INVESTMENT BANK

OBJECTIVES

1. Describe the roles of investment bank in Malaysia

2. Describe the services of investment banksa) Corporate financial and advisory servicesb) Portfolio and investment servicesc) Corporate bankingd) Fund-based activitiese) Share trading

• Investment bank is introduced by BNM on March 2005- to strengthen Malaysian Financial Sector.

• All discount houses were absorbed by the merchant banks by the end of 2006.

• The new framework required the merchant banks, stock-broking companies and universal brokers to be transformed into investment banks latest by first quarter of 2007.

• Investment banks is licensed to perform investment banking functions by Securities Commission and BNM.

INTRODUCTION

• The establishment of investment banks, in line with the recommendation of the Financial Sector Master plan, aims to strengthen the capacity and capabilities of domestic banking groups through internal rationalisation so that they can contribute to the economic transformation process and better face the challenges of liberalisation and globalisation.

• Following the successful rationalisation of the commercial banks and finance companies within the banking groups, the model is now extended to the merchant banks, discount houses and stockbroking companies within the banking groups to achieve greater efficiency and effectiveness.

• With enhanced capacity, the new investment banks would also play a greater role in developing a more dynamic and efficient domestic capital market.

• The framework for the investment bank has been developed by Bank Negara Malaysia (BNM) and the Securities Commission (SC) based on the following principles:-Enhancing the scope of activities for the merged entity;Enhancing capacity for growth and business expansion through

industrywide rationalisation; andMinimising unnecessary regulatory burden that may arise from the

dual regulatory regime.

• The Guidelines on Investment Banks (the Guidelines) are therefore issued jointly by BNM and the SC pursuant to Section 126 of the Banking and Financial Institutions Act 1989 (BAFIA) and Section 158 of the Securities Commission Act 1993 (SCA).

• It sets out the requirements and processes for the setting up of the investment bank and the regulatory framework within which the investment bank would operate.

THE STATUTORY RESERVE REQUIREMENT

• The SRR is a monetary policy instrument available to the Bank to manage liquidity and hence credit creation in the banking system. The SRR is used to withdraw or inject liquidity when the excess or lack of liquidity in the banking system is perceived by the Bank to be large and long-term in nature.

• This requirement also apply to merchant/investment banks licensed under the Banking and Financial Institutions Act 1989.

• Effective 16 July 2011, the SRR rate for banking institutions is 4% of EL.

• Any banking institution which fails to comply with the minimum SRR requirement shall be liable to pay a penalty.

DEFINITION

• It is a financial institution that related to the creation of capital for other companies.

• Investment banks underwrite new debt and equity securities for all types of corporations and also provide guidance to issuers regarding the issue and placement of stock, also aid in the sale of securities in some instances. Investment banks also aid in the sale of securities in some instances.

• They also help to facilitate mergers and acquisitions, reorganizations and broker trades for both institutions and private investors.

• They can also trade securities for their own accounts.

1. Raising Capital & Security Underwriting

• Banks are middlemen between a company that wants to issue new securities and the buying public.

2. Mergers & Acquisitions

• Banks advise buyers and sellers on business valuation, negotiation, pricing and structuring of transactions, as well as procedure and implementation.

3. Sales & Trading and Equity Research

• Banks match up buyers and sellers as well as buy and sell securities out of their own account to facilitate the trading of securities

FUNCTION

4. Providing brokerage services for trading of stocks, bonds, derivatives, commodity and equity securities

5. Managing investments6. Acting as intermediary between an issuer of securities and the

investing public7. Facilitating private equity, corporate restructuring, placements, merger

and acquisitions and others

Financial products offer by Investment Banking are basically similar to Commercial Banking and Corporate Banking, however Investment and Corporate Banking normally providing financial facilities differ with commercial Banking in the following aspect; The amount is larger/ bigger Facilities offered in the form of revolving or blanket, e.g

Istisna Revolving Project Financing and Murabahah Revolving Working Capital Financing etc.

PRODUCTS

Various facilities offered in one limit but under multi- changeable

Providing a financial package according to total requirement of a customer/ company

Offer high amount of financial facilities through Syndication or Club Deal

Offering hybrid products such as sukuk, Islamic Private Debt Security or Islamic Bond.

