THE ECONOMICS OF THE PRIVATE MARKET
The Role of Regulation
Banks and their subsidiaries may engage in agenting without prior permission; they are subject only to prudential supervision that focuses on ensuring disclosure of possible conflicts of interest. Bank holding companies and their nonbank subsidiaries, including section 20 (securities) subsidiaries, must obtain permission from the Federal Reserve Board to act as agents, and such agents are subject to various restrictions. See appendix C for a detailed description of legal and regulatory restrictions on the private placement agent activities of banks.
Regulatory restrictions that focus on agenting itself do not appear so far to have imposed many competitive disadvantages on banks. Limits on banks' general securities powers, however, may have imposed two disadvantages. First, banks (but not section 20 subsidiaries) are effectively prevented from acting as brokers or dealers in the secondary market for private placements because they cannot buy and sell restricted securities for their own account. As the secondary market for private placements has been relatively small to date and banks may act as riskless principals, this disadvantage has probably been minor.
Perhaps more important are Glass-Steagal restrictions on bank underwriting of new issues of public securities. Because of economies of scope between public underwriting and the distribution stage of private placement agenting, in some cases, public security sales forces can distribute private placements more efficiently than can a private placement agenting group. Only bank holding companies possessing section 20 subsidiaries with full debt powers (and full equity powers, for private equity issues) will possess such sales forces and be able to capture the cost efficiencies. Competitive pressures will cause investment banks or commercial banks with section 20 subsidiaries to win the mandate to assist most such issues.
As market participants indicated, underwriting powers may convey another, more subtle advantage. Part of the service that a financial institution typically provides is advice that leads a borrower to issue in the private market. Such advice often includes an analysis of the relative benefits of raising funds in various of markets, including the bank loan and public security markets. The advice of an institution capable of assisting financing in all the relevant markets is likely to be afforded more credibility than the advice of one that can assist only in the market it is recommending. Credibility of advice is an important factor in the minds of many issuers as they choose an agent. Thus banks with full securities powers actually have an advantage in this regard over investment banks that do not make nor syndicate loans, as such banks can assist in three markets (loan, private, and public), while such investment banks can assist in only two (private and public). Conversely, banks without securities powers may in some situations be at a disadvantage.
Table 16 lists U.S. bank holding companies that had received Federal Reserve Board permission to have section 20 subsidiaries as of May 1992, the powers of those subsidiaries, and the location within the banking organization of the private placement agenting group, if any. All the banks with full securities powers have chosen to locate their agents (if any) in the section 20 subsidiary whereas, to our knowledge, only one of those with partial securities powers has chosen to do so. This difference may occur for two reasons. First, the advantages that full securities powers confer on agents may outweigh costs of the additional regulatory restrictions that are imposed when they are located in a section 20 subsidiary. Second, and perhaps more important, regulations limiting the fraction of revenue a section 20 subsidiary may earn from ineligible underwriting activity encourage the holding company to move eligible activities (which include agenting of private placements) into the section 20 subsidiary to prevent the limitations from binding.
The three largest bank agents are located in section 20 subsidiaries with full powers. However, other banks without full powers do a substantial agenting business. Thus, lack of securities powers does not seem to be an absolute barrier to agenting of private placements.
n.a. No signs of agenting activity observed in IDD or in regulatory filings.
Source. Federal Reserve Bulletin and miscellaneous regulatory filings.