Financial Conduct Authority gives investment and corporate banks a (mostly) clean bill of health

02 November 2016

By Andrew Strange and Dominic Muller

In keeping with the saying that ‘no news is good news’, the banking industry will welcome the FCA’s final conclusions to its investment and corporate banking market study last month. Despite the review’s wide scope that threatened dramatic regulatory intervention into the prevalent ‘cross-subsidisation’ model, the FCA’s proposals will have only a minor impact on the rulebook and current market practices. 

The immediate headline is that the FCA is consulting on banning certain contractual clauses that require clients to purchase future transactional business in exchange for (often discounted) corporate broking and lending services. But more significant is the FCA’s broader conclusion that these markets are very competitive, and the degree to which the regulator used data to push back on stakeholder concerns. The FCA found that the role of large banks in practices such as cross-subsidisation of services and syndication of primary market issuance provides clear client benefits, usually around lower costs. And large firms do this without impeding market access for smaller and medium-sized banks. Even more notably, given the extent of stakeholder concerns at their increasing prevalence, the FCA debunked fears of corporate financial advisers acting as inappropriate primary market gatekeepers. It found corporate advisers are not guilty of rejecting smaller banks from the initial public offering (IPO) process. Nor do they push for IPO prices that bolster their own fees but are unsuitable for clients.

The FCA also took a restrained approach with league tables. The regulator found some problematic practices around how league table information is generated and presented, including firms entering into loss-making transactions just to improve table standing. But it decided any direct intervention, such as standardising the tables, would be too extreme. Instead, the FCA plans to work with industry to develop best practices around increased disclosure of the scope of deals covered by a league table and using the same tables in client pitches as banks use internally.

Of course, given the scope of the market study, it would have been very surprising if the FCA failed to uncover any anti-competitive activity. The regulator’s most immediate follow-up action is to seek to ban contractual clauses that bind clients to bundled corporate and investment banking services. As mentioned above, the FCA found the broader practice of offering discount lending and broking services as an incentive for future transactional business yielded significant client benefit without putting excessive competitive pressure on smaller banks. But, the regulator noted that occasionally such bundling is contractually mandated. As a result, smaller clients which may need specific primary market services from a certain bank are forced to stick with the firm that provides their corporate broking and lending.

One of the primary focuses of the market study had been around IPOs. The FCA will clearly continue to focus on this area, especially since new MiFID II requirements around equity allocation will come into force in January 2018. For the time being, though, the regulator feels it has enough tools to address potential conflicts of interest, which exist where investment banks allocate valuable IPO shares to preferred clients. The FCA has already contacted certain firms about their allocation practices, but generally the industry should be happy that the status quo remains largely unchanged.

By contrast, the FCA had indicated it may need to take more aggressive action around how delayed publication of prospectuses after the release of “connected” research prevents the development of independent research of IPOs. The regulator promises a consultation paper on this issue in winter 2016/17.

Banks had been bracing themselves for a massive shakeup as a result of the market study, and will be relieved that the FCA found very little of concern. Of course, firms should be prepared to adopt the FCA’s final rules around restrictive contractual clauses and possible future requirements around the publication schedule of prospectuses and connected research. But it would be understandable if the industry first breathes a sigh of relief.

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