Chapter 4 The Financial Services Industry: Securities Firms and Investment Banks
Overview • In this segment ... Securities Firms and Investment Banks: • Activities of securities firms and investment banks • Size, structure and composition • Balance sheets and recent trends • Regulation of securities firms and investment banks • Global issues
Securities Firms and Investment Banks • Nature of business: • Underwrite securities. • Market making. • Advising (example: M&A, restructurings). • Growth in mergers and acquisitions: • Less than $200 billion in 1990. • $1.83 trillion in 2000 • Decline in 2001
Size, Structure and Composition • Dramatic increase in number of firms from 1980 to 1987. Decline of 24% following the 1987 crash, to 2000. • 1987: Salomon Brothers held $3.21 billion in capital. • 2000: Merrill Lynch held capital of $19.3 billion. • Many recent inter-industry mergers (i.e., insurance companies and investment banks). • Role of Financial Services Modernization Act, 1999
Types and Relative Sizes of Firms • National full-line firms are largest. • National full-line firms specializing in corporate finance are second in size. • Remainder of industry: • Specialized investment subsidiaries of BHCs. • Discount brokers. • Regional securities firms (subdivided into large, medium and small). • Specialized electronic trading securities firms
Key Activities • Investing • Investment banking • Activities related to underwriting and distributing new issues of debt and equity. • Market making • Trading • Position trading, pure arbitrage, risk arbitrage, program trading
Key Activities (continued) • Cash management • Assisting with mergers and acquisitions • Back-office and service functions.
Trends • Decline in trading volume and brokerage commissions • particularly since crash of 1987, although some recovery since 1992. Record volumes 1995-2000. • Decline in underwriting activities over 1987-90. • Resurgence in activity and profitability 1991-2000.
Trends (continued) • Increases in holdings of fixed-income trading • greater interest rate and sovereign risk exposure • Pretax profits soared to $21.0 billion in 2000 • curtailed by economic slowdown and September 11 attacks • 1987: Federal Reserve allowed BHCs to expand securities underwriting. • Prohibited since 1933 under Glass-Steagall Act.
Balance Sheet • Key assets: • Long positions in securities and commodities. • Reverse repurchase agreements. • Key liabilities: • Repurchase agreements major source of funds. • Securities and commodities sold short. • Broker call loans from banks • Capital levels much lower than levels in banks
Regulation • Primary regulator: SEC • Reiterated by National Securities Markets Improvement Act (NSMIA) of 1996. • Prior to NSMIA, regulated by SEC and states. • Regulate trading activities such as shelf registration • Day-to-day trading practices regulated by the NYSE and NASD.
Investor Protection & Other Monitoring • Securities Investors Protection Corporation (SIPC). • Protection level of $500,000 • Federal Reserve also has role in overseeing securities firms and investment banks • Vulnerability of the financial system • Issue of timely settlement
Web Resources • For details of regulation of securities firms and investment banks, visit: SEC: www.sec.gov NYSE: www.nyse.com NASD: www.nasd.com SIPC: www.sipc.org Web Surf
Global Issues • Growth in securities trading and underwriting is a global event • Other countries were not encumbered by regulations such as Glass-Steagall Act • Foreign banks operating in the U.S. compete with U.S. commercial and investment banks
Pertinent Websites Federal Reserve: www.federalreserve.gov NASD: www.nasd.com NYSE: www.nyse.com SEC: www.sec.gov Securities Industry Association: www.sia.com SIPC: www.sipc.org The Banker: www.thebanker.com Thompson Fin. Securities Data: www.tfsd.com Web Surf