In October 2017, the Financial Conduct Authority (FCA) published Policy Statement 17/23 (PS17/23) containing new rules and guidance on the availability of information in the UK equity Initial Public Offering (IPO) process.
The rules and guidance in PS17/23 come into force on 1 July 2018. Investors, issuers, investment banks and firms that produce research should be aware of the impact of these new rules and ensure they are compliant where relevant.
PS17/32 follows an FCA consultation published on 1 March 2017 (Consultation Paper 17/5) which followed an earlier Discussion Paper (Discussion Paper 16/3) that was published alongside a market study of investment and corporate banking (Market Study 15/1.3).
Areas for improvement
Market Study 15/1.3 and Discussion Paper 16/3 identified certain areas of the current equity IPO process in the UK that requires improvement, namely the timing, sequencing and quality of information being provided to market participants.
The FCA has noted that the prospectus, being the primary source of information on an equity issuer, is made available too late in the IPO process. Instead of the prospectus, investor education and initial price discovery is generally informed by ‘connected’ research. ‘Connected’ research is any research produced by analysts at banks which are part of the underwriting syndicate attached to the particular IPO. Research analysts from outside the book-running syndicate may lack adequate access to issuer management to produce ‘unconnected ‘ research on a particular IPO.
The FCA has noted that conflicts of interest may arise in producing connected research. For example, it is common for analysts within prospective syndicate banks to meet with the issuer’s management and advisers around the time that underwriting or placement mandates are being considered. Analysts may come under pressure to produce favourable research on an offering to help their bank secure a mandate. Connected research may therefore be potentially biased or perceived by investors as biased.
According to the FCA, this lack of high quality, timely information may hamper the price formation process and impair the effectiveness of the UK IPO process. As no market-led reform has addressed these practices, the FCA is using policy intervention to improve practices in this area.
Discussion Paper 17/23
To address these areas for improvement, the FCA has proposed a series of new rules and guidance in the Conduct of Business (COBS) sourcebook. The new rules seek to restore the centrality of the prospectus or registration document and enhance overall standards of conduct in the IPO process.
DP17/23 includes a series of new COBS 11A rules intended to ensure that, before any connected research is released, a prospectus or registration document is published, and unconnected analysts have access to the issuer’s management.
The FCA have also set out new COBS 12 guidance to make clear that it is inconsistent with the maintenance of an analyst’s objectivity for an analyst within a prospective syndicate bank to interact with the IPO issuer’s management, shareholders and advisers around the time that underwriting or placing mandates and subsequent syndicate position are being considered.
The FCA also highlighted existing obligations of regulated firms under chapter 10 of the Senior Management Arrangements, Systems and Controls sourcebook (SYSC) to have in place measures to prevent or control the simultaneous or sequential involvement of a staff member in separate services or activities where it may impair the management of conflicts of interests. Firms are also required by COBS 12.2.21 to physically separate analysts from other persons whose responsibilities or business interests may conflict with the interests of the recipients of the research.
In PS17/23, the FCA also considered the identification of inside information in the context of the creation, receipt and disclosure of information in the IPO process, in particular information shared in analyst presentations. The FCA noted that strategic and forward-looking information on an issuer should be carefully considered to determine whether it constitutes inside information under Regulation (EU) 596/2014 (Market Abuse Regulation).
The new rules and guidance in PS17/23 will require UK equity issuers and syndicate banks providing underwriting and placement services to reconsider their usual practices. Syndicate bank research analysts will no longer be granted access to key sources of information at an earlier stage which may hamper the initial quality of their research. It is unclear whether unconnected research will emerge as a viable competitor to connected research for investors in the IPO price formation process.
The FCA has listened to industry concerns and made some appropriate modification to its COBS 12 guidance. This includes modifications for where analysts are not be aware of their bank’s Equity Capital Market division pitching efforts for underwriting and/or placement instructions. The FCA has also amended the guidance to better deal with situations where a company already has securities issued to trading and is engaging in further issuances.