Bank defends underwriters

The Bank of England yesterday stepped into the row over whether City underwriters are charging too much for share issues, by dismissing claims that there is not enough competition in the market.

An article for the Bank's quarterly bulletin said an investigation by Paul Marsh of the London Business School, commissioned by the Office of Fair Trading, heavily overstated the profits made by sub-underwriters, which were less than half the level claimed.

The OFT is inquiring into underwriting commissions, believing that there is profiteering, and may refer them to the Monopolies and Mergers Commission later this year.

The Bank admitted that it had failed to explain away all the excess profit Professor Marsh found in sub-underwriting fees, but concluded that the evidence did not show inadequate competition in the share-issuing market.

The significance of the two studies is that what began as a highly technical exercise has developed into a fundamental argument about whether the City is operating restrictive practices. If it is, that could keep the cost of capital for industry artificially high compared with international competitors.

The Treasury is also known to be concerned about the impact of the high cost of capital on company financing.

In a related development, it is thought to be backing pressure from industry to loosen the right of existing shareholders to have first refusal of new shares in rights issues.

Of the normally fixed fee of 2 per cent charged for an issue, other than privatisations, 0.5 per cent goes to the investment bank organising it, 0.25 per cent to the brokers and 1.25 per cent to the sub-underwriters.

Professor Marsh claimed that the excess return made by sub-underwriters was 1.14 percentage points of their 1.25 per cent fee.

The Bank study reworked Professor Marsh's figures with additional refinements, and concluded that the excess return was only 0.49 percentage points.

The article said that despite the smaller discrepancy between fees and the cost of the service provided, "It is not possible to conclude from this that there is inadequate competition in this market, since firms do have a choice both of issuance technique and of underwriter."

The Bank said that companies in the US had "puzzlingly" moved in recent decades away from cheaper share-issue methods to sales of entire issues direct to underwriters, which is the most expensive method of all.