Although retail banks (those that offer checking accounts and underwrite mortgages — think Jimmy Stewart’s character in "It’s a Wonderful Life") have received more attention when it comes to digital transformation, investment banks (institutions that provide M&A advice and raise capital for corporations) are not immune to digital disruption. Indeed, investment banking has become an increasingly challenging business in today’s environment, with greater regulatory scrutiny and competitive pressures on traditional business margins.
This isn’t a new phenomenon. Disruption is a constant force in the world of business and investment banks have weathered change before. Senior partners at investment banks still recount stories of manually crafting stock price charts using pen and graph paper. During the '60s and '70s, clients found this valuable because historical stock price data was not easily accessible before the advent of the internet. Eventually, this data became ubiquitous and investment bankers had to find other ways to demonstrate value.
Today, investment banks’ traditional model of profiting by acting as an intermediary between buyers and sellers and serving as data gatekeepers has come under threat from two forces: increased data transparency and alternative methods of accessing financial and intellectual capital.
The Impact of Data Transparency on Investment Banking
In many capital markets, pricing and transaction data is aggregated by the sell-side (the investment banks) and remains obscured to clients. This information monopoly has historically supported investment banks' pricing power, allowing them to charge higher fees for transactions and maintain higher spreads (the gap between buyer's bids and seller's asking prices).
However, as research from Deloitte shows, digital technologies have the potential to make aggregating and disseminating pricing and transaction data easier, faster and cheaper, encouraging startups to fill in the gaps left by investment banks. As Deloitte concludes, “the trend toward greater transparency in pricing and transaction data will continue,” reducing the need for a middle man for many transactions (similar to what happened with equities exchanges a decade ago).
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The Impact of Competition on the Investment Landscape
Thanks to the emergence of low-cost cloud computing, startup costs are lower than ever. Changes in the investment landscape mean that startups also have easier access to a multitude of private sources of financial capital and advice, including angels and VCs, accelerators and incubators, and crowdfunding platforms. Companies have found ways to capitalize and grow while staying private longer. A paper from McKinsey & Company noted that the “average age of US technology companies that went public in 1999 was four years” while “the average age of technology companies going public in 2014 was 11 years.”
These competing avenues for funding and strategic advice are taking a bite out of IPO fees.
Even when companies do go public, new approaches have allowed companies like Spotify or Google to bypass or reduce the involvement of investment banks. When Spotify went public in 2018 it did so via a direct listing, where the company sold shares directly to public investors. For Spotify, there was less need for a bank to underwrite the offering because the company was generating ample cash and was already well-known to the investing public. While direct listings are generally regarded as more risky, they may become more prevalent with the emerging crop of well-known private brands that require no introduction.
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Digital Opportunities for Investment Banks
It’s not all doom and gloom for investment banks. In fact, they have a unique opportunity to leverage their global network of historical transaction and pricing data within a unified digital platform. Startups, such as Origin Markets, are already capitalizing on information centralization in certain pockets of the capital markets and have partnered with large investment banks, including Bank of America, Merrill Lynch and Credit Suisse.
The acceleration of data transparency won’t completely disintermediate investment bankers. There will always be a need for expert advice on more complex and large-scale deals. But by embracing data democratization, investment banks can find value even in smaller, less complex deals by accessing a larger base of clients at reduced cost. The aggregation of financial data and the addition of behavioral information across the platform can also help banks better understand clients and their motivations.
Investment banks must also find new revenue streams and ways to protect their high-margin advisory businesses. One approach has been to acquire or invest in emerging fintech companies as a way to add technical capabilities and stay connected to promising startups. This trend has driven billions of dollars into fintechs globally. More recently, investment banks are increasingly looking to collaborate with fintech startups through incubation programs and joint innovation partnerships as a way to tap into technology advances while reducing risk and commitment. This can make sense as long as the partnership fits into the bank’s overall digital strategy. A fintech partnership, no matter how cutting-edge the underlying technology is, isn’t going to solve a customer service problem.
Data integration and analytics can also identify new M&A opportunities. Investment banks already have internal, proprietary information about clients and the transactions they’ve advised on. This information can be coupled with data from third-party sources, such as Thomson Reuters or S&P CapIQ to further enrich the dataset. Investment banks can then use predictive tools and analytics to help identify new deals and generate insights. Companies like Refinitiv, a financial markets information provider (recently acquired by LSE), are already leveraging advanced analytics and AI to uncover potential M&A targets by combing through public filings, proprietary databases of transactions, etc.
Technology won’t displace the need for expert M&A advice or the value of the relationships bankers have built with clients over time. But aggregation of data and insightful analytics can help investment bankers deliver additional value to potential buyers and focus their efforts on likely targets. Despite the challenges, digital disruption can create valuable opportunities but investment banks will need to adapt to capture them.