LE PRIX FIXE
Despite a few recent high-profile fee cuts, real competition among Asia's investment banks on deal fees is still only a mirage.
By Jasper Moiseiwitsch

The relationship between Asian CFOs and their investment bankers has always been something of an uneasy détente. The special conditions of Asia - high sovereign risk premiums, fickle institutional investors, and the fact that the major banks are from the world's money centers in the US and Europe - mean that finance managers here pay a lot more for their money than CFOs in the banks' home markets.

Add to this constant burden high corporate finance fees that barely differ from bank to bank. Then, starting in March, everything seemed to change. A few high-profile transactions hit the market with fees at bargain rates. Have banks finally taken the prix fixe off the menu?

The answer, according to CFOs and CFO Asia's research, is no. Commissions on most instruments for most markets have shown a strong resilience. The recent cuts are turning out to be the exceptions that prove the rule.

Some recent exceptions include a bond issue in March by the Republic of Philippines, which reportedly paid its brace of bankers a gross spread of 32.5 basis points for the service - six months ago that same deal would have been done at about 60 basis points. A Federation of Malaysia bond was issued at about the same time for an equally cut-rate commission.

And then, in April, the Hong Kong utility China Light and Power released a ten-year bond, paying its bankers a miserly 25 basis points of the proceeds - a deal that would normally be done for about 45 to 50 basis points. Sources say banks were keen to do the CLP deal, as the A+/A3 credit was sure to be well received by investors.

One senior banker describes the price cutting as controversial, while another labels the recent fee pressure as "irritating and frustrating". Yet another warns gravely: "Once you start cutting fees there is only one way to go."

Adds Paul Smith, head of Asian bond/loan syndicate at Deutsche Bank in Hong Kong: "[Fee cutting] is not positive for the industry. These deals require a lot of resources. There is a lot of behind-the-scenes work. In the end, sales desks have to get paid and they have to be motivated."

Intriguingly, no one wants to be identified as the bank that's behind the cuts. The bulge-bracket firms tend to blame the second-tier banks, suggesting that diminished fees equate diminished service. But, along with HSBC in Hong Kong, US investment banks Salomon Smith Barney (SSB) and Morgan Stanley led the CLP deal, and these two houses are firmly bulge-bracket. The Philippine bond involved most of the major players in Asian debt markets.

Holding Hands

The idea that corporate finance fees are in decline for some markets and a handful of well-regarded issuers begs the question: have the fee structures for the array of these services in the past been largely fixed? It is a controversial point but it is supported by many with direct knowledge of the way banks operate. "There are certain norms of what the fee structure will be," says SingTel's CFO, Chua Sock Koong, who has overseen several international transactions. Adds a former Hong Kong-based equity analyst with a large US investment house: "I don't think there is competition [among investment banks] on pricing [for their corporate finance services]. I think it is pretty much standard. Essentially the industry structure is an oligopoly."

And then, adds Martin Cubbon, group finance director for Hong Kong conglomerate Swire Pacific: "You look at the fees for debt and equity issues. Why are they broadly the same by security type?" He adds: "If you were to go to HSBC, JPMorgan, Salomon, Merrill, CSFB, Goldman, they would all charge the same [fees]. Which is strange - almost cartel-like, you might say."

Indeed, cartel is the word on the tip of everyone's tongue - either to assert that one exists, or to deny, unprompted, that it does. Bankers interviewed for this story generally agree that there are certain fee "norms", that vary according to a company's credit rating, deal size, instrument, tenor, market and the overall complexity of a given transaction. So, 30-year bonds carry a steeper fee than their ten-year equivalents; IPOs are more expensive than follow-on issues, and so on. But within a category (US-dollar, ten-year bonds issued on behalf of an investment-grade company, for example) fees tend to be consistent.

Bankers discuss fees in terms of the industry's pricing "precedence" for its services, or in terms of "benchmarks", et cetera. They all deny, however, that there is any aspect of collusion among the large banks in their fee pricing.

Says one Hong Kong-based head of a large US investment bank: "This is about the most uncoordinated industry there is. I spend zero percent of my time talking to my counterparts in other firms in terms of their strategy and pricing, or fees."

Nevertheless, a review of large (US$300 million-plus) US-dollar denominated ten-year bonds issued over the past year shows a steady fee pattern: most of these deals cluster around the 45 to 50 basis point range. The one glaring inconsistency is the United Overseas Bank bond issued by JPMorgan for a derisory spread of ten basis points.

