What is In­vest­ment bank­ing

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An in­vest­ment bank is a fi­nan­cial in­sti­tu­tion that as­sists in­di­vid­u­als, cor­po­ra­tions, and gov­ern­ments in rais­ing fi­nan­cial cap­i­tal by un­der­writ­ing or act­ing as the client’s agent in the is­suance of se­cu­ri­ties (or both). An in­vest­ment bank may also as­sist com­pa­nies in­volved in merg­ers and ac­qui­si­tions (M&A) and pro­vide an­cil­lary ser­vices such as mar­ket mak­ing, trad­ing of de­riv­a­tives and eq­uity se­cu­ri­ties, and FICC ser­vices (fixed in­come in­stru­ments, cur­ren­cies, and com­modi­ties).

Un­like com­mer­cial banks and re­tail banks, in­vest­ment banks do not take de­posits. From 1933 un­til 1999, the United States main­tained a sep­a­ra­tion be­tween in­vest­ment bank­ing and com­mer­cial banks. Other in­dus­tri­al­ized coun­tries, in­clud­ing G7 coun­tries, have his­tor­i­cally not main­tained such a sep­a­ra­tion. As part of the Dodd–Frank Wall Street Re­form and Con­sumer Pro­tec­tion Act of 2010 (Dodd-Frank Act of 2010), the Vol­cker Rule as­serts full in­sti­tu­tional sep­a­ra­tion of in­vest­ment bank­ing ser­vices from com­mer­cial bank­ing.

The two main lines of busi­ness in in­vest­ment bank­ing are called the sell side and the buy side. The “sell side” in­volves trad­ing se­cu­ri­ties for cash or for other se­cu­ri­ties (e.g. fa­cil­i­tat­ing trans­ac­tions, mar­ket-mak­ing), or the pro­mo­tion of se­cu­ri­ties (e.g. un­der­writ­ing, re­search, etc.). The “buy side” in­volves the pro­vi­sion of ad­vice to in­sti­tu­tions con­cerned with buy­ing in­vest­ment ser­vices. Pri­vate eq­uity funds, mu­tual funds, life in­sur­ance com­pa­nies, unit trusts, and hedge funds are the most com­mon types of buy side en­ti­ties.

An in­vest­ment bank can also be split into pri­vate and public func­tions with an in­for­ma­tion bar­rier which sep­a­rates the two to pre­vent in­for­ma­tion from cross­ing. The pri­vate ar­eas of the bank deal with pri­vate in­sider in­for­ma­tion that may not be pub­licly dis­closed, while the public ar­eas such as stock anal­y­sis deal with public in­for­ma­tion.

An ad­vi­sor who pro­vides in­vest­ment bank­ing ser­vices in the United States must be a li­censed bro­ker-dealer and sub­ject to U.S. Se­cu­ri­ties and Ex­change Com­mis­sion (SEC) and Fi­nan­cial In­dus­try Reg­u­la­tory Au­thor­ity (FINRA) reg­u­la­tion.

Or­ga­ni­za­tional struc­ture - Core in­vest­ment bank­ing ac­tiv­i­ties

In­vest­ment bank­ing is split into front of­fice, mid­dle of­fice, and back of­fice ac­tiv­i­ties. While large ser­vice in­vest­ment banks of­fer all lines of busi­ness, both “sell side” and “buy side”, smaller sell­side in­vest­ment firms such as bou­tique in­vest­ment banks and small bro­kerdeal­ers fo­cus on in­vest­ment bank­ing and sales/trad­ing/re­search, re­spec­tively.

In­vest­ment banks of­fer ser­vices to both cor­po­ra­tions is­su­ing se­cu­ri­ties and in­vestors buy­ing se­cu­ri­ties. For cor­po­ra­tions, in­vest­ment bankers of­fer in­for­ma­tion on when and how to place their se­cu­ri­ties on the open mar­ket, an ac­tiv­ity very im­por­tant to an in­vest­ment bank’s rep­u­ta­tion. There­fore, in­vest­ment bankers play a very im­por­tant role in

is­su­ing new se­cu­rity of­fer­ings.

Front of­fice

Front of­fice is gen­er­ally de­scribed as a rev­enue gen­er­at­ing role. There are two main ar­eas within front of­fice, i.e. In­vest­ment Bank­ing and Mar­kets.

