Investment Banking III

Investment Banking III Fall 2012 Global Development Institute Okyu Kwon

Contents Ⅰ. Raised Issues Ⅱ. Trends of Global IB Ⅲ. Domestic IB -Current Status & Problems Ⅳ. Suggestion for Development of Domestic Investment Banks

Stage of development of the domestic financial system Stage 1 • External financing of enterprises mainly relied on • bank borrowings. • Interest was the bank's main source of income. Bank-oriented • Individual and institutional investors increased • their equity investment. • -Non-bank financial companies invented bank deposit-like • product such as MMA to compete with banks. • -Banks reduced traditional deposit-loan business and expand • IB business such as PI, securities underwriting, and asset • management. Stage 2 Market-oriented Korea now -Direct financing at financial market became main channel of finance for enterprises and financial companies. *Securitization of mortgage and retail loans became important financing tools for financial companies. *Firms rely on bond or CP issues rather than bank borrowing. -Banks move from traditional deposit-loan business and put more emphasis on IB business including PI, securities underwriting, advisory services, and asset management. Securitization -oriented Stage 3

Shrinking margins (NIM continued to decline) Foreign dominance in the IB market Track record shortage in domestic IB Status of the Korea’s financial industry Intensified competition in the banking industry Enlarged overseas competition ① ③ Lagged behind overseas expansion *Performance of overseas business -Total number of branches: 120 -Net profit: $ 500 million * Citi Bank: 9,000 branches, net profit $12 billion Herd Behavior Continued. Source of interest income decreased as loan demand decreased. Paradigm shift needed Rush of non-bank financial institutions ② ④ Lack of scale and efficiency Money Moves ! * From safe assets (deposits) to Risky assets (stocks, etc.)

Problems with domestic IB(1) There are many financial institutions doing investment banking business, but with small scale. - Bank: Size of total assets of Korea’s nine banks is about 1.4 times bigger than the global number 1 bank, but net income, equity, and market cap are significantly small. -Securities: Mostly compete in brokerage market, and short of efforts to develop its own sources of revenue. - Asset Management Company: Global market share is negligible. Domestic fund size compared to GDP is 20%, much less than that of US(70%) or UK(30%). (As of 2011, trillion won)

Comparison of Korea and the U.S. investment banking fee rate (Unit : %) 7.0 U.S. Korea 3.0 3.0 1.8 0.5 0.2 IPO Paid-in Capital Corporate Bonds Problems with domestic IB(2) Despite of securities underwriting market expansion, the minimal increase in fee income due to intense competition In particular, due to their homogeneous services, fee competition intensifies. Domestic securities companies are avoiding risks, while global IB actively collect, mitigate, and distribute risks by development of new financial products with ‘risk warehouse’ concept.

Problems with domestic IB(2) Shortage of supporting infrastructure such as credit rating, legal service, accounting service, etc. -Development of high-risk, high yield bond market is lagged behind. - Legal and financial services to support corporate and financial institutions are still not sufficient. Shortage of manpower with expertise - Investment banking area is in shortage of manpower with expertise. *Compared to global IB, compensation scheme is insufficient to attract overseas high caliber manpower. * Ranking of financial professionals in global competitiveness survey (IMD) -Korea ranked at 46, United States at 8, Singapore at 11, Hong Kong at 7, China at 51.

Contents Ⅰ. Raised Issues Ⅱ. Trends of Global IB Ⅲ. Domestic IB -Current Status & Problems Ⅳ. Suggestion for Development of Domestic Investment Banks

Global IB is likely to develop in Korea? To foster local IB that can compete with global IB is a difficult task. • HSBC and UBS were once local banks. → Their growth as global IB was through M&A. •On the other hand, Japanese banks, among the world's top 10 in the early 1990s, failed losing momentum to grow. Korea got a momentum to develop its own global IB considering three factors; (i)establishment of Capital Market Law, (ii)enhanced soundness and profitability of domestic financial companies, (iii)ever-increasing national wealth, and (iv)established framework to raise financial experts. Supporting innovative SMEs and mid-sized businesses Achieving economic stability & increased efficiency Developing domestic financial companies Leading financial innovation Banks, security firms, and the government co-lead innovation of financial industry.

