The Future of Investment Banking
Warren Buffet and Charlie Munger on investing in investment bank marketable securities:
Regulation has had the effect of making large banks less profitable than smaller banks due to capital requirements. You can change the math of banking and the attractiveness of banking totally by capital requirements. If a bank had to be totally equity, then it would be a terrible business to be in...[Capital requirements haven't] turned it into a terrible business, but it is a less attractive business. We didn't make investments in Wells Fargo due to investing banking. Investment banking--Charlie and I are little jaded because we ran one for sometime--are not something that we have invested in. I can't recall us making a purchase of a marketable security of an investment bank in a long time.
Here are some of the issues–perceived or otherwise–related to investment banking:
- Investment banks are heavily regulated and for good reason, but volumes could be written on what that does to capital returns.
- Investment bankers often get a bad rap due to fees and public sentiment, thanks in part to the media shark frenzy during the financial meltdown of 2008
- Investment banking fees are high thanks in part to some of the regulatory risks, but also due to information asymmetry
- Investment banks can suffer from lack of transparency and sometimes lack of trust
- Like many industries, investment banking is becoming less profitable
- In both the mid-market and bulge-bracket, the larger investment banks are completing a larger quantity and quality of the deals. The big get bigger, thanks at least in part to the Pareto Principle
- Scale is difficult without an increase in human advisory capital
- Scope does not have a silver bullet. Deals and industries require industry-specific expertise based on the vertical. This is becoming especially critical as companies and markets become more complex
- Investment banks in the middle and lower middle-market often deal with securities that are much less liquid than their counterparts at bulge-bracket firms
Where will investment banking be in five or ten years?
Investment banking and capital advisory in the coming decades is likely to look much different than it does today. Fintech and Regtech will help disrupt and ameliorate at least some of the issues noted above. For instance:
- Financial technology is likely to streamline many manual processes related to compliance, regulation and due diligence through automation and big data tools
- Fees are likely to slowly decrease over time as the need for intermediaries subsides
- Scale, scope and information asymmetry is likely to be greatly bridged through the use of online platforms and the right matching algorithms
- Liquidity issues in private security debt and equity are likely to see at least some respite thanks to tokenization through blockchain tech
The two areas that are less-dependent on technology include public sentiment toward investment banks and the 80/20 rule: the bigger banks are likely to scale and do more deals, leaving a big gap at the other end of the market.
Bernard Lunn of DailyFintech hit the nail on the head.
The leading mid-market discovery sites are likely to gradually add…functionality such as deal rooms, CRM, workflow and NDA processing/recording. These tools will appeal to niche intermediaries who don’t want to create tech platforms in-house and need to be super efficient on the admin side.
The trickiest issue is how marketplaces can earn their success fees if the transaction does not conclude on their platform...This is a networks effects game. One big winner could emerge. The network effects winner will have to create value for all the niche intermediaries who operate at the ShortListing and Due Diligence stage. It is unlikely that these deals will happen without any intermediation (there is too much at stake). When something truly disruptive appears...it does so by empowering a new type of intermediary (and those intermediaries are essential to the network effects)...I see many niche intermediary firms in this space but no disruptive plays and I expect these niche intermediary firms will gravitate towards the discovery network effects winner and let that discovery marketplace handle the commodity admin processing. It is possible that a big network effects winner will emerge and that winner will a) be a Unicorn and b) change the M&A game and c) enable lots of niche intermediaries to thrive...
Web-based investment platforms are often focused on niches (e.g. oil & gas, software & tech, real estate, etc.). However, as investors get more savvy and scale is achieved, there are likely to be an expansion in the features and breadth of deal types. Disintermediation in investment banking is coming, from compliance to processes. Achieving scale is both the cart and the horse that will drive features and deals to the most relevant private market systems. The disruptive shift is already here, but the widespread market adoption will make things look much different over the coming decade.
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