In­vest­ment Bank­ing in­volves ad­vis­ing the world’s largest or­gan­i­sa­tions on merg­ers, ac­qui­si­tions, as well as a wide ar­ray of fund rais­ing strate­gies. Mar­kets is di­vided into sales, trad­ing, some re­search and also struc­tur­ing. This is, on av­er­age, the most pres­ti­gious and high­est paid depart­ment in the bank with first year an­a­lysts typ­i­cally mak­ing £60,000 up­wards (depend­ing on in­di­vid­ual, team and firm per­for­mance). [ci­ta­tion needed]

In­vest­ment bank­ing

Cor­po­rate fi­nance is the tra­di­tional as­pect of in­vest­ment banks, which in­volves help­ing cus­tomers raise funds in cap­i­tal mar­kets and giv­ing ad­vice on merg­ers and ac­qui­si­tions (M&A); this may in­volve sub­scrib­ing in­vestors to a se­cu­rity is­suance, co­or­di­nat­ing with bid­ders, or ne­go­ti­at­ing with a merger tar­get. A pitch book of fi­nan­cial in­for­ma­tion is gen­er­ated to mar­ket the bank to a po­ten­tial M&A client; if the pitch is suc­cess­ful, the bank ar­ranges the deal for the client. The in­vest­ment bank­ing di­vi­sion (IBD) is gen­er­ally di­vided into in­dus­try cov­er­age and prod­uct cov­er­age groups. In­dus­try cov­er­age groups fo­cus on a spe­cific in­dus­try – such as healthcare, public fi­nance (gov­ern­ments), FIG (fi­nan­cial in­sti­tu­tions group), in­dus­tri­als, TMT (tech­nol­ogy,

media, and telecom­mu­ni­ca­tion) – and main­tains re­la­tion­ships with cor­po­ra­tions within the in­dus­try to bring in busi­ness for the bank. Prod­uct cov­er­age groups fo­cus on fi­nan­cial prod­ucts – such as merg­ers and ac­qui­si­tions, lever­aged fi­nance, public fi­nance, as­set fi­nance and leas­ing, struc­tured fi­nance, restruc­tur­ing, eq­uity, and high-grade debt – and gen­er­ally work and col­lab­o­rate with in­dus­try groups on the more in­tri­cate and spe­cial­ized needs of a client.

Sales and trad­ing

On be­half of the bank and its clients, a large in­vest­ment bank’s pri­mary func­tion is buy­ing and selling prod­ucts. In mar­ket mak­ing, traders will buy and sell fi­nan­cial prod­ucts with the goal of mak­ing money on each trade. Sales is the term for the in­vest­ment bank’s sales force, whose pri­mary job is to call on in­sti­tu­tional and high-net-worth in­vestors to sug­gest trad­ing ideas (on a caveat emp­tor ba­sis) and take or­ders. Sales desks then com­mu­ni­cate their clients’ or­ders to the ap­pro­pri­ate trad­ing rooms, which can price and ex­e­cute trades, or struc­ture new prod­ucts that fit a spe­cific need. Struc­tur­ing has been a rel­a­tively re­cent ac­tiv­ity as de­riv­a­tives have come into play, with highly tech­ni­cal and nu­mer­ate em­ploy­ees work­ing on cre­at­ing com­plex struc­tured prod­ucts which typ­i­cally of­fer much greater mar­gins and re­turns than un­der­ly­ing cash se­cu­ri­ties. In 2010, Banks also un­der­take risk through pro­pri­etary trad­ing, per­formed by a spe­cial set of traders who do not in­ter­face with clients and through “prin­ci­pal risk”—risk un­der­taken by a trader af­ter he buys or sells a prod­uct to a client and does not hedge his to­tal ex­po­sure. Banks seek to max­i­mize prof­itabil­ity for a given amount of risk on their bal­ance sheet. The ne­ces­sity for nu­mer­i­cal abil­ity in sales and trad­ing has cre­ated jobs for physics, com­puter science, math­e­mat­ics and en­gi­neer­ing Ph.D.s who act as quan­ti­ta­tive an­a­lysts.

Re­search

The se­cu­ri­ties re­search di­vi­sion re­views com­pa­nies and writes re­ports about their prospects, of­ten with “buy” or “sell” rat­ings. In­vest­ment banks typ­i­cally have sell-side an­a­lysts which cover var­i­ous in­dus­tries. Their spon­sored funds or pro­pri­etary trad­ing of­fices will also have buy-side re­search. While the re­search di­vi­sion may or may not gen­er­ate rev­enue (based on poli­cies at dif­fer­ent banks), its re­sources are used to as­sist traders in trad­ing, the sales force in sug­gest­ing ideas to cus­tomers, and in­vest­ment bankers by cov­er­ing their clients. Re­search also serves out­side clients with in­vest­ment ad­vice (such as in­sti­tu­tional in­vestors and high-net-worth in­di­vid­u­als) in the hopes that these clients will ex­e­cute sug­gested trade ideas through the sales and trad­ing di­vi­sion of the bank, and thereby gen­er­ate rev­enue for the firm. Re­search also cov­ers credit re­search, fixed in­come re­search, macroe­co­nomic re­search, and quan­ti­ta­tive anal­y­sis, all of which are used in­ter­nally and ex­ter­nally to ad­vise clients but do not di­rectly af­fect rev­enue. All re­search groups, nonethe­less, pro­vide a key ser­vice in terms of ad­vi­sory and strat­egy. There is a po­ten­tial con­flict of in­ter­est be­tween the in­vest­ment bank and its anal­y­sis, in that pub­lished anal­y­sis can af­fect the bank’s prof­its.

