LBO Typical Structure & Sales/Trading PDF

Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions LBO typical structure: Buyout: A buyout refers to the investment method where an entity, typically a private equity (PE)...

Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions LBO typical structure: Buyout: A buyout refers to the investment method where an entity, typically a private equity (PE) firm, purchases a company, or a significant part of it. The purpose of such an acquisition is often to take control of the target company, optimize its operations, and later sell it for a profit. Buyouts are a significant activity within the PE sector, making up the majority of the capital invested by these funds on a global scale. Through buyouts, funds obtain a controlling interest in companies. Once in control, the acquiring party often seeks to enhance the performance of the target company. This can be achieved by revising its financial structure, improving its governance policies, and refining its operational processes. The three main levers in a buyout strategy are: 1. Equity Control: Owning a significant part of the company to influence its decisions and directions. 2. Leverage: Using borrowed capital (debt) to finance the buyout, which can enhance returns but also comes with increased risk. 3. Economic Alignment: Ensuring that the interests of the management and the PE firm are aligned, often through performance-based incentives. Even though PE firms gain control through buyouts, they still need to maintain a proactive relationship with various stakeholders. This includes the company's management team, its employees, debt providers, and sometimes even its customers and suppliers. The most relevant part of most Private Equity transactions is not the “Equity” but the “leverage” (i.e., the credit loans or securities that finance 50-75% of the total investment). Without a sound understanding of the credit market, we could understand the PE business. Credit market for buyouts: - Most buyouts are structured as LBOs, with the majority of the target company’s capital structure post-buyout consisting of 50-75% debt. - The debt capacity of a target is a function of several factors, including the stability of cash flows across an industry, the target’s ability to generate cash flow from operations (i.e., its cash conversion rate), market conditions and the buyout investor’s reputation. - As PE firms have to raise finance through debt for each deal, their teams work hard on designing the securities that are convenient for the issuer (the target firm) and attractive for investors (banks, alternative lenders, hedge funds, HYB investors…). Example of a buyout Buyout valuation and value drivers: This example explains the mechanics of a “standard” LBO and illustrates value creation at both the company and equity level. It shows how returns can be broken down and attributed to the various basic value drivers in a buyout. 21  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions TOPIC 5: SALES AND TRADING I This topic relates to one of the IB services: Securities Markets. It includes (1) Brokerage and trading, and (2) Equity, FICC, Derivatives, Structuring and Securitization. The securities division: (1) Facilitates access to global financial markets (investing and raising capital). (2) Provides liquidity to investors (through execution and risk taking). (3) Help clients to manage and transfer risks. (4) Invest the bank’s capital. The trading floor: what does it look like? Each sales box represents rows of desks all facing toward the trading desks, which are in the centre row with the readers sitting back-to-back, facing the sales desk. Fixed Income trading floor: Equities trading floor: Trading does not always involve face-to-face or verbal communication, as is the case in open outcry trading (where traders physically gather in a trading pit or on a trading floor to make transactions by shouting out buy and sell orders). Modern trading methods often involve electronic or computer-based systems, where transactions are executed electronically without the need for traders to physically gather and shout orders. Electronic trading platforms have become increasingly common in financial markets, offering greater efficiency and speed in executing trades compared to the traditional open outcry method. The main activities or trading platforms are: 1. Brokerage (just execution or broking services). 