An investment bank is a type of financial institution that primarily works in ‘higher finance’, helping large organisations access capital markets to raise large sums of capital. Here, we will look at how an industry that is integral to the UK economy generates income, some of the risks involved and the various areas of graduate work.
What do investment banks do?
- A typical investment bank will engage in at least one (and often all) of the following activities:
- Raising equity capital through new share issues and placements.
- Raising debt capital, by issuing government and/or corporate bonds.
- Structuring new financial instruments and products, such as credit default swaps.
- Providing expert corporate finance advice on the amount and type of finance to raise, syndication and underwriting, and the optimal timing, terms and method of distribution, to ensure maximum take-up of a new issue to suit the needs of both the issuer and investors. Syndication involves the collaboration of several investment banks so that the risks associated with a very large new issue are shared and underwritten between them.
Two main areas of interest in investment banking for graduates are typically Mergers & Acquisitions (M&A) and Proprietary Trading.
Mergers & Acquisitions
M&A refers to the consolidation of multiple companies. A merger is a combination of two companies to form a new one. An acquisition is when one company buys another, but no new company is created.
This refers to when a bank trades on its own account to generate in-house profit. This may involve taking analytical positions within limits which are carefully calculated and controlled in order to prevent exposing the bank to dangerous levels of risk. The growth of this activity in recent years has required considerable focus on advanced risk management measures, as the potential losses can be significant and impactful.
Governments, supranational agencies and corporates all need access to substantial amounts of capital to finance social, scientific, technological and environmental projects in infrastructure, welfare and aid, energy, commodities, communication, medical and service sector expansion and development. Securities are marketed widely and, if necessary, across several markets in different countries to raise large amounts of capital while minimising the risks and costs to both issuers and investors.
Investment bank structure
‘Buy side’ and ‘sell side’
Investment banks are often divided into the ‘buy side’ and the ‘sell side’. The ‘buy side’ works with institutional investors needing to invest capital – such as pension funds, insurance companies, mutual funds and corporates – to maximise their returns when trading or investing in financial securities. The ‘sell side’ typically refers to selling new share issues, placing new bond issues, engaging in market making services, or helping clients facilitate transactions. Market making consists of holding shares in order to enable trading – being in a position to both bid for and sell shares.
Many investment banks’ activities are also organised into three categories – front office, middle office, and back office services. Front office investment bank services typically involve direct engagement with clients and market participants. Activities include M&A, corporate finance, investment management and strategy formulation for institutional and high net worth investors, and the business/financial/economic analysis of companies, industry sectors, markets and countries/regions.
Middle Office investment bank services include specialist activities like treasury, compliance with industry regulations and client mandates, and risk management. Capital flow monitoring ensures that that the firm doesn’t get into financial difficulty; this essential cash management process feeds back into front office activities by defining the scope and level of permitted trading and investment risk.
There are multiple complex, time-critical operational activities that enable investment banks to operate efficiently. Investment in state of the art technology and a highly skilled, IT-literate operational workforce is essential within a business that can potentially involve high-volume, high value trading in thousands of financial instruments on hundreds of markets every day. Crucially, the significance of IT extends beyond the systems, platforms and processes required for efficient trading, investment management and record keeping. Newer areas include big data analysis and the creation of highly advanced trading algorithms, complex financial instruments and investment strategies.
The future for graduates
Investment banks tend to be major multinationals such as Bank of America Merrill Lynch, Barclays, BNP Paribas, Deutsche Bank, Goldman Sachs and UBS. Responsible for raising and transacting huge sums of money around the world, investment banking can generate substantial risk-related upsides and downsides, and has therefore been perceived as both the most attractive and the most destructive sector within the financial services industry.
Investment banking performs an important political and economic function which is constantly under scrutiny. Those who tend to succeed in investment banking are risk-aware, cool under pressure, resourceful, innovative and level headed. London is Europe’s largest international banking centre, and it vies for global primacy with New York; its reputation attracts talent from all over the world.
Participants play a key role in the business world and the financial rewards for those who are successful can be considerable, as it is one of the best paid areas in finance. However, the competition and pressures of work combined with long and often unsocial hours can be strenuous. Job satisfaction and security can be affected by the state of the market with cycles of boom and bust, and by the increasing need to engage with sophisticated technology. It is essential that those who work in this sector remain aware of economic trends, market conditions and risk management.
The future direction and expansion of the investment banking industry will bring with it a wealth of exciting opportunities and possibilities for the right graduate.
Sian Lloyd MBA FCSI is a Senior Adviser for the Chartered Institute for Securities and Investment (CISI) with over 25 years of experience in the investment management industry.