PRODUCTS

SCOPE OF INVESTMENT BANKS

PUBLIC OFFERINGS OF DEBT AND EQUITY SECURITIES

There are four general types of public offerings:

a) Initial public offerings (IPOs) of securities issued by companies that have never before issued any public securities (normally common stock is the first security to be issued in an IPO);

b) Initial public offerings of new securities that companies that are already public have not before issued (e.g., a new class of convertible debt security);

c) Further public offerings of securities that are already publicly traded (e.g., the issuance of additional common stock when its price is sufficiently high so that cost of capital is sufficiently low);

d) Public offerings by company shareholders of securities that are already publicly traded (e.g., when an original large shareholder, say a private equity fund, wants to cash out its position).

• Private placement is the selling of securities to investors without the regulatory requirements of public offerings.

• The regulations defining private placements are complex and the securities and investment vehicles offered are numerous.

• Ranging from corporate equities to real estate interests, privately placed securities carry a higher return than similarly structured securities that can trade in the public markets.

• The loss of liquidity enhances risk and therefore requires a proportionally higher return.

PRIVATE PLACEMENTS OF DEBT AND EQUITY SECURITIES

MERGERS AND ACQUISITIONS (M&A)

• This is the front-page stuff – the huge acquisitions, takeover battles, hostile attacks and fierce defences. But it’s not all war. The vast majority of M&As are friendly.

• Investment bankers seek to optimize price and terms, so that the “best price” may not be the highest price for client sellers (all cash or confidence in closing may be more important) nor the lowest price for client buyers (certainty of getting the deal done may be more vital).

• Investment banks find, facilitate, price, and finance mergers and acquisitions. Also included in M&A are leverage buyouts by private equity, the restructuring and recapitalization of companies, and the reorganization of troubled companies

• Financial advisory services have grown dramatically as investment banks work with the large number of private funds – hedge funds and private equity.

• Services include:

i. raising of capital for general funds,

ii. M&A acquisitions,

iii. financing acquisitions,

iv. IPOs of portfolio companies owned by the funds (when appropriate) and

v. M&A of these companies (when IPOs are not appropriate).

• Investment banks like to involve themselves with hedge funds and private equity since they are transaction oriented, generate huge fees and are in perpetual deal mode .

FINANCIAL ADVISORY / SPONSOR GROUP FINANCE

• Fairness opinions support M&A, leveraged buyouts and restructurings for public companies.

• Providing an independent, defensible, expert statement on values and the “fairness” of those values is an essential part of any such public transaction.

• Investment banks command what may seem to be exorbitantly high fees for giving fairness opinions, considering the number of hours worked (and the amount of paper produced). The reason is the significant liability the investment bank assumes, which can be realized both in the courts via shareholder suits and in industry reputation. In fact, major investment banks do not like to provide fairness opinions – the risks are too high for the fees – but generally do so only to serve important clients.

FAIRNESS OPINIONS

• The creation of synthetic financing mechanisms and structures makes possible allocations of capital with better risk-return features for both issuers and investors. This is generally achieved by instruments that:

(i) pool assets,

(ii) allocate liabilities into different “trenches” (with different risk-return profiles), and

(iii) are contained within an independent legal entity.

• Securitization is the process by which formerly illiquid assets, mostly small consumer receivables of all kinds (e.g., home mortgages, automotive loans, credit card receivables), can be liquefied by their being “rolled up” into large, publicly tradable securities with improved risk-return for both issuers and investors. (Such innovations exemplify investment banking’s contribution to financial markets.)

STRUCTURED FINANCE / SECURITIZATION

• Securitized obligations are sophisticated in design and often require statistical analysis and sensitivity testing of key criteria (e.g., default rates, prepayment profiles, interest rate sensitivity, tax changes, etc.). For example, a change from forecasted rates of prepayment (e.g., due to interest rate declines and the resulting refinancing of older, higher-rate mortgages) can result in shocking differences in returns from initial expectations. (Principal itself can suffer significantly.)

• Other kinds of structure finance include project finance, which is used to fund large-scale enterprises such as power plants and infrastructure.

RISK MANAGEMENT

• Hedging positions in interest rates, foreign currency exchanges and commodity positions through swaps, options and futures are an essential building block of financial markets.

• Swaps are the mechanism by which two or more parties exchange their debt obligations in order to control more precisely each party’s desired risk/return profile. Swaps work because different entities have different comparative advantages when pricing different categories of debt in different financial markets.

