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FCA seeks greater fairness and transparency in UK IPO market

StreetTalk – Episode 69: Banks left with pockets full of cash and few places to go

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FCA seeks greater fairness and transparency in UK IPO market

Bankscan take some comfort from the U.K. Financial Conduct Authority's report oninvestment and corporatebanking, amid suggestions that certain recommendationswere more benign than expected.

Equitycapital markets, debt capital markets and mergers and acquisition activitiesproduced a quarter of universal banks' revenues in 2014, generating $17 billionin gross fees in the U.K., according to the FCA's report. The regulator saidmany clients feel well-served by these primary market services.

Thereare, admittedly, some provisos, most notably about the IPO process itself, withthe FCA highlighting the insufficiency of information available to investors,the potentially skewed allocation of shares and the misleading use of bankingleague tables.

But,as a bank analyst said in an interview, the FCA previously flagged up that theywere uncomfortable with bundled products and unclear charging structures, andthat the service provided to corporate clients in ECM and DCM activity couldhave been better. The analyst, who did not wish to be named, suggested theseissues now do not seem to be such a great problem for the regulator. Followingthe release of this report, which had the potential to discomfort the universallenders, bank share prices appeared unaffected, he observed.

"Inthe context of potential unbundling with itemized charging, to ask fortransparency in a relatively woolly way is a benign outcome for some of thelarger banks," he said.

MarkHughes, a partner at PricewaterhouseCoopers specializing in capital markets,said in an interview that the FCA had made "a constructivesuggestion" in proposing that the quality and timing of the informationavailable to investors should be improved.

Thereis a two-week blackout phase during an IPO in the U.K. between the publicationof research from syndicate banks and that of the pathfinder prospectus; thusinformation often arrives late on the desks of investors and independentresearch analysts. This, the FCA said, results in a "heightened risk ofbias due to potential pressure on connected analysts," and the independentassessment of IPOs often comes too late to affect investment decisions.

TheFCA said the timing of the publication of the prospectus and connected researchcould be changed to make the prospectus "the primary source of informationavailable to investors." At the same time, "unconnectedanalysts" could have early access to management and should be able toproduce timely independent research.

Hughessaid greater market transparency and improved information was, in principle, apositive goal. Yet he said syndicate houses could, given Chinese walls, produce"a good set of independent research."

Thebank analyst said that he personally felt he could use syndicated research asthe basis for independent analysis, and that there was often little financialincentive for independent researchers to become involved earlier in the IPOprocess. However, he admitted that some IPOs in the past had been characterizedby a lack of independent broker comment on which the media and investors coulddraw.

TomHinton, head of capital markets at SyndicateRoom, an equity crowdfundingplatform, said in an interview that the U.S. method of publicly publishing theIPO prospectus should be adopted to provide greater transparency.

Hughesobserved that the U.S. process was far more directed at retail as well asprofessional investors who represented the vast majority of IPO participants inthe U.K.

However,there is no reason why this should not change as bank disintermediationincreases. Hinton said primary capital markets should be more accessible andtransparent and thus attract more retail investors in the U.K. This indeed isthe idea behind SyndicateRoom, which seeks to offer retail investors the sameaccess to IPOs as institutions.

TheFCA 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 greateropportunities.

However,the FCA document does reveal that the U.S. process is significantly more costlyto 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, thecomparable figure is between 3% and 4%. This could reflect the domination ofprofessional investors in Europe who are cheaper to service, Hughes observed.

Giventhe level of client or issuer satisfaction indicated, it is not surprising thatthe FCA has not been too critical of the banks. Hinton said the regulator isseeking support within the industry and had "soft-pedaled." He said,however, that it depended upon which issuer one spoke to. Certainly, the largecorporates that benefit from considerable choice and control the ECM and DCMsyndicates they use seem untroubled by bundling services. This is unsurprising,not least given that the companies obtain loans and corporate broking belowcost in exchange for lucrative transactional work.

"Thismodel seems to work well," the FCA said, while cautioning that smallercompanies were less fortunate and that contractual clauses forced clients tofavor their lending banks or corporate broker on future deals. The FCA wants toeliminate such clauses. This could lead to corporate lending and brokingbecoming both more competitive and more expensive. This could prove to be themost significant measure proposed by the FCA.