What happened to the merchant banking business model?
A decade ago all the BB firms and a few EB firms had their own principal investing groups, but those have all but disappeared aside from a few outliers (GS MBD, MS Private Equity). Firms like JPM, Citi, DB, CS have all divested their PE arms, resulting in independent shops like Court Square, CCMP, One Equity, Metalmark, MidOcean, etc. Blackstone divested its M&A and RX practice, resulting in PJT.
The common answer is the conflict of interest results in the advisory and investing unable to coexist under the same firm, but we see a few new firms that have both capabilities, such as Centerview, BDT, LionTree, and Raine. Does anyone have insight on why the merchant banking business model has become less popular among the bigger firms? Is it mainly a regulatory concern? Or are there implications for profit and general business as well?
Interested as well.
Bump interested as well
Bump - decent discussion
Not sure why it would, but perhaps industry verticals come into play?
LionTree, Raine and Allenco seem to thrive within TMT. Both their advisory and investing practices seem to be consistently executing
Is the difference between an investment bank and merchant bank that merchant bank has a principal investing team besides the usual advisory businesses?
Yup. A merchant bank is an investment bank in that sense, but an investment bank may not necessarily be involved in merchant banking activity. Merchant banking refers to the ability to co-invest alongside clients in deals and businesses.
Private Equity and the LBO boom in the 1980's happened; when firms like KKR, Blackstone, etc... that specialized in the actual investing side of these deals came along, IBs weren't prepared to compete on that level and the one's who did got chewed out by the same shop(s) they beat (if they ever did) for fucking up and cutting into their business - PE firms essentially told IBs on the street "if you want my business on the lending front," which, of course, they all did, "stay in your fucking lane," and, for the most part, they did. Merchant Banking has been slowly dying ever since.
That makes sense. Interesting to see whether things change now that some investment banks can survive off of advisory alone, without the need for a lending business. Could be why firms like Centerview Capital Partners and Greenhill Capital Partners have continued to operate. Could also explain why GS and MS kept their principal investing groups, because they had the balls to stick it back to the PE firms.
Yeah I don't think they're really "sticking it" to anybody....most of those funds focus on LMM to MM opportunities. Those banks aren't particularly focused on winning business from clients focused on doing deals of those sizes (although GS push into the MM might be changing this).
Furthermore it looks like the banks have successfully gotten the deadline to comply with the Volcker Rule pushed out so far, that they can still be operate those funds legally. Its possible the other BB's have decided not fuck around at all and GS & MS are just holding on until they are absolutely forced out.
https://www.wallstreetoasis.com/forums/volcker-rule-and-pe-groups-at-ib…
King of Capital, Carey & Morris: "Private equity's power on Wall Street had never been greater. Where buyout firms had ones been supplicants of the banks they relied on to finance their takeovers, the banks had become addicted to the torrent of fees the firms were generating and now bent over backward to oblige the Blackstone of the world. In a telling episode in 2004, the investment arms of Credit Suisse First Boston and JPMorgan Chase, two of the world's largest investment banks, made the mistake of outbidding Blackstone, Kohlberg Kravis, and TPG for an Irish drugmaker, Warner Chilcott. Outraged, Kohlberg Kravis cofounder Henry Kravis and TPG's Jim Coulter read the banks the riot act. How dare they compete with their biggest clients! The drug takeover went through, but the banks got the message. JPMorgan Chase soon shed the private equity subsidiary that had bid on the drug company and Credit Suisse barred its private equity group from competing for large companies of the sort that Blackstone, TPG, and Kolhberg Kravis target." (pgs. 4-5)
The Volker Rule was a development that, while materially negative for MB divisions at BBs, had marginal effects/really just reaffirmed the structural changes which had been occurring on the Street for the two to three decades prior. Speaking to my earlier post re: Banks getting cucked into behaving by BB PE, see: King of Capital by Carey & Morris "Private equity's power on Wall Street had never been greater. Where buyout firms had ones been supplicants of the banks they relied on to finance their takeovers, the banks had become addicted to the torrent of fees the firms were generating and now bent over backward to oblige the Blackstone of the world. In a telling episode in 2004, the investment arms of Credit Suisse First Boston and JPMorgan Chase, two of the world's largest investment banks, made the mistake of outbidding Blackstone, Kohlberg Kravis, and TPG for an Irish drugmaker, Warner Chilcott. Outraged, Kohlberg Kravis cofounder Henry Kravis and TPG's Jim Coulter read the banks the riot act. How dare they compete with their biggest clients! The drug takeover went through, but the banks got the message. JPMorgan Chase soon shed the private equity subsidiary that had bid on the drug company and Credit Suisse barred its private equity group from competing for large companies of the sort that Blackstone, TPG, and Kolhberg Kravis target." (pgs. 4-5) As I'd said, BB IBs knew where their bread was buttered and opted not to (in what would have been a remarkable display of utter stupidity) murder the shit out of the geese that were laying fuckloads of golden eggs for them in the form of fee revenues from underwriting the billions upon billions in debt required to fund BB PEs LBO binge, and which were so consistently and reliably massive, Gordon Gekko might actually jizz himself just thinking about it.
I think it had to do with the Volcker Rule impacting BBs, not sure how GS and MS found a workaround to that. Must be a unique ownership structure that lets them keep their funds.
The Volcker rule is so weirdly structured that it's surprisingly easy to make principal investments while remaining in compliance. Essentially, it limits commingling firm and client funds for the purposes of investing unless the firm contribution is less than 3% (then it's fine). If the fund is 100% firm money or 100% client money and you plan to hold the asset for more than 60 days (or less than a day) it's also fine.
Both MS and GS's merchant banking practices are holding assets for years and the capital contribution of the firm is less than 3% so they are compliant. GS Investment Partners (the VC-ish team), I believe, is entirely client money. GS SSG has historically been entirely firm balance sheet.
Volcker really tried to cut down on prop training and hedge funds/pe. To constitute it being prop trading, it has to be public market investing for the short-term (holding for 1-60 days per Volcker rule) with the firm balance sheet, which no bank is engaged in. And I guess what makes it a hedge fund/PE in the eyes of Volcker rule is the client-to-firm capital ratio in fund which firms dance around.
And practically all the other firms have investment arms: Citi Ventures, JPM Strategic Investments, Barclays Strategic Investments, etc.
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