Investment Banking Rifts
European Straits | Friday Reads
Hi, it’s Nicolas from The Family. Here’s a Friday Reads edition for paid subscribers. This is where I sketch new ideas and attract your attention to things you might care about.
Today’s Agenda 👇
A translated version of an old essay about Richard Descoings
Thoughts about the end of global investment banks
Following up on topics I covered over the recent weeks
A comprehensive reading list on France and its elites
I’ll be honest: One reason why I don’t write about France 🇫🇷 much is because I find it too easy and I don’t learn much in the process 🤓
However, I wanted this week to be quiet and lazy and so I dedicated my Wednesday essay to France (instead of, say, Japan, value investing, or Silver Lake 😜). Well, it turns out the article is still making the rounds on Twitter as I write and is en route to do even better that my previous record (which was 11 Notes on McKinsey).
In particular, readers have asked for an English translation of an old personal essay I referred to in Wednesday’s article (Richard Descoings ou la Radicalité), and so here it is 👇 If you haven’t had enough of French elites for the week, and you want to learn more about my aspirations as a young adult, click HERE (or on the picture below).
What’s more global than a global investment bank? Theirs is usually a brand that sounds familiar all around the world. Most of them have long been operating on both sides of the Atlantic, and then later expanded into emerging markets in China, Asia, the Middle East, Africa, and Latin America.
This is why the retreat of the global investment bank strikes me as yet another sign of what I call The Great Fragmentation: the fact that we’re leaving a globalized world (if it ever was) to enter one in which it’s each country for itself.
Investment banks are interesting because they’re an early example of a service business pursuing international expansion—not because it’s cool to get bigger and to operate in several countries, but because the nature of financial services makes them benefit from a more global approach:
There are increasing returns to scale, which create a huge incentive to scale up. Specifically, those returns are driven by powerful network effects, which means you need to multiply the nodes from which the bank operates and the related counterparties.
In other words: investment banks are exactly like tech companies. International expansion is not about lowering the unit cost of production (supply-side economies of scale), but rather about maximizing network effects (demand-side economies of scale).
It turns out that it has never been that easy for investment banks to expand globally. In my 11 Notes on Goldman Sachs (2017), I dedicated an entire section (Note #4) to Goldman’s many attempts to expand in Europe—and the unique playbook they finally discovered along the way.
The problems encountered by Goldman Sachs as it sought to expand at a global scale were in fact the same as today’s tech companies. There are perfectly good reasons to concentrate assets, talent, and focus on the US domestic market: it is large enough for a leading investment bank to make most of its business there, and the powerful network effects at work in the investment banking business make it possible to operate a global business from a very concentrated, US-based center. However, being too concentrated from a geographic point of view results in the inability to deal with remote clients as well as local regulatory authorities. It also stretches the firm too far to be able to maintain consistency, which leads to frustrations, weaknesses, and above all a potentially damaged reputation for its precious brand.
Brett Bivens, a Paris-based VC with TechNexus, wrote about exactly the same thing:
Through reading The Partnership [a book about Goldman Sachs], I landed on three core principles that I believe should be represented in any company's "International Culture Stack", around which a strategy can be built and on the ground tactics can be deployed: 1. Make credible commitments. 2. Grasp the contextual complexity. 3. Align internal incentives.
It’s been even harder for non-US investment banks to expand globally. The reason, as you can guess, is that the smaller domestic market of European investment banks translates into weaker network effects, which in turn means less velocity as they enter the international expansion phase. This was explained in a brilliant 2016 white paper by Bruegel, one to which I often refer and which you should really read in its entirety (The United States dominates global investment banking: does it matter for Europe?):
It seems anomalous that, at a time when the European authorities are trying to establish a banking union and a capital markets union, the effect of their regulatory reforms has been to cause EU banks to concentrate their focus on their national roles, leaving the US banks as the only pan-European actors on this particular stage. Does it matter that the European authorities are left dependent on banks over which they have less ability to subject them to their demands?
It so happens that large investment banks, like many other firms, are suffering in these times of accelerated fragmentation. They need to scale back:
The combination of Brexit and the pandemic is prompting some of them, including large US franchises, to scale back their London operations: see here and here.
European investment banks are seeing their business collapse in the US, as explained here. Meanwhile, US banks are now refraining from doing business with European clients.
Recent decisions by the Chinese government supposedly make it easier for foreign investment banks to operate in China, but as you can guess the reality is rather adverse. Meanwhile the US government is now considering sanctions that would impact HSBC’s operations in Hong Kong.
There are exceptions: China supports its domestic banks in their efforts to expand in the US, and some European banks are still defending their international presence (see BNP Paribas).