(1)Capital Market Law provided legal framework for the development of investment bank Capital Market Law • Allowed investment banks to do business across the border • including wealth management, principal investment, securities services, and trust • except commercial bank and insurance business. • Adopted a negative system for financial products • - that can be diversified in derivatives such as CDS, CDO, emissions right, etc. Two years have passed since the law was enacted, but structural change through innovation is not yet realized.

(2)Increase in domestic wealth: $1 trillion should be managed by 2015 Increases in public sector funds Increase in pension fund Expansion of foreign exchange reserves (trillion won) 314 324 ($billion) 290 200 141 155 ‘03 ‘07 ‘09 ‘10 ‘03 ’12.7 Private sector funds also expanding - Corporate pension and other pension funds continue to rise. Size of domestic funds Insurance premiums received 198 (trillion won) 113 (trillion won) 129 71 ‘00 ’10.12 ‘04 ’10

(3)Framework for advanced financial specialist training Framework to train financial experts Status Financial sector and the government need to strengthen efforts to train financial experts. *Financial resources need to be mobilized for training. For example, Korea Exchange’s IPO can contribute to fund raising. A long-term plan need to be drawn based on the survey on the supply and demand prospects for manpower in financial sector. World-class MBA programs are necessary in finance such as KAIST Graduate School of Finance. *KAIST MBA program was selected among the top 100s in 2010. In Asia, only seven MBA programs were included. Financial companies need to attract top talented manpower. • Worker’s share in financial industry is low compared to that of developed countries. • * Korea, 3.5%, US 4.2%, Switzerland 5.2%, Luxembourg 18% (2010) • Theory-oriented education→Low utilization at working in the field • Focused on a simple task such as general business and sales. • *The proportion of simple tasks: • bank 92%, securities 67%, insurance 93%

Success factors of global IB Brand(Trust and reputation) People(Professionalism) Capital(Money) ▪ Big five U.S. securities firm: average wage was $340 thousand (2006) ▪ In Goldman Sachs, 150 nationality employees are working, and labor cost is amounted to 44% of total revenue. ▪HSBC fostered derivatives specialists (550 people). ▪ Big customers have deposited their wealth across the generations. *UBS: Family customer's average transaction period is 40 years. ▪ Goldman Sachs paid $11 million to SEC to maintain reputation due to conflicts of interest relating to analysis. • Global IB’s capital size is on average 10 times bigger than that of locals. • Goldman Sachs ('07) mobilized $20 billion for PEF, $145 billion for alternative investments (including hedge funds and commodities), $70 billion for capital replenishment. • IB’s revenue from PI takes up 1/3 of the total revenue. Global IB can strengthen competitiveness.

Review of key elements in IB • Core elements for success of IB's mission are capital power, risk management capabilities, financial expertise, network, etc., and these factors affect by integration rather than separately. • Since involving high-risk high-yield business, IB needs enough capital to take high leverage, appropriate risk management ability to distribute risks, product development and trading technique for hedging, and professionals to perform all of theses. • Unlike simple brokerage business, IB needs expertise not only in their own field, but also expertise in market conditions, investor networks for customer acquisition, as well as sales network to dispose of acquired securities. • In order to attract skilled personnel, IB needs advanced and reasonable pay system. • As products and markets are rapidly changing, IB needs flexible organization and thoughts to meet changes. • As IB’s works are connected each other in a series of tasks such as customer acquisition, pricing, sales, etc., IB needs IB culture in which the above key elements are operated in a comprehensive manner.

Key area of IB business(1)-IPO • IPO services are composed of pre-IPO stage services such as pricing, marketing, distribution of shares, etc. and post-IPO stage services such as price stabilization, market making, research, etc. • In the United States due to inelastic demand, the IPO commission rate is by 7% high compared to that in Europe, and is IB selection criteria include reputation, quality of service in post-IPO stage, etc. - This is because whether the IPO firm is included in the coverage of prominent analyst is much important than IB’s market making function or price stabilizing function. - Also the reason why there is a tendency to select multiple main underwriters is the benefit that in this case, the IPO company can have more chance to be included in the analysts' favorite stocks. - Therefore, in order to secure competitiveness of IPO business, IB needs to have excellent in-house analysts. • Regardless of IPO size, IPO business takes a certain fixed costs, meaning there is economy of scale. Therefore, large IB tends to focus on large size IPO. Thus, in case of small size IPO, extra compensation such as right to purchase issuer’s shares is given to the underwriter in addition to the IPO fee. • Unlike brokerage firms, banks have benefit to enter SMEs’ IPO market since banks can utilize customer information on SME through loan business, while brokerage firms can not utilize such information, and therefore they do not enter SME’s IPO.

