INVESTMENT BANKING

INVESTMENT BANKING

INDEX Sr. No Topic

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. Executive Summary Introduction Investment Banking and Merchant

Page No.
1 2 Banking 4 6 10 12 13 15 19

Distinguished Evolution of American Investment Banks European Investment Banks Global Industry Structure Business Portfolio of Investment Banks The Indian Scenario Characteristics and Structure of Indian Investment Banking Industry Service Portfolio of Indian Investment Banks Interdependence between Different Verticals Investment Banking Regulatory Framework for Investment Banking Regulatory Framework for Merchant Banking Anatomy of Some Leading Indian Investment Banks Recent Trends in Investment Banking The Conflict of Interest Issue Conclusion

23 in 29 31 35 38 51 56 60

EXECUTIVE SUMMARY

Introduction
At a very macro level, Investment Banking as the term suggests, is concerned with the primary function of assisting the capital market in its functions of capital intermediation, i.e. the movement of financial resources from those who have them (the Investors), to those who need to make us of them for generating GDP (the Issuers). As already discussed banking and financial institutions on the one hand and the capital market on the other are the two broad platforms of institutional intermediation for capital flows in the economy. Therefore, it could be inferred that investment banks are those institutions that are the counterparts of banks in the function of intermediation in resource allocation. Nevertheless, it would be unfair to conclude so, as that would confine investment banking to a very narrow sphere of its activities in the modern world of high finance. Over the decades, backed by evolution and also fuelled by recent technological developments, investment banking has transformed repeatedly to suit the needs of the finance community and thus become one of the most vibrant and exciting segment of financial services. Investment bankers have always enjoyed celebrity status, but at times they have paid the price for excessive flamboyance as well. To continue from the above, in the words of John F. Marshall and M.E. Ellis, investment banking is what investment banks do. This definition can be explained in the context of how investment banks have evolved in their functionality and how history and regulatory intervention have shaped such as evolution. Much of investment banking in its present form thus owes its

origin to the financial market in USA, due to which, American investment banks have been leaders in the American and Euro markets as well. Therefore, the term investment banking can arguably be said to be of American origin. Their counterparts in UK were termed as merchant banks since they had confined themselves to capital market intermediation until the US investment banks entered the UK and European markets and extended the scope of such businesses.

Investment Banking and Merchant Banking Distinguished

At this stage, it would be relevant therefore, to draw a fine line of distinction between the terms Investment Banking and Merchant Banking as both these terms are extensively used in this project. Merchant Banking as the term suggests, is the function of intermediation in the capital market. It consists of assisting issuers to raise capital by placement of securities issued by them with investors. However, merchant banking is not merely about marketing securities in an agency capacity. The Merchant Banker has an onerous responsibility towards the investors who invest in such securities. The regulatory authorities require the merchant banking firms to promote quality issues, maintain integrity an ensure compliance with the law on own account and on behalf of the issuers as well. Therefore, merchant banking is a fee based service management of public offers; popularly know as issue management and for private placement of securities in the capital market. In India, the Merchant Banker leading a public offer is also called as the Lead Manager. On the other hand, the term, Investment Banking has a much wider connotation and is gradually becoming more of an inclusive term to refer to all types of capital market activity, both fund-based and non-fund based. This development has been driven more by the way the American investment banks have evolved over the past century. Given this situation, investment banking encompasses not merely merchant banking but other related capital market activities such as stock trading, market making, underwriting, broking and asset management as well. Besides the above,

investment banks also provide a host of specialized corporate advisory services in the areas of project advisory, business and financial advisory and mergers and acquisitions. The activity profile of investment banks is discussed in more in detail later in this chapter.

Evolution of American Investment Banks

The earliest events that are relevant for this discussion can be traced to the end of World War I, by which time, commercial banks in the USA were already preparing for an economic recovery and consequently, to the significant demand for corporate finance. It was expected that American companies would shift their dependence from commercial banks to stock and bond markets wherein funds were available at a lower cost and for longer periods of time. In preparation for a boom in the capital markets in the 1920s, commercial banks started to acquire stock broking businesses in a bid to have their presence made in such markets. The first of such acquisitions happened when the National City Bank of New York acquired Halsey Stuart and Company in 1916. As in the past, in the entire 1920s, investment banking meant underwriting and distribution of securities. The stock and bond market boom in 1920s was as opportunity that banks could not miss. But since they could not underwrite and sell securities directly, they owned security affiliates through holding companies. However, they were not maintained like water tight compartments. The affiliates were sparsely capitalized as were financed by the parent banks for their underwriting and other business obligations. While the boom lasted, investment banking affiliates made huge profits as underwriting fees, specially in the segment called Yankee Bonds issued by overseas issuers in US market. In the stock market, the banks mainly conducted broking operations through their subsidiaries and lent margin money to customers. But with the passage of the McFadden Act in 1927, bank subsidiaries began

underwriting stock issues as well. National City Bank, Chase Bank, Morgan and Bank of America were the most aggressive banks present at that time. The stock market got over-heated with investment banks borrowing money from the parent bank in order to speculate in the banks stock, mostly for short selling. Once the general public joined the frenzy, the price-earning ratios reached absurd limits and the bubble eventually burst in October 1929 wiping out millions of dollars of bank depositors funds and bringing down with it banks such as Bank of United States/ In order to restore confidence in the banking and financial system, several legislation measure were proposed, which eventually led to the passing of the Banking Act 1933 (popularly know as Glass-Steagall Act) that restricted commercial banks from engaging in securities underwriting and taking positions or acting as agents for others in securities transactions. These activities were segregated as the exclusive domain of investment banks. On the other hand, investment banks were barred from deposit taking and corporate lending, which were considered the exclusive business of commercial bank. The Act thus provided the water tight compartments that were needed before. Since the passing of this Act, investment banking became narrowly defined as the basket of financial services associated with the floatation of corporate securities, i.e. the creation of primary market for securities. It was also extended to mean at a secondary level, secondary market making through securities dealing. By 1935, investment banking became one of the most heavily regulated industries in USA. The Securities Act, 1933 provided for the first time the
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preparation of offer documents and registration of new securities with the federal government. The Securities Exchange Act, 1934 led to the establishment of the Securities Exchange Commission. The Maloney Act of 1938 led to the formation of the NASDAQ, the Investment Company Act, 1940, which brought mutual funds within the regulatory ambit and the Investment Advisers Act, 1940 which also regulated the business of investment advisers and wealth managers. After the passing of the Glass-Streagall Act of the 1930s, until the beginning of the 21st century, investment banking had been through several phases of transformation which had broken down the water tight compartments to a great extent. Due to the 1973 Arab oil embargo, world economies were under pressure and inflation and interest rate volatility became disturbing. It was at this time that institutional investors madder their advent into securities markets. It was also the time when the industrial and financial service sectors were beginning to expand and globalize. Due to these developments, investment banking and commercial banking once again became constrained by the very legislation that was meant to clean up the system in the 1930s. This led to several relaxations over the years such as the Securities Acts Amendments, 1975 which had permitted commercial banks to have subsidiaries (called section 20 subsidiaries) that were allowed to underwrite and trade in securities. In 1990, J.P. Morgan was the first bank to open a section 20 subsidiary. Since the Glass-Streagall Act did not apply to foreign subsidiaries of US banks, they continued to underwrite in the Eurobond market and by 1984, they had a 52% market share in that business. But there was stiff competition from Japanese banks in this market and by 1987, they underwrote only 25% of the Eurobond issuances.
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During the economic growth and globalization of the 1980s, investment banking expanded to several new areas and services which had included currency trading, real estate, financial futures, bridge loans, mortgagebacked securities and several others. But the stock market crash of 1987 once again brought the focus back to core areas of specialization. Similarly, the ambitious expansion that took place on a global scale was also halted to some extent. However due to technological advancements in the 1990s and the availability of global access through the revolution in communication technologies fuelled the global growth again. But this time though, investment banking is no more restricted to underwriting new issuances and security dealing. The shift is more towards providing expertise in new products and risks. Apart from these activities, investment banking also encompasses a considerable spectrum of advisory services in the areas of corporate restructuring, mergers and acquisitions and LBOs, fund raising and private equity. On the dealing and trading side, investment banks participate in derivatives market, arbitrage and speculation. In the area of structured finance, investment banks also provide financial engineering through securitization deals and derivative instruments.

