“An efficient equity capital market is vital for the long-term growth of the UK economy. Our in-depth study has found that the market is not working well, with little effective competition on underwriting fees.”
Sonya Branch, OFT Senior Director of Services and Public Markets
The Office of Fair Trading (“OFT”) published its market study into equity underwriting and associated services on 27 January 2011. The OFT’s market study considered the different types of follow-on share issues used by FTSE 350 listed companies to raise capital in the UK, including how such services are purchased, how they are provided and how the regulatory environment affects their provision. In the report on its market study, the OFT sets out its findings as to how the market works, identifies its key concerns and suggests options for achieving more cost effective outcomes.
The OFT concluded that there had been a significant increase in the fees paid to investment banks since the onset of the financial crisis and fees have been slow to fall in line with the stabilisation of the equity markets from mid-2009 onwards and subsequent reductions in risk.
The OFT surveyed FTSE 350 listed companies that had raised follow-on equity capital between 1 January 2006 and 31 August 2010; from the results, it concluded that companies prioritised speed, confidentiality and a successful ‘take-up’ over the cost of equity underwriting services. The OFT also concluded that some companies lack regular experience of raising equity capital and institutional shareholders have failed so far to put sufficient pressure on companies to reduce fees paid.
Whilst the OFT’s study did not raise significant concerns in relation to the available choice of providers of equity underwriting services and the concentration of equity underwriters amongst investment banks, the OFT considers that concerns about the level of fees are best tackled by companies and institutional shareholders rather than by further regulatory intervention by authorities such as the OFT or the Competition Commission.
How Can Companies Get a More Cost Efficient Outcome?
The OFT suggest that companies could do more to create competition between underwriters and apply more downward pressure on fees. The report sets out the following options for companies raising equity capital:
- Seeking advice from persons that are more experienced in the equity raising process—such as their legal advisers, institutional investors, board members or independent advisors.
- Improving the competitive tension between those pitching for equity underwriting ap-pointments, for example by:
- Inviting banks that the company has an existing relationship with to com-pete with each other for certain ele-ments of the equity underwriting work; and/or
- Increasing the number of investment banks that the company has relation-ships with in order to expand the pool of potential providers when they award equity underwriting or other transactional work.
- Putting greater pressure on fees, perhaps by asking the underwriters provide a breakdown of their proposed fees into separate charges for different elements of the work.
The OFT also made clear that institutional share-holders also have a role to play and need to be willing to hold directors to account to achieve a reduction in fees. The OFT report includes the following options for institutional shareholders:
- Applying greater pressure on companies they own shares in to reduce fees and discounts—for example, by having regular discussions with company executives about the principles that they would like to see adhered to on fu-ture equity raising.
- Taking steps during the equity raising process itself, such as:
- Committing, where possible, to sub-underwrite issues to reduce the risk that the underwriter bears and potentially the underwriting fee; and
- Indicating that they are willing to accept lower sub-underwriting fees and applying pressure for underwriters in turn to bring down their fees to reflect the reduced cost of bearing the risk.
The OFT study complements, and reaches a similar conclusion to, the Rights Issue Fees Inquiry (the “Inquiry”) whose report was published in December 2010—in essence that companies and institutional shareholders are better placed to address concerns than competition authorities (for more information see “Transparency, Competition and Shareholder Involvement: The Rights Issue Fees Inquiry Pub-lishes Its Recommendations”, DechertOnPoint (December 2010)). For this reason, the OFT has provisionally decided not to make a market investi-gation reference to the Competition Commission at this stage. Responses to the OFT’s decision are invited by 11 March 2011.
The OFT makes less specific and less onerous recommendations than the Inquiry and, notably, no changes to legislation or regulations are recom-mended (whereas the Inquiry recommended changes be considered to the Listing Rules, the Transparency Obligations Directive and the Stew-ardship Code). However, given the considerable interest in this issue, boards of UK listed companies contemplating follow-on share issues would be well advised to keep in mind the recommendations of the OFT and the Inquiry or expose themselves to the risk of questions from, and potential dissatisfaction of, shareholders.