Other areas of IB business(2)-Bond underwriting, M&A, PI, asset management Bond underwriting M&A • M&A brokerage needs to secure financial experts and trust with customers by long-term relationship. • - When there is M&A demand, IB needs capabilities to identify company's financial problems and provide solutions. • - In addition, IB needs capabilities to secure internal information by long-term relationships with companies, to read industry changes to which the company belongs, and to provide M&A synergy effect. IB’s expertise on financing and pricing is also essential. PI Asset management • Key factors for PI business are sufficient capital, efficient investment and risk management capability, and specialized manpower. • -Since PI is high-risk high-yield business based on the capital power and high leverage, PI requires investment professionals. • -In addition, professionals in risk management are necessary to manage market risk and liquidity risk through derivatives. • Since reputation is important in the field of asset management, BI needs to secure high caliber manpower and long-term relationships with customers. • - By recruiting high skilled personnel, IB needs to ensure professionalism on asset management. • - IB also needs to enhance customer profitability by providing new products and personalized services to meet customer demand. Corporate bond underwriting business needs to maintain long-term relationships with customers and to produce productive information. -Corporate customers, while maintaining long term relationships with a small number of underwriters, pay a low fee. - Underwriter can be mutually benefited by less expensive information cost due to long-term relationship with issuers. Companies in less exposure to capital markets or with low credit rating, tend to select commercial banks from which they get loans.

Review of IB development strategy • It is necessary to review the process in which leading IBs have evolved. That can be used as benchmark for IB development strategy. (1)Do we need to take organic growth or external growth? (2)Do we have to pursue professional IB or comprehensive financial group? (3)What is the development path of global IBs? (4)Medium size IB should take selection and concentration strategy. What would be the specialized business, specialized customers, specialized industry, or specialized region? • Banks and securities companies need to develop a step-by-step strategy for their own IB business by setting up visions and goals considering conditions they face. -To accomplish this, in the beginning, financial companies need to pursue domestic IB taking advantage of superior position in the domestic market and network. And then, they can expand in the future to cover Northeast region, and finally, they can enter global market. * All domestic financial institutions need not to be a global IB. Only a few leading financial institutions need to pursue a global IB strategy. • The basic strategy would be to aim at specialized IB based on professional manpower and infrastructure. After they get competitiveness, considering potential customers, profitability, and growth potential, they can pursue organic growth or M&A strategy.

Two track approach can be considered; - First track is the government sector in which KDB and Daewoo Securities merge and lead the IB industry. *These two firms have track record in research on industries and corporate financing, which are essential for IB business. *Maybe, another government securities company, Woori Securities can join together to increase he size. -Second track is the privatesector in which securities companies take the initiatives. *In this case, they have to construct international connection by jointly participating IB business with global partners. *For example, some Asia-Pacific IBs have incentives to invite Korean companies which have enough capitals, and Korean financial firms can accumulate their experiences in IB business. *Starting from the region and industry which we know very well, as experiences are accumulated, they can move to expand. -ICB strategy pursued by KDB seems not to fit well, since IB and CB business are totally different and therefore, difficult to be incorporated together within one house. *CB business by KDB may need nation-wide branches to get deposits, the lowest cost fund. Without it, KDB can not compete with commercial banks with high cost fund such as bond issue. In addition, KDB bond can not receive triple A rating after privatization.

