking, it is only

known that many have theorized that all investment banking products and services would be commoditized. New products with higher margins are constantly invented and manufactured by bankers in hopes of winning over clients and developing trading know-how in new markets. However, since these can usually not be patented or copyrighted, they are very often copied quickly by competing banks, pushing down trading margins. For example, trading bonds and equities for customers is now a commodity business, but structuring and trading derivatives is highly profitable. Each OTC contract has to be uniquely structured and could involve complex pay-off and risk profiles. Listed option contracts are traded through major exchanges, such as the CBOE, and are almost as commoditized as general equity securities. In addition, while many products have been commoditized, an increasing amount of profit within investment banks has come from proprietary trading, where size crates a positive network benefit (since the more trades an investment bank does, the more it knows about the market flow, allowing it to theoretically make better trades and pass on better guidance to clients). The fastest growing segments of the Investment Banking Industry are called PIPEs, otherwise known as Private Investments into Public Companies (otherwise known as Regulation D or Regulation S). Such transactions are privately negotiated between companies and accredited investors. These PIPE transactions are nor-rule 144A transactions. Large Buldge Bracket Brokerage firms and small boutique firms compete in this sector. SPACs (Special Purpose Acquisition Companies or Blank Check Corporations) have been created from this industry.

Vertical Integration

In the US, the Glass-Steagall Act, initially created in the wake of the Stock Market Crash of 1929, prohibited banks from both accepting deposits and underwriting securities which led to segregation on Investment Banks from Commercial Banks. Glass-Steagall was effectively repealed for many large financial institutions by the Gramm-Leach-Bliley Act in 1999. Another development in recent years has been the vertical integration of debt securitization. Previously, investment banks had assisted lenders in raising more lending funds and having the ability to offer longer term fixed interest rates by converting the lenders outstanding loans into bonds. For example, a mortgage lender would make a house loan, and then use the investment bank to sell bonds to fund the debt; the money from the sale of the bonds can be used to make new loans, while the lender accepts loan payments and passes the payments on to the bondholders. This process is called securitization. However, lenders have begun to securitize loans themselves, especially in the areas of mortgage loans. Because of this, and because of the fear that this will continue, many Investment Banks have focused on becoming lenders themselves, making loans with the goal of securitizing them. In fact, in the areas of commercial mortgage, many Investment Banks lend at loss leader interest rates in order to make money securitizing the loans, causing them to be a very popular financing option for commercial property investors and developers.

CHAPTER - 5

POSSIBLE CONFLICTS OF INTEREST

Possible conflicts of interest

Potential conflicts of interest may arise between different parts of a bank, creating the potential for financial movements that could be market manipulation. Authorities that regulate investment banking (the FSA in the United Kingdom and the SEC in the United States) require that banks impose a

Chinese wall which prohibits communication between investment banking on one side and research and equities on the other. Some of the conflicts of interest that can be found in investment banking are listed here:

Historically, equity research firms were founded and owned by

investment banks. One common practice is for equity analysts to initiate coverage on 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 directly for investment banking business. On the flip side of the coin: companies would threaten to divert investment banking business to competitors unless their stock was rated favourably. Politicians acted regulator and a series of lawsuits, settlements, and prosecutions curbed this business to a large extent following the 2001 stock market tumble.

Many investment banks also own retail brokerage. Also during the

1990s, some retail brokerages sold consumers securities which did not meet their stated risk profile. This behaviour may have led to investment banking business or even sales of surplus shares during a public offering to keep public perception of the stock favourable.

Since investment banks engage heavily in trading for their own

account, there is always the temptation of possibility that they might engage in some form of front running. Front running is the illegal practice of a stock broker executing orders on a security for their own account (and thus affecting prices) before filling orders previously submitted by their customers.

CHAPTER - 6

LIST OF INVESTMENT BANKS

List of the Investment Banks

ABN Amro Banc of America Securities Barclays Capital Bear Stearns BNP Paribus

 Citigroup Credit Suisse Deutsche Bank Dresdner Kleinwort Goldman Sachs Greenhill HSBC JPMorgan Chase JP Turner and Company Lazard Lehman Brothers Macquarie Bank Merrill Lynch Morgan Stanley Nomura Securities Raymond James Rothschild RBC Capital Markets Thomas Weisel Partners UBS Wachovia

Corporate ranks within Investment Banks

Partners Managing Director Executive Director Vice President Associate Analyst

CHAPTER - 7 CAST STUDY - INVESTMENT BANKING, THE THIRD MILLENNIUM Market Leaders identify the Key Strategic Issues Authoritatively researched by BRAXXON

