What firms should look out for in the FCA’s IPO review
07 January 2019
Those involved in primary capital markets will have noticed that the Financial Conduct Authority (FCA) has been particularly active in this space in recent years, and the regulator’s 2018/19 business plan suggests this is set to continue. A core aspect of its wholesale supervisory agenda is to review how firms have implemented a series of new UK and EU-wide rules related to the management of securities offerings, as well as how those rules are impacting on market practice. But where is the FCA likely to focus its scrutiny, and how can firms prepare to meet the regulator’s expectations?
First, though, it is worth briefly recapping on what the regulatory changes are. In July 2018, the new UK regime for equity initial public offerings (IPOs) took effect. This seeks to help investors make more informed decisions by improving their access to a higher quality range of information, namely an official prospectus and independent or ‘unconnected’ research produced by analysts from outside the book-running banks. The FCA wants to reduce the prominence of ‘connected research’ during price formation, given its concerns around conflicts of interest within book-runners.
The new EU-wide regime, introduced as part of MiFID II, is broader in scope and covers both equity (e.g. IPOs) and debt transactions. The aim here is to improve conflicts management by banks in relation to advice on pricing and allocations, and to ensure that the issuer’s interests are central to decision-making.
It may be possible to answer the questions posed above by casting our minds back to the areas which proved most challenging for firms when implementing the rules. The new UK IPO rules require firms to make a number of complex judgements, particularly around providing unconnected analysts with access to the issuer’s management team. What is deemed an ‘unreasonable restriction’ to impose on unconnected analysts? What constitutes a ‘range’ of unconnected analysts? The trade associations AFME and Euro IRP carried out valuable work to produce industry guidelines to help with these issues, but the FCA will be looking for evidence that firms are set up to make decisions on a case-by-case basis, reflecting the unique features of the specific transaction in question, rather than relying on the guidelines to apply a blanket approach.
Some firms have also struggled with implementing the rules banning connected analysts from interacting with the issuer’s representatives in the context of IPO pitches. For example, there has been significant uncertainty around judging when a pitch begins, given that banks will be having exploratory conversations with private companies long before those companies decide to pursue a transaction. Banks will be expected to demonstrate robust plans for making judgements of this kind across a range of scenarios.
On MiFiD II, the FCA might be expected to take a keen interest in how firms are justifying the allocations made to each investor given the concern raised about skewed allocations to favoured clients in its 2015-16 market study of investment and corporate banking. Also on its radar could be how firms are managing conflicts of interest when pricing bond issuances, which has recently attracted attention from the industry-led FICC Market Standards Board.
In terms of the regulator’s expectations of firms, some clues could be found in IOSCO’s recent guidance, published in September 2018, for regulators on how to enhance conduct amongst banks in equity capital-raisings. This new global standard captures the sentiment of the EU requirements, but is more tailored to equity transactions and may therefore offer insights on how the FCA views MiFID II implementation. IOSCO has also signalled that it will take a close look at debt issuances in 2019, so firms should keep an eye out for this.
Firms will no doubt be eagerly awaiting the FCA’s output from its supervisory work. But, in the meantime, they would be wise to get a head start on reviewing their implementation of the UK IPO rules and MiFID II regime and get comfortable that their approaches would withstand scrutiny by the regulator.