Module III·Article V·~3 min read
Investment Banks and the Sell-side
Brokers, Dealers, and Market Makers
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Investment banks: the sell-side of the financial industry Investment banks occupy a central place in the financial system, acting as intermediaries between issuers and investors, providing market liquidity, research, and consulting services. Understanding the business model of investment banks helps assess their role and interaction with other market participants.
Main Activities
Investment Banking Division (IBD) deals with corporate finance: organizing IPOs and secondary offerings, issuing bonds, providing advice on mergers and acquisitions (M&A). Revenues are generated from transaction fees — typically a percentage of the deal amount.
Sales & Trading provides client trade execution and proprietary trading. Sales specialists maintain relationships with institutional clients, transmit investment ideas and orders. Traders execute orders, manage positions, and risks.
Research — analytical studies of companies, sectors, and macroeconomics. Equity research offers recommendations on stocks (buy/hold/sell). Fixed income research analyzes credit risks and relative value of bonds. Research is distributed among clients and serves as a way to attract trading business.
Conflicts of Interest and Regulation
The traditional model created conflicts of interest. IBD is interested in positive recommendations for shares of clients-issuers. The trading desk may trade against client positions or use information about client orders. Chinese walls — information barriers between divisions — are designed to prevent abuses. IBD employees should not share insider information with traders. Analysts are formally independent from IBD.
Reforms after the 2000s (Global Research Settlement in the USA, MiFID II in Europe) tightened requirements on research independence, conflict of interest disclosure, and separate pricing for research and execution.
Prime Brokerage
Prime brokerage is a set of services for hedge funds: clearing and settlements, asset custody, financing (margin lending, repo), securities lending, reporting, and operational support.
The prime broker — hedge fund relationship is mutually beneficial. The fund receives infrastructure and financing at competitive rates. The bank earns fees, spreads on financing, and trading flow from the fund.
Concentration in prime brokerage creates systemic risks. Lehman Brothers was the largest prime broker; its bankruptcy froze client assets and caused chaos in the markets. After 2008, many funds diversified relationships among several prime brokers.
Electronization and Disintermediation
Electronic trading has reduced the need for traditional traders. Algorithmic execution replaced voice trading for most liquid instruments. This compressed margins in the trading business.
MiFID II in Europe required separate payment for research, instead of bundling it in trading commissions. This led to reduced spending on research and industry consolidation.
Technology companies are competing with banks in certain niches: Bloomberg, Refinitiv provide data and analytics; fintech platforms — trading services for retail clients; alternative data providers — new sources of information.
Interaction with the Buy-side
The sell-side and buy-side are in complex relationships of competition and cooperation. The buy-side uses the sell-side for execution, research, and market information. But the buy-side also competes — large asset managers develop their own trading desks and research teams.
Best execution requirements oblige the buy-side to seek the best execution terms, not limited to a single broker. Commission Sharing Agreements (CSA) allow directing part of trading commissions to pay for research from any providers.
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