1. Business Areas : • Specialized vs. • Advanced to wide range 2.Target Market: • (1)Region • (2)Target company • (3)Target industry Setting strategy 4. Growth Strategy: Organic vs. External 3. Organization Structure: Universal banking vs. Holding company vs. Securities firms Primary axis of the IB development strategy

Strategy(1)-Business Areas • Business areas should be set in the direction that based on SWOT analysis each financial companies maximize its strength and opportunities. - Though global IBs run business in all the areas of investment banking, they have some specialized fields where they have absolute advantage. * For example, Goldman Sachs showed strength in M&A and PI in particular since 1990s. * Lazard specialized in advisory services including M&A brokerage, corporate restructuring advisory, and asset management, and thanks to that, ranked at global top 10 with a relatively small size of capital. <SWOT Analysis of domestic financial companies>

Strategy(2)-Target Market • Global IBs are strong in big deal by taking advantage of global network where they have strength. -Global IBs take most of the deals in domestic companies’ foreign bond underwriting and overseas IPO. • In order to get comparative advantage to compete with global IB, domestic IB needs; (1)in terms of target company, to specialize in start-ups and SME with growth potential; (2)in terms of target industry, to specialize in IT, bio, pharmaceuticals, medical service, etc. which need industry expertise; (3)in terms of region, to pursue a strategy to cultivate skills in the beginning in local business, and then to expand to neighboring region where domestic IB knows well. <Examples of specialization in company size or industry>

Cohen & Steers Lazard FBR(Friedman, Billings, Ramsey, Inc) Business Specialization Case: Lazard, Cohen & Steers, FBR Late-comer IBs specialized in their business. • -Ranked at the 10th in global M&A in 2011 with total asset size of $107 billion. • Beginning from food company→ entered banking(1876)→specialized in three areas; • M&A advisory, corporate restructuring advisory, and asset management. All the areas • are linked with advisory service and therefore, synergies can be exerted. • -Ranked at the 1st in the US real estate management sector. • Operating real estate fund in 1986 → developed to a real estate IB in 1989 • → built a global network on real estate sector. -Per capita net income is bigger than Goldman Sachs’. -Specialized in research and brokerage of real estate in 1989 → expanded to home mortgages and MBS.

Business Specialization Case: Jefferies & Co., Thomas Weisel Partners -Jefferies & Co., started in 1962 from one person, targeted SMEs and succeeded to secure many customers by strengthening network and research capabilities. -This company provides differentiated services in the way that CEO interviews customers directly and manages the progress, etc. -In addition, they strengthen expertise by employing professionals laid off from large IBs. -Thomas Weisel Partners, founded in 1998, is a small IB with asset size of $300 million. In order to enhance expertise, they specialized in IT, medical industry, and consumer goods industries. *They have grown by focusing on underserved emerging IT companies. When customer base became weak with the collapse of the IT bubble, they added medical and consumer goods industries. -Selection and concentration in a particular industry was their strategy. To build network, they strengthened expertise by hiring industry professionals, and to provide differentiated services, senior executives participated in all the deals and the customer's long-term development plan.

Strategy(3)-Organizational Structure • Three different organization structures-universal banking, holding company’s subsidiary, and sole IB-have their own advantages and disadvantages. Therefore, each financial company should select its own structure considering existing competitive factors and potential changes in regulatory framework for IB. • In Korea, commercial banks mostly involve IB business through subsidiary, and securities companies directly carry IB business, while KDB and overseas business of commercial banks select internalized IB section. <Comparison of advantages and disadvantages among organizational structure>

Case(1)-Sole IB: Goldman Sachs • Global equity underwriting and M&A market are mostly taken by sole IB and holding company’ subsidiary IB, of which the latter intensified its IB business to make up losing growth base of CB business due to spreading disintermediation phenomenon. • Goldman Sachs, started as cp dealer, has grown as global leading IB thanks to its quality management, risk management capabilities, new business expansion, etc. -In 1940s, GS became famous as a pioneer of risk arbitrage by investing heavily in acquired companies by M&A. <Growth path of Goldman Sachs> 1869 1900s 1970s 1980s Started and pioneered CP market Pioneered IPO market Developed hostile M&A defense strategies Leading overseas expansion and privatization market

