Show me the money!

IFR India Special Report 2011
12 min read

Growing competition between international banks is being complicated by the rise of India’s domestic firms, especially in the equity markets, where local brokers are becoming increasingly powerful. How are market participants looking to stand out?

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While India’s ability to continue its rapid growth trajectory is giving investors and economists pause for thought, banks – both foreign and domestic – seem to be unswervingly sure of the potential of the country’s investment banking market.

Elsewhere in the world, banks may be scaling back their operations and cutting staff counts, but, in India, they are boosting resources.

Credit Suisse is expanding its equities, fixed-income and investment banking teams. At end-August, it announced 11 fresh appointments to these groups. The Swiss bank received its Mumbai bank branch licence from the Reserve Bank of India in August 2010.

Barclays Capital India is hiring for its newly set up equities business, with more appointments expected in the next couple of months. The UK lender recently merged its commercial and investment banking teams in India, and retrenched 20–25 staff.

Locally, consolidation is also taking place among domestic players. In November 2010, Axis Bank announced its merger with Enam Securities, complementing each other’s strengths. Religare Capital Markets has continued to add to its bench of experienced investment bankers.

These moves, however, come at a time when the pipeline of advisory and underwriting mandates in India is looking shaky on a threat from global growth fears, as well as depressed domestic market conditions.

It is also far from clear if advisers will be able to translate these opportunities into revenues, since years of cutthroat competition for trophy cross-border acquisitions have savaged underwriting fees with arrangers falling over each other to build relationships with the narrow field of business leaders in Asia’s third-biggest economy.

Ask any seasoned banker in India about the low or zero-fee phenomena in the country and you will not be surprised to hear the answer. “Fee is a foreign concept in India. The only way one investment bank differentiates itself from another is its services and distribution reach and yes, the capability to throw its balance sheet behind the deal,” said the head of a foreign bank in India.

Investment banking has been a fighting turf for fees and market share and over years the competition has grown more intense and complicated with the rise of the domestic firms.

The spike in competition has been equal on both the equities and bond sides. The surge of local firms JM Financial, Enam, Kotak Mahindra Capital and, more recently, Religare on the equities side only shows that local brokers are becoming increasingly powerful.

Local competition

With the country expected to post GDP growth of over 7% in the next few years, the Indian growth story will continue to offer enormous opportunities and attract more market makers.

“Domestic players will continue to dominate the local market because they have bigger appetites than international players,” said the head of a foreign bank in India.

Many agree that local players, such as Axis Bank, ICICI Bank, Yes Bank or State Bank of India, are insurmountable on the domestic front. For their part, foreign banks do acknowledge this fact as the gap is simply vast between local and overseas players, in terms of distribution capabilities or holding capacity of the balance sheet.

So, how does one define the competition in the Indian capital markets – healthy or chaotic? The answer is anybody’s guess. Maybe, it is both. “The origination business is not a revenue opportunity in India. Where the banks make money is trading and, there again, how much money is made depends upon the view the bank holds on interest rates and the credit,” said a senior banker with a US-based bank.

Most agree the business is good if you are smart and canny. “I don’t see the fee characteristics of the Indian market changing quickly. It is very easy to lower fees, but very difficult to reinstate them,” said another banker with a European bank.

An artisan paints a statue of Ganesha on a roadside in the western Indian city of Ahmedabad.

Source: Reuters/Amit Dave

An artisan paints a statue of Ganesha on a roadside in the western Indian city of Ahmedabad.

Competition, no doubt, has been driving down the fees and some issuers have not shied away from further lowering the booty of bankers with each new mandate. State-owned refiner, Indian Oil Corp is a good case in point.

The record-low fee IOC paid on its recent US dollar bond in July indeed left Asian underwriters wondering if the time had come to start paying issuers to win deals.

BNP Paribas, Citigroup and RBS beat off some stiff competition to win the mandate for this US$500m 10-year Reg S deal for just US$1. Clearly, the motive was getting league table credit and it was one of three banks that drove down the pricing.

One of the banks quoted the US$1 fee and a cap of US$260,000 on expenses the bookrunners incurred, including legal fees. The other two mandated banks were said to have submitted proposals for fees of around US$5,000 and an expenses cap of around US$380,000–$400,000.

According to some, the IOC deal left each of the three banks at least US$75,000 in the red. Furthermore, the US$500m deal brings each bank just US$167m of league table credit for fees of 0.000000066%. Typical fees on a Reg S bond issue from India range from around 0.20% to 0.30%.