INTRODUCTION In Spring 1999 Braxxon Technology commissioned Davis International Banking Consultants (DIBS) to undertake a survey of issues facing the investment banking industry once EMU and Y2K are things of the past. This involved interviews with 43 senior executives in around 30 investment banking organisations based in the UK. A list of participating organisations - to whom we are extremely grateful for their enthusiastic co-operation and support - is listed at Appendix 1. Participants spanned a broad range of functions and included Chief Executive Officers, Managing Directors of specific business units, Chief Operating Officers, Chief Information Officers and Heads of Technology. The distribution of participants by institution type and function is set out at Figure 1 below. GRAPH 1 The primary objectives of the research was to explode the challenges facing the investment banking industry in the 3-5 years period following the millennium and the operational responses to which they are likely to give rise. Whilst key areas of consensus emerge, such as the continued trend towards consolidation in the industry, they also tried to explore areas of dissonance - be they between different types of institution or functional roles - and analyse their implication for the industry. External Challenges facing the Banking Industry a) Consolidation trend set to continue Consolidation in the investment banking business is by far the most widespread concern of the executives interviewed. Virtually all mentioned it, while for many it dominates their strategic thinking. The functional breakdown between those who rated this amongst their top 3 or 4 issues is shown below. Unsurprisingly, it equally concerns executives across all aspects of the business. GRAPH 2 The universal view is that the current consolidation process will continue with the global market increasingly polarised in size between a handful, primarily US based, of the super-bulge firms and, on the other hand, niche players. The former group is led by the Big Three- Goldman Sachs, Merrill Lynch and Morgan Stanley Dean Witter - with the latter included specialist advisory firms such as the Lazard Houses and NM Rothschild. The handful of successful global firms in steadily winning market share, especially in post-EMU

Europe, in large past at the expense of the traditional European universal banks. Even one of the firms positioned just below the top three competitors characterise their scope and size as awesome. Another dimension of this polarisation is the increasing distance between the leaders in the securities business - largely the US competitors and those in the advisory sector. It was told by many competitors that the securities sector essentially debt and equity capital markets is becoming commoditised just as commercial banking businesses like global custody and syndicated lending during the 1980s. Thus the increased volume and pressure on profits described below is forcing the global securities houses to drive costs downward. In contrast, in the corporate advisory (or M&A) sector, in which personal relationships and good ideas from creative people are the critical success factors, small specialists can survive, if not even thrive, by providing the service which the larger competitors cannot. Origination is not a commodity business - people are the key resource. (Managing Director, European Investment Bank) Technology is critical at the sales and trading end of the business. (Managing Director, US Investment Bank) Mixed views on the outlook for the muddling middle As for the competitors in the middle, we found a sharp difference in opinion. On the one hand, many executives feel that the universal banks in markets like Germany, Spain and France would be unable to sustain what is essentially a geographic franchise based on local relationships in the face of the onslaught from the global competitors. Others - including many of the latter believe that local loyalties, the ability to provide a better service, and the cost of servicing the mid-sized national client would ensure a continuing role for the European banks. Most of the universal banking strategy is indeed keyed to servicing the mid-sized client which could not be effectively served by the larger US firms. The middle layer will either be acquired or will retreat to its core competence - its domestic retail banking operation. (Chief Technology Officer, US Investment Bank) The big losers will be the middle layer who still have the high fixed cost base but cannot attract the revenue required to support it. (Chairman, US Investment Bank) Investment banking is going to grow up...decisions being taken now will require a new level of seriousness. (Managing Director, European Investment Bank)

Geography is no longer a defensible niche, especially in Europe where deregulation and EMU have eroded national boundaries. (Managing Director, US Investment Bank) The European wannabes are in denial over their lost franchise...they have delusions of grandeur and are living well beyond their means. (Managing Director, US Investment Bank) For those competitors - and even more for the niche players in the advisory sector - the quality of people is central to their survival. There is a widespread view that industry consolidation will spin off a number of highly talented individuals who prefer to work in a smaller, more flexible environment. There are independent by minded, free-thinking, highly intelligent personal available who simply dont want to be absorbed into a large, impersonal organisation, where they have less profile and less authority. (Deputy Chief Executive Officer, UK Investment Bank) The power of the US-based global bulge firm is universally agreed to be overwhelming. They have invested heavily over time in the European market at the cost of short term profits; they are prepared to pay top dollar for the best staff as well as offer the prestige of working for a global leader, and their progress in gathering market share across Europe is impressive. Many smaller competitors acknowledged the competitive advantage represented by the U.S. firms ability to invest massively in technology as well as other sectors. However, a minority - though possibly more far-sighted - view. was expressed by one global competitor who questioned the ongoing need to build up a large, geographically dispersed infrastructure at a time when the front office is centralising and virtualising in exactly the same way as many back office operations have already. The exchanges are linking up - as are the clearing mechanisms - how long will we need the bricks and mortar if we can just plug into a universal socket...The infrastructure we are investing in so heavily today may not be needed tomorrow. (Managing Director, European Investment Bank) In the same way that the back office has undergone centralisation, the same is likely to happen over time to the front office...The only question is how virtual can the front office become. (Head of European Wholesale Financial Services Technology, International Investment Bank) Cultural compatibility A key dimension of the consolidation process is the issue of whether an investment banking activity can co-exist within a universal banking group along

with a major commercial banking business. Most of our sources expressed serious reservations on the cultural compatibility - specifically compensation structures and risk appetite - of the two businesses, in particular mergers such as Deutsche Bank/Bankers Trust and Citigroup which involve blending different cultures. The impact of Euroland Another key unknown for competitors active in the EU is the likely future shape of the European market post-EMU. One view - not surprisingly propagated by the US firms - is that Europe will increasingly resemble the US market. They suggest a Euroland with a much larger and deeper debt markets keyed to corporate credit differentials, a market shift in European investor preferences and rapid restructuring of the corporate sector leading to booming IPO and private equity markets. While admitting that these trends are clear, many US and European banks feel that it is still possible that a unique Euro-model would emerge somewhere between the US and the pre-EMU profile. Several interviewees noted that Euroland - based banks to date in 1999 had regained some market share based on their natural distribution capacity in the Euro. It is of interest that COOs and other executives responsible for Operations were the ones who focused most frequently on those issues. This reflects the fact that they and their areas of responsibility have been the first to be seriously affected through the diversity of options available for settlement in the Euro. GRAPH 3 The outcome of this European restructuring is of central importance to the handful of European-based global aspirants such as CSFB, Warburg Dillon Read and Deutsche Bank, most of who acknowledge that they would gain from a model which enabled them to compete on the basis of their home market strengths. All of our sources agreed, however, that Europe would be a very attractive market on a global scale for the reasons suggested above: corporate restructuring, the growth in size and differentiation of the debt markets, and increased cross-border portfolio balancing. The Euro will create bigger, deeper, more unified markets and plenty of opportunities. (Chief Operating Officer, US Investment Bank) EMU will create phenomenal opportunities in Europe. (Managing Director, US Investment Bank)

