Syndicates: definition, functioning and types of syndicates
What is a Syndicates?
A syndicate is a temporary association of firms that join together to carry out a large transaction that would be difficult or impossible to carry out individually. The syndicate facilitates companies to pool their resources and share risks, for example when a group of investment banks work together to bring a new securities issue to market. There are different types of unions, e.g. underwriting unions, banking unions and insurance unions.
Understanding syndicates
Types of syndicates
Syndicates are usually composed of companies in the same sector. For example, two pharmaceutical companies may combine their research and development (R&D) teams and form a consortium to develop a new drug. Or several real estate companies may form a consortium to manage a large construction project. Sometimes banks form a consortium to lend a large sum of money to a single entity. Companies may also form a consortium to manage a particular commercial project if the opportunity promises an attractive return.
Some projects are so large that a single company may not have all the skills necessary to complete the task efficiently. This is often the case with large construction projects such as the construction of a stadium, a motorway, a bridge or a railway line. In these cases, companies can form a consortium so that each company can contribute its specific expertise to the project. For tax purposes, consortia are generally regarded as partnerships or corporations.
Risk management
The amount of risk assumed by each member of the consortium may vary. For example, in an undivided underwriting syndicate account, each member is responsible for the sale of an allocated amount of shares, as well as excess shares not sold by the entire syndicate.
Thus, an individual syndicate member may have to sell many more shares than he or she has been allocated, whereas in other types of syndicates the risk for each member may be limited.
Placement syndicates
In an initial public offering (IPO), several investment banks and broker-dealers join together to form a syndicate to sell new shares or debt securities to investors. The syndicate group shares the risk and contributes to the successful sale of the new issue of securities.
The lead manager of the new issue initiates and manages the syndicate. The syndicate is compensated by the underwriting spread, i.e. the difference between the price paid to the issuer and the price received by investors and other intermediaries. A syndicate usually dissolves 30 days after the completion of the sale or if the securities cannot be sold at the offering price. However, there are other types of syndicates that work together but are not limited in time.
Syndicates and insurance risk
Syndicates are often used in the insurance industry to allocate insurance risk among several companies. Insurance agents assess the risk of insuring a particular person or asset and use this assessment to determine the price of an insurance policy.
For example, an underwriter of a corporate health insurance policy may assess the potential health risks of a company’s employees. The underwriter’s actuary would then use statistics to assess the health risk of each of the company’s employees. If the potential risk of health insurance is too high for a single insurance company, it can form a consortium to share the insurance risk.
