It’s pretty much been a one-way street for investment banks since the UK and US governments started to deregulate financial markets in the 1980s.
Indeed Philip Augar, former investment banker and author of The Death of Gentlemanly Capitalism, has called it a “stairway to heaven” because of lack of competition, regulatory tolerance of conflicts of interest, and the supineness of most of the i-banks’ customers.
Obviously, the crisis of October 2008 caused something of a hiccup for the industry. But even after that near-death experience, for which the investment banks must bear a large portion of the blame, we have yet to see concrete legislative changes limiting their range of activities or boosting competition in the sector.
Given what some describe as a clear case of market failure in the sector, governments are feeling the need to step in and do the investors’ work for them. The US Securities and Exchange Commission started the process with its case against Goldman Sachs on April 16. The case, and related actions, allege that Goldman defrauded its own clients in the Abacus 2007-AC1 synthetic CDO transaction.
On Thursday the British government, which has traditionally been very close to the investment banking sector, also started to flex its muscles. Its anti-trust agency the Office of Fair Trading declared it was launching a competition probe into investment banks’ grip and possible price-fixing in the underwriting of equity capital raisings (also known as rights issues, these are when listed firms issue new shares and offer them to existing shareholders at a discount).
Underwriters basically agree to take on any unwanted shares in the event of existing shareholders failing to take up their rights. The risk is usually minimal, unless the company’s actual share price falls below the offer price.
Last year there was a crescendo of complaints from some investors and corporates that the investment banks were abusing weaker competition in the sector post-Lehman in order to bump up fees.
It emerged RBS (formerly Hoare Govett) and Citigroup (formerly Schroder Salomon Smith Barney) charged the packaging group Rexam a whopping 3.5% for underwriting a £350m rights issue. It is the sort of behaviour that has led some observers to accuse the investment banking sector of being “socially useless”, “parasitical on the real economy”, and being "rent-gougers".
According to Dealogic the range of fees on rights issues worth more than $1bn in the UK has risen to between 2.3% and 3.5% since September 2008. This compares with 1.5% to 2.5% before Lehman's demise.
The OFT said it will examine rights issues and other types of equity-raising by the 350 biggest British public companies, scrutinizing the fees paid by corporates for handling capital raisings.
“Economic growth and productivity rely on companies being able to raise capital efficiently for investment,” said OFT director Clive Maxwell in a statement. “We plan to study the efficiency of the equity underwriting market and identify any areas for improvement. Our study will also help us to advise the Government in its wider thinking about wholesale financial markets.”
UK listed companies raised £70bn ($102bn) in rights issues in 2009, for which they paid investment banks fees of £2 billion (1.5% of the money raised). In March, Vince Cable, the UK’s business secretary, who was then in opposition, called for an inquiry saying that a “magic circle” of City firms were stifling competition by shutting rivals out of the biggest deals.
Possible outcomes of the OFT’s inqury include enforcement action; a market investigation reference to the Competition Commission; recommendations to government or regulators for changes to laws, regulations or policy; voluntary action by banks to address any problems found; or a clean bill of health for the industry.
The sector was last examined in 1997 when the Competition Commission ended an inquiry into underwriting fees by concluding that a “complex monopoly” existed in the UK market, adding that:
…the use of standard fees for sub-underwriting operates against the public interest in that it results or may be expected to result in some issuing companies being charged higher underwriting fees than would otherwise be the case.
But little action was taken...
Further reading on deregulation of banks and rights issues
- Raising Capital in the United Kingdom, by Lauren Mills
- Equity Issues by Listed Companies: Rights Issue and Other Methods, by Seth Armitage
- Raising Capital by Issuing Shares [checklist]
Tags: banking , capital raisings , City of London , investment banks , Lehman Brothers