The investment banking opportunities in Europe are outstanding. (Managing Director, US Investment Bank) We can never be as local in our marketing as a well-positioned, local investment bank. (Managing Director, US Investment Bank) Consolidation on the buy-side Finally on consolidation, another dimension of this process is taking place on the buy-side, as they institutional fund management sector is starting to undergo a similar consolidation process. Its impact on investment banking suppliers is taking the form both of a reduction in the number of providers and the level of commissions paid, as fund managers feel the same cost pressures as their investment banking providers. Several of the US majors expressed the view that they are particularly well placed, by virtue of their global distribution and global, sectoral - based research, to win market share in this consolidating business. In contrast, banks like Deutsche Bank acknowledge that they are under pressure to provide such a sectoral - based research capability on a global scale. b) Intensifying competition depress profitability Competition and its impact on profits is another issue which preoccupies many of the executives interviewed. In a scale business such as investment banking, most costs are effectively fixed because of the need to provide a competitive customer - facing capability regardless of market conditions, and the inevitable volatility of volumes can have a devastating impact on profitability. In particular, competitors losing market share and therefore transaction volume can suffer an even greater profit hit. The US majors are the focus of much of the concern over increased competition. Their full bore efforts to build market share - largely at the expense of the national universal banks in Europe - continue to bear fruit. One of the Big Three acknowledged that their strategy is to grow fast by spending money. Another US major confirmed that attaining a higher market share in all major businesses - advisory, debt and equity capital markets - is a key strategic goal. For many of the banks interviewed, the challenge of lower profits means one thing: reduce costs, and slash them by a wide margin. Several executives referred to the need to cut costs in key processes by 50% or more, rather than the traditional 10%, which clearly implies a totally new approach to business processes. In 1998 liquidity dried up...customers atrophied...we had the same fixed costs and no income. Niche players have low fixed costs and can survive on crumbs. (Chairman, US Investment Bank)

Investment banking is an incredibly difficult business to make money in...we are still suffering from the star culture and inflated remuneration levels of the late 80s and early 90s. (Managing Director, US Investment Bank) If youre not in the top ten, youre nowhere. (Director of Information Technology, UK Investment Bank) C) Risk in need of greater management control The increased impact of risk on both revenues and reputation is another preoccupation for many of our sources; it is widely acknowledged that a number of mergers have been triggered by exceptional trading losses. The impact of the 1998 market turmoil continues to be felt in the form of concern over the real value and use of VAR market risk models. In those extreme market conditions, they did not prevent serious trading losses. The drying up of liquidity in key markets during the fall of 1998 highlighted the issue of co-variance - in particular the interaction of market price and liquidity. One leading European investment bank spoke of the death of the boffin referring to the loss of confidence in complex models on which management had previous relied. Another dimension of the risk issue is the desire to reduce settlement risk. Under heavy pressure from regulators - as well as the cost (estimated by one source at $600 million per annum) of fails - the major competitors have acknowledged that settlement risks must be reduced by such measures as straight through processing, netting and the introduction of CLS. To achieve the long term goal of real time settlement, the merger of clearing systems such as Euroclear and Cedel, as well as national stock exchanges, and the setting up of new clearing systems for products such as Swaps and Repos becomes a necessity. At the same time, many interviewees pointed to the sharp difference in risk performance during the 1998 market crisis, with some major players suffering substantial losses in Russia and other markets while others sailed through the crisis virtually untouched. The events of 1998 have brought to the attention of senior managers and regulators alike the shortcomings of econometric models based on historical precedents. (Manager, Strategy and Planning, European Investment Bank) Models for assessing risks and their tolerance levels will have to change. (Director of Information Technology, US Investment Bank) d) Globalisation creates the super-bulge elite

