The investment industry is comprised of a wide variety of sectors and service providers. At the top of the list are the giant asset managers, like BlackRock, a firm managing assets that total more than $3 trillion, an amount so immense that it was equal to the gross national products of Russia and India combined in 2010. Also at the top of the industry are the biggest exchanges, were billions of shares trade hands yearly, along with the major investment banks, those firms that raise money for corporate clients by selling their stocks and bonds to the public and arranging massive loans. Investment banks also deal in private equity investments and asset management, and they earn immense fees by brokering mergers and acquisitions.
Then there are the big firms that provide stock brokerage services. Some of them, like Merrill Lynch, are also investment banks. Others, like Charles Schwab, are primarily stock brokers that deal with millions of individual customers. However, the lines have blurred between sectors in recent years. It is common for one firm to operate in multiple segments of the business at once: commercial banking, investment banking, asset management, insurance, mortgages, financial advisory, venture capital, mergers and acquisitions and more.
The Global Investment Industry: This is a massive, global industry, and, in light of the fact that it provides the services that enable companies to have access to capital, it is one of the most important industries of all. Global mutual fund assets totaled $25.9 trillion on June 30, 2011, according to the Investment Company Institute. The World Federation of Exchanges estimated the total value (market capitalization) of stocks on all of the world’s significant exchanges at $51.6 trillion as of August 2011, with shares available in more than 46,000 companies.
After an extremely turbulent 2008 and 2009 during the Great Recession, the global investment industry was greatly altered. Lehman Brothers was allowed to fail completely. Bear Stearns was taken over by JPMorgan Chase at a nominal price. Global banking and investment industry leader RBS (Royal Bank of Scotland) was bailed out by government capital to the extent that it became controlled by the U.K. government. Insurance industry giant AIG was bailed out by the American government. The world became familiar with phrases like “toxic assets,” and American taxpayers, whether they liked it or not, backed emergency plans and market support programs with acronyms like TARP (Troubled Asset Relief Program) and TALF (Term Asset-Backed Loan Facility). By the end of 2009, the U.S. government had created initiatives based on corporate bailouts, asset purchases, emergency lending and financial market support totaling more than $2 trillion. These were only a few of the massive changes wrought by the upheaval of the global financial crisis that began quietly in the late summer of 2007 and roared into a full financial hurricane in 2008.
As the financial crisis unfolded, governments around the globe issued emergency funding to leading banks and investment banks. At one time, virtually all stock market indexes had been down by as much as 40% to 60%, depending on geographic location. A handful of extremely clever investors made vast profits by skillful, courageous, contrarian investing during the turmoil.
By the end of the painful 2008-09 period, the investment industry, on a global basis, had been through losses, layoffs, scandals, bankruptcies, forced mergers, government intervention, bailouts and/or disappointments on a scale not seen in decades. In 2010-11, the industry began rebuilding and reshaping its strategy while markets remained volatile and the future remained questionable due to a crisis in European debt and credit markets and a continuing overhang of bad mortgages in the U.S. housing market.
There clearly remains daunting global risk within the banking and investment industry, in particular the risks to banks and asset pools holding bonds issued by deeply indebted European nations including Italy, Spain and Greece. Banks around the world are subject to immense potential losses from such bonds, whether they hold the bonds directly or they are parties to derivatives, credit swaps, guarantees or financial transactions partly reliant upon the stability of these bonds.
China is the biggest growth story in the investment world by far. A large percentage of the world’s IPOs are now on Chinese exchanges, including Hong Kong. While foreign investors generally cannot purchase shares on exchanges based in mainland China, they can buy shares on the Hong Kong exchange. Meanwhile, large numbers of China-based firms are going public, the Chinese economy has been growing at a substantial rate and merger, acquisition and investment activity of all types has been high.
Regulation: In many cases, investment companies and banks are closely related. Some of the world’s largest investment banks, such as Merrill Lynch (forced into a merger with Bank of America during the recent financial crisis), are owned by major commercial banks. New regulations are placing investment firms and banks under significant pressure, making it more difficult to operate and more difficult to earn profits. The EU has established stringent new rules on banks. In October 2011, major European nations were so concerned about the exposure of their banks to potential losses on bonds issued by highly indebted European nations that leaders in Germany and France were recommending that Tier-1 bank capital requirements be raised to a very high 9% of assets by 2013. (Tier-1 capital is a ratio of equity capital plus stated bank reserves to assets, and is a commonly used measure of a bank’s core financial stability.)
Meanwhile, the global committee known as the Basel Committee on Banking Supervision (BCBS) continues to monitor the health of the banking system and issue recommendations for minimum bank capital and risk management. The biggest upcoming changes faced by banks that plan to comply with the latest round of recommendations, the “Basel III” accords, will be in raising sufficient capital. The Tier-1 capital requirement will increase to 10.5% by 2019. (In contrast, the massive UK bank RBS had only about 3.5% of Tier-1 capital when the Great Financial Crisis began, and the bank promptly needed bailing out. U.S. banks endured losses equal to about 7% of assets during the recent crisis.) The intent is to make it much less likely that massive bank failures will be faced in the future, even during a major financial crisis.