2. Trading (principal trades i.e., taking risk) or liquidity proving (market making). Trading Market participants Investing Liquidity providing (e.g., principal Broking (e.g., broker trades) floors trades) types Clients (the end user) Yes No No Smaller or specialist financial entity No Sometimes Sometimes Central market platform No No Yes Major bank No Yes Sometimes Trading: buying and selling securities Type of institution Focus Time Horizon Type of trading Investment banks – trading Market-making, profit form a bid-ask spread Short Brokerage desk Take proprietary positions and profit from them Short Proprietary Asset Management Buy securities for clients according to their preferences for Long Brokerage portfolio allocation. Provide a low price. Hedge Funds Explore vulnerabilities in market pricing and profit from them. Short Proprietary Trading floor’s clients: Many trading floors are purposefully designed to meet the needs of institutional investors. These institutional investors are primarily financial companies involved in various financial products. However, it's important to note that trading floor clients extend beyond traditional investors. In addition to these investors, trading floors also serve corporates seeking to manage their operational and financial risks effectively. Furthermore, government entities often play a role in influencing market prices and are considered clients in the trading ecosystem. The barrier to enter the Trading market, is the access to institutional investors. 22  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions Market-making and liquidity providing: Providing liquidity: When a bank provides liquidity to its clients, it is generally taking the risk that the price of the financial product moves before it is able to: 1. Close out a position: To close out a position in a stock or bond means that if the bank has bought a stock or bond from a client, it needs to sell that same stock or bond on to another market participant. 2. Hedge a position: To hedge a derivative means that if the bank has bought an option from a client it needs to sell a similar option to another market participant. Bid-ask spread: The prices will include a margin to profit from the trade or to cover potential losses. Market making: At the core of a bank's trading floor operations lies the critical function of market making. This function revolves around the bank's primary mission—providing liquidity to their clients, which essentially means creating markets for client trades. The process of market making involves the collaborative efforts of Salespersons and Traders, who collectively act as a unified entity known as the "market maker." Making a market by asset classes: 1. Equity: Works with bid-ask prices. $ 9.90 at $ 10.00 – the trader will buy shares at a price of $ 9.90/ share and – sell shares at a price of $ 10.00/ share 2. Bond: 101.1% at 101.2% – the trader will buy a bond with a price of 101.1% of the principal and – sell at 101.2% of the principal 3. Currency: Works with bid-ask rates for currency pairs. 76.13 at 76.14 – the trader will buy $ 1 at 76.13 yen and – sell $ 1 at 76.14 yen. Market maker (trader) and market taker relationship (client). Sales People vs. Traders - Has the client relationship. - Rarely speaks to clients. - Talks to the client about financial market activity: - Provides prices on financial products when clients want to Investing in financial products. trade (this is providing liquidity and taking risk). Financial risk management. - Manages the risk from doing trades with the bank’s clients. - Is busy entertaining clients and maintaining the relationship - Despises Sales people. with a bit of wining and dining. - Fears traders. The complexity of working on the trading floor is about understanding the different theoretical models that different investors use as well as having a grasp of market supply and demand. The trader needs to interpret all this information and be able to put a price on a trade for a client. At what price are securities traded? Fair price. Supply and demand ultimately determine the price at which something trades. Theoretical analysis is generally based on historical relationships and historical data plus market participants’ expectations and assumptions, what in the end is subjective. What financial markets people say is that the fair price is the market price (where the product last traded or where most market makers are prepared to make a market). As a result, a trader on the trading floor is keen to see as many client trades as he can to get a sense of the supply and demand for a financial product which helps him to make markets for his clients. Traders (market makers) vs. Proprietary Traders The trader must be prepared to buy or sell whenever a client needs Prop traders invest their banks’ own capital for direct market gain to buy or sell. In other words, he must be prepared to put a price on (and not fee or margin commission on behalf on clients). The a trade even if he doesn’t want to. Hence, he makes markets. proprietary trader gets to decide when and if he wants to trade. He is a market taker. Risk management: Banks assess potential risks in transactions, trades or positions to ensure they aren’t jeopardizing their assets or that of their clients. This encompasses both market risk (the risk of financial loss due to market fluctuations) and credit risk (the risk that a borrower will not repay a loan). - Front office (revenue generating): Risk Analysis for Debt Structuring and More: Involves evaluating the potential risks associated with structuring debt in certain ways, as well as with reorganizing, syndicating loans, and turning assets into tradable securities (securitization). Credit Risk Solutions: Offers strategies to minimize the risk of a borrower defaulting. This is crucial in various scenarios like debt structuring, securing financing post-exit, loan amendments, financing large-scale projects, and executing leveraged buy-outs (acquiring a company using a significant amount of borrowed money). Services to Investors: Provides specialized services such as offering derivative solutions that can help investors hedge against potential losses, managing portfolios, consulting on portfolio structures, and offering risk advisory services. 