Globalisation is another key strategic issue. While the term is widely used for a variety of purposes, in the investment banking realm it refers primarily to the provision of a global service to corporate and institutional clients. The expense of establishing customer service, research and distribution capabilities across the glove is clearly beyond the reach of many competitors, while the super-bulge group has largely completed its global network. The impact of globalisation is being felt even among national clients with no particular international dimension. Not only are the global majors able to promote their securities distribution strength across geographies. In the advisory realm, these competitors have also been able to market their brand to these mid sized domestic clients seeking an advisor for a critical M&A or restructuring mandate. Many of our interviewees, including the mid-sized universal banks, acknowledged the competitive attraction of bringing in a global house at least as co-manager for such critical transactions. What business executives describe as the challenge of globalisation, their IT colleagues perceive as the necessity of systems integration. Digging behind the somewhat surprising findings displayed graphically below, the business executive sees the issue as globalisation, for which, systems must necessarily be integrated worldwide; the IT executive sees systems integration as a necessary pre-cursor to effective globalisation. Not surprisingly, as the meat in the sandwich, those responsible for running operations see both as very significant issues! Large customers will look for an integrated provider who will provide a full service and be capable of tailored solutions. (Director of Information Technology, US Investment Bank) GRAPH 4 e) Capacity constraints and the challenge of doing more for less The recent surge in transaction volumes, largely attributable to EMU, has posed a major issue of capacity and unit costs. Several of the US-based as well as European majors point to volumes in early 1999 in FX, equity and debt trading and cross border transactions in general which are double or triple those prevalent before EMU. While unit costs may have fallen as a result of this volume surge, the impact on overall profits in many cases has been negative, as the extra absolute costs have exceeded incremental revenues. Moreover, should such volumes remain high, the issue of adequate long-term capacity is being raised by a

concern to minimise operational risk and avoid consequential reputation damage. Coupled with the increased number of banks passing through a merger process and the overall need to reduce unit costs, many investment banks are confronting the need to spend heavily on integrated systems able to handle much larger volumes at a profit. US investment alone in Europe is likely to rise from 2-3% of the typical US institutional portfolio to 20-30% of Euroland securities. With the UK now likely to join, the process will be accelerated. (Head of European Equity Technology, US Investment Bank) f) Disintermediation continues apace Disintermediation of broking and investment banking intermediaries is another issue mentioned by a significant number of our sources. While this trend is particularly relevant in the US where Internet usage is surging, most of our interviewees acknowledged that it was only a question of time before it impacted the European market. While all agreed that the retail market would be transformed by Internet technology, several questioned whether the wholesale/institutional market would be equally impacted - except by accelerating the on-going process of commission attrition. Several of our sources expressed concern that smaller equity offering in the US are being made over the Internet without the help of an investment banking intermediary. Initiatives to tap this market segment, such as those by Merrill Lynch (the purchase of DE Shaw) and DLJ (DLJ Direct), are clearly forcing the hand of other major US investment banks to respond in kind, at least for the client segment which prefers low cost rather than advice. In addition, it has not escaped of the major firms that Internet and other new technology offers a unique opportunity for new, low cost niche competition to win market share. Another dimension of the disintermediation issue is the likely introduction of straight through processing. It will reinforce the ability of fund managers to reduce the cost of execution by channelling orders to those investment banks able to provide the lowest cost processing capability. Finally, it is widely agreed that the dissemination of research and portfolio analytics on the Internet will further commoditise the securities business. There is much more information much more readily available. The average client - both on the sell-side and the busy-side - will be much more reluctant to pay for advice. (Head of Information Technology, Japanese Investment Bank)

The Internet does not actually cause disintermediation, but it does facilitate it. (Manager, Strategy and Planning, European Investment Bank) The availability of increased bandwidth will make the Internet truly usable - once this happens, all industries will come under pressure...it lowers barrier to entry, provides open access and required transparency. (IT Director, UK Investment Bank) The Internet will not have the same far reaching effects on investment banking as it has had in retail banking...its not the way business is done. (Chief Technology Officer, US Investment Bank) GRAPH 5

Of those who raised disintermediation as one of their top three or four issues, a marked predominance were those responsible for IT. It appears that the more you know about the power of Internet-related technologies, the more you fear the damage they can wreak for the traditional leaders in the Investment banking industry. g) And the winner is... Overall, we found remarkable agreement across our interview universe whether top management, business development or operations/IT executives - on what they key issues facing the industry are. We asked our participants to identify just those three or four issues which were dominant for them into the next millennium. The principal topics raised are listed below, ranked in order of the frequency with which they were repeated. Ranking of industry issues raised by all survey participants 1. Consolidation 2. Euroland 3. Disintermediation 4. Risk management 5. Cost management 6. Profitability 7. Quality of management 8. Attracting and retaining quality staff 9. Systems integration 10. Globalisation 11. Competition 12. Regulation/Deregulation 13. Straight through processing

14. Integration of stock exchanges/clearing mechanism 15. Diversification / cultural compatibility 16. E - commerce 17. Press image 18. Collateralisation This ranking shows the relative importance of each issue to the sample as a whole. The chart below shows the percentage of the total sample of participants who raised one of the Top 10 issues within their own list of three or four major concerns.

GRAPH 6 Consolidation in the industry was the top issue mentioned by virtually all survey participants, with the flattering out of the above graph detailing other issues to be ranked with relatively lower but similar lower priority. The issues prompted by consolidation for senior management concerned competitive positioning in the new landscape. For operations and IT executives the issues prompted concerned the challenges of operational and system integration and the problem of legacy systems. Similarly Euroland was very high up on the list for many participants irrespective of their responsibilities or business orientation, but it meant different things to each. For senior management the question was whether the franchise was being opened up or eroded; operational and IT executives focussed on the practical issues of handling increased volumes and the need for straight through processing with reduced rates of manual intervention. For those two groups of executives straight through processing was perceived as an industry issue in its own right The issue of profitability was noticeably higher up on the list for senior management than for other participants, whilst the related area of cost management was an equally important issue for senior management and heads of the operations function. Attracting and retaining quality staff and the challenge of managing change (in many cases, a merger) were also important issues for senior management. After consolidation, the top issue for IT executives was disintermediation. This group as a whole seemed to be much more aware of the potential applications of technology and the implicit threat to established ways of doing things. For them, the virtualisation of the front office - implied by the integration of stock exchanges and clearing systems across Europe - is already apparent. Risk management also was higher up on the list for IT directors than for senior management and operations executives.