European Investment Banks

In continental Europe (excluding UK), the concept of a Universal Bank had been the undercurrent since the late nineteenth century, when most of these banks were set up. The term universal banking meant the coexistence of commercial banking (lending activity) along with investment banking (investment and distribution activity). Their universality was in the sense of harnessing the vast retail customer base that these banks enjoyed to market security issuances by their investment banking arms. These issues were mostly in the local markets designated in the local currencies. Frances Banques daffiars and Germanys Universalbanken are good examples. The United Kingdom, which is considered as Europes largest investment banking market, had its own structure evolved from history. The oldest merchant bank in London was Barings Brothers which had played a prominent role in the nineteenth century. Securities distribution was the function of stock brokers, secondary market trading was held by jobbers and advisory services were provided by merchant bank. The term merchant bank was evolved so as to distinguish between commercial banks and those that provided capital market advice. However, the breaking down of such barriers in 1986 by allowing banks to own broking outfits led to a consolidation and most of the broking firms got absorbed by larger and diversified entities. Around the same time, the US too was witnessing the disappearance of distinction between pure broking entities restricted to the secondary markets and investment banking entities involved with the primary markets. The US investment banks with their integrated global business model entered UK and Europe and later into Japan. The
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introduction of the Euro currency in 1999, helped the US invasion further by neutralizing the local currency advantages enjoyed by European universal banks. By 2001, the US bulge group garnered 29.7% of the investment banking fee generated in Europe as compared to 16.3% by the European universal banks. Post-1986, the merchant banks and commercial banks in UK could not match up to the US onslaught which ultimately led to the sale of SG Warburg, the merchant bank to Swiss Bank Corporation (which was acquired by UBS later) in 1995. In 1997, Natwest Bank and Barclays Bank exited investment banking business. Morgan Grenfell, a merchant bank was sold to Deutsche Bank in 1990. In this upheaval, niche players such as Drexel Burnham and Barings Bank also collapsed with internal deficiencies. This led to cross border M&A between European banks inter-se and their American counterparts to create bigger investment banks. UBS Warburg was born out of merger of UBS and Swiss Bank Corporation which had earlier acquired SG Warburg. Deutsche Bank acquired Bankers Trust.

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Global Industry Structure

The investment banking industry on a global scale is oligopolistic in nature ranging from the global leaders (known as the Global Bulge Group) to Pure investment banks and Boutique investment banks. The bulge group consisting of eight investment banks has a global presence and these firms dominate the league tables in key business segments. The top ten global firms in terms of their fee billing as in 2001 are listed in Table Within the listing given in the table referred to above are the top pure investment banks, i.e. which do not have commercial banking connections, which are Merrill Lynch, Goldman Sachs and Morgan Stanley Dean Witter. Listed therein are also the leading European Universal Banks that are called so due to their role in both commercial and investment banking. The five leading universal banks in the world and their important group affiliates are given in Table Therefore, the global investment banking industry ranges form the acknowledged global leaders to a larger number of mid-sized competitors at a national or regional level and the rear end is supported by boutique firms or advisory and sectoral specialists.

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Business Portfolio of Investment Banks

Globally, investment banks handle significant fund-based business of their own in the capital market along with their non-fund service portfolio which is offered to clients. However, these distinct segments are handled either on the same balance sheet or through subsidiaries and affiliates depending upon the regulatory requirements in the operating environment of each country. All these activities are segmented across three broad platforms equity market activity, debt market activity and merger and acquisition (M&A) activity. In addition, given the structure of the market, there is also a segmentation based on whether a particular investment bank belongs to a banking parent or is a stand-alone pure investment bank. Figure represents the broad spectrum of global investment acitivity. From this diagram, it may be appreciated that investment banking encompasses a wide area of capital market based businesses and services and has a significant financial exposure to the capital market. Though investment banks also earn a significant component of their income from non-fund based activity, it is their capacity to support clients with fundbased services, which distinguishes them from pure merchant banks. In the US capital market, investment banks underwrite issues or buy them outright and sell them later to retail investors thereby taking upon themselves significant financial exposure to client companies. Besides, being such large financial power houses themselves, the global investment banks play a major role as institutional investors in trading and having large holdings of capital market securities. As dealers they take positions and make a market for many securities both in equity and derivative segments. They hold large
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inventories and therefore influence the direction of the market. Goldman Sachs, Salomon Brothers, Merrill Lynch, Schroeders, Rothschild and other significant Market Investors both on their own account and on behalf of the billions dollars of funds under their management. The global mergers and acquisitions business is very large and measures up to trillions of dollars annually. Investment banks play a lead advisory role in this booming segment of financial advisory business. Besides, they come in as investors in management buy-outs and management buy-in transactions. On other occasions, wherein investment banks manage private equity funds, they also represent their investors in such buy-out deals. In the case of universal banks such as the Citigroup or UBS Warburg, loan products form a significant part of the debt market business portfolio. Pure investment banks such as Goldman Sachs, Merrill Lynch and Morgan Stanley Dean Witter do not have commercial banking in their portfolio and therefore, do not offer loan products. Besides the larger firms, there are a host of other domestic players present in each country and mid-sized investment banks, which either specialize in local markets or in certain product segments. Some investment banks in the overseas markets also specialize in niche segments such as management of hedge funds, bullion trade, commodity hedges, real estate and other exotic markets.

