Banks can take some comfort from the U.K. Financial Conduct Authority’s report on investment and corporate banking, amid suggestions that certain recommendations were more benign than expected.
Equity capital markets, debt capital markets and mergers and acquisition activities produced a quarter of universal banks’ revenues in 2014, generating $17 billion in gross fees in the U.K., according to the FCA’s report. The regulator said many clients feel well-served by these primary market services.
There are, admittedly, some provisos, most notably about the IPO process itself, with the FCA highlighting the insufficiency of information available to investors, the potentially skewed allocation of shares and the misleading use of banking league tables.
But, as a bank analyst said in an interview, the FCA previously flagged up that they were uncomfortable with bundled products and unclear charging structures, and that the service provided to corporate clients in ECM and DCM activity could have been better. The analyst, who did not wish to be named, suggested these issues now do not seem to be such a great problem for the regulator. Following the release of this report, which had the potential to discomfort the universal lenders, bank share prices appeared unaffected, he observed.
“In the context of potential unbundling with itemized charging, to ask for transparency in a relatively woolly way is a benign outcome for some of the larger banks,” he said.
Mark Hughes, a partner at PricewaterhouseCoopers specializing in capital markets, said in an interview that the FCA had made “a constructive suggestion” in proposing that the quality and timing of the information available to investors should be improved.
There is a two-week blackout phase during an IPO in the U.K. between the publication of research from syndicate banks and that of the pathfinder prospectus; thus information often arrives late on the desks of investors and independent research analysts. This, the FCA said, results in a “heightened risk of bias due to potential pressure on connected analysts,” and the independent assessment of IPOs often comes too late to affect investment decisions.
The FCA said the timing of the publication of the prospectus and connected research could be changed to make the prospectus “the primary source of information available to investors.” At the same time, “unconnected analysts” could have early access to management and should be able to produce timely independent research.
Hughes said greater market transparency and improved information was, in principle, a positive goal. Yet he said syndicate houses could, given Chinese walls, produce “a good set of independent research.”
The bank analyst said that he personally felt he could use syndicated research as the basis for independent analysis, and that there was often little financial incentive for independent researchers to become involved earlier in the IPO process. However, he admitted that some IPOs in the past had been characterized by a lack of independent broker comment on which the media and investors could draw.
Tom Hinton, head of capital markets at SyndicateRoom, an equity crowdfunding platform, said in an interview that the U.S. method of publicly publishing the IPO prospectus should be adopted to provide greater transparency.
Hughes observed that the U.S. process was far more directed at retail as well as professional investors who represented the vast majority of IPO participants in the U.K.
However, there is no reason why this should not change as bank disintermediation increases. Hinton said primary capital markets should be more accessible and transparent and thus attract more retail investors in the U.K. This indeed is the idea behind SyndicateRoom, which seeks to offer retail investors the same access to IPOs as institutions.
The FCA is looking for stricter control over share allocation in IPOs. Currently, banks favor the investors from whom they obtain significant revenues elsewhere. This might not be in the interest of issuers, the FCA remarked, and could “shut out other investors.” Retail investors might have greater opportunities.
However, the FCA document does reveal that the U.S. process is significantly more costly to issuers than the European method. In the U.S., IPO fees ranged between 6% and 7% of the transaction value between 2005 and 20015; in Europe, the comparable figure is between 3% and 4%. This could reflect the domination of professional investors in Europe who are cheaper to service, Hughes observed.
Given the level of client or issuer satisfaction indicated, it is not surprising that the FCA has not been too critical of the banks. Hinton said the regulator is seeking support within the industry and had “soft-pedaled.” He said, however, that it depended upon which issuer one spoke to. Certainly, the large corporates that benefit from considerable choice and control the ECM and DCM syndicates they use seem untroubled by bundling services. This is unsurprising, not least given that the companies obtain loans and corporate broking below cost in exchange for lucrative transactional work.
“This model seems to work well,” the FCA said, while cautioning that smaller companies were less fortunate and that contractual clauses forced clients to favor their lending banks or corporate broker on future deals. The FCA wants to eliminate such clauses. This could lead to corporate lending and broking becoming both more competitive and more expensive. This could prove to be the most significant measure proposed by the FCA.
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