Case(2)-Holding company group: Credit Swiss • Holding company groups are superior in bond underwriting market, since bond business and loan business have similarity and they have advantages in capital mobilization capability.Thus, in bond underwriting market, holding company groups have comparative advantage due to ample experiences in lending business, strong network for big companies as well as SMEs, and vast capital base. • CS, started as a commercial bank in 1856, has grown as a global IB with acquisition of First Boston and DLJ. -Since DLJ has high expertise in the bond business, its acquisition contributed to enhance CS’s competitiveness. <The growth path of Credit Suisse> 1940 1856 1978 1988 2000 Acquisition of First Boston Established as a commercial bank Strategic partnership with First Boston, an IB Acquisition of investment bank DLJ Established its first overseas branch in New York

Strategy(4)-Growth Strategy -Growth strategy can be divided by (1)organic growth strategy, (2)M&A strategy, and (3)mixed strategy of both. *Growth strategy needs to consider various growth goal including expansion of existing IB business, entering new IB business, pioneering new overseas market, potential synergy effect with existing business area, etc. <Advantages and disadvantages of organic growth and M&A>

<A Variety of Growth Strategy Cases of Advanced IB> 1933 2000 2004 JPMorgan and Morgan Stanley separated. (Glass-Steagall Act) Chase Manhattan’s acquisition of JPMorgan (IB business reinforced) Acquisition of Bank One (card business reinforced) 1988 1999 2000 2001 2003 Merged Warburg (IB business reinforced) Acquisition of SLC(asset management) Acquisition of Volaris (investment advisory) Acquisition of First Boston (IB strengthened and entered the US market) Acquisition of DU (strengthened high yield bond underwriting) 1906 1970 1986 1990 Specialized in IPO Add bond business Add asset management Strengthened M&A business and overseas expansion

Case(1): Organic growth- Australia's Macquarie The growth path of Macquarie • Organic growth is a self-development strategy through pioneering new markets. It has advantage in maintaining its own company culture and technology, but disadvantage at the same time for latecomer difficult to grow rapidly and risks to fall into mannerism. • Macquarie has grown as Asia's leading investment bank from Australia. Without extensive M&A, it pursued organic growth strategy aiming at infrastructure funds and real estate, a niche market other financial companies overlooked. 1985 1994 1996 2005 Listed ) Organizational Structure of Macquarie Group Macquarie Group A large increase of capital Entering banking business Pioneering infrastructure fund Macquarie capital Bank, securities Real estate Fund, etc. Advisory, PEF, underwriting, etc. Retail banking, IB, Credit card Fund, Devlpt financing. Asset size $A24 bil. (‘07) Asset size $A 64.4 bil. (‘07

Investment Bank • (Corporate, IB) • Asset Management • (Private clients and Asset Management) Case(2): External growth-Deutsche Bank • Securities and investment advisory • Corporate finance and trading • Net revenue of €14.6 billion(2007) • - Pension funds, real estate • Mutual funds, etc. • Net revenue of €7.6bil. • (2007) The growth path of Deutsche Bank • Deutsche Bank • External growth is a strategy to absorb other company's know-how and network through M&A or business partnership in a short period of time. It is advantageous for latecomer necessary to grow fast, but without chemical bonding through coordination, difficult to achieve synergies. • This strategy is mainly undertaken by commercial banks which started investment banking late. In 1995, Deutsche Bank declared transformation in order to improve profitability through strengthening investment banking sector, and overcame limitation of the profitability of loan business. 1995 2006 1870 1999 Organizational Structure of Deutsche Bank • Corporate Investment Merged Bankers Trust Merged United Financial Established commercial bank Declared to transform to IB • Venture capital and real estate • Net revenue of €1.35 billion(2007)

Strategies suggestedfor brokerage firms and banks Securities Given the pros and cons by growth strategies, brokerage firms and banks can adopt the following strategy. -Large brokerage: Since there is a limit to take organic growth strategy by using internal reserves or paid-in capital, it is suggested to take overseas M&A strategy. -Small and medium-sized securities firms: It is suggested to specialize in niche market IB targeting SME, venture capital, etc. Banks or holding company -Within a holding company system, it is suggested to strengthen collaboration between bank and securities. -It is also suggested to expand high value-added business such as advisory service including M&A advisory, securities investment, and derivatives trading, all of which are allowed under current laws, and to enhance risk management. -It is suggested to strengthen links with other IBs in terms of product selection and manpower training.

