OFT warns on issue underwriting
Friday 24 March 1995
Describing underwriting as an "opaque area of City practice", Sir Bryan Carsberg, the director general of the OFT, said there was no justification for the fixed fees traditionally charged for issue underwriting, and the lack of variation in discounts on new equity.
The City was relieved by Sir Bryan's decision not to refer the matter to the Monopolies and Mergers Commission, but recognised the need for changes to a business that one top corporate financier described as "a nice little earner".
The OFT report found "strong evidence of overcharging for underwriting and little evidence that issue prices are adjusted to bring the fixed fee into line with the risks of particular issues".Underwriting fees have been generally set at 2 per cent of the value of the issue for more than 15 years, according to the report.
Although the OFT found no evidence of a fee-fixing cartel, as some complaints from issueing companies had suggested, it identified a clear competition problem.
"I am concerned by the generally fixed level and structure of fees, the limitations which current arrangements are said to impose on the scope for competition in fees and innovations in underwriting methods, and the potential for conflicts of interest between advisers, underwriters and sub-underwriters," the OFT said.
In not referring the matter to the MMC, Sir Bryan said he is giving the industry a chance to sort out its affairs. He said he will keep underwriting under scrutiny, publishing a review in 1997.
John Rogers of the National Association of Pension Funds, whose members are traditionally active underwriters, said: "Issue underwriting is an area where things have just jogged along without ripples for too long. The City must seize this opportunity to sort things out."
Richard Regan, head of the investment office of the Association of British Insurers, said: "We welcome the fact that, instead of disrupting the system with a referral, the OFT will let the market look at matters in a practical and sensible way."
In calling for changes to underwriting, the OFT said issueing companies should take the initiative by being more demanding of their advisers. "They might consider appointing separate merchant banking advisers and lead underwriters and might more fully explore variants, such as deep discounting, to the traditional underwritten issue typically recommended to them," the OFT stated.
"They could also find ways of avoiding some of the constraints, such as those arising from rigid timetables, on the scope for competition between sub-underwriters. These and other options should all be reviewed before a company settles the terms on which it wished to make an issue," the report said.
This latest call for reform is part of a broad review of financial market practices, focusing on areas left unfinished by the radical upheavals of "Big Bang" in the Eighties. The OFT recently proposed cutting back some of the privileges given to market makers, and ending the unfair advantages given to the Stock Exchange over competitors wanting to introduce an order- driven system of dealing.
The Stock Exchange will propose to its consulting members next week a new rule which would remove the privilege allowing market makers to hide stakes of 3 per cent or more in big companies. This is in reaction to criticism of Swiss Bank Corporation, whose market makers hid a big stake in an electricity company at the time of a takeover in the sector.
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