Chapter 2 Investment Banking Industry 1 I

Chapter 2 Investment Banking Industry 1

I. Investment Banking in the U. S. A. Investment Banking Regulations a. 1933 The Securities Act and 1934 The Securities Exchange Act a) The Securities Act of 1933 n n b) Regulation before public offering Full disclosure in Prospectus(Due-diligence) The Securities Exchange Act of 1934 n n Securities Exchange Commissions (SEC) Securities Exchange Systems Securities Settlement Rules Registration Requirements 2

I. Investment Banking in the U. S. Illegal trades § Registration statement (S-1) n v v n Financial statements Pricing Underwriter commission Contracts, documents Securities Exchange Commission (SEC) v v Regulations Implementation Corporate Finance Market Regulation Investment Management 3

I. Investment Banking in the U. S. b. The Glass-Steagall Act of 1933 n n Separate the deposit-taking and loanmaking banker form the underwriter or dealer banker; create firewall between the commercial bankers and investment bankers The commercial banker was prohibited from participating in risk taking with regard to all corporate securities and governmental securities. e. g. J. P. Morgan, Morgan Stanley 4

I. Investment Banking in the U. S. c. Gramm-Leach-Bliley Act of 1999 n n n Glass-Steagall Act repeals n Section 20 repealed n Section 32 repealed Financial holding company or Financial affiliation Financial activities n Insurance n Securities underwriting n Merchant banking 5

I. Investment Banking in the U. S. B. Investment Bankers a. The New Inter-firm Competition n Specialization n Deregulation n n Individual investors – Merrill Lynch Institutional investors – Salomon Smith Barney Shelf-registration M&A and Junk bonds (LBOs) 6

I. Investment Banking in the U. S. b. Leading Investment Bankers a) Securities Underwriting n n n Conventional Negotiated Debt (Salomon Smith Barney, Morgan Stanley) High-yield Corporate Debt (Drexel Burnham Larnbert) Asset-Backed Debt (Salomon Smith Barney, CS First Boston) Municipal Debt (Merrill Lynch, Goldman Sachs) U. S. Government Securities (Merrill Lynch, Goldman Sachs) Corporate Equity Securities (Merrill Lynch, Lehman) 7

I. Investment Banking in the U. S. b) Secondary Market Business n n c) Commissions Trading profit Research Service (Merrill Lynch, Goldman Sachs) Money management (Merrill Lynch, Lehman) Corporate Financing Activities n n Traditional Corporate Finance M&A (Goldman Sachs, Morgan Stanley) Venture Capital ( Donaldson Lufkin and Jenrette, DLJ) Real Estate (Morgan Stanley, Goldman Sachs) 8

I. Investment Banking in the U. S. C. Investment Banking Activities a. Investment banking n n n n n Securities underwriting Merger and acquisition Financial consulting Venture capitalist Securities (derivatives) dealer and broker Bonds (derivatives) dealer and broker Futures Forex trading Investment Management Real estate investment 9

I. Investment Banking in the U. S. b. Underwriting types a) Negotiation Underwriting (Full Underwriting) n n n Syndicate (Syndicate Manager) Proportional distribution Price stabilization Gross spread (1%-10%, Mostly 7%) • Hot issue? • Risk? (Market, idiosyncratic) • Distribution channel Components of revenue • Syndicate manager expenditures • Investment bankers return • Selling commission 10

I. Investment Banking in the U. S. n n b) Stand-by Underwriting n c) Hot issues • Overallotment ( short 15%) • Overallotment Option (Green Shoe, x<p) Pricing • Price negotiation • Underpricing (10% -20%) Absorb by investment bankers Best-efforts Underwriting n Commission only 11

II. Investment Banking in the U. K. A. Investment Banking Regulations a. 1986 Financial Services Act n Department of Trade and Industry n Securities and Investment Board Limited v Minister of DTI v Governor of the Bank of England § The Securities and Futures Authority, SFA (The Securities and Investment Board, SIB) 12

n b. The Financial Services and Markets Act, 2000 n Financial Services Authority n n Market confidence Public awareness Protection of consumers Reduction of financial crime 13

