OFT: investment banks - market study

The Office of Fair Trading has today announced its intention of undertaking a market study into the investment banking sector. In its press release, the OFT has stated that its primary concern is the competitive efficiency of equity underwriting and that it is likely to focus on rights issues and other forms of equity-raising by the 350 largest UK public companies.

The OFT expects the formal launch of its market study to take place in the summer. It hopes to conclude the “initial phase” of its work by the end of 2010, although it will confirm the precise scope and timing of the investigation as part of its summer launch. The OFT has invited interested parties to submit written views by 9 July 2010 on its first-stage proposals so that investment banks and other market participants will have an important opportunity to contribute to the development of the OFT’s investigation.

What is an OFT market study?

Under the Enterprise Act 2002, the OFT has a broad remit to investigate competition and consumer issues across an entire sector. The legislation does not stipulate any particular process or timetable for such market studies.

The main feature of these studies is that they do not target the behaviour of individual companies and are therefore distinct from enforcement of the mainstream competition infringements under the Competition Act 1998. For this reason, a market study cannot lead directly to a financial penalty being imposed on market participants (although it may indirectly do so – see outcomes below).

The possible outcomes of a market study are as follows:

• A clean bill of health
• A reference to the Competition Commission, which then conducts a market investigation, which is a more formal and in-depth enquiry taking up to two years.
• A separate investigation by the OFT itself under the Competition Act 1998 – in other words, information uncovered by a market study may prompt scrutiny of the potential anti-competitive conduct of individual companies, which may ultimately be fined.
• Recommended changes in the legal or regulatory framework, including self-regulation.
• Campaigns to promote consumer education or awareness.

What is the proposed scope of the OFT’s market study?

The OFT proposes to focus on rights issues and other types of equity-raising by large public companies (FTSE 350). It will also consider whether to scrutinise equity-raising by companies whose securities are traded on the AIM and also whether to include IPOs in the scope of its market study. The main activities to be covered are the provision of advice to companies, arranging issues and the actual underwriting. The OFT does not intend to focus directly on legal services or advice provided purely for M&A purposes.

What are the OFT’s concerns regarding the investment banking sector?

In informal discussions with corporate users of equity underwriting services, the OFT has identified three key areas of potential competition concern which, on a preliminary assessment, it believes should be addressed:

• How are underwriting and related services provided? This concern addresses whether competition is in place at the time when advisers and underwriters are appointed, as well as the issue of how they are remunerated for the work that they perform. It would also cover issues of conflicts of interest.
• How are underwriting services purchased? In other words, why do companies choose to raise equity capital from particular providers and what information is available to purchasers and what incentives affect their decisions?
• How does the regulatory environment affect the provision of these services? This includes looking at the rules that govern the role of professional advisers and other firms and whether they facilitate or hinder competition.

As well as the press release, the OFT has issued a Q&A document and a summary of the market study’s proposed scope on its equity underwriting market study page. Also, a clear hint of the OFT’s interest in the investment banking sector was given by the OFT Chairman, Philip Collins, on 30 March 2010, in the third annual Currie lecture at the Cass Business School.

How might participants approach the OFT's investigation?

The preliminary consultation process (with a deadline of 9 July 2010) will allow companies providing equity underwriting services to have their say in the future scope of the OFT’s new market study. The OFT has indeed specifically asked for market participants’ views on both the scope and the preliminary issues identified (as described above in both cases)

The OFT Chairman’s 30 March 2010 speech shows that the competition authorities’ recent enforcement activity has increased their understanding of the functioning of financial markets in difficult economic times. However, this is a highly specialised area and participants in the study will probably wish to explain the mechanics of equity underwriting services to the OFT at the outset of its market study.