Last year, the Office of Fair Trading (OFT) became aware of a growing dissatisfaction amongst companies and institutional shareholders, since the onset of the financial crisis, with equity underwriting services. In particular, it noted an issue in relation to increases in underwriting fees and discounts on rights issues.
In response the OFT conducted a market study to explore these concerns. Its findings are broadly consistent with those of the Rights Issue Fees Inquiry conducted by the Institutional Investor Council which was published on 14 December 2010. Both bodies highlight the fact that fees and discounts have been slow to fall in line with the reduction in risk in the market since mid-2009. They also agree on the conclusion that there is more companies can do to negotiate better outcomes, and more that institutional shareholders can do to ensure this happens.
In the light of their findings, the OFT has provisionally concluded that a Market Investigation Reference would not have been appropriate in this instance. They are consulting on this provisional decision and responses should be emailed to firstname.lastname@example.org by Friday 11th March 2011.
Key findings of the OFT study:
- There has been a significant increase in underwriting fees since the onset of the financial crisis. Average fees rose from 2.0/2.5% in 2003-2007, to more than 3% in 2009. In the same period, average discounts on rights issues rose from approximately 30% to nearly 40%. While such increases can partially be explained by increasing volatility and risks in this period, the OFT suggests that fees and discounts have been slow to fall in line with subsequent reductions in risk; particularly from lower stock market volatility.
- The OFT does not have significant concerns over the number of available providers of equity underwriting services. It feels that the provision of underwriting services does not appear to be too highly concentrated amongst investment banks.
- The OFT suggests that the trends towards higher and greater clustering of fees and discounts may be the result of companies not negotiating cost effective outcomes. This may be compounded by investment banks and shareholders not putting sufficient pressure on companies raising equity capital to reduce costs. Its research has found that companies typically lack regular, repeated experience of equity-raising and are not focused principally on the price they are paying for equity underwriting services when they issue shares.
Conclusions and next steps
The OFT feels there is little competitive tension between investment banks during the equity raising process. It has set out several options that companies and institutional shareholders could consider in order to apply greater pressure on underwriting fees and discounts:
For companies these include:
- Reducing the knowledge and experience gap by seeking advice from those with more experience of the process, such as legal advisers.
- Improving competitive tension between providers pitching for equity underwriting appointments through a number of different means: by inviting banks, corporate brokers and lenders to compete for elements of the equity underwriting work; and expanding the pool of providers by increasing relations with investment banks.
- Putting greater pressure on fees by requesting the underwriters provide a breakdown of their proposed fees into separate charges for the different elements of the work. This will allow companies greater insight to enable them to challenge elements of the fee.
For institutional shareholders these include:
- Applying greater pressure on investee companies to reduce fees and discounts.
- Committing to sub-underwriting issues before they are announced to reduce the risk the underwriter bears and potentially the underwriting fee.
- Indicating they are willing to accept lower sub-underwriting fees and applying pressure for underwriters in turn to bring down their fees, reflecting the reduced cost of bearing the risk.