The investment industry is comprised of a wide variety of sectors and service providers. At the top of the list are the giant asset managers, like BlackRock, a firm managing assets that total more than $3.5 trillion, an amount so immense that it is roughly equal to the gross national products of Russia and India combined. Also at the top of the industry are the biggest exchanges, were billions of shares trade hands yearly, along with the major investment banks, those firms that raise money for corporate clients by selling their stocks and bonds to the public and arranging massive loans. Investment banks also deal in private equity investments and asset management, and they earn immense fees by brokering mergers and acquisitions.
Then there are the big firms that provide stock brokerage services. Some of them, like Merrill Lynch, are also investment banks. Others, like Charles Schwab, are primarily stock brokers that deal with millions of individual customers. However, the lines have blurred between sectors in recent years. It is common for one firm to operate in multiple segments of the business at once: commercial banking, investment banking, asset management, insurance, mortgages, financial advisory, venture capital, mergers and acquisitions and more.
The Global Investment Industry: This is a massive, global industry, and, in light of the fact that it provides the services that enable companies to have access to capital, it is one of the most important industries of all. Global mutual fund assets totaled $26.05 trillion on September 30, 2012, according to the Investment Company Institute. The World Federation of Exchanges estimated the total value (market capitalization) of stocks on all of the world’s significant exchanges at $47.4 trillion as of the end of 2011, with shares available in 46,814 companies. Worldwide during 2011, 28.0 trillion shares were traded.
After an extremely turbulent 2008 and 2009 during the Great Recession, the global investment industry was greatly altered. Lehman Brothers was allowed to fail completely. Bear Stearns was taken over by JPMorgan Chase at a nominal price. Global banking and investment industry leader RBS (Royal Bank of Scotland) was bailed out with public funds to the extent that it became controlled by the UK government. Insurance industry giant AIG was bailed out by the American government. The world became familiar with phrases like “toxic assets,” and American taxpayers, whether they liked it or not, backed emergency plans and market support programs with acronyms like TARP (Troubled Asset Relief Program) and TALF (Term Asset-Backed Loan Facility). By the end of 2009, the U.S. government had created initiatives based on corporate bailouts, asset purchases, emergency lending and financial market support totaling more than $2 trillion. These were only a few of the massive changes wrought by the upheaval of the global financial crisis that began quietly in the late summer of 2007 and roared into a full financial hurricane in 2008.
As the financial crisis unfolded, governments around the globe issued emergency funding to leading banks and investment banks. At one time, virtually all stock market indexes had been down by as much as 40% to 60%, depending on geographic location. A handful of extremely clever investors made vast profits by skillful, courageous, contrarian investing during the turmoil.
By the end of the painful 2008-09 period, the investment industry, on a global basis, had been through losses, layoffs, scandals, bankruptcies, forced mergers, government intervention, bailouts and/or disappointments on a scale not seen in decades. In 2010-12, the industry began rebuilding and reshaping its strategy.
China is the biggest growth story in the investment world by far. A large percentage of the world’s IPOs are now on Chinese exchanges, including Hong Kong.
Regulation: In many cases, investment companies and banks are closely related. Some of the world’s largest investment banks, such as Merrill Lynch (forced into a merger with Bank of America during the recent financial crisis), are owned by major commercial banks.
New regulations are putting banks under pressure, making it more difficult to operate and more difficult to earn profits. The global group known as the Basel Committee on Banking Supervision (BCBS) continues to monitor the health of the banking system and issue recommendations for bank capital and risk management. The biggest changes faced by banks that plan to comply with the latest round of recommendations, the “Basel III” accords, will be in raising sufficient capital. The Tier-1 minimum capital requirement will increase to 10.5% by 2019. (Tier-1 capital is a ratio of equity capital plus stated bank reserves, to assets, and is a commonly used measure of a bank’s core financial stability. The massive UK bank RBS had only about 3.5% of Tier-1 capital when the financial crisis began, and the bank promptly failed. U.S. banks endured losses equal to about 7% of assets during the recent crisis.) The intent is to make it much less likely that massive bank failures will be faced in the future, even during a major financial upheaval.
