Private and investment banking: an unhappy union

Private banking clients often need investment banking services for acquisitions, divestitures, capital raising or restructuring, hedging and prime brokerage.

Historically however, the relationship between investment and private banking has been strained. Many opportunities to assist clients in meeting their investment banking needs – and hence for a bank to deepen its client relationships and earn more fees –have been lost.

This is especially true in “universal” banks, which have both investment and private banking divisions. While the focus here is on the relationship between investment and private banking, the same friction and lost opportunities equally apply to the relationship between the corporate and private bank.

In the case of private banks which are not part of larger institutions, and which focus exclusively on wealth management, in most cases clients have to take their investment banking needs elsewhere.

Some of these private banks have a list of select third-party investment banks on whom they have conducted due diligence and with whom they have entered into formal referral agreements. In most cases, the client is made aware of the agreement and independently selects one of the banks on the list.

Investment banking fees typically are based on size and complexity of the project and the referring private bank may receive 20 to 50 per cent of the investment banking fee. For a referring private banker however a bonus for the referral is usually discretionary.

Skin in the game

Where the industry has seen more success in referrals to and from private and investment banking has been in classic merchant banking boutiques where the partnership model forges much closer dialogue among partners and staff who all “have skin in the game”. This has led to the question whether synergy in the big universal banks is truly possible given “turf” and “Chinese Walls” issues. Ultimately, it boils down to the culture within the institution.

Within banks with investment, corporate, private and retail banking divisions, it is astonishing how few institutions have been truly successful in creating collaborative environments which encourage, recognise, and reward cross-divisional referrals. 

Worse are all the lost opportunities to enhance client relationships and generate higher overall revenues to the bank through cross-referrals.

The three principal reasons for generalised failure to bring private and investment banking sides of the business to work with each other have been:

• Lack of senior management support

• Failure to appoint credible senior management to lead the cross-departmental effort

• Failure to agree on revenue sharing

With respect to the first issue, senior management – at the CEO level – must proactively create collaborative culture within the organisation. Unfortunately, while the CEO may be supportive, internal political rivalries prevent the message from being delivered to the staff and, in many banks, senior investment banking managers discourage staff from “wasting time” working with private banking colleagues because deals may be too small. They often view private bankers with some measure of disdain.

Reciprocally, many senior private banking managers admonish staff referring business to the investment bank because they fear the investment bank will not compensate them for the referral or the investment bankers will damage the relationship with the client (private bankers often say they are “relationship-oriented” while the investment bankers are “transaction-oriented” and will not treat their clients well).

Private bankers complain that once they have referred their client to the investment bank, they are not advised of the progress of the transaction and are effectively shut out of the deal. 

While there are legitimate issues of regulatory “Chinese Walls” which may prevent the investment bank discussing what happens once the referral is made and a mandate is awarded to the investment bank, it is more a question of culture within the organisation that creates the walls rather than the regulators.

Unfortunately, the two sides of the business have historically not respected or worked well with each other. This doesn’t have to be the case and it is up to senior management to proactively and repeatedly deliver the message.

Some progress in building synergies and the right culture within larger institutions has been made through the following examples:

• A major global bank’s CEO has established a special bonus pool to reward staff for successful cross-referrals.

• The regional head of a global player has heads of private, corporate and investment banking on the executive committee draw up a list of business-owner clients in the region who may be prospective targets for all three divisions. He insists on disciplined joint calling by the combined teams, and reviews quarterly the results of the calling programme.

• The country head of a global bank’s subsidiary in an emerging country actively participates in joint calls with investment and private bankers on prospective clients. Where the good efforts often break down is when the in-country local team has to refer the business to the investment banking team in New York or London.

It is a matter of not only “talking the talk” but also “walking the walk”. Senior management must be seen to actively participate in joint calling.

Credible leadership

With respect to the joint venture leadership issue, banks which have tried to create synergies between institutional and retail sides of the business often put together task forces to execute the strategy, or appoint an investment banker to head up the private bank. 

All too often these efforts fail because the designated investment banker leading the effort lacks credibility within one or both teams: on the investment banking side because the assignment was an elegant way for management to deal with a unsuccessful investment banker or on the private client side because the investment banker just could not understand the dynamics of the private bank and dislikes and is disliked by its staff.

