Investment Banks and Derivatives Markets

Interest rate derivatives

• The interest rate derivatives market is dominated by euro and US dollar currencies.
• The market grew after the 2000-02 stock market crash due to traders wanting to hedge their positions against risks.
• FX derivatives are used to speculate on currency movements and hedge currency positions.
• Equity-linked, credit, and commodity contracts are used to hedge or speculate.

Insurance Markets

• Insurance markets provide personal, corporate, and life event risk management.
• The top five largest markets by premiums in 2021 are: US, China, Japan, UK, and France.
• Major players include China Life, Allianz, and AXA.
• Lloyd’s is a marketplace connecting insurers with risks.
• Traditionally, Lloyd’s members were individuals with unlimited liability, but now, corporate members with limited liability dominate.

Investment Banks

• Investment banks provide advice and finance for companies going public, raising more capital, and M&A.
• They also provide services for institutions like pension funds and asset managers.
• Investment banks provide services including:
  • Finance-raising and advisory work for governments and firms.
  • Securities trading for equities, bonds, and derivatives.
  • Treasury dealing for currencies and financial engineering.
  • Investment management for large investors.
• Most investment banks specialize in specific areas.

Custodians

• Custodians safely hold assets like shares and bonds for others, like fund managers.
• They provide:
  • Safekeeping of assets
  • Settlement of security purchases/sales
  • Asset servicing (collecting income and processing corporate actions)
  • Provision of company information and AGM details
  • Cash transaction management
  • FX transactions when required
  • Reporting on portfolio activities: trades, corporate actions, etc.
• Global custodians dominate; examples include Bank of New York Mellon and State Street.
• Custodian services also commonly include stock lending, portfolio performance measurement, and cash return maximization.

Retail/Commercial Banks

• Retail/commercial banks provide services to retail and business customers, such as deposits, lending, payments, and money transmission.
• Traditionally, they operate through physical branches, but are increasingly using online and phone-based services.
• Larger retail banks offer additional financial products like investments, pensions, and insurance, becoming "financial conglomerates."
• A financial conglomerate is a group of companies under common control that provide services in two or more financial sectors (banking, securities, insurance).
• Challenger banks are smaller banks focusing on niche areas underserved by large banks.
• They use modern technology and have no physical branches.
• Private banking is offered by domestic and offshore banks (operating in different jurisdictions, usually for favorable tax reasons).
• The number of private banks has grown, causing increased competition.
• There are many medium-sized and small players in the private banking market.
• The distinction between private and retail banks is blurring as private banks lower investment thresholds to compete, and retail banks expand services to attract wealthier customers.

Sovereign Wealth Funds (SWFs)

• SWFs are state-owned investment funds holding financial assets.
• Examples include The Norway Government Pension Fund, Abu Dhabi Investment Authority, SAMA Foreign Holdings of Saudi Arabia, and China Investment Corporation.
• SWFs invest in foreign financial assets to achieve financial objectives using specific investment strategies.
• Their assets are funded via balance of payments surpluses, foreign currency operations, privatization proceeds, fiscal surpluses, and commodity export revenues.
• They are major global investors with funds under management predicted to surpass $10 trillion.
• They often have undisclosed objectives but focus on above-average returns on overseas investments.
• Their size and diversification allow them to invest in the best opportunities, manage risks, and stabilize their local economies.
• They are private investment vehicles.

Independent vs. Restricted Advice

• Investment firms provide independent or restricted advice.
• Independent firms must provide unbiased recommendations based on a comprehensive analysis of all products available in the market.
• Restricted firms give advice only on their own products, and customers must be aware of this limitation.

Execution Only

• Execution-only firms carry out transactions based on specific customer requests without giving advice or suggesting products.
• Customers are responsible for assessing the suitability of the product.
• Firms must record and retain written evidence that they did not provide advice and clarified their lack of responsibility for product suitability.

Robo-Advice

• Robo-advice uses technology to provide financial advice without human advisors.
• Investors input financial data, and an algorithm determines suitable investment strategies.
• Strategies often focus on passive investments through index funds or ETFs.
• Robo-advice can fully automate or provide tools for investors to choose their own solutions.
• It uses asset-and-risk modeling, risk-targeted portfolios, and ongoing monitoring/rebalancing.
• Robo-advice is established in the US with major industry players.