While this may be desirable from a stability point of view, it places significant constraints on banks. As a result, they will earn a lower profit ratio on assets. Also, in many cases, they will be required to sell large amounts of new stock, thus diluting the positions of existing stockholders. (An alternative way to raise capital is to sell large amounts of assets, which many banks have been doing.) Compliance with Basel accords is recommended to the governments and regulatory authorities where global banks are based, including the U.S. Nations may choose whether and to what extent to comply on a voluntary basis.
In June 2012, the U.S. Federal Reserve Board approved three proposals implementing the Basel III standards. Basel III requirements and capital increases were planned to be phased-in at American banks starting on January 1, 2013. However, after wide-ranging complaints and criticism, the Federal Reserve, in November 2012, delayed implementation of a large part of the requirements pending further study. The rules are considered by many to be particularly hard on small banks. Combined with the recent Dodd-Frank banking act, and a stringent new Market Risk Final Rule covering risk capital, Basel III is part of a dramatic overhaul of the American banking system. Globally, in order to comply with the Basel III standards, analysts at Fitch Ratings estimated that 29 of the world’s leading banks would need to raise $566 billion in additional capital from 2013 to 2019. Banks got something of a break in January 2013 when the rules were relaxed slightly. Certain requirements that would have begun in 2015 were pushed back to 2019, and the types of assets that can be counted toward meeting a bank’s liquidity requirements were made more flexible and lenient.
In the U.S. a sweeping reform bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act, was signed by President Obama in July 2010, after European finance ministers approved similar regulations for much of Europe a few months earlier. In general, requirements under the law include broad powers for the government to monitor systemic financial risk and to intervene where it deems necessary. For example, it requires a bank to shrink in size if the government believes that the bank is posing financial risks, and an orderly liquidation process has been set out for extreme cases in which regulators need to seize and auction off financial firms that are nearing bankruptcy.
Another requirement is the creation of a Consumer Financial Protection Bureau (CFPB) to oversee and regulate the issuance of products like mortgages, credit cards, personal loans and retirement plans. The bureau has a $500 million budget that does not require Congressional approval. The budget is funded by the Federal Reserve. By the beginning of 2013, the CFPB had begun to clarify how new rules would apply to the creation of mortgages when it issued a definition of a “qualified” mortgage, that is, a mortgage that can be assumed to be relatively safe that was issued to a borrower who will be likely to meet the monthly payments.
Under Dodd-Frank, credit card issuers will be required to operate under modified rules that are much more consumer-friendly than in the past. Debit card processors will be required to charge lower fees on transactions. Other provisions of the bill include a permanent increase in federal deposit insurance from $100,000 to $250,000; requiring mortgage lenders to verify that borrowers are likely to be able to repay their loans; and the establishment of a new Federal Insurance Office within the Treasury Department to oversee the insurance industry. Supporters of the new law contend that the recent financial crisis proves the need for government protection of consumers against abusive financial practices. Detractors are concerned with the potential for too much new oversight enforced by inefficient new bureaucracies, placing a strangle-hold on business and productivity.
The U.S. Investment Industry: Employment in America alone, in firms that are involved in securities and investments, was estimated at 803,100 as of October 2012, down by about 4,000 from the previous year according to numbers published by the U.S. Bureau of Labor Standards.
About 51 million Americans participate in 401(k) investment plans at their places of work, with assets totaling about $3.2 trillion as of June 2012. Mutual funds in America held $12.8 trillion in assets as of November 2012, while ETFs held $1.295 trillion. U.S. retirement account assets totaled about $18.5 trillion in mid 2012, according to ICI, the Investment Company Institute (www.ici.org).
America’s stock exchanges are highly electronic today, trading vast amounts of stocks, bonds and options at blazing speed. Average daily volume on the NYSE was running at a 1.14 billion shares rate in late 2012 and a 1.74 billion shares rate on the NASDAQ.
Despite these high volumes of trading, America has lost the title it held for decades as the world’s leader in public stock offerings. The Sarbanes-Oxley accounting and public company disclosure regulations, passed in 2002, created a huge blow to the industry. Many firms now choose to list on exchanges in Asia or London instead of New York City. Meanwhile, Hong Kong has been a leading exchange for IPOs since 2009, competing with the NYSE and the NASDAQ. However, the CME Group, based in Chicago, Illinois, retains the top spot as an exchange for futures and options.