The future of investment banking in the GCC
Investment banking in the UAE in particular and the GCC in general experienced an unprecedented jump in activity in the period 2003 through 2008.
After a couple of decades of basic boom-bust IPO activity, the explosion of business in the equity markets triggered a smaller but no less dramatic growth of investment banking that involved the deployment of investment banking teams in new standalone institutions, as well as branches of international banks and divisions in local commercial banks. The global financial crisis that was triggered in late 2008 ended the expansion era.
After six years in the doldrums, there are whispers about the rebirth of investment banking. The opportunities do indeed exist, but not where conventional wisdom is pointing.
The future of investment banking lies in selecting the right mix of services and business model. Services can be broadly categorised into four areas – equity capital markets (ECM), debt capital markets (DCM), mergers and acquisitions (M&A) and sales and trading (S&T).
ECM basically consists of raising equity funding – IPOs and rights issues. Supporting services include a strong distribution network, the ability to underwrite offerings, which requires a large balance sheet, and S&T services to support post-offering trading (in other words, making sure that people can trade the new shares).
DCM is similar to ECM except that it targets funds raised by debt. The supporting services are the same.
A successful M&A practice – companies buying and selling other companies – really requires deep relationships with local and regional clients with a full understanding of their business. S&T requires infrastructure and a large balance sheet to allow clients to trade on margin. These descriptions are already beginning to point to a certain conclusion.
There are three types of providers of investment banking services: pure investment banks, commercial banks and consulting firms, each of which can be further divided into international and local.
International investment banks actively worked to develop a presence in the 2003-08 period but it became clear that their cost structure required deal sizes (US$100 million-plus) and fees (circa 5 per cent) that represented a small part of the economy. Although these banks continue to be committed to the region it is not clear that they will play a large or active role in providing investment banking services to the broader economy.
Local investment banks suffer from three main issues – the lack of a strong balance sheet to support underwriting and margin facilities, lack of a deep client network for placing and sourcing deals, and finally their reputations have been tarnished in the aftermath of the 2008 global financial crisis. The ability of local investment banks to survive, let alone prosper, as stand-alone institutions is not clear.
Consulting firms, by the nature of their business and the regulatory framework, cannot and do not provide the full range of investment banking services. S&T is completely excluded. Furthermore, as consulting firms do not have balance sheets, underwriting is also excluded.
From a regulatory standpoint IPOs and rights offerings cannot be managed solely by a consulting firm. But where these firms excel is at the breadth of their client base, the depth of their relationships and their fee structure. The secret is that consulting firms are providing their IB services to their clients as an additional service to an existing core set of consulting services. In other words the incremental cost to acquire clients and to provide them with services is tiny relative to the cost at a standalone investment bank.
Furthermore, cross-selling a service to an existing client has a much higher success rate than offering the same service as a new adviser, which is what standalone investment banks would have to do. All of this allows consulting firms to provide a fixed fee that is much cheaper than the contingent fees offered by investment banks.
This points to the only logical conclusion as to the successful provider of investment banking services – the commercial banks, both local and international.
The commercial banks already have an extremely broad client base. Client-acquisition cost is zero. Commercial banks also have the deepest relationships with these clients; they have done due diligence on them for lending purposes. No institution can match the distribution channels of commercial banks and their branch networks. Commercial banks have by far the largest and, just as importantly, the lowest-cost balance sheets.
The future of investment banking services is clear. Commercial banks will dominate this business. With the challenges faced by local independent investment banks, a model copied from the global industry, commercial banks are already beginning to aggressively move in this strategic direction.
Sabah Al Binali was formerly a senior executive at Credit Suisse Saudi Arabia and Shuaa Capital, a board member at Credit Suisse Saudi Arabia and was vice-chairman of Shuaa Capital Saudi Arabia. He is an active investor and entrepreneurial leader, with a track record of financing, building and growing companies in the Mena region.
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