Credibility is paramount in getting buy-in from both sides and assigning the wrong person to bring the two together is a recipe for failure. Senior management makes the appointment, a task force is set up, within a year the effort is abandoned and the two sides of the business further reinforce their silos.

Good intentions for collaborative cross-division referrals very often fail because of  disagreements over fee sharing. Some banks have no fee sharing arrangements for referrals and take the view that internal cooperation is a “value” that doesn’t need monetary reward.

Where banks do have some sort of cross-divisional referral agreement, most private bankers do not know if they will be compensated for referrals and if they are, the bonus is traditionally discretionary. Where there is more clarity, the referral bonus can be up to 20 per cent of the investment bank’s gross fee but this will depend on the complexity and size of the deal and total bonus is often capped at a maximum of $500,000 (€450,000).

Cross-divisional fee sharing agreements are especially hard to execute where the transaction takes on a multi-jurisdictional aspect because of taxation issues. It may be more beneficial for a bank to capture and retain the fee in one country rather than make a transfer payment to a sister unit in another country. Needless to say, this leads to frustration for the private banker who is not rewarded for the referral.

In the case of one major bank, a global joint venture was created which combines investment and senior private bankers to focus on big family offices and billionaire clients. The fees are split 50-50 between the private and investment bank – regardless of size or complexity of the deal – and this unit is meeting some success, especially in Asia where so many entrepreneurs are both potential investment and private banking clients.

Education

A very important issue when trying to forge ties is training. Many investment bankers surprisingly have little understanding of the private client side. While most referrals are usually from the private banking side of the business to the investment bank, investment bankers who conclude transactions for business owners who receive significant cash and securities payouts rarely think about referring clients to their private bankers. 

Equally true is that for most private bankers, investment banking is a mystery and many private bankers who have tried to navigate the capital market side of the business have been embarrassed and frustrated because they do not know who to approach and how.

This is where training of how to identify potential opportunities for both investment and private bankers comes in.

Some private banking divisions of universal banks have formed their own “middle market” investment banking teams – and have had some measure of success – as they recognise there is a lot of opportunity in providing investment banking services-and benefitting from sale of divestitures for example – in the $50 to $1bn transaction size, below a typical investment banker’s thresholds. 

Other private banking divisions have engaged capital market specialists who have been successful in derivative structuring, a hedge against private client security positions and adds to the loan-to-value levels that banks will lend against. This has proven quite important for clients with concentrated stock positions in their own companies or in “exotic” securities markets where it is difficult to use these security positions as loan collateral.

So what are the criteria for successful synergies between private and investment banking?

First, for private banks not part of a larger organisation but who want to assist clients in meeting investment banking objectives, the solution is either entering into third-party agreements with a select list of investment banks and/or hiring an internal team of capital market specialists to assist private bankers in identifying potential investment banking opportunities and interfacing between external providers.

Preferably, if there is a fee-sharing agreement in place, this should be disclosed to the clients and the referring banker should receive a discretionary bonus for the referral.

For those private banks who are part of larger organisations, the following are recommended:

•CEO proactive endorsement of cross-

divisional synergy, setting specific targets for senior management team for collaborative efforts, and internal recognition – including bonus payments – for successful referrals.

• Appointment of credible senior executives to spearhead the joint effort.

• Training of both private and investment bankers in identifying cross-referral opportunities, especially with anecdotal examples.

• Fee-sharing (be they “hard” or “soft” dollar) arrangements, service level
agreements between the two divisions and clarity regarding potential bonus awards.

• Joint-calling between private and investment bankers on prospective target clients. This is especially relevant in emerging markets where the majority of businesses are family-owned.

• Quarterly (or monthly) local and regional senior management review of results of the joint calls. There must be a disciplined process with senior manager review to ensure success. Senior management participation on joint calls has proven very important both for the client and for the teams.

• Internal recognition – whether at Town Hall meetings or internal communication of successful collaborative efforts.

In conclusion, while the banking industry has seen progress in cross-

divisional collaboration, it is lamentable how few banks have been successful in what would seem to be such an obvious way of capturing client loyalty and generating important fees to both sides of the business. 

What is not lacking are examples of many past successes and failures; what has really been principally lacking is the fostering of the right internal culture for professionals to work together.   

Gerard Aquilina is an independent family office adviser based in London and was previously a senior leader with UBS, Barclays, HSBC and Merrill Lynch