19 June, 2017
High underwriting fees levied by investment banks on companies' initial public offerings (IPOs) are "akin to tacit collusion" and "work against long-term productive investment", global watchdogs have warned.
The median underwriting fee is 7% of the total proceeds from the IPO in the US, and has risen to 8% in Japan and China, according to the Organisation for Economic Cooperation and Development (OECD). For IPOs valued at less than $100 million, between 9% and 11% is usually lost to fees, according to the report.
"This means that for every 10 IPOs, the market value on an entire new company accrues to fees," the OECD said.
"The failure of underwriting fees to adjust after the [financial] crisis raises important questions about the competitive structure of investment banking and regulatory attitudes towards it. A deeper assessment of the competitive conditions in these markets may be valuable," the OECD said.
The watchdogs found, however, that companies in Europe had been paying "about half" of the fees paid by US and Japanese companies in order to list.
The OECD's findings came as part of its annual 'Business and Finance Outlook' report, which this year makes a number of recommendations intended to improve perceptions of economic "fairness" and tackle the perceived backlash against globalisation. Countries and companies participating in globalised markets "need to commit to a common set of transparent principles that are consistent with mutually beneficial competition, trade and international investment" in order to restore public trust, according to the report.
The report also addressed the growth and impact of state-owned enterprises; collusion and cross-border cartels; and the need for stricter enforcement of bribery and corruption laws.
In its report, the OECD said that corporate debt issuance had "dominated" the use of equity finance since the financial crisis of 2008. It said that this was "unfortunate" given the benefits of equity finance, particularly for projects with a longer-term investment outlook.
"High levels of debt in the corporate sector constrain companies' investment and development, particularly in emerging markets," the OECD said.
Despite these findings, non-financial companies have increasingly opted for debt over equity since the financial crisis, according
to the OECD. This has partly been driven by the continuing low interest rate environment, but the increased costs of equity finance have also played a part, the OECD said.
The report acknowledged that some of the increase in fees was due to new reporting and compliance requirements for listed companies, following "some high-profile corporate governance scandals of the early 2000s". However, the cost of an initial listing, and of underwriting fees in particular, is often "neglected" in the debates around improving market access, according to the OECD.
Corporate law expert Jonathan Beastall of Pinsent Masons, the law firm behind Out-Law.com, said that underwriting fees charged by European banks tended to be significantly lower than those identified by the OECD in its report. Recent research by Pinsent Masons, which looked at the potential returns for private equity investors when using an IPO as an exit mechanism, found that the typical cost of a private equity IPO in the UK was closer to 3%.
"The FCA, in its investment and corporate banking market study published in April 2016, did not find compelling evidence of a lack of available suppliers in the market, but said that they would monitor the competitive situation for medium-sized corporate clients," he said.
"In regard to these clients, the FCA had identified the potential for banks to withdraw from this market in reaction to regulatory requirements or an economic downturn to focus on larger, more profitable clients," he said.
For further information, please contact:
Ian Laing, Partner, Pinsent Masons
ian.laing@pinsentmasons.com