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The Indian Scenario Origin

In India, though the existence of this branch of financial services can be traced to over three decades, investment banking was largely confined to merchant banking services. The forerunners of merchant banking in India were the foreign banks. Grindlays Bank (now merged with Standard Chartered Bank in India) began merchant banking operations in 1967 with a license obtained from the RBI followed by the Citibank in 1970. These two banks were providing services for syndication of loans and raising of equity apart from other advisory services. It was in 1972, that the Banking Commission Report asserted the need for merchant banking services in India by the public sector banks. Based on the American experience which led to the passing of the Glass-Streagall Act, the Commission recommended a separate structure for merchant banks so as to distinct them from commercial banks and financial institutions. Merchant banks were meant to manage investments and provide advisory services. Following the above recommendations, the SBI set up its merchant banking division in 1972. Other banks such as the Bank of India, Central Bank of India, Bank of Baroda, Syndicate Bank, Punjab National Bank, Canara Bank also followed suit to set up their merchant banking outfits. ICICI was the first financial institution to set up its merchant banking division in 1973. The later entrants were IFCI and IDBI with the latter setting up its merchant

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banking division in 1992. However, by the mid eighties and early nineties, most of the merchant banking divisions of public sector banks were spun off as separate subsidiaries. SBI set up SBI Capital Markets Ltd. in 1986. Other such banks such as Canara Bank, BOB, PNB, Indian Bank and ICICI created separate merchant banking entities.

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Growth
Merchant banking in India was given a shot in the arm with the advent of SEBI in 1988 and the subsequent introduction of free pricing of primary market equity issues in 1992. However, post 1992, the merchant banking industry was largely driven by issue management activity which fluctuated with the trends in the primary market. These have been phases of hectic activity followed by a severe setback in business. SEBI started to regulate the merchant banking activity in 1992 and a majority of the merchant bankers who registered with SEBI were either in issue management or associated activity such as underwriting or advisorship. SEBI had four categories of merchant bankers with varying eligibility criteria based on their networth. The highest number of registered merchant bankers with SEBI was seen in the mid-nineties, but the numbers have dwindled since, due to the inactivity in the primary market. The number of registered merchant bankers with SEBI as at the end of March 2003 was 124, from a peak of almost a thousand in the nineties. In the financial year 2002-03 itself, the number decreased by 21.

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Constraints in Investment Banking

Due to the over dependence on issue management activity in the initial years, most merchant banks perished in the primary market downturn that followed later. In order to stabilize their businesses, several merchant banks diversified to offer a broader spectrum of capital market services. However, other than a few industry leaders, the other merchant banks have not been able to transform themselves into full service investment banks. Going by the service portfolio of the leading full service investment banks in India, it may be said that the industry in India has seen more or less similar development as its western counterparts, though the breadth available in the overseas capital market is still not present in the Indian capital market. Secondly, due to the lack of institutional financing in a big way to fund capital market activity, it is only the bigger industry players who are in investment banking. The third major deterrent has also been the lack of depth in the secondary market, especially in the corporate debt segment.

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Characteristics and Structure of Indian Investment Banking Industry

Investment banking in India has evolved in its own characteristics structure over the years both due to business realities and the regulatory regime. On the regulatory front, the Indian regulatory regime does not allow all investment banking functions to be performed under one entity for two reasons(a) to prevent excessive exposure to business risk under one entity and (b) to prescribe and monitor capital adequacy and risk mitigation mechanisms. Therefore bankruptcy remoteness is a key feature in structuring the business lines of an investment bank so that the risks and rewards are defined for the investors who provide resources to the investment banks. In addition, the capital adequacy requirements and leveraging capability for each business line have been prescribed differently under relevant provisions of law. On the same analogy, commercial banks in India have to follow the provisions of the Banking Regulation Act and the RBI regulations, which prohibit them from exposing themselves to stock market investments and lending against stocks beyond certain specified limits. Therefore, Indian investment banks structure their business segments in different corporate entities to be able to meet regulatory norms. For e.g. it is desirable to have merchant banking is a separate company as it requires a separate merchant banking license from the SEBI. Merchant bankers other than banks and financial institutions are also prohibited from undertaking any other business other than that in the securities market. However, since banks are subject to the Banking Regulation Act, they cannot perform

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investment banking to a large extent on the same balance sheet. Asset management business in the form of a mutual fund requires a three-tier structure under the SEBI regulations. Equity research should be independent of the merchant banking business so as to avoid the kind of conflict of interest as faced by American investment banks. Stock broking has to be separated into a different company as it requires a stock exchange membership apart from SEBI registration. A complete overview of the regulatory framework for investment banking is furnished later. Investment banking in India has also been influenced by business realities to a large extent. The financial services industry in India till the early 1980s was driven largely by debt services in the form of term financing from financial institutions and working capital financing by commercial banks and non-banking financial companies (NBFCs). Capital market services were mostly restricted to stock broking activity which was driven by a noncorporate unorganized body industry. Merchant banking and asset management services came up in a big way only with the opening up of the capital markets in the early nineties. Due to the primary market boom during that period, many financial business houses such as financial institutions, banks and NBFCs entered the merchant banking, underwriting and advisory business. While most institutions and commercial banks floated merchant banking divisions and subsidiaries, NBFCs combined their existing business with that of merchant banking. Over the subsequent years, two developments have taken place. Firstly, with the downturn in the capital markets, the merchant banking industry has seen a tremendous shake out and only about a 10% of them remain in serious
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business as pointed out earlier. The other development is that due to the gradual regulatory developments in the capital markets, investment banking activities have come under regulations which require separate registration, licensing and capital controls. Due to the above reasons, the Indian investment banking industry has a heterogeneous structure. The bigger investment banks have several group entities in which the core and non-core business segments are distributed. Others have either one or more entities depending upon the activity profile. The heterogeneous and fragmented structure is evident even if Indian investment banks are classified on the basis of their activity profile. Some of them such as SBI, IDBI, ICICI, IL & FS, Kotak Mahindra, Citibank and others offer almost the entire gamut of investment banking services permitted in India. Among these, the long term financial institutions are gradually transforming themselves into full service commercial banks (called universal banking in the Indian context). They also have full service investment banking under their fold. Other entities such as NBFCs or subsidiaries of public sector banks mainly offer merchant banking and other capital market services. There are also several others who are providing only corporate advisory services but prefer to hold merchant banking or underwriting registrations. Presently, there are no global Indian investment banks although there is a bulge bracket of investment banks in India that have some overseas presence to serve Indian issuers and their investors. At the middle level are several niche players including the merchant banking subsidiaries of some public
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sector banks. Some of these subsidiaries have been either shut down or sold off in the wake of two securities scam seen in 1993 and in 2000. However, certain banks such as Canara Bank and Punjab National Bank have had successful merchant banking activities. Among the middle level players are also merchant banks structured as non-banking financial services companies such as Rabo India Finance Ltd, Alpic Finance etc. There are also in the middle level, some pure advisory firms such as Lazard Capital, Ernst & Young, KPMG, Price Waterhouse Coopers etc. At the lower end are several niche players and boutique firms, which focus on one or more segments of the investment banking spectrum.

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Service Portfolio of Indian Investment Banks Core Services

Merchant Banking, Underwriting and Book Running The primary market which was quite small in India, was revitalized with the abolition of the Capital Issues (Control) Act 1947 and the passing of the Securities and Exchange Board of India Act, 1992. The SEBI functions as the regulator for the capital markets similar to its counterpart, the SEC in USA. SEBI vide its guidelines dated June 11, 1992 introduced free pricing of securities in public offers for the first time in India. Over the last ten years, there have been two distinct phases of primary market boom the first between 1992-1996 and the second between 1998-2001. The third wave of primary market issues could shape up in the near future. This market is very closely regulated by SEBI. In the days when the public offers market is very vibrant, this area of service forms the main activity for most Indian investment banks. In the past few years, though public offers have been very few, the private placement market especially in the debt segment has been very active and has served as an important source of funds for prime-rated corporates. Notable among such offerings are related privately placed debentures issued by public sector corporations and leading private companies. Financial institutions have been raising funds via the public offers and hand holding them in the private placements as well. Once the private placement markets also come under regulatory stipulations, investment banks would have a wider role to play in such issuances.