23  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions - Back Office (Control): Middle Office Functions: Deals with credit risk associated with capital market activities. This involves checking the risk of syndicated loans (where multiple banks lend to a single borrower), bond issuance, financial restructuring, and high-debt financing methods. Market Risk Control: Focuses on the risks associated with fluctuations in the financial market. The team reviews sales and trading activities, often using the Value at Risk (VaR) model, which quantifies the potential loss an investment portfolio might face over a specific period for a given confidence interval. Other Risk Groups: Depending on the bank, there might be teams that focus on: - Country Risk: The risk of doing business in a particular country. - Operational Risk: Risks from internal processes, people, systems, or external events. - Counterparty Risks: The risk that the other party in a financial contract will not fulfill their contractual obligations. Risk Committees are established at the Firm and business levels. These committees periodically perform comprehensive reviews of the risk profiles of their business and the firm. Prime Brokerage: Prime Brokerage: is a financial service provided by large banks and financial institutions to hedge funds and other institutional clients. It offers a one-stop shop for various services, including trading, clearing, lending, and securities custody, making it easier and more efficient for clients to manage their investments and trading activities. Services to clients with complex financial needs: 1. A prime broker provides sophisticated institutional investors (mostly, hedge funds) with: a. Execution and custody services b. The ability to borrow stocks and bonds (aka “securities lending”). Securities lending is the practice of temporarily loaning out stocks, bonds, or other securities to other market participants in exchange for a fee or collateral. c. The capacity to borrow money to buy stocks and bonds (aka “margin financing capabilities”). Margin financing capabilities refer to the ability to borrow funds from a brokerage to purchase securities, using the securities themselves as collateral. 2. The prime broker stands as an intermediary between hedge funds and two important sets of counterparties - on the one hand, pension funds and other institutional investors with shares to lend (for the ultimate purpose of short selling); and on the other, commercial banks with money available for margin loans. 3. At JP Morgan, Prime Brokerage offers a full product suite of services across multiple asset classes to meet its clients’ evolving needs. Among the services they offer, you can find: a. Financing (borrowing, loan and collateral). b. Equities financing. c. Securities lending. d. Fixed Income (clearing, execution and funding) e. Other services: consulting, synthetic prime brokerage, technology platform… 24  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions Example of market making: A Treasury trade. 3 people: Trader, Sales Person and Investor (institutional) 1. Market taker (Client) institutional Investor: “Where is the market, in size, for the 5-year on-the-run treasuries?” - We don’t know if he is a buyer or a seller, and we don’t know if he wants to operate or just wants to know (clients do this in order to have a fair bid-ask, clients don’t trust Investment Bankers). He is actually asking for the bid-ask price. i. Does the client want an indicative (quick) or a firm (live) price? ii. Which side of the trade does the client want to do (two-way market quote)? iii. Is the bank “in comp” (in competition with other banks)? iv. How quickly does he need the quote? - Where is the market? → Means that the client wants the bank to make a market. There is a market for the particular product for a particular size. - In size → Means that the client wants to transact a large amount. i. US treasuries regularly trade in blocks of $ 100 million at a time in the institutional investor space. So size means anything from $ 1 billion to multiple billions. ii. In the corporate bond market, which normally trades in blocks of $ 10 million to $ 20 million, size might mean $ 100 million. - On-the-run → Is a term used in a lot of financial markets and means the current benchmark product (most liquid). 