Target business areas and target markets -Domestic financial firms and pursue a variety of strategies depending on what is their long-term vision. (1)If the goal is to be a global player for specific business areas, they can take a strategy based on the strengthened competitiveness in that business area, to expand target market from domestic to region, and then to global market. (2)If the goal is to be a regional IB providing comprehensive IB services, they can take a strategy to expand business areas, but at the same time, limit target market within domestic and region. (3)If the goal is to be a comprehensive global IB, they can take a strategy to expand business area and target market at the same time, but in a step-by-step manner. • In terms of organization structure, considering synergies with existing resources, they can internalize IB business at the beginning, and then spin off during the process of step-by-step expansion of business areas and target markets. - In case of overseas expansion, they have to think about various options such as opening of branch office, establishment of subsidiaries, establishment of joint venture, or M&A of local financial companies, considering their positions in the surrounding environments.

Organizations: internal department vs. subsidiary Achieving the vision <Growth phase> Expanding business areas and target markets Area Formulation and implementation of growth strategies Area <In early stage> Business areas and target markets Industry Firm Size Strategies by the phase of growth Industry Firm Size Expansion of the organization: internal dept.  domestic and foreign subsidiaries or M&A Task Task

Overseas expansion strategy • Intensifying competition due to domestic market saturation and foreign • company’s penetration after market opening. • Distribution of risk is required due to derivative expansion and • increase in short-term foreign currency assets.. • Shrinking net interest margins and decreasing loan growth as GDP • growth rates going downward. • -Upward trend in funding costs due to increased consumer sensitivity • to interest rates •  It is necessary to excavate overseas market as well as domestic • to secure stable revenue base. Necessity Capacity -Domestic financial companies face a limitation as a latecomer such as disadvantage of scale, insufficient localization, lack of professional manpower, shortage in R&D capabilities, etc. -Overseas expansion is biased to several regions such as Vietnam. • -First of all, it is important to strengthen core importance. • *KB has comparative advantage in retail banking and IT base. • -Globalization is necessary particularly in manpower training and research capabilities • -Selection of target markets and business areas is important. • *Target market could be a region where there is relatively low presence of global IBs and at the same time, we are familiar with such as provincial regions of China, Southeast Asia, CIS, etc. • Various options are to be reviewed as entry methods such as branch/ subsidiary/ strategic alliances/ JV/ M&A, considering risk tolerance levels and required speed of localization. • Cooperation with global financial institutions should be actively pursued including M&A by consortium. Overseas expansion strategy

Overseas expansion of global IBs Goldman Sachs - While strengthening business in BRICs, GS pointed out so-called "Next 11" countries as promising areas. *Next 11countries include South Korea, Indonesia, Mexico, Turkey, Bangladesh, Egypt, Iran, Nigeria, Pakistan, Philippines, and Vietnam Citigroup • Citi classified more than 100 countries around the world into three groups, and among them, focused the following 13 countries. • Mature(4countries) : Steady economic growth, strong competitive edge, and low country risk • * Germany, Japan, Spain, United Kingdom • Growth(5countries) : High economic growth, expanding middle class, and the middle level of competitiveness and risk • * South Korea, Brazil, India, Mexico, Poland • Emerging(4countries) : High economic growth, the middle class emerged, high portion of state financial institutions, and high country risk • * China, Indonesia, Russia, Turkey

