Here, there and everywhere

May 17th 2007
From The Economist print edition

Investment banks are scouring the globe for new business


MAKE the mistake of describing Goldman Sachs as “sort of a global bank” to Lloyd Blankfein, its boss, and you get a thundering response: “Sort of! What do you mean, sort of?”

Empire-building is as important to investment banks today as it was to their forebears more than a century ago, when Citibank had offices from Mexico City to Manila and Deutsche Bank financed railways from the Wild West to Baghdad. As in that earlier era, capital now moves effortlessly across time-zones, political systems and asset classes. Within the past decade Europe's single currency has taken root and China and India have grown flush with capital, as have oil exporters such as Russia and the Gulf states. Japan, too, has begun to emerge from a decade of stagnation. America, meanwhile, has wrapped up its own financial markets in red tape and may be losing its hegemony.

Huw van Steenis at Morgan Stanley in London estimates that securities markets outside America are expanding three times faster than those within, which they overtook in size in the first half of 2006. The pace of debt and share issuance in Europe since 2002 has easily outstripped that in America. Since 2005 volumes of mergers and acquisitions outside America have been larger than inside. And revenues of the biggest Wall Street banks' subsidiaries generated from trading in Europe have doubled since 2000 (see chart 8).

Yet there is room for further growth. McKinsey calculates that in 1995 the outstanding stock of debt and equity securities in the future euro-zone countries was 1.3 times the size of their collective GDP. By 2004 it had grown to 2.4 times. But it still fell short of America's, where the capital markets were more than triple the size of the economy. Investment banks' sales and trading revenues in Europe still represent only 50-60% of those in America.

Gregory Fleming, the ebullient head of markets and investment banking at Merrill Lynch in New York, predicts that in perhaps only seven years' time up to 75% of his firm's global markets and investment-banking revenues may come from outside America, compared with 50% now. “This is not because of a lack of growth in this country. It is more because of growth of economies around the world,” he says. “For the first time there is a broad-based global financial system.”

Next stop the N11
Having already occupied Europe, the top ten investment banks have set their sights on the rest of the world, too. Almost all of them are now increasingly involved in the so-called BRIC economies, Brazil, Russia, India and China. Next in line may be some of those Goldman has dubbed the N11 (for next 11); in alphabetical order, Bangladesh, Egypt, Indonesia, Iran, South Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam.

Banks have travelled these trade routes before in moments of global bullishness, probably once a decade, only to retreat hastily after some emerging-market crisis. But this time they believe it will be different. They are not just seeking to sell cheap emerging-markets assets to investors from the rich world. The developing world, with big, commodity-rich companies and surplus savings looking for safe returns, is itself shopping in the West for everything from Treasury bonds to wax museums and steel plants.

The abundance of petrodollars and hard-currency reserves is one reason why the world is awash with liquidity and long-term interest rates are low. But many emerging markets have lower domestic borrowing costs too, thanks to investment-grade debt ratings and nascent domestic capital markets. Mr Klein of Citigroup notes that it now costs the same to borrow overnight from a bank in China as from one in Germany. “The last remaining wall separating emerging markets from developed markets, the cost of capital, has been almost eliminated in the past four years,” he says.

As a result, large developing-country companies with global ambitions, such as China's CNOOC, Russia's Gazprom or India's Tata Steel, can get access to international finance as readily as their counterparts from the rich world. That means investment banks have to deploy more staff on the ground to find out what these firms are up to. “These are large, highly complex companies with increasingly complicated needs. To really understand a company like Gazprom requires more than just an occasional visit from head office,” explains Jonathan Chenevix-Trench, chairman of Morgan Stanley International.

Putting down roots
But what is the best way to tackle global expansion? Citigroup, for example, has offices in 106 countries and can afford to deploy lots of staff. For the first time this year it has put large emerging-market companies under the leadership of a single global corporate bank. It is also betting heavily on stronger domestic markets in countries such as Russia and China. Its philosophy, says Mr Klein, is “when you enter a country, you don't leave.”

The philosophy of pure investment banks, such as Morgan Stanley, is changing too. “Banks used to take a cyclical approach to emerging markets, investing when assets were cheap. When there was trouble, they would sell,” says Mr Chenevix-Trench. “Now it's not a matter of trading assets in these countries, it's a matter of building businesses.”

To underline these new priorities, the lifts in Morgan Stanley's headquarters in London's Canary Wharf display posters about the firm's growing involvement in the Middle East. The firm has moved 40 bankers to Dubai, and has recently signed a joint venture with the Capital Group in Saudi Arabia, where it acts mainly as an intermediary for the region's vast wealth. In Russia, where it has a bigger presence, dating back to before the dark days of 1998, it is targeting not just initial public offerings and acquisitions but also a growing domestic market. Last year securities trading in Russia rose by over 60%, it estimates.

Maria JeevesMorgan Stanley is also one of many banks excited by talk of a resource-rich “great crescent” stretching from Russia through Central Asia to North Africa. The optimists—of whom there are many in investment banking—believe this region could eventually provide the equivalent of another Germany to capital-markets revenues. McKinsey expects the share of petrodollar-related revenues in the industry to grow between 9% and 15% in a decade. The potential pitfalls, however, are huge, especially in Russia, where the rulebooks are new and untested and talent is so hard to come by that the best people shuttle between global and local banks.

Caution is indeed warranted. Credit Suisse lost $1.3 billion after Russia defaulted on its domestic debt in 1998, and Merrill Lynch sacked staff just after the default (only to re-hire them months later when the markets proved more resilient than it had expected). Earlier this year Merrill secured a broking licence in Moscow, but has moved cautiously.

Many investment banks expanding in emerging markets have trouble finding local people whom they can trust to maintain the firm's risk-management culture. This has become all the more important because investment banks are increasingly devolving risk-taking responsibility to regional hubs and even local offices. Risk management is following.

“As recently as five years ago, Merrill Lynch had a New York-centric operating model with a lot of global products managed from here,” says Mr Fleming. This is changing. Banks now tend to believe that the closer they are to their markets, the better they are able to assess the risks.

Lehman Brothers is also actively considering decentralisation, says Jeremy Isaacs, its chief executive in London. Until now the people running its main global divisions have been based in New York. But in early May the firm announced that the new head of its global fixed-income business would be working from London.

The region that probably has a greater variety of local peculiarities than anywhere else—and where investment-banking revenues have grown fastest recently—is Asia.