There was also a perceptible difference in the comfort level with which different categories of participants addressed different areas of our survey. Senior management were very comfortable when discussing business issues but often less at ease (and admittedly so) with operational and technology issues. The opposite was true in many cases with IT executives, with one interviewee remarking: We dont really get involved on the business side. Our role is to facilitate communication between investment bankers operating globally. (Director Information Technology, US Investment Bank) Operations executives as a group seemed more able to comfortably straddle the two areas. This dissonance tangibly demonstrates an issue openly discussed in the course of the research - namely the alignment between business and technology together with the level of senior management involvement in operational and technology issues. THE OPERATIONAL RESPONSES a) Investment in technology is set to increase From an operational standpoint, for virtually all the banks interviewed, IT investment budgets will continue to increase - in some cases by a massive amount. We found no bank forecasting lower technology costs. To describe their view on such costs, phrases such as the following were used: the constant recurrence of non-recurring costs; continued changed and churn; continued obsolescence; spend to save IT treadmill. One senior operations executive of a major US house noted that one third of his systems should be replaced each year. Only a few interviewees provided an indication of their total absolute and relative technology spend, but one fairly typical response indicated that IT costs are now about 15% of the total and are likely to increase both in absolute and relative terms. For a handful of the larger global providers, this ratio is approaching the 20% mark. Technology budgets never go down. (Director of Information Technology, US Investment Bank) Strategy is technologically obsolete the minute its implementation commences. (Chief Technology Officer, US Investment Bank) Key areas of IT investment include the following:

Straight Through Processing: A major driver of new investment will be the effort to achieve straight through processing from receipt of client instruction to final settlement. This is a major preoccupation of the 5-10 global majors who feel they must make this investment themselves rather than, as discussed below, outsource or share/insource this function. One of these firms suggested that roughly $1 billion could easily be spent by each competitor in replacing the current transaction processing systems - invariably a patchwork of legacy systems - with state-of-the-art straight through processing. For a global aspirant, this is a massive investment in a consolidating market. Straight through processing is more appropriate for some products than others, but the trend is clear. Risk Management Systems: Another investment challenge for many banks is to improve and consolidate risk management systems. Even some of the largest competitors often have a number of different systems for different regions and products and, especially after the events of 1998, regulators are well as top management are demanding a consolidated, real time risk management reporting system covering all types of risk. One major US bank uses as its maxim Good is in the numbers to express its commitment to improving its management information. Management Information Systems: Management information systems thus need upgrading in many cases. A number of banks expressed concern that they could not dig down into their existing database to evaluate client and product profitability. One interviewee expressed a fairly commonly held view that his own banks MIS was inept...all paper, no content and little use! Management information in the financial sector is worse than in any other sector...investment decisions are made on a wing and a prayer. (Managing Director, European Investment Bank) Global Standardisation: Finally, many European investment banks lad considerably behind their US peers in the centralisation of bank office operations. One major European universal bank still has over 10 processing centres in Europe in contrast to banks like Citibank and Chase which have centralised on a regional and, in some cases, global basis their FX, custody and securities processing. Several banks are spending heavily to standardise systems across a global network. While acknowledging the virtues of such a strategy, many of our sources feel it would considerably reduce their local operational flexibility. One size fits all standardisation is fine as long as you are near the lowest common denominator...If youre not, its a straightjacket. (Head of Information Technology, European Investment Bank)

For several of the heads of technology interviewed, the question of performance overhands this extensive menu of technology investment. One executive noted that the track record of investment banks in successfully managing major IT projects has not been brilliant. While major obligatory projects such as EMU and Y2K have (to date) met expectations, concern was expressed at whether the same commitment and energy could be achieved in a discretionary project such as improved MIS without externally-imposed time deadlines. b) Outsourcing - at least a partial solution To meet this investment challenge, outsourcing in various formats is rising on most banks agendas. Most interviewees expressed a number of negative opinions about outsourcing. These mainly centred around increased cost, increased risk, reduced flexibility and control, and poor track record. Most interviewees, however, have and would continue to consider outsourcing as a serious option and most predict the practice to rise. While outsourcing support and other services has become fairly widespread, entrusting an outside provider with the core transaction processing business has met the entrenched resistance of in-house operations personnel who are reluctant to become dependent on a single supplier for such a central element of their business. Being a hostage to a supplier remains a major concern to technology mangers. Outsourcing basic processing can work in commercial banking where the downside is usually a misposting in a customers account, but when it occurs in the market environment of an investment bank, disaster can strike, and the IT partner may not be able to handle the crisis. (Managing Director - Global Operations, European Investment Bank) We were told, however, by technology executives in many of the major firms that such attitudes are changing in the face of the pressure to reduce costs and increase capacity as well as the massive investment cost involved in projects such as straight through processing. In addition, the succession of mergers through which many competitors are passing has reduced some of the institutional resistance to change. While most of the 8-10 largest investment banks are highly likely to build their major new systems in-house, it is clear that outsourcing discussions are taking place both with outside providers and between potential partners within the bulge group; some of these leaders may join forces. There remains serious resistance, however, to outsourcing transaction processing until industry protocols are agreed and technological change slows down arguably a highly unlikely event! Major players in the midst of a merger phase with new heads of operations without commitments to past systems and behaviours are prepared to

