The terms of reference confirm that the focus of the FCA’s study will be on choice of banks and advisers for clients, transparency of the services provided by banks, and bundling and cross-subsidisation of services.
The launch of this market study coincides with the FCA’s assumption of new powers on 1 April 2015 to investigate and take enforcement action against financial firms under competition law. These powers include the ability to refer a market, which has features that it suspects may be restricting competition, to the Competition and Markets Authority for an in-depth “market investigation”. This opens the possibility that FCA concerns about aspects of a financial services market could end up leading to an 18-month investigation by the CMA and the spectre of intrusive remedies, such as mandatory contractual provisions and break-up orders.
The study’s genesis can be found in the Wholesale Sector Competition Review, started in July 2014 and concluded in February 2015, from which the FCA identified potential concerns relating to the operation of both the investment and corporate banking markets – the FCA also intends to conduct a separate study concerning asset management later in the year. The concerns were twofold: first, that limited transparency over pricing in fees and quality of services may make it difficult for clients to assess value for money and monitor conflicts of interest; and, second, that bundling and cross-selling of services make it difficult for new entrants to compete, and may contribute to the limited transparency identified as the first concern.
While the FCA acknowledges that buying a set of services from the same provider that has built a deep client relationship may be efficient, it has indicated that it intends to examine concerns raised by participants in the Wholesale Sector Competition Review about transparency and value for money where services are bundled, in particular for smaller corporate clients who may have relationships with only one bank.
The FCA has identified concerns that banks may not be adequately fulfilling best execution requirements and, instead, may be over-reliant on the presumption that clients will switch providers if they are not receiving best execution. Related to this, the FCA will look at principal-agent issues, that is, that brokers may execute orders to serve their own interests, rather than acting in their clients’ interests, which may go undetected by clients.
The FCA also has an interest in examining syndication activities, including IPOs and debt raising, and whether the interests of participating banks are aligned with clients’ interests, including competition for mandates. This is likely to revisit issues considered previously by the Office of Fair Trading – the predecessor of the CMA – in its 2011 report on equity underwriting, which found that an increase in the average number of banks participating in IPOs has some positive effects – for example, more banks being involved may increase competition for the lead underwriter position as co-managers become competitors for future issuance. It concluded that “the potential conflicts identified initially generally seem to be managed appropriately, or do not raise significant concerns”. However, in the new study, the FCA intends to look at persistent suggestions that investment banks may favour their prime brokerage and hedge fund clients when allocating shares in an IPO, which may not be in the interest of the issuer, and that larger syndicates may result in an inefficient book-building and allocation process.
The concerns about barriers to entry appear to be based on the difficulties faced by smaller investment banks to compete with larger institutions. These include capital and/or operational requirements, accessing payment systems, reputational barriers and larger banks being able to secure client loyalty through offering some services below market value – or for free – on the basis of other future services once “locked in”. Whether these sorts of practices should be a concern in a market which is not highly concentrated, where new entrants can obtain authorisation relatively easily and where the buyers are sophisticated customers, will be a key issue examined under the study.
The focus of much of the FCA’s recent work has been in the retail sector which, together with the FCA’s ongoing credit cards market study and the CMA’s market investigation into personal current accounts and SME retail banking, has focused the regulatory spotlight on consumer issues and, in particular, concerns that consumers may not be making informed choices. The announcement of a study into investment and corporate banking signals the FCA’s willingness to apply a similar focus in the wholesale sector, looking at whether poor decision-making by customers might be mitigated through regulatory intervention. The scope of the new study and its potential implications, therefore, will be of interest, and potential concern, to investment and corporate banks of all sizes.
The study is likely to provide stakeholders with an opportunity to comment prior to publication of the final report in Spring 2016. Any subsequent reference to the CMA for a “market investigation” would add another 18 months. The sector can therefore expect to be under scrutiny for a significant period of time.
The study also has practical implications for banks – the FCA has wide powers to require the provision of vast amounts of internal documents and other evidence, and is likely to issue expansive information and financial data requests at the beginning of the process. At the same time, there will be an opportunity to present evidence on the concerns raised in the Wholesale Sector Competition Review and to engage with the FCA on how competition is currently operating in investment and corporate banking.
Mark Simpson is a partner and Shaha El-Sheemy is an associate at Norton Rose Fulbright
Key points
The FCA announced plans to launch a market study looking into potential competition concerns in investment and corporate banking.
The FCA has identified concerns that banks may not be adequately fulfilling best execution requirements.
The concerns about barriers to entry appear to be based on the difficulties faced by smaller investment banks to compete with larger institutions.