Risk man­age­ment

Risk man­age­ment in­volves an­a­lyz­ing the mar­ket and credit risk that an in­vest­ment bank or its clients take onto their bal­ance sheet dur­ing trans­ac­tions or trades. Credit risk fo­cuses around cap­i­tal mar­kets ac­tiv­i­ties, such as loan syn­di­ca­tion, bond is­suance, restruc­tur­ing, and lever­aged fi­nance. Mar­ket risk con­ducts re­view of sales and trad­ing ac­tiv­i­ties utiliz­ing the VaR model and pro­vide hedge-fund so­lu­tions to port­fo­lio man­agers. Other risk groups in­clude coun­try risk, op­er­a­tional risk, and coun­ter­party risks which may or may not ex­ist on a bank to bank ba­sis. Credit risk so­lu­tions are key part of cap­i­tal mar­ket trans­ac­tions, in­volv­ing debt struc­tur­ing, exit fi­nanc­ing, loan amend­ment, pro­ject fi­nance, lever­aged buy-outs, and some­times port­fo­lio hedg­ing. Front of­fice mar­ket risk ac­tiv­i­ties pro­vide ser­vice to in­vestors via de­riv­a­tive so­lu­tions, port­fo­lio man­age­ment, port­fo­lio con­sult­ing, and risk ad­vi­sory. Well-known risk groups in JPMor­gan Chase, Gold­man Sachs and Bar­clays en­gage in rev­enue-gen­er­at­ing ac­tiv­i­ties in­volv­ing debt struc­tur­ing, restruc­tur­ing, loan syn­di­ca­tion, and se­cu­ri­ti­za­tion for clients such as cor­po­rates, gov­ern­ments, and hedge funds. J.P. Mor­gan IB Risk works with in­vest­ment bank­ing to ex­e­cute trans­ac­tions and ad­vise in­vestors, although its Fi­nance & Op­er­a­tion risk groups fo­cus on mid­dle of­fice func­tions in­volv­ing in­ter­nal, non­rev­enue gen­er­at­ing, op­er­a­tional risk con­trols. How­ever, risk man­age­ment groups such as op­er­a­tional risk, in­ter­nal risk con­trol, le­gal risk, and the one at Mor­gan Stan­ley are re­strained to in­ter­nal busi­ness func­tions in­clud­ing firm bal­ance-sheet risk anal­y­sis and as­sign­ing trad­ing cap that are in­de­pen­dent of client needs, even though these groups may be re­spon­si­ble for deal ap­proval that di­rectly af­fects cap­i­tal mar­ket ac­tiv­i­ties. Risk man­age­ment is a broad area, and like re­search, its roles can be client-fac­ing or in­ter­nal.

Mid­dle of­fice

This area of the bank in­cludes trea­sury man­age­ment, in­ter­nal con­trols, and in­ter­nal cor­po­rate strat­egy.

Cor­po­rate trea­sury is re­spon­si­ble for an in­vest­ment bank’s fund­ing, cap­i­tal struc­ture man­age­ment, and liq­uid­ity risk mon­i­tor­ing.

In­ter­nal con­trol tracks and an­a­lyzes the cap­i­tal flows of the firm, the fi­nance di­vi­sion is the prin­ci­pal ad­viser to se­nior man­age­ment on es­sen­tial ar­eas such as con­trol­ling the firm’s global risk ex­po­sure and the prof­itabil­ity and struc­ture of the firm’s var­i­ous busi­nesses via ded­i­cated trad­ing desk prod­uct con­trol teams. In the United States and United King­dom, a comptroller (or fi­nan­cial con­troller) is a se­nior po­si­tion, of­ten re­port­ing to the chief fi­nan­cial of­fi­cer.

In­ter­nal cor­po­rate strat­egy tack­ling firm man­age­ment and profit strat­egy, un­like cor­po­rate strat­egy groups that ad­vise clients, is non-rev­enue re­gen­er­at­ing yet a key func­tional role within in­vest­ment banks.

This list is not a com­pre­hen­sive sum­mary of all mid­dle-of­fice func­tions within an in­vest­ment bank, as spe­cific desks within front and back of­fices may par­tic­i­pate in in­ter­nal func­tions.

Back of­fice Oper­a­tions

This in­volves data-check­ing trades that have been con­ducted, en­sur­ing that they are not wrong, and trans­act­ing the re­quired trans­fers. Many banks have out­sourced oper­a­tions. It is, how­ever, a crit­i­cal part of the bank.

Tech­nol­ogy

Ev­ery ma­jor in­vest­ment bank has con­sid­er­able amounts of in-house soft­ware, cre­ated by the tech­nol­ogy team, who are also re­spon­si­ble for tech­ni­cal sup­port. Tech­nol­ogy has changed con­sid­er­ably in the last few years as more sales and trad­ing desks are us­ing elec­tronic trad­ing. Some trades are ini­ti­ated by com­plex al­go­rithms for hedg­ing pur­poses.

Firms are re­spon­si­ble for com­pli­ance with lo­cal and for­eign gov­ern­ment reg­u­la­tions and in­ter­nal reg­u­la­tions.

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