2. Salesman: “I need a firm market for $1 billion on-the-run 5-years. We’re in comps” - The salesman knows the client as he gives him colour on the market daily. - Salesman puts the client on hold. - The salesman will try to get more colour on the trade (Is this part of a larger transaction? Is this a new position?). - Salesman knows that the market quote on ETS is 16.5 – 16.75 (narrower bid-ask spread) but for only $ 300m. 3. Trader: “16 at 17” - Traders use lingo (jargon) to refer to the decimals for his bid-ask market as, by convention, Treasuries trade in 1/ 32 of 1%. - Bid is 100% + 16/32 * 1% = 100.5%. - Ask is at 17/32nds = 100.53125%. - The handle (big number, in this case 100%) does change much intraday and is known by all market participants. For this reason, traders only say the last part of the number (the decimals). 4. Client: “I lift the offer for $1bn 5-year OTR Treasuries at 100 and 17/32nds” - Lift the order means the client is a buyer. Conversely, the client could have hit the bid if it wanted to sell treasuries. - The client could have been nervous about telling the bank which direction it wanted to go because he doesn’t want the bank to front run it. - Frontrunning: the bank starts buying the treasuries ahead of trade, moving prices upwards. 5. Bank: “Done” - The sales person will immediately open a line to the trader and repeat those exact words to the trader. - Open lines are telephone lines that record the conversations. Which means, it immediately converts into a contract. - Salesmen and Traders repeat the verbatim in this recorded line. - The word done is crucial when deals are executed verbally. 6. Trader: “I need to buy the Treasures I just sold ASAP” → The Trader has sold something he doesn’t have. He had to disclose the price before having the securities, so the trader faces the risk that the market changes in a second and not make a profit with the bid-ask spread. The Salesman ears on a commission over the 1bn, but the trader just makes money from the bid-ask spread. - The trader has sold something he doesn’t actually own; the trader is not sitting around with $ 1 billion 5-year treasuries on his books waiting for someone to buy them. - He will make a price where he is prepared to sell them based on the knowledge that he will be able to buy them from a client or from another bank that same day. This is called going short. - The treasury trader agreed to deliver something he doesn’t yet own in exchange for cash. - He can’t close out his position until he is able to buy what he agreed to deliver, at which point he will be flat or neutral. - The risk to the trader is that the market price moves up before he is able to close out his position. - The opposite of being short is being long, which means having a position where the risk is that the price goes down. The larger the block of any trade, the risker for the trader, so the wider the bid-ask spread. Main takeaways 1. Very simply, banks, and in particular trading floors, have a valid purpose and are necessary for the smooth operation of the global financial markets. 2. For any asset, regardless its complexity, regardless its lack of liquidity, regardless the market momentum and regardless the deal size. 3. A bank will always be there… to trade. Banks usually try to sell you as an amazing opportunity what they want to take off their BS. A typical trading day: Get to your desk at 6:30am Morning meeting Coffee No chatting End of the day Get to desk at 6:30-7:00. Includes traders and sales and Watch for market Closing the books: they ensure that all - Preparation: Review the trading people. Big events for the lunch movement. Intensely trades are put into the systems correctly. book positions and P&L from day are discussed (+recap of at focused, talking in short Confirm with the middle office that prices the day before. previous day). their staccato sentences. They are accurate. Send an overnight - Review market events. Traders send out the desks close their books at the end commentary. Send important instructions - Check for any big events morning market of the day. to the overnight trader. expected. commentary. 25  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions TOPIC 6: SALES AND TRADING II Cash Equities, FICC and Securities Services Category Product type Description Typical Investors Equities Blue Chips Well recognized and established large firms that have stable Mutual funds, Pension funds earnings. Aka “investment grade” companies. Other stocks The residual universe of stocks includes all other listed Insurance companies. Retail companies. Among them could be distinguished Mid and investors Small Cap, stocks and have different risk profiles. Fixed Government bonds Government bonds are considered as less risky, although Mutual funds, Pension funds, Income there is a big difference among governments. Credit Rating Insurance Compnaies agencies track the credibility of governments to repay their debt. Corporate bonds Bonds issued by corporations. CRAs value most of the Mutual Funds, Insurance corporations and assign them with a rating. Based on this Companies, Retail Investors