Lowest-bid tactic

Obviously, the lowest-bid tactic is useful for those trying to get a foothold in the already crowded market. Banks also hope that, some day, their presence will reap better dividends.

India’s burgeoning economy is slated to become world’s third largest come 2030. The country did not figure among the top 10 in 2010 based on IMF data, according to which, the US (US$14.6trn) remained the No 1 with China (US$5.7trn) and Japan (US$5.4trn) next in that order.

A Standard Chartered global research report has stated that, come 2030, India will be in the No 3 position with an economy of US$30.3trn, behind China (US$73.5trn) and the US (US$38.2trn)

“… India is likely to grow faster, on average, than China over the next two decades,” the bank said in the report, titled “India in the Super Cycle”.

It is this potential in India and its capital markets that is driving every participant to get a share of the pie, but, literally, at any cost.

IOC’s case was not the first instance where the Indian bond market saw arrangers being handed peanuts. In February 2010, National Thermal Power Corp’s Rs84.6bn (US$1.9bn) follow-on placement paid Rs17m or 0.075%–0.08% to each of the four bookrunners. The four banks hired to arrange the upcoming sale of US$1.5bn stake in Bharat Heavy Electricals are expected to earn a fee of just one rupee.

IOC has also been here before. Its debut offering in January 2010 was the harbinger of the fee compression on Indian G3 bonds. In December 2009, IOC mandated Deutsche Bank, HSBC and StanChart on its US dollar bond debut for an extraordinarily low fee of just 3bp – or just 0.01% per bank.

While many believe the low-fee regime will continue, issuers will gradually realise the side-effects of such deals as these sans commitment from the arranger to bring out the best possible outcome.

“Why would an arranger provide any aftermarket support if he has no fee buffer to dip into? We know that the quality of execution is not going to determine the chances of winning a follow-on mandate, so there is no reason to fret over quality service,” said another Mumbai-based banker with a foreign bank.

It may be a slow process, but issuers and arrangers alike have started to recognise the need to change the existing fee-income models and some corrupt practices of “cash back”, where a certain portion of the fee is returned to the issuer either officially or as a bribe.

“In choppy markets, issuers are beginning to realise the value of service of good arrangers and how they are ultimate losers if arrangers continue to work for them for free. Hopefully, this will change the issuers’ penchant for low fees,” said a banker with a domestic bank.

Winds of change are blowing with some positive shift seen in the state-run rupee bond mandates.

Rural Electrification Corp and Power Finance Corp are among a handful of issuers to have started paying fees, albeit small. For instance, REC paid fees of 3bp, 5bp and 7bp for three-, five- and 10-year paper, respectively, in a recent issue. The company raises a hefty Rs300bn annually from the rupee debt markets.

However, there are still some notorious issuers, such as Steel Authority of India and Power Grid Corp, which do not pay any fees. IDBI Bank also joined this team recently.

The fight of domestic bond houses against the stinginess of state-run firms was conspicuous in the last Steel Authority of India issue, where the largest steel maker in the country asked for commitments for its minimum Rs2.5bn fundraising. Underwriters were asked to bid at least Rs500m.

The company had to pull back the deal temporarily for few days after it did not receive any good response from the market. The reason was no fees and the company’s intention to raise the 10-year money at a really fine price of 9.0% – way below the 9.3% cut-off the market has expected.

Arrangers did not succumb to the issuer’s pressure tactics because they knew there was no money in the deal except in taking it up on its book at the right price.

Sail had to buckle and come back after three days at 9.3%, the price arrangers had sought. In the end, the company raised Rs4bn from the issue against expectations of Rs20bn–Rs30bn.

The writing is on the wall. Issuers and arrangers are becoming well aware of the change in market conditions. Domestic institutions are showing this prowess to change, gradually and steadily. SBI Capital Markets, the merchant banking arm of State Bank of India, is creating its own niche in the competitive arena.

SBI Caps has already established itself as the leading arranger on the loans side with the backing of a 300-strong team. Now, the arm has ventured into the fixed-income market with a 15-member team.

The outfit apparently is not banking on its parent’s balance sheet and is trying to create its own name by earning fees from the non-liquid (related to non-state-run corporations) segment of the market.

Even foreign banks, such as Credit Agricole, HSBC, Barclays and RBS, are playing the same tune of offering their expertise in lieu of some decent fees for their clients.

“The fee we earn is dismal, but it is better than not getting anything. At least, our airfare and some basic expenses are covered now. I am sure issuers will, in future, understand the importance of introducing some professionalism to this market,” said a Delhi-based banker.

By Manju Dalal, Senior Reporter

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