The art of the captive deal

In investment banking, where fees are under constant pressure and clients demand more for less, there’s one scenario every seasoned banker covets: the captive client. It’s a rare opportunity where the usual rules of competition are suspended, and banks can flex some real pricing muscle.

Let’s be real, most investment banking services have become commoditised. Your average equity or debt deal? Any major bank can underwrite an IPO or distribute a bond. It’s (mostly) routine stuff. Clients know this and they use it to their advantage, squeezing fees or demanding an expanding array of ‘value-added services’ that are thinly veiled incentives for them to reward a bank with future business.

But the captive situation? That’s where the real money is made. These are deals where clients find themselves, by circumstance or necessity, unable to shop around without risking major complications.

Consider confidentiality in high stakes M&A. When a corporation is plotting its next big move, it can’t exactly put out an RFP to every bank on the Street. The moment word gets out, you’ve got competitors, interlopers, activists, and regulators swarming. So the select few banks brought into the inner circle have a big advantage. The client might negotiate hard, but they’re not going to risk blowing up their plans by quibbling over fees. It is not the time to haggle.

The appeal of captive situations explains why investment banks find the UK corporate broking model so appealing. Corporate brokers perform a lot of work for free, just to have that ability to lock down a major equity or advisory mandate without competitive tendering or having to fend off interlopers.

As corporate brokers, Barclays and JP Morgan pocketed an estimated £70m each on National Grid’s £7bn rights issue in May and secured the entirety of the league table credit for themselves — an extraordinary outcome made possible by their privileged roles as well as the need for total confidentiality.

Now let’s fast forward to an even more recent example, taken from the world of corporate equity derivatives: UniCredit’s stake-build in Commerzbank. On the surface, it seems straightforward — one bank wants exposure to another bank and uses financial instruments to build a synthetic position. But it’s a textbook case of why these deals are so appealing to investment bankers.

First, there’s the confidentiality factor. UniCredit couldn’t broadcast its intentions without sending Commerzbank’s stock price skywards or arousing immediate opposition. So their options for picking advisors were limited from the start.

And it gets better. Even if UniCredit had wanted to shop around, finding unconflicted banks would have been a challenge. Commerzbank has its advisors. So does the Supervisory Board of the ECB. The German government, with its stake in Commerzbank, might have its own team too. Deutsche Bank has been rumoured as a potential white knight, and it has its own advisors. Before long, most of Frankfurt and London’s investment banks are off-limits.

The best part? These deals are sticky. Once a bank structures one of these complex trades, the documentation and structure become so tangled that the client is pretty much stuck. When the time comes to restructure or unwind — and it always does — the client essentially has to return to the same bank. Sure, a client such as UniCredit has the in-house sophistication to price the derivatives and negotiate hard, but the bespoke nature of these deals makes it nearly impossible to bring in new advisors.

This is also why capital markets bankers get excited when they land on the buy-side of an M&A deal. It’s not just the prestige; it’s the knowledge that they’ve hit the jackpot with a quasi-captive situation.

Think about it. A CEO plotting a major merger needs absolute secrecy, rapid execution, and a team that can navigate the regulatory maze. Oh, and they need billions in financing immediately too. Are they really going to jeopardise the whole thing to save a few million in fees?

Of course not. They’ll pay the premium because what they’re buying isn’t just financial advice, it’s insurance against disaster — a guarantee that when they make their big move, they have top tier support. They’re also buying undivided loyalty.

These captive situations are crucial to investment banking profitability. In an industry where technology, regulation and robust competition have commoditised so many services, it’s these opportunities that keep the margins healthy.

To be clear, we’re not talking about exploiting unsophisticated clients. The players in these situations are typically large, savvy entities. They know how the game works and can negotiate hard. When they can put situations out for competitive tender, such as in a block trade, they’ll push fees down to the bone. They will take banks to their pain tolerance level, and beyond.

What we’re really describing is a careful balance of mutual interests. The client needs unwavering reliability, loyalty and discretion at a critical moment. The bank, meanwhile, needs to prove its value in an increasingly competitive landscape. When these align, it results in substantial fees. In a business where margins are under constant pressure, these captive situations remind us of exactly when banking expertise commands a clear premium.

So, the next time you hear about a surprise M&A deal or a complex derivatives trade that has everyone scratching their heads, consider the bankers behind the scenes. They’re not just counting profits, they’re also breathing a sigh of relief knowing that for a moment, they’ve carved out a piece of high-margin business from a market that is becoming more commoditised by the day.

And for the CEOs and CFOs out there? Remember: when you need absolute secrecy, undiluted loyalty and total commitment, your chosen banks will be there, ready to help. Just don’t expect a bargain. You get what you pay for.