The Office of Fair Trading ("OFT") has published its provisional decision following an investigation into equity underwriting and related services. It has concluded that it should not refer the market to the Competition Commission for detailed review and that no new regulation is needed. It does, however, make a range of recommendations for ways in which boards and institutional shareholders might seek a better deal from banks.
In its role as UK competition regulator, the OFT has been formally investigating equity underwriting services since summer 2010. It ultimately decided to limit the scope of that investigation to secondary share issues by FTSE 350 companies, having earlier consulted on whether the investigation should include IPOs and the raising of equity by smaller companies.
The OFT's findings follow three reports by the then-UK competition regulators in the 1990s, a report in 2008 by the Rights Issue Review Group and the 2010 report of the Institutional Investor Council Rights Issue Fee Inquiry, which identified some concerns.
In a provisional decision published on 27 January the OFT's key findings were as follows.
- Average fees in 2009 were above 3 per cent, up from 2 to 2.5 per cent in 2003 to 2007. In the same period, average rights issues discounts rose to nearly 40 per cent from 30 per cent. Sub-underwriting fees, too, had risen. The range of fees and discounts had also become more tightly clustered.
- These higher fees and discounts at least in part reflected increased risk and volatility, but adjustment back has been slower than would be expected.
- However, there are adequate numbers of competing providers of equity underwriting and corporate broking services.
- There are not significant concerns about possible conflicts between the interests of companies on one hand and banks and institutional shareholders on the other.
- The persistently high fees and discounts are attributable largely to companies (and their shareholders) not doing all that they could to obtain as good a price as they could have done. In particular, companies lack experience of equity-raising and are more interested in other factors (confidentiality, speed and high take-up) than price.
Considering all this, the OFT did not consider it appropriate to refer the market to the Competition Commission for further investigation. This is effectively its ultimate sanction where it finds that competition in a market is not working. Such an investigation could have run for two years and could have been followed by mandatory measures imposed by the Competition Commission.
Instead, the OFT set out a number of options which may be available to companies and shareholders to achieve more cost-effective outcomes, as summarised below:
- The OFT found that even companies which were sophisticated in other areas of business often had little experience of, and information about, the equity underwriting process. It therefore suggested that companies seeking to raise equity could take more advantage of possible sources of information, internal to the company as well as from institutional shareholders and legal advisers.
- Companies could run a competitive process to appoint underwriters, rather than simply appointing their corporate brokers, as is common practice.
- The OFT highlighted several options available to companies by which they could improve competitive tension between banks pitching to be appointed as underwriters:
- requesting a breakdown of the underwriter's proposed fees into constituent components and possibly negotiating these components at different points in the process
- inviting banks with which they have an existing relationship in another area, including corporate brokers and lenders, to compete with each other for elements of the underwriting work
- increasing the number of banks with which they have relationships.
- Institutional shareholders were found by the OFT to be more concerned about high fees and discounts than were companies, and the OFT suggested that they could apply greater pressures to the companies in which they own shares to reduce underwriting fees by more active involvement at an early stage of equity raising planning.
- Institutional shareholders could in some cases also directly take part in the equity raising process in a way that could reduce underwriting fees:
- they could commit to sub-underwriting issues before they are announced, reducing the risk borne and fee charged by the underwriter
- in offering to sub-underwrite, they could offer lower fees, applying downward pressure on primary underwriters.
In addition to deciding not to refer the market to the Competition Commission, the OFT considered but rejected a number of other possible proposals.
- It considered and rejected recommending regulation to require banks to publish detailed information on underwriting fees. This would reduce information asymmetries between banks and companies, but the published prices could also provide a focal point around which banks might base their own fees. This might lead to less price competition rather than more.
- The OFT rejected the idea of using regulation to unbundle underwriting, sub-underwriting and corporate broking, noting that companies could choose whether or not to purchase these services in a bundle, that there could be advantages to such bundling and that there was limited appetite for forced unbundling.
The OFT is consulting on the provisional decision prior to issuing the final version. Typically, there would not be expected to be major movement in the OFT's conclusions as a result of this consultation process, though some change is certainly possible. The consultation period runs until 11 March 2011.
The full text of the OFT provisional decision is available here.