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Mergers and Acquisitions Advisory

The mergers and acquisitions industry was pretty nascent in India prior to 1994 and continues to be tiny compared to the global scale of such transactions. However, two main features that have given a big push to this industry are: The forces of liberation and globalization that have forced the Indian industry to consolidate. The institutionalization of corporate acquisitions by SEBI through its guidelines, popularly known as the Takeover Code. One of the cream activities of investment banks has always been M&A advisory. The larger investment banks specialize in M&A as a core activity. While some of them provide pure advisory services in relation to M&A, others holding valid merchant banking licenses from SEBI also manage the open offers arising out of such corporate events.

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Corporate Advisory
Investment banks in India also have a large practice in corporate advisory services relating to project financing, corporate restructuring, capital restructuring through equity repurchases (including management of buyback offers under section 77A of the Companies Act, 1956), raising private equity, structuring joint-ventures and strategic partnerships and other such value added specialized areas.

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Support services and Businesses Secondary Market Activities

Most of the universal banks such as ICICI, IDBI and Kotak Mahindra have their broking and distribution firms in both the equity and debt segments of the secondary market. In addition several other investment banks such as the IL & FS and pure investment banks such as DSP Merrill Lynch and JM Morgan Stanley have a strong presence in this area of activity. In the past few years, the derivatives segment has been introduced in Indian capital market and this provides an additional avenue of specialization for investment banks. Derivatives trading, risk management and structured products offerings are the new segments that are fast becoming the areas of future potential for Indian investment banks. The securities business also provides extensive research offerings and guidance to investors. The secondary market services cater to both the institutional and non-institutional investors.

Asset Management Services

Most of the top financial groups in India which have investment banking businesses such as the ICICI, the IDBI, Kotak Mahindra, DSP Merrill Lynch, JM Morgan Stanley, SBI and IL & FS also have their presence in the asset management business through separate entities. As per the three layer structure propounded by SEBI, the parent organization acts as the sponsor of the fund and the fund itself is constituted as a trust. The trust is managed by

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an asset management company and a separate trustee company which oversees the interests of the unit holders in the Mutual Fund. The whole structure has as arms length distance from the sponsors other businesses and entities.

Wealth Management Services (Private Banking)

Many reputed investment banks nurture a separate service segment to manage the portfolio of high networth individuals, households, trusts and other types of non-institutional investors. This can be structured either as a pure advisory service wherein the investment manager does not have any access to the funds or as a fund management service wherein the investment manager is given charge of the funds. In the former case, it becomes a nondiscretionary portfolio and in the latter case, it becomes a discretionary portfolio. Such activity is regulated under the SEBI guidelines as already discussed. In other cases, wealth management may be restricted to a research based activity wherein the investor is provided good investment recommendations from time to time.

Institutional Banking
Institutional investors have been a recent phenomenon in the Indian capital market, which till then had the presence of a handful of public financial institutions such as the UTI and the insurance companies. The term lending institutions such as the IDBI and IFCI did not participate in secondary market dealing as a matter of policy. With the advent of liberalization, there

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are presently a large number of domestic institutional investors in the secondary market apart from approved foreign institutional investors. In addition, institutional investments have risen significantly in the primary markets through venture capital and private equity investments by investors in both the domestic and non-domestic categories. Several of the leading investment banks either have dedicated venture funds or private equity funds that invest in primary market. In addition they make proprietary investments in the secondary market through their dealing and market activities. The business portfolio of Indian Investment Banks has been briefly discussed in Fig.

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Interdependence between Different Verticals in Investment Banking

As is evident from Figure , there are different verticals in investment

banking and they do enjoy synergies with one another. While some of the service or business segments form the core of investment banking, others provide invaluable support. This inter-dependence and complementary existence has been explained below. While merchant banking largely relates to management of public floatations of securities or reverse floatations such as buy backs and open offers, underwriting is an inherent part of merchant banking for public issues. Similarly, bought out deals and market making are a part of the process of floating issues on the OTC Exchange of India. The concept of market making has now been introduced for listing of certain scrips in the main stock exchanges as well. Advisory and transaction service have a close linkage with merchant banking as more often than not, such services culminate in a merchant banking assignment for a public issue or a reverse floatation. Such services also help in maintaining an enduring relationship with clients during those times when merchant banking is not a hot activity due to depressed market conditions. The other segment of primary market activity, i.e. venture capital and private equity has equal synergies with merchant banking. Being in venture capital business which enables identification of potential IPO candidates quite early, which helps not only in generating good fee income from merchant banking services, but also good in capital gains for the venture capital invested at earlier rounds of financing in such companies. Similarly, being in private equity business helps in harnessing the potential offered by later stage and listed companies,
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which may approach an investment bank primarily for merchant banking services. The support business vertical in the secondary market operations also have synergies with those in the primary equity and debt market segment as far as investment banking is concerned. Stock broking and primary dealership in debt markets nurture institutional, corporate and retail clients who can be tapped effectively for asset management, portfolio management, and private equity business. In addition, presence in the equity derivative and foreign exchange derivatives segments can help in offering solutions in treasury management to clients. In addition, the advisory and transaction services vertical can draw expertise from such segments in providing structured financing solutions to its clients. All these verticals are driven by support services such as sales and distribution and also equity research and analysis. Lastly but more importantly, the capability in sales and distribution also determines the success of the merchant banking vertical. Thus, it may be seen that the growth and success of an investment bank depends on its strengths in each vertical and how well it combines them for synergies. To sum up, investment banking is a business that is very sensitive to the economic and capital market scenario and therefore, the broader the platform of its operations, the more is likelihood of an investment bank surviving business cycles and sudden shocks from the market.