consider solutions they would have rejected out of hand in years gone by. (Head of Operations and Technology, US Investment Bank) Over the last few years there has been much more readiness for competitors to co-operate on issues such as EMU and the development of industry standards and protocols for initiatives like straight through processing. (Chief Operating Officer, US Investment Bank) For other functions, however, cost pressures and the willingness to offload functions which can be better executed by specialists should increase the overall proportion of outsourced technology. Three of our interviewees were willing to predict sharp increases in this percentage for their own operations; such increased ranged from a current 10-20% of the technology budget to 4090%. One mid-sized bank during the past year has already reduced its IT staff from 150 to 75 and plans to shrink it to provide an interface with external providers. A number of contacts pointed out that outsourcing rarely reduces costs but does provide up-to-date technology and specialist expertise. It also allows management to focus on objectives rather than the means of achieving them. Outsourcing does not save money, but its possible to get a better service because staff specialise more and are competent at what they do. (Vice President - Infrastructure Service, US Investment Bank) The main objective of outsourcing is to gain a level of technical proficiency that the bank cannot attain itself. (Chief Operating Officer, US Investment Bank) Its not about costsits about losing the distraction. (Managing Director, UK Investment Bank) We interviewed several banks which have carried outsourcing to an extreme in the form of partnership with external IT providers. By and large, the outcome has bee muted, with both positives and negatives present. One such bank reaffirms the distinction between corporate technology which should be outsourced as opposed to areas close to the business like risk management, MIS, modelling and financial reporting. b) Renewed focus on risk management Risk management systems are being re-examined in the light of the events of 1998. As indicated above, there is considerable disillusionment with the reliance on market risk models, and efforts are being made to introduce a judgmental override to provide a more balanced risk assessment. Many banks have yet to install global risk management controls, which now exist only on a regional or

product basis. Increased efforts are being made to control credit risk in view of the presumed increased use of credit derivatives and growth of a high yield market in Europe. Several banks noted the transfer of highly regarded executives to the job of senior risk manager in leading investment banks. Many banks interviewed have significantly reduced the volume and risk profile of proprietary trading. Yet many executives acknowledge that the appetite for risk is cyclical and that sectors such as emerging markets, eschewed following the 1998 crisis, will regain popularity again in one form or another. A more traditional, balanced, holistic approach (to risk management) which includes qualitative and intuitive factors is likely to replace the current narrow, quantitative approach. (Manager, Strategy and Planning, European Investment Bank) Weve become a control company. (Director - Global Operations, European Investment Bank) d) Redefining the business profile Revisiting the product and client profile is another strategic response. Aspirants for the global bulge group are making major efforts to broaden the product array to compete with the Big Three. As one such bank, currently undergoing a merger for this purpose, points out: we need more gold clubs in our caddy. On the other hand, European universal banks and mid-sized firms with a geographic franchise are refocusing their product and client priorities with the result, in many cases, that the top tier of clients is being replaced by smaller, less sophisticated firms as the target market. We found many competitors who have exited investment banking business in order to concentrate on defensible niches. Thus several Japaneseowned banks have exited capital intensive and competitive segments in favour of fee earning, specialist activities. Many interviewees pointed to the UK clearers as an example of strategic refocusing on more profitable business such as the retail market. Achieving scale in a niche, however, as State Street has in global custody and Bear Stearns in securities clearing, is a highly respected achievement. To say that the industry will be shared between global, universal providers on the one hand and niche players on the other is just simplisticmost players will reappraise the business they are in and concentrate on those they can remain in profitably. There is thus likely to be a trend towards increased specialisation. (Manager, Strategy and Planning, European Investment Bank) On the product side, many investment banks outside the top tier are targeting business in which success is not tied to market share in such highly

competitive segments as M&A equity and debt capital markets. Thus private equity, high yield debt, and industrial sectors such as high tech are being given a higher strategic priority. Several banks view credit derivatives as a major growth area. Credit will no longer be a take and hold product - it will become a highly liquid tradable instrument. (Chief Operation Officer, US Investment Bank) As for geographic areas, we found little consensus on priorities for the future. Apart from the view that Europe offered unique restructuring potential, most interviewees noted that previously unfashionable merging markets would move up the strategic agenda. e) Reviewing the skills set Changes in skill set are another competitive response to the factors outlined above. Investment in transaction processing has already significantly reduced the level of clerical staff in the bank office functions. One major US bank will, for example, cut 30% of its cost base as it introduces straight through processing for its corporate client base - the savings from which, however, will be reinvested in systems. The numbers of back office support staff dont actually reduce, they just become IT support staff. (Head of Operations, US Investment Bank) At the same time, a reduction in the commitment to proprietary trading for many banks means a cut in the dealing team. While many dealers can be redeployed in middle office functions, for such banks there could be a net reduction in the numbers of staff needed for trading. Successful IT staffs are being promoted to more senior operations functions, but there seems to be relatively little movement from the bank to the front office. One bank noted that their support staffs were currently all graduates as opposed to school leavers in the past. Technology has professionalized the support function. (Chief Operating Officer, US Investment Bank) Overall, many investment banks are concerned with their ability to attract and retain the best and brightest technology staff. Such individuals are increasingly interested in competing, glamorous sectors like the software business, and even the most prestigious global investment banks expressed their concern on this issue. The problem is much more acute for the smaller, less visible players, who must rely heavily on outside contractors and providers for much of their technology talent.

