Barely three years after the birth of investment banks (IBs) in Malaysia, the landscape is set to change again as competition heats up.

As it stands today, the investment banking sector is overcrowded. There are 15 IBs, of which six are standalones and the others, bank-backed. Given an industry where more than 50% of the market share is dominated by the top three IBs, consolidation is inevitable. With the cap on foreign shareholding raised to 70%, this will happen sooner rather than later.

Although IBs at home were relatively sheltered from the direct effects of the US banking crisis, they were not spared from the indirect effects on the real economy. A global recession that is showing little signs of recovering has hurt the market and led to a sharp fall in the number of corporate deals being done.

Thus, competition has become even more intense with the pie getting smaller. More so when the government has also issued five stockbroking licences to foreign houses Credit Suisse, Macquarie group, JP Morgan, CLSA and Nomura Holdings. Margins are thinning as a result of the intensifying competition.

Against this backdrop, how will the recent liberalisation of the sector pan out for the IBs here?

Already, the move to allow foreigners to hold up to 70% equity interest in an investment bank has given rise to speculation that the standalone investment banks will be among the first to come on the radar screen of foreign players looking to enter the market or to enlarge their presence.

The stock prices of the listed standalone investment banks have jumped since the announcement of the liberalisation measures. For example, ECM Libra Financial Group Bhd’s stock touched its six-month high of 67.5 sen last Friday, up 82% from 37 sen a month ago. Another local standalone investment bank, K&N Kenanga Bhd, also saw its stock touching its six-month high of 71.5 sen last Friday, up 70% from a month ago.

According to K&N Kenanga’s group director Tengku Zafrul Tengku Aziz, the standalone banks have become quite attractive as they are now seen as potential M&A targets.

“It’s standard operating procedure for multinational banks to only invest if they have 51%. Previously, the guideline was 49%. But now, this opens the door for the multinationals and international investment banks to look into our market as they can have more than a 51% stake,” Zafrul tells The Edge.

While this is good news for shareholders, he says from the perspective of management, the views are mixed.

“Of course going forward, there is worry about competition. It’ll be tougher and there’ll be pressure on margins, definitely, as well as landing deals,” Zafrul says. He adds that standalone investment banks are already finding it difficult to do financing deals above RM500 million due to balance-sheet constraints.

“We can, however, do large deals above RM500 million if it doesn’t involve our balance sheet, like IPOs, M&A as well as restructuring,” he says.

Nevertheless, Zafrul notes that unlike the commercial banks where the barriers to entry are high, the local IBs have had to compete for jobs and fees with the bigger global investment banks even before the recent liberalisation.

“When you look at it objectively, competition is going to get tougher but in practice, the competition is already tough. The clients are comfortable about dealing with foreign banks that are here already although they might not be physically here. It’s not as grave as it sounds,” he explains.

Already, assets in the industry have decreased year on year. According to Bank Negara data, the total assets of merchant and investment banks in March this year stood at RM59.1 billion, down 26% from RM79.9 billion a year ago.

On its strategy to face the inevitable increase in competition, Zafrul says Kenanga is in the process of strengthening its internal competence. “Going forward, we want to focus more on our niche market. We are not a bank-backed IB, so our balance sheet is quite limited. We need to focus on areas in which we are comfortable, such as our core business, which is broking,” he adds.
Nevertheless, banking analysts believe the liberalisation will be good for the sector.

“When foreign players come in, they would probably bring with them more sophisticated structures and instruments for deals. The competition is good for consumers too. But all of this will take time,” says a banking analyst with a local research house.

A banking analyst with a foreign research believes the entry of foreign players into the market will add sophistication to the investment banking scene in Malaysia. “There will also be competition for human capital, so it’s great for the local investment bankers,” he says.

He adds that the local bigger boys are quite secure where they are, doing ringgit deals. “Foreigners don’t want to touch that, at least not for now. Foreign banks are risk-averse now. This means that in the next two to three years, there won’t be added competition but in the longer term [when business activities improve], there will be increased competition,” the banking analyst notes.

Nevertheless, he adds that by opening up the segment, the pie for the investment banks here will grow and as a result, “everybody will benefit”. “Deals in the market will grow and the foreign banks will bring in foreign money… something the local banks do not have much access to at the moment,” he adds.

Just how the liberalisation will unwind itself in the sector remains to be seen. But thus far, the path for the local IBs, like for the global ones, has not been all that smooth. Looking at the financial results of the bigger bank-backed boys, they were not spared despite their size and market leadership.

The country’s investment banking leader — CIMB Group — saw its income from corporate and investment banking as well as treasury and investment segments dip 30% and 52% to RM866.3 million and RM964.4 million respectively for FY2008. AMMB Holdings Bhd saw its investment banking segment register a loss of RM8.9 million for the nine months ended Dec 31, 2008, compared to a profit of RM307.3 million for the same period a year ago.

Be that as it may, local IBs have weathered the banking storm well up until now, thanks to the stringent guidelines imposed by the central bank. But going forward, the game is about to change. And in this new landscape, size may well make a difference.