Market insiders suggest that the UOB deal was part of a package of corporate financing work done on behalf of the Singapore bank at that time, during which JPMorgan was arranging the funding of UOB's US$10 billion acquisition of Overseas Union. Known as 'relationship pricing', JPMorgan - which will not comment on its fee policies - might have offered a deal on the UOB bond for consideration of fees earned on other transactions spun out of the merger process.

The same goes for equity. Banks traditionally issue euro-convertibles for a commission rate of 2.5 percent. Jay Ritter, Cordell professor of finance at the University of Florida, and an expert on investment banking practices in equity markets, says that, historically, main board listings in Hong Kong have gone for a 2.5 percent gross spread. Interestingly, he says that since 1999 that figure has been rising - this despite feeble equity activity in the region. He adds that he finds consistent IPO fees across most Asian markets, with the exception of Australia.

But Asian CFOs should consider themselves lucky. US markets show even greater rigidity and stateside IPOs are much more dear. Says Ritter: "In the last six months, every IPO in the US that has raised between US$20 million and US$150 million has paid a gross spread [fee] of exactly 7 percent.".

Ready? Steady

So clearly, not withstanding the recent fee compression witnessed in Asian debt deals, CFOs are confronted by rather sticky cost structures for their corporate finance work. Assuming that there is no price-fixing or related collusion among the big investment banks, the question becomes how these institutions are able to keep their fees steady.

Discussion of fee structures focuses on the competitiveness of the market for investment banking services. Specifically, the industry is at the last leg of a long consolidation process - a fact seen in an ever-increasing list of names appended to an ever-decreasing list of investment banks. What is now known as JPMorgan Chase used to be Chase, JPMorgan, Robert Fleming, Jardine and H&Q. What is now Salomon Smith Barney (SSB) used to be Salomon Brothers, Smith Barney and the investment banking arm of Schroders. SSB itself falls within the Citigroup fold, which also encompasses Travelers Group.

As finance becomes increasingly globalized, companies need banks with a global presence and distribution reach. Only the largest institutions can manage this, just as only these have the balance sheet to underwrite the bigger deals. Which is why one sees the same names (typically American) associated with the grander issues.

And then within the dwindling investment bank ranks there is wide degree of cooperation. For example, in debt markets, Smith of Deutsche Bank notes that there has been a growing trend over the past two years for the appointment of two to three joint-lead managers. He says this has created greater awareness of fee relativities between the houses. Says Smith: "Usually the fees for executing the deal are agreed among the joint leads and the issuer, at a single level, despite each bank having perhaps proposed different fee levels for that deal."

And then after joint leads are established, deals are typically divvied up among many banks in a syndication process. David Webb, the Hong Kong-based editor of Webb-site.com and founder of Hong Kong's Association for Minority Shareholders, says the process brings the banks into what could be politely described as a confluence of interests. He says: "In large syndicated deals, a lot of the big players will be involved in each deal. There is an understanding of reciprocity between the syndication desks. You would be shunned if you undercut other banks on fees just to win a deal."

More disturbingly, one Hong Kong-based investment banker says that, in his long career, he has seen cases of outright collusion. "In good times, [when] they are unable to cope with so many deals, it's definitely a case of, you scratch my back, I'll scratch your back," says the banker. "[They say] I'm not going to upset you, I'm not going to come in and cut your fees, but you bring me in as joint lead," he says.

Equity markets are not much better. Banks also typically cooperate in the larger issues through the co-underwriting process. To the extent that a bank is likely to participate in a given transaction, it would be illogical to undercut competitors' fees. Where a bank drives down competitors' prices today they might find their own co-underwriting spreads diminished tomorrow.

There are also only a handful of banks that can reliably manage an IPO. It is a difficult process: bankers must introduce and then sell unknown companies through exhaustive road shows and hundreds of phone calls to a globally dispersed investor base.

This difficult and valuable service commands a price, which is why American listings earn such a healthy commission. Says one Hong Kong-based investment banker with a large US house: "The equity decision is much more complicated [compared to debt financing]. The fees will hold up because there are fewer firms that can do it credibly. If you screw it up, you (the CFO) have to answer to your board of directors."

But the banks are offering more than just expertise in the listing process. They push important levers with their research function and with their matchless access to investors - two aspects of the investment banking system that have come under intense scrutiny in the US in the past two years.

Companies have largely ceded control of the distribution process to the banks. Part of this is logistical. No company wants to hire a full-time team of IR officers to market to global investors whenever a deal comes up. The banks handle this function well. They have relationships and reputations that allow them unique access to investors. But there is an inherent conflict of interest in this dual role. Banks on one hand need to serve the best interests of their corporate clients, but they also have to keep their investor base happy, to ensure an ongoing relationship. And this conflict keeps revealing itself.