Latecomer's successful overseas expansion - Santander -Through the acquisition of Banesto Bank in 1995, Santander became the largest bank in Spain.  Since 1996, with small capital, Santander acquired small and medium-sized banks in Latin America where the same Spanish language was used.  Through this, Santander achieved two goals, i.e. establishment of network and distribution of risks.  Immediately after Santander can build up local management expertise, they began to merge large banks.  Santander became the South America's largest bank, and expanded acquisition in Eastern Europe. -Santander’s success factor in M&A is that; (1)Speed of decision making was very fast by centralized and simplified system in major management activities such as M&A. (2)In top management, M&A experts were placed. (3)Headquarter thoroughly analyzed credit risk, and maintain enough fund necessary for M&A. <The history of Santander Bank’s M&A> 1994 2000 2004 2007 Acquisition of Banesto Acquisition of Banespa Acquisition of Abbey National Partial acquisition of ABN AMRO Santander, the 5th largest in Spain, became number 1 by acquisition of Banesto Bank driven into bankruptcy. In 1995, it jumped to the world’s top 65th. Since 1996, Santander landed in Latin America by acquiring SME size local banks, and built its presence in Latin America with the acquisition of Banespa, a large Brazilian bank. In 2000, it jumped to the world's top 36th. Santander built its British network through a long-term strategic partnership with RBS, and became the world's top 12th by acquisition of Britain's Abbey National which had recorded deficit after the failure of Enron. Santander, with RBS, succeeded in acquisition of ABN AMRO, which was at the 13th in the world, but facing difficulties due to financial crisis. In 2008, it jumped to the top 9th by absorbing ABN AMRO’s Brazil and Italy sector.

<The history of Santander Bank’s M&A> 1994 2000 2004 2007 Acquisition of Banesto Acquisition of Banespa Acquisition of Abbey National Partial acquisition of ABN AMRO Santander, the 5th largest in Spain, became number 1 by acquisition of Banesto Bank driven into bankruptcy. In 1995, it jumped to the world’s top 65th. Since 1996, Santander landed in Latin America by acquiring SME size local banks, and built its presence in Latin America with the acquisition of Banespa, a large Brazilian bank. In 2000, it jumped to the world's top 36th. Santander built its British network through a long-term strategic partnership with RBS, and became the world's top 12th by acquisition of Britain's Abbey National which had recorded deficit after the failure of Enron. Santander, with RBS, succeeded in acquisition of ABN AMRO, which was at the 13th in the world, but facing difficulties due to financial crisis. In 2008, it jumped to the top 9th by absorbing ABN AMRO’s Brazil and Italy sector.

1. Securing professional manpower 2. Advancement of risk management 6. Enlargement of size Enhancing Competitiveness of Investment Banking 3. Establishment of an advanced compensation system 5. Enhancement of organizational flexibility 4. Expansion of domestic and international network Strategies to enhance competitiveness of IB

Strategy(1)-Securing professional manpower Composition of staff by countries(%) -Proportion of professional manpower in domestic financial institutions is significantly low compared to that of the financial hub competitors. Domestic financial institution’s retail banking-oriented business is another cause. -Absolute lack of professional manpower is difficult to be resolved by way of scouting experts from other financial companies.  Internal training system of the financial companies as well as state or private sector’s professional training programs are needed to develop. Examples of IB specialist training programs

Composition of staff by countries(%) Source: Bank of Korea Economic Research Institute Examples of IB specialist training programs Source: Literature search, Orbis, Each agency website

Strategy(2)-Advancement of risk management & (3)Establishment of advanced compensation system (2)Advancement of risk management • Risk management is a key factor of successful IB business considering high risk high yield factor as well as high leverage. - To this goal, it is critical to establish a computerized risk management system and a separate department independent from sales, and to secure professionals manpower. • In particular, as risk-based derivatives are inevitable to expand, it is essential to secure professional staff to handle it. (3)Establishment of advanced compensation system • Advanced compensation system is necessary for professional workers to exert their ability as much as possible. -Since in developed countries, excessive compensation linked with short-term performance evaluation is causing problems in financial institutions where public money is injected, it is necessary to develop a compensation system linked with medium-term performance evaluation. Proportion of fixed salaryProportion of incentive (%) Domestic brokerage firm A 69.6 30.4 Goldman Sachs 1.6 98.4