rating, some mutual and Pension funds can buy only certain bonds (less risky ones). Other Commodities Trading goods, such as: coffee, corn. Live cattle, rice, sugar, Companies, Commodity Financial gold, silver, crude oil, gas. etc. traders, Hedge Funds Instruments Derivative Derivative financial instruments are many and vary Companies, Hedge Funds Instruments significantly in their nature. Some of them are used for hedging purposes by companies (in order to reduce risk), while others are for speculative reasons. E.g., forwards, futures, options, swaps… Cash Equities, FICC and Securities Services: 1. Fixed-income, Currency, and Commodities (FICC): Facilitates trades in fixed income instruments, currencies, and commodities contracts. This group seeks opportunities to profit from movements in interest rates and credit products. a. Foreign exchange (FX): trading of currencies. Products include Spot FX, Forward FX, FX options… b. Flow rates: It's about trading instruments that help institutions manage their short-term liquidity needs and hedge against interest rate changes. Products: S/t interest rates and money market, benchmark funds, covered bonds and flow derivatives. Structured rates: more sophisticated products designed to meet specific hedging or investment needs. Structured interest- rate swaps, correlation swaps, flow-inflation swaps, long-dates and structured FX, interest-rate hybrids. c. Flow credit: focus is on debt instruments and products that are derived from them. Products: Corporate bonds, CDS, total return swaps, credit-linked notes, corporate-bond futures and options, ABS, corporate and residential MBS, par loans, syndicated loans. Structured credits: Cash-collateralized debt obligations, synthetic collateralized debt obligations, baskets, tranche options, index tranches, correlation transactions. d. Commodities: Products: Trading of flow commodities derivatives and swaps of structures products, trading of structures commodities derivatives, structuring of complex hedges, commodities originations, complex investment products, asset- backed trading. 2. Cash Equities: Facilitates trades in equities: Also involved in proprietary trading and equity derivatives. a. Cash equities: providing a platform for buying and selling shares of individual companies. Products: Full-service brokerage/secondary trading of single stocks, direct market access, portfolio trading. b. Flow equity derivatives: Sophisticated financial products derived from the value of underlying equities. They allow investors to hedge or speculate on the movement of stock prices without owning the actual stock. Products: Delta 1 swaps, delta 1 certificates, warrants Structured swaps/options, certificates, hybrid derivatives, convertibles. 3. Securities Services: provides essential services that keep the wheels of the financial markets turning. They ensure that when trades are made, assets and cash change hands smoothly and securely. Provides financing, lending, clearing and settlement services. a. Prime services: often cater to hedge funds and include lending securities for short-selling or providing financing for trades. Products: Security lending, security financing. b. Proprietary trading: Here, the institution is trading using its own money, taking on risks to earn returns, rather than facilitating trades for clients. Trading on institution’s account rather than client business. 26  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions An example of structured credit (Cash) – A type of CDO Think of a CLO as a big pot where investors pool their money. This pot then lends out to various businesses, especially riskier ones promising higher returns. As these businesses pay back, the CLO distributes returns to its investors, prioritizing those who sought safer investments. However, many CLOs often lend to the same set of businesses. If these businesses falter, multiple CLOs can get hit. This shared risk among CLOs is called "collateral overlap". → We go from BB to AA. Example of structured credit (synthetic) Synthetic markets: Credit default swaps: They include: (1) Credit default swaps (CDS), (2) Traded credit indexes and CDS enable the isolation and transfer of credit risk (3) Index tranches. between two parties. The LF synthetic markets are relatively young. They are bilateral financial contracts which allow credit Traded credit indexes: risk to be isolated from the other risks of an instrument, - In TCI, single-name CDS contracts are grouped by market segment, such as interest rate risk, and passed from one party to specifically the high-yield bond segment (denoted CDX. HY) and the loan another party. segment (denoted LCDX). Other reasons for the use of credit derivatives include: – - Considered a barometer of market sentiment, hedging tool, arbitrage asset replication/diversification, leverage, yield and relative value positioning, and capital structure positioning tool. enhancement, hedging needs, and relative value Investors: arbitrager players, correlation desks, bank portfolios, proprietary