Are investment banks competitive yet?
GlobalCapital, is part of the Delinian Group, DELINIAN (GLOBALCAPITAL) LIMITED, 4 Bouverie Street, London, EC4Y 8AX, Registered in England & Wales, Company number 15236213
Copyright © DELINIAN (GLOBALCAPITAL) LIMITED and its affiliated companies 2024

Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement
People and MarketsCommentGC View

Are investment banks competitive yet?

Martin Wheatley

You might think the UK’s Financial Conduct Authority had enough on its plate. The UK regulator has a wide remit, running from insider trading to insurance, and from Wonga to Warburg Pincus. So why is it proposing another review of whether investment banks are competitive enough?

The FCA said last week that it could be time for a competition review in wholesale financial services.

Now that the UK’s Financial Services Authority has been split in two, the Prudential Regulation Authority (which sits within the Bank of England) is supposed to do the heavy lifting of stopping banks blowing up the financial system. The FCA has a whole variety of other tasks, ranging from defending widows and orphans to stopping Gilts traders front-running the Bank of England.

The FCA's remit also extends to competition. On the agenda for its proposed review (which is subject to consultation) are by-now-familiar topics. Are issuers appointing relationship banks to raise equity? Do favoured clients get favourable allocations? Why are IPO fees so high? Who pays for research? Is the cost of advice transparent?

The FCA acknowledges that these issues have already been extensively investigated. It even cites the last attempt to examine equity underwriting, by the Office of Fair Trading in 2011, as well as the National Audit Office’s report into the Royal Mail IPO.

But these previous inquiries apparently haven't discouraged the FCA from digging further – apparently just because it can and hasn’t yet done so.

“We have considerable experience of dealing with [financial services] markets and their participants but we have not previously approached them from a competition perspective,” says an FCA paper calling for input on the review. “We are therefore conducting a review of competition in the wholesale sector to identify any areas that might merit further investigation through an in-depth market study.”

And why not? But potentially more worrying is the language the FCA uses, which suggests a different approach to a mere competition review.

Talking a different language

The FCA says: “Some clients may be unable to anticipate correctly the cost of advice on infrequent, complex transactions such as underwriting, M&A or on transactions that combine a suite of products as part of an overall solution. It could also be that banks are not providing to clients the costs of services for every bundled product offered. Switching providers may be difficult if the current adviser has a better understanding of the client’s business and a strong relationship with the management.”

All that is probably true, but it seems to start from the premise that investment banking is a series of discrete transactions, which could be, but are not, offered as separate services.

The banks themselves argue that the right model is a continual relationship, which generates fee income at a variety of points in different proportions and includes a heavy dose of “free” services in the mix as well.

Pushing that belief too far has encouraged banks to diversify into products they are no good at for the sake of completeness and to build expensive, revenue-free new “capabilities”.

But some version of the “relationship” model is surely correct. For strategic transactions, a profound relationship is always going to trump cheap fees when it comes to winning mandates.

And for straightforward, flow capital raising higher up the capital stack, fees have, in fact, been competed down to wafer-thin levels.

Investment bankers might talk the talk on “fee discipline” (a curious phrase for self-professed capitalists) but the margins on, say, investment grade loans or SSA bonds suggest that, behind closed doors, they are achieving the very opposite.

Other aspects of the FCA review are equally puzzling. It says: “If stand-alone or small advisory providers are unable to compete effectively by using the quality of advice provided, it may cause detriment to smaller clients who rely on advice, particularly if they find it difficult to evaluate the cost and quality of the advice or services provided.”

With boutiques, or even “kiosks” providing a pure advisory service, riding high in the league tables, raising this issue looks poorly timed. In Dealogic's league table of announced M&A in Europe this year, Lazard ranks as the sixth biggest adviser, Rothschild eighth and Zaoui & Co 15th.

Perpetuating myths

The FCA review, if it gets off the ground, is unlikely to do much damage to the financial services sector. It might find a few disgruntled investors grumbling about not getting allocations they wanted on a few hot IPOs, but it would no doubt conclude that investment banking, across debt and equity, is competitive.

Yet there remains a potentially destructive language gap as the scope of regulation pushes wider. Senior bankers need to explain their businesses to the FCA and acknowledge that some activities are more transactional, others more strategic. Some relationships pay right away, others bear fruit only after five years.

The FCA has just taken on Julia Hoggett, a former financial institutions banker at Bank of America Merrill Lynch, as head of investment banking, so there could be a sympathetic ear in place. If the FCA is going to do some kind of review, it needs to be talking the right language. 

Gift this article