How the financial world goes round - a primer on financial information resources
Jinfo Blog

By Dave Dixie

Abstract

For those that are new to it, the world of financial information can seem dry and daunting. But despite its impenetrable jargon and some pretty esoteric practices, the working of the financial system is not a branch of metaphysics. It can, and should, be understood by the layperson.

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"Information about money has become almost as important as money itself" Walter Wriston, 1985.

For those that are new to it, the world of financial information can seem dry and daunting. But despite its impenetrable jargon and some pretty esoteric practices, the working of the financial system is not a branch of metaphysics. It can, and should, be understood by the layperson. So let's start by looking at the roles of some of the major players in the banking world, how they fit together and some of the information sources associated with them.

I used to wonder how banks made money until I took out a loan. Then I soon realised that the profit comes either from borrowing money more cheaply than it's lent or from fees. Broadly speaking, the way a bank makes its money reflects the type of bank it is. Investment banks earn most of their income from fees, whereas the revenue of commercial or high street banks comes from interest charges.

Strange but true

Despite all the money banks make, if you are looking for the sales figure of a bank, you won't find it, because it is not there. Unlike most businesses, neither banks nor insurance companies call their income "sales". So if you are asked to rank the largest banks by turnover, forget it. I have no idea why this is so. I guess, like lots of accounting conventions, that's just the way it is.

The main income of banks is interest income. They start the profit and loss account by showing interest income less interest expenses, to give net interest income. The next lines show the non-interest income and expenses. These are such items as investment income, insurance income, asset gains, fee income and other income. Add all of these up and you get an approximation of total income.

Financial companies cannot be included in company rankings based on turnover. Although there are several other ways to calculate a company's size, all of them have drawbacks. In most of the Financial Times (FT) rankings we use market value, which is the number of shares in issue multiplied by the share price. This number can be calculated across all sectors and does give a good idea not only of the size, but also of the value that the market places on the company. Each Monday the FT newspaper publishes a table of the world's largest companies (FT Global 500) based upon market values; and once a year my colleague, Dermot McGrath, compiles a more comprehensive snapshot of the world's top companies for the FT Magazine.

The main drawback of rankings based on market value is that they exclude businesses that do not have a stock-market quotation. This includes most of the big independent investment banks, which are privately-owned firms.

The FT Research Centre can prepare customised ranking tables based on almost any numerical criteria that appear in company accounts. For instance, if you are selling software or training into the sector, you may wish to identify the top banks by number of employees. If you are a bank, on the other hand, you could use our data to benchmark your profitability (return on capital employed), or your productivity (sales per employee), or your growth rates against your competitors. There are numerous ways of crunching this data.

The Old Lady

At the heart of the banking system is the Bank of England, which since 1734 has occupied a gaunt, windowless fortress in Threadneedle Street. The Bank's website <http://www.bankofengland.co.uk> is where you can find all of the Bank's publications, including reports, news releases and speeches. There is also a facility to search, select and download monetary and financial statistics. However, the 'Old Lady of Threadneedle Street' no longer regulates the banking system.

The regulators

Since 1997, banking regulation has been the province of the Financial Services Authority <http://www.fsa.gov.uk/Pages/About/Teams/Banking/>, which focuses on protecting the consumer, maintaining market confidence and reducing financial crime. What the FSA does not do (and some say it should) is promote competition. This is handled by the Competition Commission <http://www.competition-commission.org.uk> and the Office of Fair Trading (OFT) <http://www.oft.gov.uk/>.

However, the big gap in regulation is money transfers, which are unregulated and mostly controlled by the big banks. It took considerable consumer pressure to get the banks to offer free access to their cash machines, and even now the number of ATMs that charge consumers to withdraw their own money is on the rise again. Another irritant to many British consumers is that it still takes at least three days to clear a cheque or to receive an electronic payment, compared to overnight in some other countries. This nets the banks a scandalous GBP 20m a year according to the OFT.

On the regulatory front, there is also a voluntary Banking Code of Practice for banks, building societies and credit card issuers. This is run by the Banking Code Standards Board <http://www.bankingcode.org.uk/thecode.htm>, an independent body, which does not have the power to fine banks, but can 'name and shame' them if they breach the rules.

