Fishburn Hedges

16.06.2010

So the OFT is to look at the fees charged by investment banks for underwriting.  It’s possible of course that they will conclude that the City has indeed been operating as a cartel and that fees will be required to be charged at lower rates - but that is to miss the point.

What is clear is that this is a significant issue for UK companies looking to access capital markets – and for the investment banking community that serves them. The London Stock Exchange’s statistics reveal that over £50bn was raised by rights issues during 2009 alone, a near-100 per cent increase on 2008.  With commissions to the banks typically around the 2.5 per cent level this generated over £1.25bn of commission for the underwriters.

But back to the question of competition. There are two main levers for determining the appropriate value for the underwriting of risk in a rights issue - the commission paid to the banks is, of course, one of these, but more relevant is the level of discount that the issue is priced at. You’d imagine that rights issues would be priced at discounts that reflect the risk inherent in the deal, right? Wrong. A quick trawl through the London Stock Exchange’s stats shows that net discounts on recent rights issues have - with few exceptions - been at or near an amazing 40 per cent to the theoretical ex-rights price.

So, if they’re all undertaken at essentially the same pricing, the price that the banks charge for underwriting that risk will vary widely, right? Surely, as in credit markets, there are different prices for different risks, right? Again, wrong.

Compare the 2009 rights issues of HSBC, Rio Tinto and William Hill: very different companies, with very different challenges and, theoretically at least, different risks (though, predictably, all at discounts at or near to 40 per cent). The underwriting fees? HSBC: 2.75 per cent (plus a success fee of 0.5 per cent), Rio Tinto: 2.75 per cent and William Hill, 3.25 per cent. Hardly the variation one might expect.

So the OFT is right to investigate. But should it need to? Why haven’t shareholders been pressing the companies that they own to say more about why the pricing for the rights issues they announce is uncannily similar to the last company through the door –and the one before that?

And more to the point, why haven’t companies been pressing banks for rights issue pricing - and fees - that reflect the risk that they represent to the underwriting banks’ balance sheets?

As ever, so much of this is down to communications. It is to be hoped that the next companies to announce rights issues will be rather more consultative in their dealings with shareholders on issue structure and pricing - and tougher on the banks on commissions. There is some evidence that this process has started - witness the current fundraising by Clive Cowdery’s Resolution, which has much lower than normal fees.

Should companies fail to do so, we may see more CEOs having to deal with the ire of disgruntled shareholders. And that’s just not nice.  Just ask Tidjane Thiam.