II. Investment Banking in the U. K. Lord Chancellor Financial Service tribunal Secretary of state For Trade and Industry Financial Services Authority Self-regulatory organizations Recognized Investment exchanges 14

II. Investment Banking in the U. K Characteristics n n n The U. K. Structure is fundamentally pyramidal The secretary of state for Trade and Industry is vested with the full oversight authority and power of the system FSA has power to regulate the functioning of a broadly defined financial and investment business in the U. K. 15

II. Investment Banking in the U. K n n SROs are responsible for regulating the relationships between their members and customers The International Stock Exchange determines listing requirement (LSE) 16

II. Investment Banking in the U. K. B. Investment Bankers a. Financial System in the U. K. n n b. Clearing banks (Commercial Banks) Merchant banks (Investment Banks) Stock brokers Jobbers Investment bankers a) Merchant bank (S. G. Warburg, N. M. Rothschild, J. Henry, Schroder Wagg) n Financial advisory services ( James Capel, Barclays, Warburg) 17

II. Investment Banking in the U. K. n n b) Stock brokers n c) M&A Underwriting securities (Samuel Montagu, Goldman Sachs) Fixed commission agent for individual or institutional investors ( Zoete & Bevan, Strauss Turnbull, etc. ) Jobbers n Market makers (Specialist) (Akroyd & Smithers, Wedd Durlacher) 18

II. Investment Banking in the U. K. C. Investment Banking Activities a. Securities Underwriting a) b) Corporate Equity Underwriting n Merchant banks n Underwriting syndicates n Right offerings Debt underwriting n Debentures (secured) n Loan stocks (unsecured) 19

II. Investment Banking in the U. K. b. U. K. Government Securities Trading n n c. Short (up to five years) Medium (5 -15 years) Long (over 15 years) Undated (perpetual) Other Securities Trading a) b) * Eurobonds *Domestic equities *International equities The Stock Exchange Automated Quotation System (SEAQ) 20

II. Investment Banking in the U. K. c) d. e. f. * * Alpha stocks – most active Beta stocks – second rank in volume Gamma stocks – less active Delta stocks – least liquid Research activities Money Management Mergers and Acquisitions 21

II. Investment Banking in the U. K. b. Underwriting Types a) Full Underwriting n n Merchant banks Syndicates (Syndicates Manager) * Merchant banks * British institutional investors * Foreign securities firms n n Offering for sale ( proportional distribution) Shares may be privately placed directly to institutions 22

II. Investment Banking in the U. K. b) Best-efforts Underwriting n n c) Moral underwriting No legal obligation Rights offering n n Existing shareholders Purchase price 15 -30% below current market price 23

III. Investment Banking in Japan A. Investment Banking Regulations Characteristics of Japanese Business Environment A pervasive national concern with external perils n Society’s acceptance of a major role for government in the financial markets § Openness to adapting the practices of Western financial institutions to its own needs n 24

III. Investment Banking in Japan § The particularly Japanese structure of Industrial organization – the “zaibatsu” • Meiji era • Giant Conglomerates • Holding company with a major private bank • The bank nourished the companies in its zaibatsu with the necessary financing 25

III. Investment Banking in Japan a. The early Meiji Restoration Period a) The Stock Exchange Regulations, 1878 v London Stock Exchange style v Tokyo Stock Exchange, etc. v Government bond issues ( Warriors of samurai family) v Two sessions’ trade ( 10 a. m. and 2 p. m. ) b) Bourse Regulations, 1887 v German legal advisor, Hermann Roesler v Public securities trading 26

III. Investment Banking in Japan b. WWI to the Great Depression n c. 1922, the Law of Trust Companies The postwar recovery to internationalization a) 1947, Securities and Exchange Law Article 65: A bank, trust company or such other financial institution as may be designated by a Securities and Exchange Commission Regulation shall not engage in any of the acts enumerated in Paragraph 8 of Article 2. 27