opportunities. trading desks, and credit hedge funds. Exchanges and trading platforms: Key concepts for understanding trading in CMP Financial products Trades and traders - Plain vanilla: standardized or basic version of a financial - Principal trades: a bank providing liquidity to a client by taking instrument, usually bonds and derivatives. risk. - Exotic instrument: more complex, non traditional or tailor - Broker or Agency trades: a bank placing orders on a CMP. made financial instruments. - Major Dealers: large banks that are liquidity providers for The word “tailored” is generally used with derivatives multiple financial products globally. – and “structured” generally with bonds. - Specialists: smaller banks, securities firms or specialist - ETPs: The financial products that trade on exchanges are called financial entities which may only provide liquidity in a few exchange traded products. financial products or none at all. - OTCs: products traded over the counter, i.e. financial products, and derivatives in particular, which are not exchange traded but are standardized → biggest, as the derivative market is the biggest. Central Market Platforms (CMP): These platforms are the background providers of the financial market’s matchmaking between buyers and sellers for standardized financial products. How a bank provides liquidity is sometimes via its: 1. Client base: If a client wants to sell a bond, the bank buys it, regardless of having an immediate buyer. Bigger banks handle more trades, reducing risk by matching sellers with their own buyers internally. This internal matching is termed "dark pools of liquidity." While still reported, these trades essentially occur outside the main exchange. 2. Exchanges: Products traded on exchanges are called ETPs. Clients typically use exchange brokers, often big banks designated by the exchange, for these transactions. Market transparency comes from data on trade price and volume. For ETPs, banks usually act as brokers rather than liquidity providers. 3. Interbank brokers, mainly known within financial markets, historically dealt only with major banks. They primarily matchmake for standardized financial products, especially derivatives, that aren't traded on exchanges, known as OTC products. These brokers often trade via phone and there's no central trade database. While only about 10% of derivative contracts are exchange-traded, the majority are traded OTC. 4. Electronic trading systems: Electronic Trading Systems (ETS) like Tradeweb, Bloomberg, and MarketAxess, operated by exchanges, interbank brokers, or banks, have increased transparency in financial markets. Now, anyone can trade standardized ETP and OTC products from their computers. Major banks still play a pivotal role by providing bid and offer prices, ensuring liquidity in the market through partnerships with ETS platforms. Example: a bank buys a stock, the bank is not guaranteed to have another client who wants to buy the same stock. The bank calls up several different liquidity providers itself. Alternatively, the bank can go to a central market platform. 27  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions Research: Research ideas are a revenue-making source. Daily ideas → Trust → Revenues. Researchers don’t cover clients, they don’t take risks and they don’t create products. They create ideas. Their role is to analyse companies or financial markets and publish reports giving their views. This research is made available to the bank’s clients via a combination of email distribution (including bloombergs) and client access to the bank’s proprietary section of its website. Every morning meeting, Sales people listen to the Research team’s main investment opportunities and divestment recommendations and quickly call their clients to present the new ideas. A bank’s research classification: - Analysts: Equity or credit analysts They analyse (cover) individual entities (issuers). Industry-specialised. Depending on the bank’s strategy, it picks some companies to cover in detail (the rest on statistics). The job: fundamental analysis, competitive landscape, impact of macro forces on industry. The analyst “kick the tires” (due diligence). Equity analyst: Equity investors look for growth (i.e., an increase in the value of their investment). Credit analyst: Credit investors look for stable income (i.e., whether the company will remain stable over the life of the debt). - Economists: Global or regional. They analyse macroeconomics. They are looking at the state of the economy globally and by jurisdiction. Example of a macro strategy is to overweight equities and underweight fixed income, and to avoid autos. Traders discuss macro trends with Strategists, as they need to have a view on the financial market on their product in particular. - Strategists: Product or asset class. They focus on financial products such as interest rate swaps or equity derivatives. Example of a recommendation from a strategist is to buy 2-year equity options and sell 3- month equity options. Traders discuss macro trends