The trade association for payment and clearing services is APACS, which has a reasonably informative website at <http://www.apacs.org.uk>. For a European perspective on payment systems the European Central Bank <http://www.ecb.int/pub/html/index.en.html> publishes a so-called 'Blue Book', or, to give it its long title, "Payment and Securities Settlement Systems in the European Union and in the Acceding Countries". This provides a wealth of fascinating facts, such as the number of ATMs in each country and the trends in cheque transactions. The latest edition available on the ECB website was published in March 2006 and gives 2004 data. Continuing on the colour theme, the Bank for International Settlements provides similar information on selected developed countries in its annual "Red Book" <http://www.bis.org/statistics/payment_stats.htm>. Just to complete the spectrum, the BIS also publishes yellow and green books covering the same territory in less developed countries. All of these sources are valuable for comparing the size and structure of the banking markets and customers' payment habits across national territories.

The investment banks

Investment banks make most of their money from fees earned by arranging deals such as mergers and acquisitions (M&A) or raising capital. They have been making shed loads of money recently, due to the current M&A boom. For a more detailed discussion of the macroeconomic influencers, drivers and players in the M&A scene, read Jill Fenton's article in FreePint 204 <http://www.freepint.com/issues/130406.htm>. Suffice it to say here that nothing feeds the appetite of the City better than a long, drawn-out, bid battle. A hostile bid, in particular, enriches not only the bankers, but also the lawyers, accountants and PR firms. Big bids make millions for the men in sharp suits. Whether they are good for industry and consumers is a moot point.

Goldman Sachs made a net profit of $2.5bn in the first quarter of this year alone. Annual pay and benefits for the investment bank's 23,600 employees average $900,000. No wonder the corks are popping in the City wine bars.

Typically, M&A fees average between 0.125 per cent and 0.5 per cent of the target company's market value. Some fees depend on success, while others are linked to the premium achieved over the stock price of the company they are advising. There are also success fees and break fees for the banks on the losing side. When competition is intense, some companies will demand a cap on fees.

The trade association for London-based investment banks is the London Investment Banking Association <http://www.liba.org.uk/>, which does not have much of a website, but does provide a list of members.

If you need to know which investment banks are doing the deals, then the biggest database of financial transactions is Thomson Financial's <http://www.thomson.com> SDC Platinum that provides detailed information on new issues, M&A, syndicated loans, private equity and project finance. It is not cheap, but it is good. Dealogic <http://www.dealogic.com> offers a similar service.

A cheaper option for keeping up to date with what is happening in the M&A market is the journal Acquisitions Monthly <http://www.acquisitions-monthly.com/>, which is now part of Thomson and publishes extremely useful monthly tables of bids and deals, broken down by country. The review of the year in the January issue also ranks the top financial advisors (investment banks) with their market share over the previous twelve months. This is highly recommended, not just because it was started by one of my ex-colleagues in the FT Research Centre.

Those looking for a quick overview of the M&A scene, could do worse than look at Thomson's extremely useful quarterly Mergers & Acquisitions Review, which is available free on the Thomson Financial website <http://digbig.com/4hpyf>. This is 20 or so pages long and contains numerous tables of the biggest deals by geography and advisor rankings.

The reference point for new capital-raising issues is another Thomson product, International Financing Review (IFR), <http://www.ifre.com>, a magazine specialising in global capital markets. A lot of information on this website is subscriber only, but if you are looking for new issues information, then IFR is undoubtedly the leader in this field.

The analysts

Most investment banks have teams of analysts who produce valuable comment and analysis in reports, showing which shares are attractive or overvalued and why. Although these reports can provide useful background, if you need to research a company or sector, they should be taken with a large pinch of salt. The analysts are often taking views on companies that the fund management arm of the bank is investing in or the corporate finance team (who handle mergers and acquisitions) are advising. In both cases, it is in the analysts interest to 'talk up' the stocks. Another reason for making a favourable recommendation is that companies do not like bad reviews any more than actors or writers like them. Analysts who tell their clients to sell a company's shares may well find the door closed next time they want to interview the CFO to prepare an in-depth report on the company's finances. This can be a real problem.

The net result of these pressures is that analysts make very few 'sell' recommendations. At the time of writing, investment bank analysts' consensus recommendations suggest that you should buy or hold 95 per cent of the shares in the FTSE 100. There are only five exceptions (British Energy, Kelda, Royal and Sun Alliance, Sainsbury and Alliance & Leicester), which is blatantly absurd.