For example, CSFB recently paid a US$100 million settlement following a year-and-a-half long investigation into its practice of allocating shares during the tech bubble. The US Securities and Exchange Commission and the National Association of Securities Dealers accused the Swiss bank of making preferential allocations of hot issues to favored investors, in return for a share in their profits. That settlement follows the launch of many investor class-action suits that allege similar practices at other banks.

In Asia, following our own Internet boom and bust, bankers were quick to deflect responsibility by saying that investors demanded allocations from them. The matter points to the black-box manner by which investment banks build their books in the issuance process. No one outside the inner circle knows what goes on between the investment banks and the largest institutional investors. It is one of the most secretive and opaque sets of relationships in the industry. But there is huge scope for conflicts of interest.

As the CSFB case suggests, the banks have powerful control over investors in the allocation process. If favored clients on a bank's distribution list become too fussy about the investments they take, the banks can sideline them on the next big deal. Liu Chee Ming, the managing director of Hong Kong investment house Platinum Securities and a former senior banker with Jardine Fleming, says there is nothing new or shocking about this idea. "Of course we have so-called hot deals, which investors A, B and C will take. Come the less hot deals, investors A, B, C will also be taking them. Now they might not take them. Then the next time we will not be giving them as much allocation," he explains. The control banks have over research and their unparalleled investor access both speak to the same issue: companies have only one road to capital markets, and it passes through a limited number of investment banks. And the greater the control these institutions have over the investment process, the more effective they are in propping up fee standards.

No Fuss Fees

But perhaps this is all too cynical. CFOs generally praise the work of their investment bankers, and publicly tend not to make too much of a fuss about fees. And the banks can point to many companies that have clearly benefited from their efforts. SSB single-handedly rescued the Korean semiconductor outfit Hynix last year, with exhaustive restructuring work and capital raising. UBS Warburg independently thought up Pacific Century CyberWorks' (PCCW) acquisition of Cable & Wireless Hongkong Telecom - and PCCW chairman Richard Li has a lot to be thankful for on that deal. And then there is just the everyday, plain-vanilla deals that the banks do on behalf on Asian companies and countries, providing the capital and direction that underpin regional economies.

Cubbon of Swire applauds the work of his investment bankers. He says they provided guidance on pricing, documentation and deal structuring on recent deals that he could not have managed with his in-house team alone. Nor does he complain about the fees he pays these banks. "I honestly don't have much of a beef with the process of issuing debt securities and what investment banks get for it. There is a skill applied there which we simply don't have," says Cubbon.

China National Offshore Oil Corporation (CNOOC) CFO Mark Qiu likewise notes that corporate finance commissions are generally lower in Asia than elsewhere and - what must be words of delight for bankers - he says he does not press the investment houses on their fees. "My philosophy is that to get true quality [in execution] you need to pay the market rate. I'd rather go to someone who is committed to putting the highest quality people on the case. I'm willing to trade some basis points for that instead of going for a cheaper proposal and later finding that inexperienced people are working on the deal," says Qiu.

It is worth noting that Qiu is a former SSB energy analyst, and might be inclined to a sympathetic view of his former banking colleagues. He also has reason to be appreciative. CNOOC executed a US$1.4 billion IPO last winter amid tough market conditions. Its bankers - CSFB, Merrill Lynch and Bank of China International - managed the listing despite a failed first attempt by SSB two years earlier.

But the concern is not so much with the cost or quality of the banks' services - although there are many examples of ill-advised or just plain greed-driven deal making (read: Internet bubble). The concern is over why fee costs do not show more flexibility. For all the banks' rhetoric about the supremacy of the market, the market for their own services functions poorly.

The issue keeps coming back to the lack of competition among the houses. The syndication and co-underwriting process requires that the banks collaborate on the bigger deals, which conditions them to support each other's fee structures.

And then there is the matter of the number of banks - there are too few of them. True, debt market fees have come under pressure in recent months. Good news, perhaps, but Qiu of CNOOC says the long-term implication of declining fees in Asia is the exit or merger of many smaller banks. He says he has witnessed the departure of a number of "spoiler" houses, or those that were prepared to underbid the large banks in their deals. The limited competition we are seeing now just might mean stiffer fees in the near future.

Jasper Moiseiwitsch is a contributing editor at CFO Asia based in Hong Kong.