The FCA, IPOs and how to achieve the square root of zero

7 min read

When I saw the Financial Conduct Authority’s recent package of IPO measures, which it said were designed to ensure the UK’s primary capital markets remained effective – a crucial end-game in a Brexit context – I kept thinking I must have missed something.

The regulator clearly became fixated with the timing of information disclosure and biased research by analysts working for underwriting banks. So it plans to introduce a formal registration document early in the process, change the rules around who has access to company management and when, and level the playing field vis-a-vis provision of research by unconnected analysts.

So why did I think I was missing something? Because based on a basic tenet of good regulation (that it needs to be effective and improve things for the overall good) I’m not sure this is taking us anywhere. Especially when, in this case, going public is just one of several options company owners have to source expansion or exit capital. Making the process even more onerous and bureaucratic won’t help.

Just to make sure I wasn’t missing anything, I reached out to some senior ECM folks for reaction; their response chimed with mine. It’s not that market participants are against the new measure per se; it’s more that their impact is expected to be neutral at best, potentially a retrograde step or – perhaps most unflattering – irrelevant.

Here’s my real beef: if, two and a half years into a process that began with a market study into investment and corporate banking, the best the FCA can come up with is measures that in the real world of deal-making could either deter companies from considering UK IPOs or – even worse from the perspective of their entire raison d’etre – push business to non-UK venues, won’t this be yet another classic case of futile and misguided regulatory interventionism?

Don’t get me wrong: aiming to improve market integrity and transparency, introduce more effective competition, facilitate price discovery, investor education and confidence, and remove conflicts of interest – which is what the UK regulator said were its underlying goals – is fine. You certainly can’t knock it.

And to be fair it’s not all bad. The new measures will apply “FINRA Toys ‘R’ Us” rules for analyst engagement to the UK. (In 2014, the US regulator meted out US$43.5m in fines to 10 investment banks for allowing research analysts to solicit investment banking business and offering favourable research coverage in connection with the retailer’s 2010 – ultimately cancelled – IPO.)

The clarity the FCA has brought here also means independent IPO advisers can no longer (even unwittingly) seek to undermine analyst independence – which is what some bankers believe they do – by turning pitch days into analyst meetings. Bankers have moaned that this puts a lot of pressure on sell-side research compliance.

But on the issue of unconnected research, one of my interlocutors had this to say: “Unconnected analysts are an irrelevance. MiFID II will make them even scarcer than they already are. The FCA doesn’t realise that for investors the main value of pre-deal research is to establish consensus forecasts (usually based on management guidance). Otherwise, investors don’t care what a connected or unconnected analyst thinks.”

Levelling the research playing field, at a time when the market is facing a potentially significant diminution in research provision thanks to MiFID II, just looks like a mightily odd thing to centre your regulatory upgrade on. Attempting to mitigate the shrinking of research capacity would be a more constructive place to channel your energies. Otherwise you end up in a situation of a level playing field that’s level on paper only. That won’t make your capital markets more effective.

If I were the FCA, tasked with making my capital markets more effective, I’d take a more fundamental starting point and try to understand why more companies didn’t go public in the first place. And I would look to ease the burden on IPO candidates, like the US did with the JOBS Act. I’m not saying the UK should copy the US; I just mean, from the perspective of understanding the underlying rationales for going public from a company perspective, making the process more streamlined and less stressful for the good of the overall economy.

Looking at Thomson Reuters UK IPO data since 1982, only eight of those almost 36 years have witnessed UK floats that have garnered more than US$10bn in proceeds, while the number of deals only exceeded 100 in seven years, with the activity surges clustered around the dotcom and pre-financial crisis bubble eras. A graph of deal volumes looks like a map of the Himalayas. Even accounting for business and economic cycles, you’d expect an advanced economy like the UK to have elicited a more constant flow of IPOs.

If I’m a CEO looking to float after the rules come into force in 2018, I’ll have to figure out whether strategic and forward-looking information in analyst presentations constitutes inside information vis-a-vis MAR rules on market sounding and securities already trading. I’ll probably have to organise two sets of analysts presentations and I’ll have to make sure my management team and my corporate finance advisers and underwriters disclose every bit of info to everyone – connected and unconnected – at exactly the same time.

I can no longer speak to analysts until the analyst presentation or until the banks’ roles are communicated in writing by the issuer, and it’ll take me longer as a market entrant to figure out how to service the public community effectively. I’d be potentially compromising confidentiality by having to include unconnected counterparties; I have to open up to investors, analysts, media and stakeholders at a much earlier stage. And so it goes on.

Will I be minded to deal with that additional stress and bureaucracy? I’d probably run for the hills and seek alternative solutions. “The FCA sounded a lot of people out but they sort of missed the point,” a senior ECM head told me. Enough said.

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