Most big investors now use their own analysts to overcome the problem of bias. So take care when you next use Investext (Thomson Financial). Probably a less biased source of in-depth company information is the credit ratings agencies, but these are obviously more interested in the solvency of companies.

The high street banks

The investment banks are not the only ones that are doing very well. This year the big five high street banks have notched up collective profits of GBP 34bn - or more than the entire gross domestic product of Croatia.

The retail banks borrow money from you and me, pay us little or no interest and then lend it at a profit. They must ensure that they have enough money to repay their customers, so their investments will be mainly short-term. Over the years this has led to many complaints of short-termism from industry. Companies need to plan long-term, but the bankers think short-term.

The commercial banks' trade association (the British Bankers Association <http://www.bba.org.uk>) publishes a valuable Annual Abstract of Banking Statistics, a compendium of useful information on the banking industry, which is now available online. So if you need to know the trends in the number of bank branches or cash dispensers then this is where to get it. The BBA website is also the place to obtain benchmark LIBOR (London Interbank Offered Rate) rates - the rate of interest at which banks borrow from each other.

The hedge funds

Hedge funds are sometimes described as unregulated banks. Whereas banks are highly regulated and have to meet capital requirements, hedge funds are usually based in offshore tax havens, in order to escape regulators and reporting requirements. Also, they are free to use trading strategies, which traditional, domestically regulated retail funds are not allowed to do. Hedge funds pool the capital of a small number (100 or less) of wealthy individuals or institutions under the direction of a single manager or small team. A key technique is to use short (selling securities not yet owned in the expectation of being able to buy them later at a lower price), as well as long, positions. This can provide protections against a falling market, hence the description 'hedge fund'.

London is now the centre of gravity of the European, if not global, hedge fund industry, with UK-based managers running $255bn, almost 80 per cent of the total assets in European funds. The UK also has the largest share of the trading talent in Europe, with nearly two thirds of European hedge funds based in the UK, mainly in London.

To judge how well the hedge funds are looking after other people's money, we need to look at the Credit Suisse/Tremont Hedge Fund Indices <http://www.hedgeindex.com/hedgeindex/en/hedgoverview.aspx> where we can see that, for instance, the funds have outpaced the FTSE All World Index by 68 per cent since the index began in 1994.

HedgeFund Intelligence <http://www.hedgefundintelligence.com> publishes newsletters, databases, directories and research reports covering the global industry. EuroHedge covers the European hedge fund industry and is a good source of information. Coverage includes all hedge fund managers based in Europe whatever their strategy, and an increasing number of US-based funds that invest exclusively in Europe. Another good, but expensive, resource is Lipper HedgeWorld <http://www.hedgeworld.com>.

At the last count there are also around 240 foreign banks in London, which are listed in The Banker magazine <http://www.thebanker.com> and represented by The Association of Foreign Banks <http://www.foreignbanks.org.uk/>.

The Council of Mortgage Lenders (CML) is the trade association for mortgage lenders in the UK, and its members undertake around 98 per cent of UK residential mortgage lending. The CML has an extremely useful website packed with information and statistics. Another useful source of statistics is the Building Societies Association <http://www.bsa.org.uk> which represents the UK's 63 remaining building societies. On the European front we have the European Mortgage Federation, <http://www.hypo.org/Content/Default.asp> the 'voice of the mortgage industry at EU level'. From the website you can order Hypostat 2004, the annual statistical review of Europe's housing and mortgage markets.

Finally, if you need to stay abreast of what's happening in the world of international banking, then it goes without saying that the FT newspaper or FT.com are must-reads. The website has almost finished upgrading its search engine, which will improve its functionality enormously. You can also receive email alerts or RSS feeds on topics of particular interest. The Banker magazine and the FT Business stable of titles, such as Investors Chronicle, Money Management or FT Mandate provide more specialist coverage.

If you get really stuck, or need more professional help, then you can ring (+44 20 7873 3547) or email <http://www.research@ft.com> the FT Research Centre. This is a commercial service and so we will charge for large and small research projects. But we are all enthusiasts and are happy to provide quick advice and the benefit of our considerable experience, free of charge. And you can't get much better than that.

Related FreePint links:

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