Klaus Diederichs

JPMorgan’s flat Q4 results highlighted the hit-and-miss nature of the bank’s trading operations and perhaps explain why its shares trade at a discount to some of its competitors (including Citigroup, which has suffered its own trading-related problems). But the figures distracted from the fact that JPMorgan’s investment banking business is doing rather well.

Advisory fees were up 36% on the same period the year before and equity underwriting is up by 46%. With global investment banking revenues of $4.1bn for 2005, JPMorgan sits in second place behind Citigroup (with $4.499bn) but well ahead of the likes of Goldman Sachs ($3.671bn). In Europe, the top 10 is configured slightly differently but JPMorgan is still in second place, well ahead of Goldman Sachs (see table) “And we didn’t catch up in a bad year – our competitors all reported record revenues last year,” says Klaus Diederichs, head of investment banking for Europe.

Some analysts explain JPMorgan’s investment banking success by the fact that universal banks are able to operate at lower cost – enabling them to pitch advisory fees as much as 50-75 basis points below competitors. One analyst says JPMorgan is the most aggressive bank in this area. Mr Diederichs laughs at this suggestion. “JPMorgan has one of the best M&A teams on the ground. Why should we undercut ourselves? We’ve been in the M&A business in Europe for 15 years, we don’t need to buy market share.”

Full service is valuable

At a time when boutique investment banking firms are making a reappearance and fears over conflicts of interest continue to tax banks and regulators alike, Mr Diederichs is adamant that JPMorgan’s success illustrates the value of the full service investment bank. “It enables you to generate more out of the same coverage,” he says simply. “Pure investment banks don’t do leveraged finance or bond underwriting.”

With the increasing importance of financial sponsors, and bearing in mind their modus operandi, these are product lines that a bank cannot afford to ignore. “Financial sponsors need debt financing and hedging; then maybe they need to restructure the debt, then perhaps to ‘outfinance’ into the market or to sell. It’s a real advantage if you can offer the full package,” says Mr Diederichs.

This focus on financial sponsors may help to explain why JPMorgan has slipped slightly in the league tables for investment grade bonds and loans (see graph). Mr Diederichs says that the firm took a conscious decision at the end of 2004 to “de-emphasise” low-margin and vanilla business in favour of high-yield and leveraged loans.

“In Europe, there are 20 banks fiercely competing to underwrite investment grade products at below the cost of capital. We will do them for our clients if they ask, of course, but we have focused our people and our capital on the other end of the market where more sophisticated structuring is required. It’s higher risk but it’s where fewer banks are playing and where we can make a difference to our clients.”

Block trades on the rise

The equity market is also undergoing significant change: the volume of block trades has risen dramatically and competitive initial public offerings (IPOs) – in which lead managers’ and brokers’ roles and remuneration are not confirmed or defined until very late in the IPO process – have become increasingly popular.

Although clients may believe that such developments achieve positive results, market practitioners do not always see them in the same way. The UK’s Financial Services Authority, for example, has warned that competitive IPOs can intensify inherent conflicts of interest by putting pressure on firms competing for a place in the syndicate to produce research that is favourable or justifies a higher valuation range.

Mr Diederichs acknowledges that the equity markets have become more polarised in terms of deals that make economic sense for investment banks and deals that do not. “European equity capital markets are anyway tougher than the US: local and regional players add two additional layers of competition to the market. There is a lot of good equity and equity-linked business being done but some recent developments are obviously less attractive for banks.

“Block trades are essentially a game of Russian roulette but the need to be in the league tables can drive banks to do them. [Regarding] competitive IPOs, we think it would be bad for the market if they became the rule.”

Lessons from Cazenove

Mr Diederichs is direct, frank and entertaining, but claims that any diplomatic skills he has have been learned from Cazenove since JPMorgan formed its joint venture with the venerable UK firm at the end of 2004. The partnership has attracted criticism for failing to add any real value to JPMorgan and for diluting, if not tainting, Cazenove’s blue-blooded reputation. Witness the loss of a string of Cazenove’s FTSE 100 clients, say detractors, including insurance group Prudential and power company National Grid Transco last month. Mr Diederichs is very persuasive in the venture’s defence, however.

He argues that the list of completed transactions – including last year’s acquisition of O2 by Telefonica and the IPOs of Inmarsat and Kazakhmys – show that the venture has more than achieved its aim: to leverage Cazenove’s enviable UK client list with the capital and international strength of JPMorgan. These were deals that may not have been possible, or may not have done so well, alone, Mr Diederichs says.

“For example, we had the international relationships to work with the Kazakhstan copper company, Kazakhmys. Cazenove, as king of the UK stock market, gave it the stamp of approval, which launched it on the UK market. The stock has risen 30% since the IPO. It was a £1.5bn deal and the company entered the FTSE 100 in December 2005. The deal created a FTSE 100 company and earned Cazenove the highest fee in its 192-year history.”

On losing some of Cazenove’s old clients, Mr Diederichs counters that 35% market share of FTSE 100 companies is not bad. JPMorgan has 239 UK clients in total, almost 100 more than its nearest competitor, UBS, and, for all the client losses, it has gained 16 clients in the past year.

Competitive environment

Mr Diederichs admits that the UK market is becoming increasingly competitive, with other banks waking up to the value of UK corporate broker relationships: Citigroup has poached staff from ABN AMRO, and Morgan Stanley has grabbed people from Merrill Lynch (as well as vice-chairman Nick Wiles from JPMorgan Cazenove) to boost market share. “Of course, this means stealing market share from the leader,” he says.

Ending relationships is a two-way street, however. It is not just clients who wave goodbye. Banks or brokers may also decide that the relationship does not generate enough ancillary business or that it conflicts with that of another client. “Every investment bank has to look at the broker relationship and decide if it is achieving what they expect from it,” says Mr Diederichs.

“We did not go into [the partnership with Cazenove] to be the broker only. It’s a great and valuable relationship but we would like to offer additional services, so we put the full product range of the bank at clients’ disposal. We have not gone in demanding other business from them. If anything we are a little too shy.”

CAREER HISTORY:

2000 Appointed head of investment banking, Europe, at JPMorgan

1995 Appointed head of M&A Europe at JPMorgan

1990 Promoted to managing director and joined M&A group at JPMorgan

1985 Moved to London and joined debt capital markets division at JPMorgan

1980 Joined JPMorgan from university

Mr Diederichs is a member of JPMorgan Chase’s executive committee and the investment bank management committee. He is also a director of JPMorgan Cazenove.

He has an MBA from Université of Lausanne, Switzerland, and a BA from University of Mannheim, Germany. He is a lecturer for the MBA programme of the Dauphine Université of Paris.