III. Investment Banking in Japan Article 2 : ” Securities business” v To buy and sell securities v To act as broker, agent or proxy with respect to buying and selling of securities v To act as broker, agent or proxy with respect to the entrustment of transaction on a securities market v To underwrite securities v To sell securities by public offering v To handle the issuance or sale of securities by public offering 28

III. Investment Banking in Japan b) 1952, Long-term Credit Bank Law v c) Authorize banks to borrow 20 -30 times of their capital to accommodate corporate borrowers 1971, Law Concerning Foreign Securities Firms v v Non-Japanese firms for branch-office license Merrill Lynch (1972) 29

III. Investment Banking in Japan B. Investment Bankers a. The Early Meiji Restoration Period 1893, Standard Securities Underwriting n n n Managed by one or two national banks National banks issue stock for public subscription Other banks act as selling agents 1902, Industrial Bank of Japan (IBJ) n n n Government created Financing the longer-term capital needs of Japanese industry Corporate debentures underwriters 30

III. Investment Banking in Japan b. WW I to the Great Depression § Emergence of leading securities firms • • • § Koike Company (Yamaichi Securities) Fujimote Bank(Daiwa Securities) National City Co. (Nikko Securities) Emergence of leading Trusts • • Mitsui Trust (1924) Mutual Trust (Yasuda Trust, 1925) Sumitomo Trust (1925) Mitsubishi Trust (1927) Issuance of new corporate debentures Underwriting new securities offerings of their group affiliated companies 1927, ”Big Five” (Daiichi+Big Four) 31

III. Investment Banking in Japan c. The postwar recovery to internationalization a) Japanese securities firms n n n b) the Big Four (Nomura, Daiwa, Nikko, and Yamaichi) 21 other large firms directly supervised by the Tokyo office of MOF Small Local firms supervised by the branch offices of MOF International investment bankers n n Merrill Lynch, 1972 1986 TSE members • • • Merrill Lynch Morgan Stanley Goldman Sachs Vickers da Costa Jardine Flemming S. G. Warburg 32

III. Investment Banking in Japan Investment banking activities C. a. Investment banking activities a) Brokerage activities n n b) Future market n n n c) Brokerage commission (60% of revenue) Secondary market trading 1985, Japanese government bond futures 1987, Nikkei stock index futures 1989, TSE futures v Interest rate futures on Euroyen and Eurodollars v Currency futures Japanese government bond underwriting n n 40%--- Competitive bids from members of underwriting syndicates 60%--- Syndicates members under fixed allocation 33

III. Investment Banking in Japan d) Corporate Underwriting § § § e) Euromarkets and TSE v Government subsides rationing v insistence of collateral in banks “BIG Four” dominance Equity-linked securities offering Offshore Corporate Underwriting § § § Securities Firms, commercial banks Commercial banks established subsidiaries in the major offshore markets MOF “three bureaus agreement” v Banking v Securities v International finance 34

III. Investment Banking in Japan f) Corporate Finance Activities n n Minor The leading securities firms v Financial engineering skills Long-term financial planning v Valuation and financing skill in M＆A) v 35

III. Investment Banking in Japan b. Securities Underwriting a) Securities underwriting procedures v v v Financial plan consulting Capital structure adjustments IPO v v v v Pricing Time table Review of corporate charter Review of directors meeting Review of management Compliance Registration(MOF) Underwriting Syndicates (The Big Four 36

III. Investment Banking in Japan • Proposal Method (MOF) v v • Electric utilities and Telephones Compete for syndicate managers Shelf Registration (Oct. 1. 1988) v Qualified issuers can preregister securities and hold them ready for an offering on short notice if market conditions become favorable Public bidding System (April, 1989) b) • • Fixed proportion for public bidding Price floor, Price ceiling (Comparison, EPS, BPS) Exclusive restriction (Major shareholders) Top-down bidding After market support c) • • Application for price stabilization (MOF) Restrictions of initiators, period, price limit, etc. 37