While this may be desirable from a stability point of view, it places significant constraints on banks. The result will be that they earn a lower profit ratio on assets, and they will likely be required to sell large amounts of new stock, thus diluting the positions of existing stockholders. (An alternative way to raise capital would be to sell large amounts of assets.) Compliance with Basel accords is recommended to the governments and regulatory authorities where global banks are based, including the U.S. Nations may choose whether and to what extent to comply on a voluntary basis. In order to comply with the recommended 2019 standard, U.S. and EU banks would need to raise more than $2 trillion in new capital.
Many banks are in much better financial condition than they were in 2008-09, as they have been raising their equity capital levels in recent months, getting a start on meeting future requirements. For example, as of mid-2011, U.S. banks had increased their total equity capital by 20%, or $264 billion, since the end of 2008. This gives them a much greater cushion against potential losses. During that time, American banks also vastly increased their amount of cash on hand, to about $1.8 trillion.
In the U.S. a sweeping reform bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act, was signed by President Obama in July 2010, after European finance ministers approved similar regulations for much of Europe a few months earlier. Unfortunately, much of the Dodd-Frank bill was vague and not yet fully defined as of 2011, leaving the banking and investment industry in a struggle to understand its full effects. In general, requirements under the new U.S. law include broad powers for the government to monitor systemic financial risk and to intervene where it deems necessary. For example, it requires a bank to shrink in size if the government believes that the bank is posing financial risks, and an orderly liquidation process has been set out for extreme cases in which regulators need to seize and auction off financial firms that are nearing bankruptcy.
Another requirement is the creation of a Bureau of Consumer Financial Protection that will oversee and regulate the issuance of things like mortgages, credit cards, personal loans and retirement plans. The bureau has a $500 million budget that does not require Congressional approval. The budget is funded by the Federal Reserve. The new agency has the authority to enforce its rules on banks with more than $10 million in assets. As of 2011, the bureau was still a work in progress.
Under Dodd-Frank, banks will be required to maintain much larger levels of capital. Credit card issuers will be required to operate under modified rules that are much more consumer-friendly than in the past. Debit card processors will be required to charge lower fees on transactions.
Other provisions of the bill include a permanent increase in federal deposit insurance from $100,000 to $250,000; requiring mortgage lenders to verify that borrowers are likely to be able to repay their loans; and the establishment of a new Federal Insurance Office within the Treasury Department to oversee the insurance industry. Supporters of the new law contend that the recent financial crisis proves the need for government protection of consumers against abusive financial practices. Detractors are concerned with the potential for too much new oversight enforced by inefficient new bureaucracies, placing a strangle-hold on business and productivity.
The act will have a broad effect on the investment industry. Large private equity companies and hedge funds (but not venture capital companies) will be required to register with regulators as investment advisors and make their books available for scrutiny. A so-called “Volcker Rule,” named after former Secretary of the Treasury Paul Volcker, bars proprietary trading by banks for their own accounts, where accounts are unrelated to bank customers. New rules also limit banks’ ownership of private equity companies and hedge fund firms. As a result, many banks have already been altering, selling or spinning off their hedge fund units. (Banks will be allowed to invest no more than 3% of their Tier-1 capital in such funds.) They will also be required to transfer their commodities derivative trading activities to affiliated companies, rather than conducting them within the parent bank organization. However, they may be able to retain trading in interest rate, foreign exchange and precious metals in-house.
A new Financial Stability Council will monitor system-wide risks within the financial services industry. It may make recommendations to the Federal Reserve regarding institutional leverage and capital requirements.
The U.S. Investment Industry: Employment in America alone, in firms that are involved in securities and investments, was estimated at 807,400 as of October 2011, according to numbers published by the U.S. Bureau of Labor Standards.
About 49 million Americans participate in 401(k) investment plans at their places of work, with assets totaling about $3.2 trillion as of June 2011. Mutual funds in America held $11.6 trillion in assets as of October 2011, while ETFs held $1.0 trillion. U.S. retirement account assets totaled about $17.0 trillion on September 30, 2011, according to ICI, the Investment Company Institute (
www.ici.org), down from a record high of $18.4 trillion on June 30, 2011.
America’s stock exchanges are highly electronic today, trading vast amounts of stocks, bonds and options at blazing speed. Average daily volume on the NYSE was running at a 1.4 billion shares rate in late 2011 and a 1.8 billion shares rate on the NASDAQ.
Despite these high volumes of trading, America has lost the title it held for decades as the world’s leader in public stock offerings. The Sarbanes-Oxley accounting and public company disclosure regulations, passed in 2002, were a huge blow to the industry. Many firms now choose to list on exchanges in Asia or London instead of New York City. Meanwhile, Hong Kong has been the leading exchange for IPOs since 2009, surpassing the NYSE and the NASDAQ.
However, the CME Group, based in Chicago, Illinois, retains the top spot as an exchange for futures and options. During 2011, about 3.4 billion futures and derivative contracts traded on CME’s markets. This is much higher volume than the 2.0 billion traded on the Eurex exchange owned by Deutsche Borse, and 1.1 billion on the Liffe exchange, based in London and owned by NYSE Euronext.