But in general you can also spot the fragmentation in investment banking with the fact that boutiques are multiplying, private equity firms are diversifying in investment banking, incumbents are losing their grip on IPOs, and in any case, tech-driven newcomers are entering the market—increasing competitive pressure on each local market and slowing down incumbents in their efforts to expand internationally.
I have nothing to add at this point except for two conclusions:
Again, if investment banks prefigured the international expansion playbook for tech companies, the fact that they’re now scaling back suggests the same thing could happen to tech companies. It supports my thesis of the Great Fragmentation.
If European investment banks are refrained from expanding at a global level because things have become too hard, maybe they’ll double down and invest more locally, which could be a good thing for exits (both M&A and IPOs)?
About that, this is a quote from my Europe Shouldn’t Be Content With Boring IPOs (October 2019):
The financial crisis and its aftermath raised the bar for investment banks operating at a global scale, which contributed to weakening European banks and, by contrast, strengthening American ones. The problem here for European tech companies is that they’re losing a lot in terms of information advantage and soft relationships. Either they deal with US players with a global footprint but without much skin in the European game, or they deal with local players that risk taking an overly parochial approach.
Work. When reflecting about household finance in a time of techno-economic change, I benefit from sharing my life with Laetitia Vitaud, an expert in the future of work. She has a newsletter on the topic, called Laetitia@Work, and recently she published an article that I liked a lot about how we must prepare to transition from job to job many times in our life: The end of linear work lives: crossings & transitions.
Journalism. The clash between Taylor Lorenz and Balaji S. Srinivasan has now morphed into a broader discussion about ‘cancel culture’. I’m kind of giving up: it’s not that we don’t have the same issues here in Europe, but I need time to reflect. Meanwhile, have a look at this summary by journalist N.S. Ramnath, this contribution on Quora, an interesting take by Mike Solana, and this in the New Yorker.
Audit. The Wirecard scandal has triggered a brutal public debate about what investors and companies themselves should expect from audit firms—a sector that too often performs below what we all think the bar should be in business services. Read the FT’s After Wirecard: is it time to audit the auditors?, Auditors are failing to catch corporate fraud. What can be done? and this thread by Cory Doctorow.
The US continues to unravel, with the virus spreading faster than ever as part of what Noah Smith suggests we call the “Southern Wave”. There have been interesting writings published on the future of the country in that context. I encourage you to give a read to historian Margaret O’Mara’s The remaking of America as well as Margaret Levi’s vision of An Expanded Community Of Fate.
The transition. In my recent essay about climate, I was mentioning the fact that stricter regulations can be a lever for improving competitiveness and fostering innovation. Here’s an interesting article about that: How Social Engineering Drives Technology. For the broader context of the transition, see How Will Covid Change the World? A Review of History, and this one about the Black Death and the Renaissance.
IPOs, and exits in general, are a recurring theme in this newsletter—because we in Europe need many more of them. Bill Gurley, who is leaving his firm Benchmark Capital, was featured in this article about the shortcomings of IPOs and why direct listings are a better option. For context, see also Tech IPOs are being badly mispriced, as Lemonade and Agora double in market debuts (CNBC).
Uber. There have been many discussions about Uber falling back on buying Postmates after being deprived of their initial target, Grubhub (see my note here about Grubhub being acquired by Just Eat Takeaway). Have a look at Ranjan Roy in The Margins: Uber + Postmates = An All-Stock No-Brainer. Also, Matt Levine (quoted by Ranjan): Uber Wants to Lose Less Money on Food.
The Great Fragmentation. The new security law is now being enforced in Hong Kong, and it appears the Internet there will become more like in Mainland China. Having gone through the experience of travelling behind the ‘Great Firewall’, I can assure you it will definitely change Hong Kong’s positioning on the global stage. See Regulation of the internet in China: An explainer.
Here’s a list of articles in which you can learn more about France in general and its elite in particular:
Computer Science and Engineers: The (Bad) French Exception (Gwendal Simon, Peerdal, January 2011)
The French elite: where it went wrong (Simon Kuper, The Financial Times, May 2013)
The Power of the Tongue: English in the Digital Economy (me, The Family Papers, January 2016)
French Engineers and Entrepreneurship: It’s Complicated (me, The Family Papers, April 2016)
Outsiders are piqued by French management cliques (Harriet Agnew, The Financial Times, April 2017)
I Think They Get It Now, Part Deux: France (Peter Zeihan, Zeihan on Geopolitics, June 2018)
French “grandes écoles” & Progress Studies (me, European Straits, April 2019)
Shutting Down ENA & Government in the Entrepreneurial Age (me, European Straits, April 2019)
Notes from a nameless conference (Martin Gurri, The Fifth Wave, July 2019)
The Rich and Privileged Can Revolt, Too (Noah Smith, Bloomberg, July 2020)
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From Normandy, France 🇫🇷
Nicolas