with Strategists, as they need to have a view on the financial market on their product in particular. Proprietary strategic research: - Desk Analyst: A desk analyst is a research analyst specifically dedicated to working with the trading desk and helping the traders form views on future price moves. This avoids the issue of conflict of interest, because the desk analyst does not publish research. - AM firm analyst: Asset management firms (from mutual funds to hedge funds) have their team of Research analysts, economists and strategists. These “buy side” analysts are similar to desk analysts, as they do not publish reports, nor talk to clients. They help implement trading and investment strategies. - Conflicts of interest: Until late 1990s, Research analysts could receive bonuses based on the investment banking fees generated with the help of their recommendations. They could be recommending to buy shares in a tech IPO despite thinking the company was a POS. Another conflict-of-interest issue is front running, i.e. traders cannot have access to the analyst’s reports before being released. 28  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions TOPIC 7: FINANCIAL SERVICES INDUSTRY Regulators, International Financial Institutions and Agencies Regulatory framework: Agents (banks) The financial system is the most heavily regulated industry in a developed economy. Central Banks are government authorities in charge of monetary policy. Their decisions affect not only interest rates and the money supply but also credit (collateralised), foreign reserves, inflation, primary and secondary markets and financial stability. As a consequence, Central Banks decisions and their communication policy are closely monitored by all market participants. Central Banks (FED, ECB) are the supervisory body for: 1. Banks (commercial, private, investment) 2. Saving banks 3. Credit cooperatives 4. Specialized lending institutions (factoring, leasing, mortgage) 5. Mutual guarantee companies 6. Public financial institutions 7. Financial markets: Interbank market, public debt and FX markets (currencies). Regulatory framework: Agents (other) The Securities and Markets regulators are independent, Government agencies responsible for protecting investors, maintaining fair and orderly functioning of securities primary and secondary markets, and facilitating capital formation. The Securities Exchange Commission (SEC), Financial Service Authority (…) are the supervisory body for: 1. Brokers 2. Investment and Mutual Funds 3. Venture Capital and Private Equity Firms 4. Securitization fund managers 5. Financial Markets: a. Stock markets b. Fixed Income markets c. Options and Futures Markets. The National Association of Insurance Commissioners are the supervisory body for Insurance companies and Pension Funds. Supra-nationals and Development Banks 1. A supranational entity is formed by two or more central governments to promote economic development for the member countries. 2. Quasi-sovereign institutions include national or state government-level issuers other than the sovereign national government. Examples: The World Bank, International Monetary Fund, KfW, Islamic Development Bank, European Investment Bank (EIB)… The European Investment Bank is the European Union’s Bank. It represents the interests of the European Union member states. It works to implement the EU policy. The world’s largest multilateral borrower and lender. Providing finance and expertise for sustainable investment projects. 90% of activity is in Europe. Four priority areas: (1) Innovation and skills, (2) Access to finance for smaller businesses, (3) Infrastructure and (4) Climate and environment. Sovereign Wealth Funds: Sovereign Wealth Fund (SWF): state-owned investment pool or entity that manages a country's reserves. Typically funded by revenues from commodities such as oil, gas, or other natural resources, or from foreign exchange reserves held by the central bank, these funds invest in a range of assets such as stocks, bonds, real estate, infrastructure, and alternative assets like private equity. Purpose: SWFs have several purposes, including: 1. Diversifying revenue streams of resource-rich countries to ensure economic stability when commodity prices fluctuate. 2. Stabilizing the country's economy by managing and diversifying its source of income. 3. Accumulating savings for future generations, especially for countries that rely heavily on non-renewable resources. 4. Protecting the economy from inflation associated with large foreign currency inflows, often termed as "Dutch disease". Characteristics: 1. Typically, SWFs have a long-term investment horizon. 2. They often invest internationally, in a wide range of assets. 3. Their strategies and operations might be less transparent than other institutional investors, leading to some concerns in host countries regarding their investment goals and strategies. 