ECM, DCM, M&A: Regulator publishes terms of reference for its investment and corporate banking study

The Financial Conduct Authority has published the terms of reference for its market study into competition in investment and corporate banking. The FCA’s accompanying press release is here. We discussed the reasons behind this market study in this article in March 2015.

Focus of the FCA’s study

The market study will, in the FCA’s words, “explore whether competition for investment banking and corporate banking study is working well“. It will focus on:

“…primary market and related activities provided in the UK by the investment and corporate banking industry. Primary market activities cover Equity Capital Markets, Debt Capital Markets, mergers and acquisitions and acquisition financing. Related activities (e.g. corporate broking and lending, ancillary services) will be considered insofar as they affect competition for primary market activities“.

Three linked topics will be covered: the choice of banks and advisers faced by selecting clients when selecting services, limited transparency in the provision of services, and the practices of bundling and cross-subsiding activities within primary market activities and between primary market and related activities.

Topic one: The choice of banks and advisers faced by selecting clients when selecting services

Three areas will be covered under this topic:

1.  The competitive landscape for investment and banking services: The FCA observes that smaller clients may be less attractive as clients and so less well served by the market, and the regulator is:

“keen to understand the extent to which this is the case and will consider the types of banks and advisers used by different groups of clients. Whilst there may be good commercial reasons for some banks not to serve some clients, we want to understand how this affects clients’ choices“.

2.  Clients’ purchasing behaviour, and the impact of syndication: Clients have told the regulator that they sometimes have a limited choice of suppliers because of their specific requirements or because they use a syndicate of banks. Clients may wish to use a bank with which they have an existing relationship, or which has deep knowledge of their sector. So the FCA is:

“keen to understand how client preferences drive competition, when and why clients opt for syndication, and how this affects the competitive dynamics in the market. In particular, we will examine whether there are circumstances in which syndication restricts instructing or issuing clients’ ability to select banks and advisers or to play them off against each other“.

3.  Entry and expansion, including the potential effects of regulation: Here, the FCA will:

“examine how banks and advisers establish a client base and explore the extent to which those new entrants looking to provide services to clients might face significant barriers arising from the current regulatory environment or practices adopted by established banks and advisers (such as bundling or reciprocal arrangements between financial institutions)“.

Topic two: Limited transparency in the provision of services

The regulator will, again, look at three areas under this topic:

1.  Adequacy of information: Clients have told the FCA that they find it difficult to assess whether their investment bank offers good value, both before and after a transaction and in giving advice. So the FCA will:

“explore the extent to which clients have access to adequate information and feel well placed to assess value, focusing particularly on the experience of smaller clients who are likely to use investment banking services less frequently than larger clients, and may be less likely to have substantial internal expertise and/or the resources to access and understand expert advice than larger clients“.

2.  Transparency of the allocation process: Remarkably, the FCA has “heard concerns from issuing clients and investors subscribing for an allocation that when issuing debt or equity issuing banks may favour certain investors“. So the regulator “wants to understand whether there is substance to this“, and whether it can be difficult for issuing clients to monitor and influence allocations.

3.  Impact of established practices, processes or regulations on transparency in the IPO process: The FCA will:

“examine whether existing rules and practices for disclosing information around IPOs allow information, such as prospectuses and unconnected research, to be released at the appropriate junctures, and whether the timing of publication of connected research gives the bank publishing it a privileged position as the only source of information during the book-building process“.

Topic three: Bundling and cross-subsidisation

The FCA has heard concerns from various parties that investment and corporate banking services are often sold together, with the result that “such bundling and/or cross-subsidisation may restrict clients’ ability to switch and create barriers to entry and expansion for standalone or boutique banks“. So the regulator will consider whether bundling and cross-subsidisation exists, and if so, whether it has adverse effects on competition and clients.

The market study’s context

The broader context for the FCA’s work includes the “Fair and Effective Markets Review” announced in June 2015, the implementation of MiFID II, and the European Commission’s work on the Capital Markets Union. On that last, see our article here.

The FCA’s use of its powers for this study

This market study is being conducted using the FSA’s powers under the Financial Services and Markets Act 2000, rather that concurrent Enterprise Act 2002 powers.

What now?

The FCA says that it will publish a report of interim findings “around the turn of the year”, and its final report in spring 2016, adding that “as with any market study these include rule-making, publishing general guidance or proposing enhanced industry self-regulation. Alternatively, we may decide to take no further action for the time being. This could be because our concerns are likely to be satisfied by upcoming legislative measures, action by the relevant firms or other circumstances“.

Source: FCA publishes terms of reference for its investment and corporate banking market study