In a merger situation with all the other uncertainties, there is a tendency to stick with the tried and tested solution and to jettison anything experimental and state of the art. The business this ties itself to the need for skills which are becoming obsolete and are literally retiring. (Head of Operations, US Investment Bank) The best and brightest want to work on front office, web-based, Javabased, object-oriented, mould-breaking, career-enhancing breakthroughsand you need someone who understands COBOL-based loans processing! (Head of Operations, US Investment Bank) f) The Y2K backlog The Y2K and Euro projects have clearly held up other IT projects for most investment banks. We found that all but a handful of major global competitors have been obliged to postpone major technology projects - and probably in some cases possible mergers and acquisitions - because of the pressure to meet the Y2K deadline in particular. Thus projects like straight through processing, major systems upgrades and consolidation, and MIS improvements, will be implemented only after the Y2K program is successfully implemented. Y2K has been a huge distraction - it has diverted managements attention and blunted responses to the far reaching structural changes going on in this industry. (Manager, Strategy and Planning, European Investment Bank) In the case of the handful of firms who were not obliged to defer such strategic projects, management had ring-fenced the Euro and Y2K programs with sufficient resources to enable other to continue of track. g) Technology leadership - an elusive goal We found that relatively few investment banks are viewed as clear leaders in the realm of operations and technology. Many of our interviewees acknowledged that investment banks are under managed in general and that the management of technology is not a core competence in this context. When asked to cite banks which were ahead of their peers in this domain, however, the leading US houses as a group were usually mentioned. Specific positive comments were made with reference to JP Morgan, Goldman Sachs and Morgan Stanley Dean Witter. Investment banks are inherently under managed - a successful investment banker wants to do deals, not manage the business and the bank doesnt want to lose the revenue stream. (Managing Director, US Investment Bank)

All investment banks are pretty much in a mess in some parts of their operations and technology. (Director - Global Operations, European Investment Bank) In this context, outside technology suppliers will play a significant role. As indicated above, the percentage of outsourcing - at least of support functions should increase for many banks. An almost universal view is that outside expertise in evaluating and selecting systems is critical to avoid the personal biases that may exist within a banks technology function. With the merger wave in full force, assistance in the merger integration process is of critical importance to several banks interviewed. One senior executive spoke of having a portfolio of sources including outsourcees, vendors, consultants and insourcers with whom joint projects could be undertaken. On balance, as indicated above, there is a general need for skilled and available talent across the board. Such talent is particularly vital in the smaller and mid-sized banks who are followers rather than leaders in the field. The position of a struggling investment bank becomes harder, because it becomes increasingly difficult to attract quality staff - particularly at senior levels. (Managing Board Member - Global Administration, European Investment Bank) b) Meeting the merger challenges The current merger wave constitutes a particular challenge for the operations function. We met with representatives of both parties to a number of on-going mergers, virtually all of whom emphasised that the merger process represents, in microcosm, the weakness of operational management in investment banking. Further multiplication of legacy systems (legacy on legacy), deferral of major IT investment programs simply to keep the merged bank in operation, and differences in culture and approach to technology all preoccupy management thinking. No specific solutions are on offer, but the fact that post merger integration was mentioned by over a quarter of survey participants as a primary area where investment banks need external assistance is some indication of the level of concern. The major issue facing many players in the investment banking industry is managing the merger process and realising its benefits. Operational integration will be the key challenge in the 2-3 years post millennium but cultural cohesion will probably take a new generation to achieve. (Director of Information Technology, US Investment Bank)

The consolidation process brings out the worst in management as senior staff jockey for position and play political games. (Head of Operations, US Investment Bank) The problems with legacy systems are pretty intractablethey are like trees with extensive root systems. (Director of Information Technology, US Investment Bank) There is a limited time horizon for management to integrate the business and realise the anticipated efficiencies and synergiesyou have to hit the ground running. (Vice President - Infrastructure Service, US Investment Bank) Several banks active in major mergers were quite sceptical of the savings to be made combining operational systems. One institution which is highly regarded for its serial acquirer skills acknowledged that it currently operated over 150 different systems and would be delighted to find an outside provider who would come up within architecture which brings it altogether quickly, comprehensively and tactically. Many executives who have or are currently working for merging entities query whether senior management has the skills to shape and lead the massive and diverse organisations they have created. Several predict a disintegration phase in several years when these firms are broken up. Some of the recent mergers are technologically pushing the boundariesthe size and complexity of the integration makes it difficult to see how the goal of achieving synergies and cost reduction can actually be achieved. (Chief Technology Officer, US Investment Bank) ISSUES FOR THE FUTURE From our research, it is clear that external challenges, coupled with new technology, will over time reshape the global investment banking sector. Thus one can, with some degree of confidence, predict the following: There will be significant attrition in the ranks of competitors in the core business of corporate advisory as well as debt and equity capital markets. One of the driving forces behind the decision of several competitors to exit these business will be the cost and complexity of the investment needed to remain competitive. Other competitors will refocus on business segments where they feel they can be competitive, such as private equity, mid-sized corporate clients and high yield debt. Achieving scale in these segments will be a strategic goal as banks struggle to replace the revenues lost to the global bulge group competition.