Strategy(4)-Expansion of domestic and international network -As Korea turns from a country in capital shortage to one in capital surplus, it is important for domestic financial institutions to move from buy side business to sell side, but they are not ready yet. * The proportion of domestic banks' overseas earnings(2010, %): Korean banks’ average 3.2, UBS 73, HSBC 68.4, Citi46.8, DBS 38.2, RBC 32.8 -Global financial companies secured Korean network through partial or whole shareholding in domestic financial companies. * City-14.71% of KB, BNP Paribas-9.06% of Shinhan Bank, Allianz-9.62% of Hana Bank, etc. -On the contrary, domestic financial institutions are still adopting organic growth strategy, which simply means expansion of branch offices to support domestic firms’ overseas business. *There are several cases of overseas share acquisition. Some of them turned out not so successful. For example, KB’s selling 25% stake in BII of Indonesia and purchasing 40% stake of BCC in Kazakhstan was a bad choice since Indonesia has much potential. KIC’s investment in Merrill Lynch reached $2.1 billion, but mark-to-market value is less than 50% of its investment. *However, domestic financial institutions are making efforts to establish network for meet further expansion of ever-increasing overseas investment demand. -It is true that basic works of IB business including M&A, underwriting, PEF, IPO and consulting, are all starting from a network. (1) Therefore, large banks need to expand acquisition of stake in overseas financial institutions; (2) As Korea's surplus capital continuously need to outflow, global IB will join further Korea’s asset management market, and Korea’s financial institutions will have more chance to strengthen their network with these global IBs. (3) As network can start from training programs, Korea can provide co-education opportunities for people from our target countries to study at MBA programs in Seoul, which will be beneficial for both. *For example, KAIST Graduate School of Finance provides excellent professional programs for finance people.

Strategy(5)-Enhancement of organizational flexibility & (6)Enlargement of size (5)Enhancement of organizational flexibility • It is important to give flexibility to organization and manpower management for financial firm's investment banking business to meet with changes in customer’s demand and to cope with changes in financial market. • Long-term based performance evaluation system is essential to foster investment banking business. (6)Enlargement of size • Domestic financial firm’s size is too small to compete with global IBs in terms of equity, asset size, and manpower. • For IB business, it is important to raise financial firm’s size in order to take advantage of superior risk management and high leverage, domestic financial companies need to enlarge their size by aggressive M&A, etc.

The role of government Track 1: Government sector -A leading IB can be established by merger of government owned financial institutions, such as KDB, Daewoo Securities, and Woori Securities. -These companies have better experiences in IB business and due to government’s back-up, they can lead the market. The government needs to take a strategic approach. Track 2: Private sector: two step approach is essential. • -Step1: Itis necessary to improve market structure by strengthening market discipline. • Promoting competition is essential by providing incentives to voluntary merger and capital increase and strengthening market discipline. Through these measures, weak securitycompanies will be weeded out and competitive companies can have a chance to lead the market, and eventually to develop to a leading IB. • * Through competition mainly among financial holding companies and independent brokerage firms, strong growth incentives will be given. Core strategy is to remove obstacles to competitive business. • Step2: A differentiation strategy is necessary between large and medium-sized IB. • Large IBs need to meet different capital requirement regulation according to business boundary. • Specialized brokerage firms need to focus on core competence instead of diversified department store style business boundary. • Medium-sized brokerage firms are to be allowed to maintain retail business, but the government license system should be operated flexibly.

Role of the government As-Is To-Be Hedge funds Business differentiation according to size Focused on retail brokerage. Everybody is doing same thing. -Lack of market discipline in underwriting • Focused on corporate financing • Underwriting • Arranging IPO • M&A advisory • Prime brokers • Hedge fund management Track 1 Large IB Public enterprises merger Enlargement Voluntary M&A and capital increase Specializa -tion --Capital regulation-- Specialized corporate financing -Underwriting -Hedge fund management -Other retail business Specialized IB Specializa-tion Free competition --Capital regulation- Low-riskBusiness Focused on retail banking -Retail brokerage -Asset management -Other limited business Track 2 --↑↓Entry & exit-- • Step 2 Policy • - Dual prudential regulation • - Allow lending business to IB • Enhance competition in brokerage market • Rearrange license system Step 1 Policy -Rearrange prime broker system -Strengthen market discipline (to promote competition). -Rearrange other market institutions Step-by-step policy issues

Treasury Secretary Hank Paulson (Mar 2006) “Because of China's underdeveloped financial system, Chinese people can only earn annual return of 2.5% on their $2 trillion savings, which will stop at $4 trillion in 30 years even on compounded basis. But if there is highly developed financial market that can return 8% on annual average, then the amount can be raised to $20 trillion. " He emphasized that ineffective and closed financial market cost average Chinese saver big sacrifice.

Thank you

Investment Banking III