On 27 January 2011, the OFT published the findings of its market study into equity underwriting and associated services. Whilst concluding that the market has not been functioning well due to a lack of competition on prices, the OFT nevertheless found that there was sufficient choice amongst investment banks offering both equity underwriting and corporate broking services.
As a result, the OFT has provisionally concluded that the threshold for making a market investigation reference to the Competition Commission has not been met and that the appropriate action consists of guidance to companies and their institutional shareholders on how to apply greater downwards pressure on fees and discounts. Third parties now have an opportunity to comment on this provisional conclusion and the OFT has invited submissions by Friday 11 March.
The OFT announced plans to conduct the market study on 6 June 2010 before confirming the scope of the inquiry on 6 August 2010. Subject to completion of the consultation phase, the OFT’s announcement brings the investigatory process to a close in just under six months.
In short, the OFT’s key finding is that equity underwriting fees increased significantly in 2009, to an average of more than 3%, compared to an average of around 2-2.5% in the period 2003-2007. Based on the estimated raising of £350bn of equity capital in 2009, this resulted in fees of around £1.9bn.
To put this in context, the Rights Issue Fees Inquiry, commissioned by the Institutional Investor Council and reporting in December 2010, found that typical gross underwriting fees for rights issues were ten times the total reward for executive directors in the year that the fundraising took place.
Whilst the OFT accepts that volatility in the markets, and consequently risk, increased significantly during the financial crisis, its evidence points to a significant clustering of fees and discounts in 2009, with underwriting fees in particular slow to fall in line with subsequent reductions in risk and decreased stock market volatility.
Given that it has no concerns regarding structural features of the market, in particular finding that concentration levels are low and that there remains significant choice amongst providers of equity underwriting and associated services, the OFT considers that companies and their shareholders are best placed to tackle any concerns over persistently high fees by applying more concerted pressure on providers of equity underwriting services, for example by:
- Demanding greater breakdowns in fee proposals
- Increasing the use of competitive tenders, including increasing the pool of potential providers
- Splitting how fees are awarded and agreed between different aspects of the work. The OFT gives the example of agreeing fees for advisory, administrative and distributional work upfront, but for delaying any guarantee of share issue proceeds until later, when the risks are clearer
- Seeking greater advice from experienced institutional shareholders or non-executive directors and seeking independent advice.
In addition, the OFT considers that institutional shareholders could play a greater role, for example by applying greater pressure on companies to agree lower fees and/or committing to subunderwriting a rights issue ahead of announcement to lower risks (and consequently fees).
These findings echo those of the Rights Issue Fees Inquiry which set out a number of recommendations to improve competition in the underwriting services market, increase transparency in relation to costs and sub-underwriting arrangements, and improve shareholder involvement in the equity underwriting process.
Market studies are an important tool which enable the OFT to identify and address potential market failures, encompassing competition issues, detrimental effects of Government regulation and possible consumer detriment. The OFT conducts market studies under section 5 of the Enterprise Act 2002 and has a range of possible outcomes, from recommending a further in-depth review by the Competition Commission by making a market investigation reference, to softer actions such as encouraging voluntary action or publishing information to help consumers of particular goods or services.
In this case, given the finding that there is no lack of competition amongst providers of equity underwriting services, the OFT has concluded that users of these services should do more to engender greater competition on fees.