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Regulatory Framework for Investment Banking

As discussed above, investment banking in India is regulated in its various facets under separate legislations or guidelines issued under statute. The regulatory powers are also distributed between different regulators depending upon the constitution and status of the investment bank. Pure investment banks which do not have presence in the lending or banking business are governed primarily by the capital market regulator (SEBI). However, universal banks and NBFC investment banks are also regulated primarily by the RBI in their core business of banking or lending and so far as the investment banking segment is concerned, they are also regulated by SEBI. An overview of the regulatory framework is furnished below: 1. At the constitutional level, all investment banking companies incorporated under the Companies Act, 1956 are governed by the provisions of that Act. 2. Investment banks that are incorporated under a separate statute such as the SBI or the IDBI are regulated by their respective statute. IDBI is in the process of being converted into a company under the Companies Act.
3. Universal Banks are regulated by the Reserve Bank of India under the

RBI Act 1934 and the Banking Regulation Act which put restrictions on the investment banking exposures to be taken by banks. The RBI has relaxed the exposure limits for merchant banking subsidiaries of commercial banks. Till now, such companies were restricting their
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exposure to a single entity through the underwriting business and other fund based commitments such as standby facilities etc to 25% of their net owned funds (NOF). Therefore these companies are now on par with other investment banks which can do so up to 20 times their NOF. 4. Investment banking companies that are constituted as non-banking financial companies are regulated operationally by the RBI under Chapter IIIB (sections 45H to 45QB) of the Reserve Bank of India Act, 1934. Under these sections RBI is empowered to issue directions in the area of resource mobilization, accounts and administrative controls. The following directions have been issued by the RBI so far: Non-Banking Financial Companies Acceptance of Deposits (Reserve Bank) Directions, 1998. NBFCs Prudential Norms (Reserve Bank) Directions, 1998. 5. Functionally, different aspects of investment banking are regulated under the Securities Exchange Board of India Act, 1992 and the guidelines and regulations issued there under. These are listed below: Merchant banking business consisting of management of public offers is a licensed and regulated activity under the Securities and Exchange Board of India (Merchant Bankers) Rules 1992 and Securities Exchange Board of India (Merchant Bankers) Regulations 1992.

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 Underwriting

business

is

regulated

under

the

SEBI

(Underwriters) Rules 1993 and the SEBI (Underwriters) Regulations 1993.

The activity of the secondary market operations including stock broking are regulated under the relevant by-laws of the stock exchange and the SEBI (Stock Brokers and Sub Brokers) Rules 1992 and the (Stock Brokers and Sub Brokers) Regulations 1992. Besides, for curbing unethical trading practices, SEBI has promulgated the SEBI (Prohibition of Insider Trading) Regulations 1992 and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations 1995.

The business of asset management as mutual funds is regulated under the SEBI (Mutual Funds) Regulations 1996. The business of portfolio management is regulated under the SEBI (Portfolio Managers) Rules, 1993 and the SEBI (Portfolio Managers) Regulations, 1993. The business of venture capital and private equity by such funds that are incorporated in India is regulated by the SEBI (Venture Capital Funds) Regulations, 1996 and by those that are incorporated outside India is regulated under the SEBI (Foreign Venture Capital Funds) Regulations 2000.

The business of institutional investing by foreign investment banks and other investors in Indian secondary markets is governed by the SEBI (Foreign Institutional Investors) Regulations 1995.

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6. Investments banks that are set up in India with foreign direct investment either as joint ventures with Indian partners or as fully owned subsidiaries of the foreign entities are governed in respect of the foreign investment by the Foreign Exchange Management Act, 1999 and the Foreign Exchange Management (Transfer or issue of Security by a Person Resident Outside India) Regulations 2000 issued there under as amended from time to time through circulars issued by the RBI. 7. Apart from the above specific regulations relating to investment banking, investment banks are also governed by other laws applicable to all other businesses such as the tax law, property law, state laws, arbitration law and other general laws that are applicable in India.

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Regulatory Framework for Merchant Banking

Merchant Bankers are governed by the SEBI (Merchant Bankers) Rules 1992 and SEBI (Merchant Bankers) Regulations 1992. According to the SEBI (Merchant Bankers) Rules 1992 a Merchant Banker means a person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management. Given the fact that Merchant Bankers are entrusted with the responsibility of issue management by law, the regulatory framework is designed to ensure that they sufficient competence and exercise diligence in their work such that the issuers comply with all statutory requirements concerning the issue. At the same time, the merchant banker shall have high levels of integrity so that quality issues alone are brought to the primary market. Keeping these objectives in mind and investor protection as the paramount objective, the SEBI has laid emphasis on ensuring that merchant bankers fulfil the eligibility criteria on an on-going basis and has therefore provided for compulsory registration every three years. All Merchant Bankers need to have a valid registration certificate under the said rules to perform the role of Merchant Bankers to issues. In considering the application for registration, SEBI shall pay regard to the professional qualification in finance, law or business management, adequate office space, manpower, office equipment and other infrastructure, at least two support staff members who have the competence to be in the field of merchant banking business, existence of

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minimum stipulated capital and previous experience to investor grievance redressal. The activities that a Merchant Banker is authorized to do are issue management and associated activities such as advising or providing consultancy or marketing services for the issue, underwriting of issues and portfolio management, though portfolio management alone requires additional registration under the relevant regulations. Merchant Bankers are precluded from carrying on any business or fund-based activity other than that associated with the securities market. Merchant Bankers are also bound by the Code of Conduct prescribed under the Regulations. In addition, Merchant Bankers have to comply with general obligations and responsibilities under the Regulations. Presently there is only one category of Merchant Bankers prescribed by SEBI (Category I) and the minimum stipulated networth for such Merchant Bankers is Rs.five crore. Such Merchant Bankers holding valid certificates of registration are alone qualified to manage public offers. SEBI levies a one-time authorization fee, an annual fee and a renewal fee from each Merchant Banker. Under the regulations, Merchant Bankers have also to submit periodical returns and any other additional information that SEBI might seek from time to time. SEBI also has a right of inspection of the books of account, records and documents of the merchant banker at any time if required. SEBI may suo moto conduct an enquiry or launch an investigation into the working of a Merchant Banker or on receipt of a complaint against such Merchant
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Banker. SEBI may even appoint an external auditor to inspect the books and report to SEBI. Based on the findings, SEBI is empowered to take appropriate action to award penalty points to the erring Merchant Banker based on the degree of the default or contravention in accordance with the SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing Penalty) Regulations 2002. The aggrieved Merchant Banker may prefer to appeal the Central Government under the SEBI (Appeal to Central Government) Rules 2003. It may also be mentioned here that a Merchant Banker is deemed to be a connected person to the issuer under the SEBI (Prohibition of Insider Trading) Regulations, 1992.

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Anatomy of Some Leading Indian Investment Banks. ICICI Securities Ltd. (I-Sec).
I-Sec is a part of the ICICI group whose parent company is the ICICI Bankm which till recently was a financial institution that converted itself into a universal bank by it merger with its own commercial bank, the ICICI Bank in 2003. I-Sec, which was initially a joint venture with J.P. Morgan of the US, became fully owned by ICICI after J.P. Morgan exited from the business. I-Sec is a full service investment bank that provides services across all the segments spanning debt market, equity market, derivatives and corporate advisory services. It has support services in research and broking. The advisory business focuses on merger and acquisitions, cross border acquisitions, equity and bidding for a number of reputed companies. The equity business offers research, sales and execution services to institutional investors in the secondary market and capital market related services such as execution of public offerings, structuring and regulatory and legal documentation services. In order to assist/provide corporate clients and institutional investors with investment banking services in the USA. I-Sec set up two US based subsidiaries namely ICICI Securities Holding Inc and ICICI Securities Inc. ICICI Securities Inc registered itself with the National Association of

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Security Dealers Inc as a broker-dealer, empowering it to engage in a variety of securities transactions in the US market. ICICI Brokerage Services Limited, a member of the National Stock Exchange of India Limited, is the domestic broking subsidiary of I-Secs distribution and secondary market services are handled by the broking company.

DSP Merrill Lynch Ltd.

