The Financial Conduct Authority (FCA) has announced that it will kick-off a market study looking at competition in investment and corporate banking services in spring 2015. This comes as part of its review into competition in the wholesale sector, published yesterday, and follows its call for inputs last July. The FCA has found that limited transparency over both price and quality may make it difficult for clients to assess the value for money of investment banking and corporate banking services, and that bundling and cross-selling of services may make it difficult for new or smaller firms to compete against the established investment banks and universal banks.
The FCA will also consider undertaking a market study later in the year on how purchasers get value for money when buying asset management services. While the competition review did not focus on trading practices within scope of the Fair and Effective Markets Review (FEMR), the FCA may consider further investigation in this area if FEMR identifies competition issues within fixed income, currency and commodity markets. Competition issues with respect to markets and market infrastructure were also identified, including on the pricing and availability of data, vertical integration of clearing and execution services, and clearing on OTC derivative markets. However, the FCA has no immediate plans to conduct market studies in these areas as it will see how competition is affected by forthcoming regulation, such as the revision to the Markets in Financial Instruments Directive (MiFID II).
While it will be some time before we know what remedies, if any, the FCA may want to impose on investment and corporate banking services as a result of the market study, the competition issues discussed by the FCA in the paper give some clues about the likely direction of travel. There could be more focus on disclosure and pricing of services, with associated implications for governance and strategy, better identification and management of conflicts of interest in equity and debt issuance, and potential remedies to reduce competition barriers for new entrants and smaller, boutique banks. There are also a number of overlaps with other initiatives that firms should bear in mind. We look at these issues in further detail below.
Bundling or tying services together into a package
While the FCA notes that buying a set of services from the same provider over time may be an efficient solution for some clients, as the bank can build up detailed client knowledge, it believes that a lack of transparency in the cost of services that are bundled or tied together makes it more difficult for clients to evaluate value for money. The issues may be exacerbated for smaller corporate clients, who are likely to have a relationship with only one corporate or investment bank and have relatively less bargaining power compared to larger corporate clients. The FCA also highlighted issues it had identified in last year's best execution thematic review, such as payment for order flow and brokers presuming that the onus should be on investors to monitor best execution, rather than the firms themselves.
Concern in this area is in keeping with the general trend at the EU level to enhance transparency of services. We have already seen focus on bundling and tying practices as part of MiFID II and the revision to the Insurance Mediation Directive (IMD II), and MiFID II will increase disclosure on costs and charges, including in relation to professional clients, and strengthen best execution requirements. The FCA also yesterday stated its support for the position taken by the European Securities and Markets Authority (ESMA) with respect to separating portfolio managers' payments for research from execution arrangements. In MiFID II technical advice, ESMA advises the EU Commission that firms providing execution services should charge for execution costs, research and any other good or service through separately identifiable charges, not influenced by the levels of payment for execution services.
If the measures expected to be introduced under EU reforms are anything to go by, there is likely to be more focus on investment banks and corporate banks setting and disclosing prices and charges for all their services, regardless of whether they are sold as part of packages, with implications for firms' strategies and profitability.
Conflicts of interest in equity or debt issuance and syndication
The FCA believes that investment banks may have incentives to allocate shares or debt to their prime brokerage or hedge fund clients or their own asset management business, in a way that is not optimal for the issuer. While it is too early to say what kind of remedies the FCA may wish to impose to address this, firms can already expect strengthened conflicts of interest requirements with respect to underwriting and placing under MiFID II. More widely, conflicts of interest have been the focus of FCA thematic reviews in asset management and wholesale insurance.
According to a 2011 Office of Fair Trading (OFT) report, the average number of banks in IPO syndicates has been increasing over time and the FCA believes that this may have both positive and negative effects on competition that it plans to consider further. For instance, more banks involved in the syndicate may increase competition for the lead underwriter position as co-managers become competitors for future issuance, but could also result in an inefficient bookbuilding and allocation process.
New entrants and boutique banks and service providers
Despite changes to the authorisation process that have made it easier for new banks to enter the market, the FCA views that "there are still substantial barriers to entry in the banking industry". These include capital and operational requirements, establishing a reputation, and access to payment systems. The FCA also believes that new entrants or stand-alone providers of services are struggling to compete against investment banks which can build their client relationships through offering some services at below market value or for free or, in the case of universal banks, cross-selling between corporate and investment banking services.
Any changes that seek to address any imbalances of power which are identified in the market study are likely to bring opportunities for new entrants and boutique banks and service providers, and challenges for incumbents. Ultimately, the FCA wants to see a competitive investment and corporate banking market that supports the wider economy. This is consistent with the focus on growth by the new EU Commission in its Capital Markets Union initiative and the bespoke regime for SME growth markets introduced in MiFID II (see our blog).
Yesterday's paper sets out the direction of travel for work that may come to have far-reaching implications for investment and corporate banking. It comes alongside a market investigation that is being undertaken by the Competition and Markets Authority (CMA) into the personal current account and SME retail banking sectors that is due to report provisional findings in September. As the FCA is set to receive concurrent competition powers with the CMA in April 2015, we are clearly entering a new phase of regulation for the FCA, where competition issues are given centre stage. We are only now beginning to find out just how significant this could be for parts of the financial services industry.
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