29  Gemma Guerrero – MIF 2023 Investment Banking and Financial Institutions 7.2 Business, Commercial and Corporate Banking REMEMBER: Services NOT typically offered by investment banks are: 1. Commercial banking: Provides banking services to corporate and individual customers: a. Retail banking: It covers online services, checking and savings, cards, investment management, specialized banking and traditional services. b. Small and Mid-sized business: Provides services in account access, checking and savings, loans and credit lines, leasing, cards merchant services, payroll and tax, and investment and retirement. Additional services include insurance, wholesale mortgage lending, and trade services. c. Full Corporate Banking service: Provides loans to large organizations, including finance, project and asset finance, leasing, cash management and trade and export finance. 2. Treasury services: Provide treasury and cash management, trade finance, payment, and liquidity management services for multinational corporations, banks and non-banks financial institutions, and governments. Banking for companies: 1. Business Banking (For Small Firms): a. Target Group: Typically caters to small businesses, startups, and local enterprises. b. Services: i. Deposit Services: Business bank accounts, term deposits, and flexible savings options tailored for small business needs. ii. Credit: Offers short-term loans, credit cards, and overdraft facilities for managing operational costs. iii. Cash Management: Provides services like electronic funds transfers, payroll services, and payment processing to streamline a business's daily financial operations. 2. Commercial Banking (For Mid-sized Firms): a. Target Group: Catered to medium-sized businesses, regional companies, municipalities, and not-for-profit entities that have more complex financial needs than small businesses. b. Services: i. Credit: Provides larger credit facilities including term loans for capital expenditure. ii. Cash Management: Advanced services, including liquidity management and treasury solutions. iii. Capital Markets and Corporate Finance Advisory: Offers advice on mergers and acquisitions, raising capital, and other strategic financial decisions. iv. Specialized Industry Solutions: Tailored banking solutions for specific industries (e.g., healthcare, real estate). 3. Corporate Banking (For Large Corporations): a. Target Group: Targets large national or multinational corporations with significant operations and financial needs. b. Services: i. Credit Solutions: Structured credit solutions that could involve syndicated loans or large-scale financing. ii. Project, Equipment, and Asset-based Finance: Financing solutions specifically for large projects, machinery procurement, or based on other assets. iii. Leasing and Factoring: Providing alternatives to traditional financing methods. Leasing for using assets without buying them outright, and factoring for selling accounts receivables to get instant cash. iv. Cash Management: Comprehensive treasury and cash management solutions, including global cash concentration. v. Trade and Export Finance: Facilitates international trade through instruments like letters of credit and export/import financing. vi. Capital Markets and Corporate Finance Advisory: High-end advisory services for major financial decisions, including international expansion and Initial Public Offerings (IPOs). Corporate banking is the basis for origination. Corporate Bankers (aka Senior Bankers) serve a specific range of corporations, institutions and governments. The provide strategic advice, capital raising and risk management expertise. Corporate Bankers specialise by industry and cover a limited number of clients. They monitor their clients’ performance, as well as their competitors, the industry drivers and financial markets. Corporate Bankers maintain regular contact with their clients and tr to cross-sell as many products and services as possible. Example: Citi Corporate Banking The Corporate Bank is a leading provider of financial services to top-tier multi-national clients around the globe, serving the financial needs of the world's preeminent corporations and financial institutions. Our relationship bankers have a comprehensive understanding of the wide range of complex financial issues facing our clients. Combined with an appreciation of the broad set of services offered by Citi, this understanding allows us to effectively deliver innovative solutions to our clients, wherever they are located. Corporate Bank's relationship bankers’ partner with product specialists to provide a full array of corporate banking solutions, from cash management, foreign exchange, trade finance, custody, clearing and loans, to capital markets, derivatives, and structured products. They also partner with our investment bankers to deliver investment banking capabilities to our relationship clients. The Corporate Bank is organized primarily along industry lines and serves clients in more than 100 countries. This organizational model draws upon a deep understanding of industry trends and market knowledge, based on a local presence dating back 100 years in many of these markets. 30