Originally incorporated as DSP Financial Consultants Ltd, its name was changed to DSP Merrill Lynch (DSP-ML) in 1996 following its conversion into a joint venture with Merrill Lynch of USA, a leading international capital raising financial management and advisory company. Merrill Lynch has a 40% equity stake in DSP-ML. DSP-ML is a part of the DSP group which has been in the securities and brokerage business for 130 years in the Indian market, thus pre-dating even the Bombay Stock Exchange. DSP-ML is a leading full service Investment Bank that provides services across debt market, equity market and corporate advisory segments. It also provides services to private customers on equity and debt products and wealth management. It has a full fledged research team serving the needs of both its institutional and retail clients. The company is among the major players on proprietary account in the debt and equity markets and is also a registered primary dealer in government securities.

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The functional divisions at DSP-ML consist of the Investment Banking Group, the Equity Sales Group, the Equity Trading and Dealing Group, Debt Sales Group, the Mergers and Acquisitions Group, the Research Group and the Private Client Group. The investment banking group generates equity and debt products emerging from IPOs, secondary issues and debt market issues as well as private placements. It is also a leading underwriter in both equity and debt products. These products are distributed through the equity sales group and the debt sales group. Both the marketing groups serve a cross section of institutional clients, other non-institutional clients such as trusts and investment companies, retail clients and overseas investors. The sales groups also distribute apart from their own products, the products emerging from other entities such as DSP Merrill Lynch Mutual Fund and other mutual funds. The sales groups are supported by a national distribution networking comprising of approximately 8000 sub-brokers and alliance partners. The trading and dealing groups support the broking activity in equities and the primary dealership activities in the debt market. DSP-ML, is one of the largest institutional broking firms in India. It is a founding member of The Stock Exchange, Mumbai (BSE) and is an active member of the National Stock Exchange (NSE) of India in both the equity segment and the wholesale debt market segment. It is an accredited primary dealer with the RBI and an active participant in the Government Securities/Treasury bill markets. As a primary dealer, it makes a market for debt securities by offering to buy and sell quotes. These quotes are also available on wire services like Reuters, Crisil Market wire, Bloomberg and Dow Jones Newswires.
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The mergers and acquisitions advisory has been structured as a separate specialist group that offers their clients financial advice and assistance in restructuring, divestures, acquisitions, de-mergers, spin-offs, joint ventures, privatization and takeover defense mechanisms. The research group offers products such as sectoral reports, company reports and special theme analyses, daily, weekly and monthly market views as well as specific policy forecasts. The private client group offers depository, broking and investment advisory services to high net worth individuals, professionals and promoters of business groups, corporate executives, trusts and private companies. In 1996, the DSP group floated a separate equity broking company called DSP Securities Ltd. which is a member of the BSE.

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JM Morgan Stanley Pvt. Ltd.

JM Morgan Stanley (JMMS) is a joint venture between the JM Financial Group and Morgan Stanley Dean Witter of the USA. In 1997, Morgan Stanley which was established in New York in 1935, had acquired Dean Witter, an investment bank founded in 1924 in San Francisco. JM Morgan Stanley commenced operations in April 1999. However, the association of the two partners is limited only to the investment banking area. Both of them have separate asset management companies in India which run independent of mutual fund businesses. Unlike DSP-ML and I-Sec which have an integrated structure, the JM Group has separate companies handling various components of the capital market business. The core functions of investment banking are performed by JMMS. This company focuses on capital raising, mergers and acquisitions, private equity and advisory work for Indian corporations in both the international and domestic capital markets. The function of distribution and marketing securities is handled by two of its wholly owned subsidiaries JM Morgan Stanley Retail Services Pvt. Ltd. (JMRS) and JM Morgan Stanley Fixed Income Securities Pvt. Ltd. (JMFI). JMRS provides equity distribution services for primary market products, mutual funds, equity sales and marketing support for the group broking activity and wealth management and portfolio management services to high net worth individuals. JMFI offers similar services in fixed income (debt) securities. A third company, JM Morgan Stanley Securities Pvt. Ltd. handles all the broking operations for the group and provides services to institutional clients and others. It also provides research support for both FII and Indian institutional clients.
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SBI Capital Markets Ltd

Founded in 1986 as a hive-off of the SBI Merchant Banking division, SBI Capital Markets Ltd. (SBI Caps) is amongst the oldest players in the Indian capital market. It is a full service investment bank that provides investment, advisory and financial services. In 2001, SBI Caps started its sales and distribution activity along with equity and debt broking services. SBI Caps provides services across the following spectrum:

Mergers and Acquisitions: This group provides advisory services with regard to disinvestment of the government, valuations, mergers and acquisitions in the corporate sector, financial and business restructuring and other areas.

Project advisory and structure finance: It is arguably one of the leading groups in the company that provides services such as restructuring and privatization advisory for public utilities, policy advisory to Central and State Governments, regulatory bodies and government departments and organizations, project structuring and advisory to the private sector and arranging finance for such projects. SBI Caps has been a major player in governmental work and in the infrastructure sector. The project advisory services consist of handholding from the concept to commissioning stage involving project structuring, contract structuring, financial modeling, preparation of information memorandum, syndication of debt and equity and assistance in documentation and financial closure. Other services include appraisals for green-field and brown-field projects, technoeconomic appraisal from banks and financial institutions for
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establishing the viability of corporate restructuring plans, and vetting of contracts, loan documents, project documentation etc.

Capital market: This group provides merchant banking services in connection with public issues, rights issues and public offers for buybacks and open offers. It also advises clients on the private placements, ADR and GDR issues and overseas bond issues by the SBI.

Treasury and Investments: This group deals with the proprietary investment of the company in the equity, debt and money markets. Resource mobilization and management is also undertaken by this group.

Broking of Equity and Debt: SBI Caps is a registered broker and a member of the NSE in the equity and wholesale debt segments and is also a member in the equity segment. The broking group caters to the secondary market needs of financial institutions, FIIs, mutual funds, banks, other corporates, high net worth individuals, non-resident investors and retail investors. The company commenced wholesale debt market broking in 2001. The company expects to have a strong presence in institutional broking. The company plans to open a derivative trading desk soon.

Sales and Distribution of equity and mutual fund products: SBI Caps has been a leading mobilizer of funds both for public offers and private placements.

Research: This group provides the research support for in-house departments and for institutional clients. Besides regular updates on companies and industries, the research group brings out India

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Strategy, Debt Market Review and Daily Debt Market review which are circulated to SBI Caps investment banking and broking clients. In its annual report for the year ending March 31, 2002, SBI Caps reported that is has two business segments (a) Fee based segment providing merchant banking and advisory services like issue management, underwriting, arranger, project advisory and structured finance. (b) Fund based segment which undertakes deployment of funds in leasing, hire purchase and securities dealing. However, as a result of SEBI directives, fresh lending under leasing and hire-purchase was stopped from 1st July 1998. For the period 2001-02, SBI Caps was ranked first among issue managers by PRIME database.