• Parties of dissimilar credit ratings or financing needs can exchange their obligations (e.g., from shorter term to longer term and vice versa) in order to optimize their financial strategy and structure. Risk management groups combine expertise in diverse hedging instruments to develop a complete hedging strategy for enterprises.

MERCHANT BANKING

• Merchant banking is the commitment of an investment bank’s own capital to equity-level investments and participations, seeking very high returns. Such commitment of capital is made for two general purposes: 1) to facilitate a client transaction (i.e., a bridge loan until permanent financing is obtained); or 2) to purchase securities in an operating company for the firm’s own account (i.e., whether 100% ownership by the investment bank, in partnership with a client, or as the manager of an LBO[BP1] fund). Bridge loans are highly profitable, combining commitment fees, placement fees, high interest rates,and equity kickers.

PUBLIC TRADING OF DEBT AND EQUITY SECURITIES

• Most large investment banks maintain strong trading capabilities, which is a significant though volatile profit center – profits are made both from commissions generated by trading for clients and from capital appreciation generated by trading for the firm’s own account. Investment banks act as brokers, dealers, and/or market makers (which can differ for different securities). In addition to traditional stocks and bonds, money market instruments and commodities (e.g., gold, silver, coffee, crude oil, various metals, various foods), investment banks create “synthetic securities” (e.g., striped Treasuries, interest only and principal only instruments), which by appealing to different investors, enhance the risk-return for all.

INVESTMENT RESEARCH AND SECURITY ANALYSIS

• The research capabilities of an investment bank’s security analysts were often the firm’s most prestigious and visible strength. (More recently, M&A, IPOs, LBOs, and private equity / hedge funds have usurped the limelight.)

• Many investment banks used the reputation derived from their investment analysis expertise to develop underwriting and money management businesses. Typical subdivisions are Global Equities and Fixed-Income. Today, after various scandals and prosecutions, investment banks must enforce strict compartmentalization between their corporate finance and investment research departments

WEALTH MANAGEMENT

• The accumulation of vast wealth by institutional investors (i.e., pension and insurance funds), and by rich and super-rich individuals, has made money management a vital business. (For individuals, the departments are called “private banking” or “private client.”).

• Investment banks compete with one another, and with large commercial banks and specialized money management firms in accumulating assets under management. Hundreds of billions of dollars are at stake.

INTERNATIONAL INVESTMENT BANKING

• The accumulation of vast wealth by institutional investors (i.e., pension and insurance funds), and by rich and super-rich individuals, has made money management a vital business. (For individuals, the departments are called “private banking” or “private client.”).

• Investment banks compete with one another, and with large commercial banks and specialized money management firms in accumulating assets under management. Hundreds of billions of dollars are at stake.

WEALTH MANAGEMENT

• The accumulation of vast wealth by institutional investors (i.e., pension and insurance funds), and by rich and super-rich individuals, has made money management a vital business. (For individuals, the departments are called “private banking” or “private client.”).

• Investment banks compete with one another, and with large commercial banks and specialized money management firms in accumulating assets under management. Hundreds of billions of dollars are at stake.

ALTERNATIVE INVESTMENTS

• The investments in financial products other than exchange-traded stocks and bonds have become a huge business, such as private equity, real estate, arbitrage, international, and the like. The development of funds under management, including private equity and hedge funds, has increased dramatically, and investment banks both develop their proprietary products and sell others.

INTERNATIONAL INVESTMENT BANKING

• “Globalization” is the byword of investment banking. Financing has become a multi-market search for the lowest cost of capital for issuers, and a 24-hour-a-day quest for the highest return for investors. Growth is highest in emerging markets, the opportunities for investment, underwriting and M&A are extensive, and all major investment banks have significant presence in many countries.

• Both issuers and investors seek the optimum level of risk for a given level of return. Such optimizations cover the uncertainties and volatilities of interest rates, currency exchange rates, credit availability (for users of capital), credit instability (for providers of capital) and equity investments. Optimum risk for a given return, or conversely optimum return for a given level of risk, is achieved by using techniques of finance theory such as hedging and diversification. The international expansion of one’s investment horizons allows more efficient optimization procedures for both issuers and investors – i.e., investment portfolios can be diversified more widely, thereby expanding their risk/return frontier and achieving higher efficiency.