RIETI Report November 2007

Investment Banks as a Global Financial Information Superhighway

As noted by Dr. Richard Portes during the recent CEPR-RIETI "Financial Globalization and Stability" workshop, London is in the midst of a "dramatic expansion of financial-sector activity." Media coverage has noted how London's dynamic growth is justifying its increasing claims that the city is overtaking New York as the global financial capital. London is being seen as more accommodating of foreign portfolio investment, less restrictive, and the business day even starts five hours earlier. Its elevating status is causing alarm among some in New York who seek to maintain the U.S. city's reputation as the hub of global financial activity. Across the Atlantic Ocean, the old city of London is newer than ever and business is booming.

RIETI Consulting Fellow Hideyuki Matsumoto is currently undertaking research in London and this month RIETI Report introduces his series of reports from the global financial frontlines.

This month's featured article

Investment Banks as a Global Financial Information Superhighway

MATSUMOTO HideyukiConsulting Fellow, RIETI

Visiting Research Fellow, School of Computer Science and Information Systems, Birkbeck College, University of London

Dr. Matsumoto has been a Consulting Fellow at RIETI and a Visiting Research Fellow in the School of Computer Science and Information Systems of Birkbeck College at the University of London since July 2007. He is also a Visiting Researcher in the Research Institute of Information Technology and Management (RIIM) at Waseda University and a European representative of the Japan Association for Information Systems (JPAIS). His research domains cover globalization, financial markets, investment banks, strategic information systems, multinational corporations, and cross-cultural study. Dr. Matsumoto has presented his research findings at numerous conferences including the European Conference on Information Systems (ECIS), UK Academy for Information Systems (UKAIS), Pacific Asia Conference on Information Systems (PACIS), and European Conference on Research Methodology for Business and Management Studies (ECRM). In 2005 he won the best paper award at the Fourth Annual International Outsourcing Conference in Washington, D.C. for his paper, "Globalization and IT/IS Outsourcing in the Multinational Investment Banking Industry." He earned a Ph.D. in Information Systems from the University of London (examined by Dr. Robert D. Galliers, former president of the Association for Information Systems and a Professor of the London School of Economics), an M.Sc. in Information Management from National University of Ireland, and a B.A. in Economics from Keio University. His recent publications include: "Movement of the European Information Systems Academy," Journal of Information System Society of Japan, vol. 2, no. 1, 2007; "Global Strategic Information Systems Management in Investment Banks," OR Newsletter, no. 431, November 2006; and "Relationship between Globalisation and Information Systems," Journal of Information System Society of Japan, vol. 1, no. 1, 2006.

Exploring the Global Financial Information Superhighway

I am currently staying in London at a place located 30 minutes from London Bridge Station by express train. Just 15 minutes after leaving that station, one begins to see pastoral scenes out the train window. My parents live in Saitama prefecture in Japan. When they visited my house in London, they told me that the rich natural environment reminded them of the Chichibu region in Saitama. The city of London continues to grow as a global financial center, yet retains this natural landscape on its outskirts. At present, approximately one-third of London's working-age population is employed in the financial and related sectors, and London internationally remains tremendously competitive in terms of financial services. Over the past 15 years, I have been visiting the sites where the international financial information superhighway is being built; in Tokyo, Singapore and London. On a daily basis, I have sensed the rapid changes in information technologies and the globalization that accompanies those changes. This is my first report in a series of reports on topics related to policy planning for financial market strategies in Japan.

Vol. 1: Investment Banks as a Global Financial Information Superhighway

In the mid-1990s, the concept of the information superhighway was introduced in the United States under the leadership of then Vice President Al Gore, who played a significant role behind the scenes of the Clinton administration. Gore's interests and concerns have since shifted from information to the environment, and he is currently involved in a worldwide campaign designed to educate people on global warming through means such as his documentary movie An Inconvenient Truth, which was a major box office hit last year and which helped earn him the 2007 Nobel Peace Prize. In the meantime, the information superhighway vision espoused by Mr. Gore about a decade ago is now having an enormous impact on international financial systems.

Investment banks have a prominent role in international finance today, constantly transferring enormous sums of funds across national borders, making full use of their global information systems. Until about 20 years ago, offices of investment banks, which were located in Tokyo, Hong Kong, Singapore, Sydney, London, New York, Chicago, and other financial centers, operated independently. Over the last 15 years, however, investment banks have constructed a global management structure that enables them to adapt to waves of advanced information, and in the process have transformed themselves into global financial information superhighways.

Hidden perspective: understanding international finance from an information infrastructure standpoint

This early summer, as I was approaching the offices of the Bank of England on the way home from the office in London where I am currently working, I bumped into an English friend I had not seen in about 10 years. I had worked with this gentleman in Tokyo and Singapore, developing global information systems. A few weeks later, we met at a pub in the city, where we had an interesting conversation. He told me that he currently worked at the London branch of a Portuguese investment bank, managing its global information system. This followed a stint at a German investment bank in Frankfurt, where he had been developing global information systems since 1997.

Not surprisingly, the development of global information systems dominated our conversation. We discussed which applications were good or bad, what lay behind failures when implementing even a good application, and what points were important when carrying out a project. After a vigorous exchange of opinions, we both found we agreed on one thing: the key to success in the investment banking business in an increasingly competitive multinational industry is to construct an efficient global information system.

Although the political, business, and academic circles in Japan have not yet paid attention to the concept of "investment banks as a global financial information superhighway" from the title of this report, this seems to be a hidden perspective, one that enables us to identify elements that could have a major impact not only on the financial industry, but also on the broader economy.

The main artery of international finance: investment banks

The term investment bank seems to have two meanings today. The first refers to an investment bank as a business, and the second to an investment bank as an organization. An investment bank as a business refers to arranging financing from the market by issuing securities and advising on corporate strategies such as mergers and acquisitions (M&A). An investment bank as an organization includes not only the investment banking division (IBD), which encompasses the first definition, but also the trading division that aims to earn profits using the proprietary account and the sales division that generates fee income by handling sell and buy orders from customers as an agent.

Although the IBD is often seen as the key source of profits for an investment bank as an organization, at a number of European and American investment banks the income generated by the IBD in fact accounts for less than 20% of total income. At these investment banks, the trading and marketing divisions play the central role in generating income. An investment bank as an organization with these various income sources is called a full-service investment bank.

Financial institutions take many different forms, such as commercial bank, securities broker, general insurance company, and life insurance company. Among them, in contrast to those financial institutions that serve as a kind of capillary vessel for local finance by providing a retail business that deals with large numbers of small transactions, investment banks are more like a main artery of international finance, operating a wholesale business that deals primarily with large transactions for institutional investors. Since management techniques for retail and wholesale businesses differ, many large financial groups run commercial banks and investment banks as separate organizations.

The organizational structure and information systems of investment banks

The profit center and cost center of an investment bank can be explored at a deeper level than was discussed previously in "Japanese Financial Market's Strategy in the Globalization Era."

At the top of the organizational structure of an investment bank sits the front office. The front office is classified as a profit center of the investment bank as it is the part that earns profits. The investment bank is obligated to completely split the front office into sections that deal in the primary market and those that handle financial instruments in the secondary market. The M&A division, which deals with the issuing of securities and corporate strategies with respect to M&As, belongs to the primary market sections. (continued...) <for full text: http://www.rieti.go.jp/users/matsumoto-hideyuki/serial/en/001.html.

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