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Kotak Mahindra Capital Company

Born in 1995 as part of a corporate re-organization as an unlimited company. The Kotak Mahindra Capital Company (KMCC), is the investment banking entity belonging to the Kotak Mahindra Group. It is a strategic joint venture between Kotak Mahindra Bank Limited (KMBL) and the Goldman Sachs Group LLP of USA. KMCC is a full service investment bank whose core business centers on equity issuances and fixed income securities, mergers and acquisitions and advisory services. As an investment bank, KMCC is registered with SEBI and is also registered as a non-banking financial company with RBI. It is also an active member of the association of Merchant Bankers of India (AMBI). KMCC has two wholly owned subsidiaries (a) Kotak Mahindra (UK) Limited, which is registered with the Securities and Futures Association, UK and regulated by the Financial Services Authority, UK and (b) Kotak Mahindra Inc based in USA, which is registered with the Securities and Exchange Commission, USA. KMCC is the first Indian investment bank to have sought such regulations in USA and UK. A third company called Kotak Mahindra (International) Limited., based in Mauritius provides distribution and other client services to non-resident investors. In KMCC, the Equity Capital Markets group focuses on structuring and executing diverse equity financing transactions in the public and private markets for corporates, banks, financial institutions and the Government. Products include initial public offerings (IPOs), rights offerings, convertible offerings, private placements and private equity for unlisted and listed companies. In the advisory business, the Structured Finance
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(Project Finance & Advisory Business) Group provides expertise in various vertical segments in the infrastructure sector including power, oil, gas, ports, automobiles, steel & metals and hotels by offering structured finance solutions to clients. The Fixed Income Securities Group at KMCC advises PSUs, Government companies, financial institutions, banks and corporates on raising capital by way of public or private placement of debt. KMCC is credited with innovating on some bond structures in the Indian market. The advisory group on mergers and acquisitions provides complete solutions on strategy formulation identification of targets or buyers, valuation, negotiations and bidding, capital structuring, transaction structuring, assistance in legal documentation and acquisition financing strategies and implementation. KMCC is supported in its functions by Kotak Securities Ltd, a broking firm incorporated in 1995 that is also a joint venture with Goldman Sachs which handles all the broking, distribution and research business of the group. Kotak Securities is a member of the debt segment of the NSE and is also a member of the National Stock Exchange Members Association. Kotak Securities offers services to investors, financial institutions, mutual funds, religious and charitable trusts, insurance companies, etc. The institutional business division has a comprehensive research cell with sectoral analysts covering all the major areas of the Indian economy. In the international arena, it provides brokerage services on the Indian securities to institutional and other investors who are based outside India. Due to its overseas presence, the company has marketing interests in Indian GDR and ADR issues as well.

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The research products brought out by Kotak Securities include:

For the institutional clients, a product called AKSESS, which primarily covers secondary market broking. It caters to the needs of foreign and Indian institutional investors in Indian equities (both local shares and GDRs).

The Daily Forex Monitor which tracks the Indian and international foreign exchange markets and opines on currency strategies on a daily basis. The Weekly Money Market Update which gives the details of the developments in markets and provides a short-term interest rate view along with indicative pricing for Triple A credits. The CURRENCY WATCH captures the monthly developments in the Indian foreign exchange markets, analyses the key influencing issues, assess future outlook and also recommends hedging strategies. Monthly FINSEC and FINSEC Focus. Kotak Securities is also a registered primary dealer with the RBI in the government securities market. As a primary dealer, the company acts as a market maker and also provides two way quotes, acts as retailer and marketing agent, provides underwriting support on government securities issues and participates in auctions held by the RBI. Besides, the above companies, the Kotak Group includes the Kotak Mahindra Bank which was formerly a non-banking finance company that has recently been converted into a bank, the Kotak Mahindra Mutual Fund

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which is managed by the Kotak Mahindra Asset Management Co. Ltd and the OM Kotak Life Insurance, which is a joint venture with Old Mutual Plc of UK and the Kotak Mahindra Venture Capital Co. which manages the private equity fund of the group.

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Recent Trends in Investment Banking

One of the trends that has been developing in the past few years in the global and Indian investment banking arena, is the strong emergence of universal banks ahead of pure investment banks as market leaders. These universal banks have the additional financial muscle of their banking arms that add to their investment banking strengths. Pure investment banks have found it unmanageable to maintain leadership positions due to difficult market conditions and the economic downturn. The year 2002 has been dubbed as the watershed year in investment banking for over a decade. Globally, universal banks such as the Citigroup, JP Morgan Chase and Deutsche Bank are emerging strongly against pure investment banks such as Goldman Sachs and Morgan Stanley. This trend could probably reappear in India as well with the emergence of SBI, ICICI, IDBI and Kotak Mahindra Bank as strong universal banks. However, in 2002, pure investment banks such as JM Morgan Stanley and DSP Merrill Lynch still occupied top positions in the investment banking league tables. Some recent developments in the investment banking industry as reported in some financial dailies and other press clippings are listed below: International

The Wall Street IPO market has seen the fewest number of issues since 1978 in the calendar year 2003, with just five in the first quarter. These have mostly been from insurance and financial services firms and four of them were IPOs.
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In 2002, there was a drop of 28% in global equity and equity related issuances according to Thomson Financial. IPOs were the main causality with a drop of 34% to $60.6 billion. European market saw a drop of 53% drop in IPOs and 54% drop in convertible bond issuances. In Europe, the market focus shifted from fund raising through IPOs and public issues to more restructuring deals. These are termed as rescue finance deals such as rights issue and fully convertible bond issues by troubled companies. Ericsson, Sonera and Zurich Financial Services are some companies that made rights issues in 2002. According to Dealogic, the volume of rights issues in Europe rose from $20.7 billion to $21.5 billion in 2002. The most popular instrument in USA and Europe has been the mandatory convertible (fully convertible) bond which is considered as a forward share sales which is superior in nature to a rights issue.

The Citigroup was Wall Streets top stock and bond underwriter in 2002. Citigroup affiliates Salomon Smith Barney arranged $414 billion of offerings with a 10.6% market share according to Thomson Financial. Merrill Lynch and CSFB were ranked second and third respectively. However, the total underwriting pie fell by 5% during the same year. The top IPO investment bank in 2002 was Salomon Smith Barney followed by Goldman Sachs. Goldman arranged the largest IPO of 2002, the $4.6 billion CIT Group Inc. (Tyco International Ltd) unit.

The reported fee of American Investment banks fell by 21% in 2002 to $14.1 billion. Salomon took the highest fee of around $2
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billion followed by the other two with around $1.2 billion each. Since April 2001, 78000 jobs were slashed in this industry in USA accounting for about 10% of the total strength. Global M&A market was also dull in 2002 witnessing a sharp fall of 47% to stand at $996 billion from $1887 billion in the previous year. The biggest deals in 2002 were HP-Compaq, AmgenImmunex Corp, AOL Time Warner-AOL Europe, Bayer-Aventis Crop Science, Comcast and Corp-AT&T Siemens Broadband, Robert Philips Petroleum-Conoco Mannesmann.