 Banks will continue to spend heavily to upgrade and integrate their legacy systems, improve risk and management information and slash costs by introducing straight through processing. While the shape and extent of outsourcing will remain the subject of active debate, there is an increasing willingness to consider either outsourcing support activities or to combine forces, either within the sector or with an outside supplier, on common facilities such as straight through processing or clearing arrangements. Disintermediation at the retail level and perhaps in the institutional sector will permit the entry of new competitors using the latest technology, a lower cost base and a targeted strategy to win market share, as well as exert further pressure on brokerage margins. Commoditisation of many traditional investment banking businesses will continue, with low cost providers in such areas as brokerage winning market share. In contrast, high value added businesses such as corporate advice will remain in large part the province of smaller, specialist firms. On the other hand, there are several unresolved issues which we believe management must address:

Managing the merger process and the resulting consolidated entity is becoming an increasingly challenging task, whether at the clientfacing or operational level. The need for clear, focused and consistent leadership is central to addressing this challenge. The criticism levelled in so many investment banks at a start/stop culture is even more relevant with todays massive and complex entities. A future phase of disintegration of todays mergers expressed by several of our interviewees could well be a reaction to todays merger mania. Managing major investment projects remains a real challenge even for the investment banking leaders. Investment banks remain to a large extent deal-focused with little time for the complex and timeconsuming detail of project management. If billion-dollar projects such as straight-through processing are undertaken, either alone of on join basis, sharing the responsibility for a major joint project could well complicate an already difficult task and produce failure rivalling the scale and scope of TAURUS in the early 90s. In this context a real commitment by top management to understand and become involved in operational issues is a critical success factor. Achieving a satisfactory balance between in-house and external resources will also continue to be a major management challenge. For the smaller players, the decision may be straightforward in view of their limited resources, but for the major players it is not as simple. Comprehensive alliances have proven difficult to manage, and the availability of top IT talent is a serious constraint even for

the majors. An independent view, particularly in the choice of technology, as well as post-merger integration seems to be the key reason for employing outside assistance. SURVEY PARTICIPANTS Braxxon Technology would like to express their grateful appreciation to all 30 of the organisations who kindly participated in this research programme including the following institutions who have agreed to be named: ABN AMRO Bank Julius Baer Bank of Tokyo Mitsubishi Barclays Capital Chase Manhattan Bank Citibank Credit Suisse First Boston Daiwa Europe Bank Deutsche Bank Donaldson, Lufkin & Jenrette European Bank for Reconstruction and Development (EBRD) Goldman Sachs International HSBC ING Barings JP Morgan Lazard Brothers Lehman Brothers Merrill Lynch International Moscow Narodny Bank National Australia Bank Nomura International Rabobank International Solomon Smith Barney Saudi International Bank Schroders Standard Bank Tokyo Mitsubishi International Warburg Dillon Read

CHAPTER - 8

CONCLUSION In todays world taking investment decision is a vital activity and significantly the process of investment Banking is constantly evolving especially as far as the investment banking products are concerned. In fact a survey in the market scene shows that these are the banks that are constantly inventing new products. What is a major factor to be taken into account is that these products are usually accompanied by very high profit margins and this basically is mandatory as the buyers arent sure how to value them. The only negative point to this whole scenario is that as these products cannot be patented or copyrighted, they are very often copied quickly by other Investment Banks. This basically causes a downslide and the margins are forced downward as the pricing approaches commodity pricing; hence it can be said with conclusion that in the history of investment banking through many have theorized that all investment banking products and services would be commoditized, and the concentration of power in the bulge bracket would be eliminated yet in real life it has failed to happen. The reason behind this is simple and while many products became commoditized, new ones were constantly being invented. Take for example the trading stocks for customers, which in now a commodity style business. However at this juncture it is worth being mentioned that by creating stock derivative contracts is now a very high margin business. This is simply as the contracts are difficult to evaluate and apart from that while many products have been commoditized, an increasing amount of investment bank profit has come from proprietary trading. This thus is a must as size creates a positive network benefit. It cannot be denied that for the first time investors or those not confident of the market the Investment banks have a vital role to play as they are basically the institutions that assist public and private corporations in raising funds apart from providing them strategic advisory services for various kinds financial transactions. Investment banks differ from commercial banks. Thus while a commercial bank serve to directly take deposits and make commercial and retail loans the investment banks act more on an advisor capacity. In recent years, however, the lines between the two types of structures have blurred and now there is not much tangible difference between both kinds of banks. It is imperative to mention here the Glass-Steagall Act of US. The act was initially created in the wake of the 1929 market crash and what is significant is that it basically prohibited banks from both accepting deposits and underwriting securities. In the coming years however we notice that the Gramm-Leach-Bliley Act repealed the Glass-Steagall in 1999. Whatever be your choice of investment the basic rule remains the same and thats you must go to a proper person for investment advice before you make a deposit. For all the mystery surrounding investment banks, the role they have played throughout the evolution of modern capitalism is fairly straightforward. These institutions provide the financial means to enable Adam Smiths invisible hand to function.

Investment banks have flourished in a variety of economies, from the merchant traders of 18th-century London and Amsterdam to the behemoths of today, whose influence spans the glove. As long as there is a market economy, there are likely to be investment bankers coming up with new ways to make money, while the rest of us marvel at how they manage to do it. by Katrina Lamb, CFA Reference: www.wikipedia.org Investment Banking and Securities Issuance - Jay R Ritter, University of Florida, Gainesville Case Study by Braxxon Technology Limited