Bosch-Atccs

Some of the big universal banks such as JP Morgan Chase took major hits in their private equity businesses due to the technology meltdown. Incidentally, JP Morgan, which is one of Wall Streets largest private equity operators with a fund base of $28 billion, generated $130 million in revenues in private equity in 2001 fuelled mainly by the IPO market boom in technology stocks. Due to the meltdown, many investment banks have felt it necessary to spin off their private equity operations into separate entities. BNP Paribas, Deutsche Bank, HSBC and Zurich Financial Services are some of these banks.

American investors poured more money into debt mutual funds in 2002 accounting to $133 billion and there were few takers for public issues of equity junk bonds and convertible bonds.

National

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During the year 2001, JM Morgan Stanley which acted as adviser to M&A deals worth Rs.16022 crore was rated the top investment bank in India. The other players in the big league were ABN-Amro (Rs.10460 crore), DSP Merrill Lynch (Rs.7130 crore), Arthur Andersen (now part of E&Y, Rs.3532 crore), Kotak Mahindra (Rs.1719 crore), Rabo India Finance (Rs.833 crore) and Lazard Capital (Rs.536 crore) (as reported in the Economic Times 21st November 2001).

In 2002, there was only one GDR/ADR issue as compared to 6 in 2001 and 9 in 2000. This was made by Mascon Global which raised $10 million through issue of 2.5 million GDRs which are listed at Luxembourg Stock Exchange. In this market, Citibank was the leading depository banks according to Instanex Capital Consultants. This was followed by Bank of New York, Deutsche Bank and JP Morgan.

In the M&A market, the year 2002 saw an increase of around 5% in the value of M&A deals in Inda. Among these, more than 50% were cross-border deals according to a survey conducted by KPMG Corporate Finance. The deals were mostly in the SME segment with average size not exceeding $25 million. The banking, finance and insurance sectors contributed almost one-third of the total volume. Privatization deals also played a significant part.

DSP-ML de-listed from the stock exchange since its promoters, Hemendra Kothari and Merrill Lynch together held more than 90% of the shares. DSP was rated the The Best Domestic Investment Bank in India for 2000 by Finance Asia. Euromoney voted it Best Domestic M&A House in India as well as Best Domestic Equity
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House in India in 2000. This distinction has returned for three years in a row with DSP-ML being named as the Best Domestic Securities House and Best Domestic Investment Bank for 2002-2003 by Asiamoney (May 2003 issue) and The Asset (January 2003 issue) magazine respectively.

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The Conflict of Interest Issue

The most burning global issue in the investment banking industry is that of conflict of interest between investment bankers and their research analysis divisions. In the wake of the Enron, Worldcom and other corporate disasters, the issue has gained some significance. The Securities and Exchange Commission in the USA (SEC) have initiated investigations into instances of investment banks issuing over-optimistic research and steering shares in hot IPOs to important clients for vested interests. In such investigations some of the banks have been imposed fines. Merrill Lynch paid up fines to the extent of $100 million in regulatory proceedings in 2002 brought against its misleading research reports. Citigroups Salomon Smith Barney is also in the dock and may find itself paying the heaviest fines. CSFB also finds itself in trouble with the regulators. Most of the other top investment banks such as Goldman Sachs, Lehman Brothers, Bear Sterns, Deutsche Bank, JP Morgan Chase and others also found their names in the fines list in 2002. CSFB was fined for misleading investors on offerings in technology shares. JP Morgan on the other hand, has been under a cloud for its role in the infamous off-balance sheet partnership it had crafted for Enron. Besides, investment banks have also been the target of several lawsuits filed by aggrieved investors. In late 2002, the French luxury goods leader LVMH filed a 100 million euro lawsuit against Morgan Stanley alleging that its research report on LVMH was biased because of the investment banks close advisory relationship with LVMHs arch rival Gucci Group NV. Morgan Stanley was also the underwriter of Guccis IPO in 1995.

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Both the NYSE and NASDAQ came out with research analysts conflict of interest rules in May 2002 which was subsequently approved by SEC. Market observers have felt that this is a good development from the point of view of addressing conflict of interest, currently a burning issue in the industry. While an investment bank may be advising a client on a buy out, its private equity arm may be in the fray for its purchase. An example of this was the sale of the power storage business of Invensys in 2001 wherein Morgan Stanley was the advisor in the $505 million sale to EnerSys a company owned by Morgan Stanley Capital Partners (Morgan Stanleys private equity firm). So how does the conflict of interest really arise? Most investment banks have in-house research divisions which act as a support function as discussed earlier. The research divisions perform vital function of tracking corporates and making recommendations to their clients in the secondary market operations or to their own dealing rooms. They also issue reviews and ratings to new issuances hitting the market. The conflict could arise if the research analyst promotes a share, the public offering for which is being handled by the merchant bank. Alternatively, it could also be that the analyst is privy to insider information being provided by their merchant banking division and there upon issue recommendations that could amount to fraudulent deceit of investors or gains for select few. Over the years, the ethical wall between merchant bankers and research analysts melted especially in the heat of the IPO and the internet boom. The compensation patterns of the investment bankers and research analyst were also getting complementary to an extent thus undermining their independence.

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A study was conducted by the SEC in 2001on full service investment banks in Wall Street focusing on these conflicting relationships. The study disclosed two main areas of conflict(a) research recommendations tending to become marketing tools for merchant banking assignments by the same bank and analysts getting paid share of such investment banking gains, (b) ownership of stocks by research analysts in the companies that they recommend or research. The study disclosed that analysts leveraged their position in pumping up recommendations in companies that they are interested in when they went public. In the revised dispensation, one of the main provisions is that analysts have to disclose their interests in their recommendations. In addition, there is sought to be a water tight compartment in the working of the merchant banking departments and research divisions. The third area has been the regulation of compensatory structures for research analysts based on the profits of the merchant banking divisions. The developments in the USA have also resulted in precautionary amendments to regulations made in India by SEBI though such instances of conflict of interest have not surfaced so far. SEBI has amended the regulations that have been in place for Merchant Bankers, Underwriters and for the prohibition of insider trading. As a result, analysts are barred from private trading in shares they analyze. There is still room for more regulation in future in this area of importance for the survival of the investment banking industry. In conclusion, it can be said that the investment banking industry has been through difficult times. On one hand, the economic slow down and the crash of the markets that were propelled to dizzy heights by the new economy
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stocks have battered their bottom lines and led to a large scale cut back in staff and operations. On the other hand, role of investment banks in corporate scandals and their questionable business practices and ethics have taken a toll on their reputation and image. A large scale cleaning up has to take place in their methods of working and service offerings. Similarly, a major resurrection of their confidence is required through resurgence of the markets, whenever that happens. In the meantime, the industry has to live up to the challenge through appropriate restructuring and consolidation.

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Conclusion
Given the scope for investment banking in India, the future looks bright for the industry as a whole in India. Many more pure investment banks and advisory firms could convert themselves into full service investment banks that would broaden the market and make the service delivery much more efficient. In addition, the technological and market developments shaping the capital market as discussed would also provide an added impetus to growth of investment banking. Better regulatory supervision and stricter enforcement of the code of conduct of market intermediaries would ensure that better quality issuers come to the market and existing issuers would follow enhanced standards of corporate governance. In the long run, all these developments would ensure fair return to investors, and bring back investor support to the market. This would augur well for the capital market in general and investment banking in particular.

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