Efficiency and effectiveness: our approach to primary markets

Speech by Christopher Woolard, Executive Director of Strategy and Competition at the FCA, delivered at Bloomberg.

Christopher Woolard

Speaker: Christopher Woolard, Executive Director of Strategy and Competition
Location: Bloomberg, London
Delivered on: 1 March 2017

Highlights:

  • The wholesale financial sector plays a critical role in the lives of everyone in the UK. The industry must show itself to be clean, effective and competitive: central to this is a transparent and robust regulatory regime that can adapt to market developments and risks.
  • Primary markets are vital in supporting the wider economy by bringing together investors, who seek investment opportunities, and issuers, who seek to access capital to finance their businesses. 
  • It is our duty to ensure that the UK’s primary markets work well in meeting both these needs. We have recently published a consultation paper on the IPO process along with a discussion paper and consultation paper which seek to improve the effectiveness and efficiency of the sector.
  • We believe strong markets are firmly in the interests of UK consumers, and we will innovate and take action to ensure those markets remain open for business.

Note: this is the speech as drafted and may differ from delivered version.


You’ll have seen this morning that we have published a consultation paper with a package of policy proposals intended to reform the IPO process. I’d like to use my speech today to talk about these proposals, but set my comments in the context of the FCA’s policy approach to primary markets more generally.

There are three key issues I would like to touch on today:

The package of measures we have proposed are part of ensuring… our wholesale markets remain efficient, effective and open for business.

  • The wider role primary markets play for the whole economy.
  • How we as the regulator see our market integrity objective encompassing the successful operation of primary markets to support the real economy.
  • How, in a time of uncertainty, the package of measures we have proposed are part of ensuring the long-term strength of UK markets.

Crucially, ensuring our wholesale markets remain efficient, effective and open for business. 

The importance of primary markets 

Primary markets play a vital role in supporting the wider economy by bringing together investors, who seek investment opportunities, and issuers, who seek to access capital to finance their businesses.

It is the FCA’s duty to ensure that the UK’s primary markets work well in meeting both these needs. The wholesale financial sector plays a critical role in the lives of everyone in the UK. They:

  • Supply financing to UK and international businesses and governments, which is vital for economic growth.
  • Determine the cost and availability of credit for consumers and small businesses and set energy, agricultural and other commodity prices.
  • Provide critical investment opportunities and opportunities to manage financial and other risk.
  • Facilitate domestic and international trade - 37% of all foreign exchange trading takes place in the UK.
  • And make a direct contribution to the UK economy, employing an estimated 1.1 million people.

But all of the above is not a given. In order to maintain this pre-eminence globally, UK wholesale markets must show themselves to be clean, effective and competitive. And for that, the sector relies upon a transparent and robust regulatory regime that can adapt to market developments and risks.

The role of the regulator

At its core, this requires empowering a successful financial system where firms can thrive, alongside high standards of conduct across the industry.

This can be a difficult line to tread and, as we all know, the costs of getting it wrong are severe.

Our task is made more complicated by the broad, challenging and ever-changing nature of the landscape in which the FCA operates.

In particular, we, like many organisations, are working hard to respond to the challenges ahead following the EU Referendum.

With such a large and complex remit, it follows that our interventions cover a huge amount of ground, from MiFID to anti-money laundering, investment fraud to FinTech.

But while our interventions may be varied, they are united by our statutory objectives: our strategic objective to make markets work well and our three operational objectives to:

  • enhance the integrity of financial markets
  • promote competition
  • protect consumers

But what does this mean in practice? First and foremost we see our integrity objective as encompassing the successful operation of primary markets to support the real economy.

Central to this is our commitment to deliver a sustainable model of regulation: improving existing rules, removing those which are unnecessary and imposing new ones where they are needed. It means being a forward looking regulator, open to innovation, embracing the power of technology provided it is consistent with effective markets. And it means ensuring that markets are underpinned by good conduct amongst participants of all levels and disciplines.

Wholesale and consumers: making the connection

When UK markets work well, when they are transparent, efficient and fair, they benefit consumers, shareholders and staff alike.

When UK markets work well, when they are transparent, efficient and fair, they benefit consumers, shareholders and staff alike.

But when standards are inconsistently applied and conduct is poor market integrity becomes compromised. And the impact of this can reverberate throughout the whole system.

Indeed, as esoteric as it may seem to the uninitiated, activity in the wholesale sector affects all of us, on a daily basis.

From direct debits to credit cards, loans to investments – how well wholesale financial markets work has a fundamental impact on the lives of consumers.

Pensions, whose funds are traded in the wholesale markets by asset managers, are a prime example of this: the amount of money in a consumer’s pension pot at retirement is a direct consequence of activity in the wholesale space. 

As the regulator, it is our job to look at the chain from top to bottom. We will pose difficult questions.

We seek to promote a healthy environment in which wholesale markets can thrive, always aware that activity at one end of the spectrum translates into real life outcomes for consumers at the other end.

This is especially topical as we consider feedback to our Mission consultation, which closed in January. One theme that kept cropping up amongst all our stakeholders was that of the linkages between wholesale and retail markets.

As respondents pointed out, scandals like manipulation of benchmarks, or share prices, are not victimless crimes. The victims are those who sold or bought at unrepresentative prices, from those investing in pension funds, to a company buying FX or hedging its cash flows.

It is the FCA’s job to consider the impact of activity in the wholesale space in the round – from competition issues, to questions of integrity and the impact of poor conduct on consumers. All of which means you’re unlikely to start hearing less from us any time soon.

But today I want to focus on one particular strand of wholesale activity – primary markets.

Proposals for IPO reform

Conducted with integrity, the activity of primary capital markets is very much in line with our objective to make markets work well. Primary markets play a crucial role in the wider economy by helping companies to access deep and liquid pools of capital to finance their activities.

This in turn allows companies to grow, which both creates jobs in the real economy and gives firms the resources they need to develop new products and services.

Pharmaceutical companies can research and bring to market new medicines. Telephony companies can develop innovative ways for their customers to communicate with each other. And global banks can offer their customers more choice over how to manage their financial futures.

However, for all this to work, primary markets must be effective for investors and issuers alike. A well-functioning equity IPO process is an essential part of this.

The existing process has considerable strengths and has contributed to the success of the UK’s IPO market.

However, having gathered evidence as part of our investment and corporate banking market study, we have identified an area of the IPO process that calls for improvement, namely the timing, sequencing and quality of information being provided to market participants. 

The market study confirmed the concerns of investors and other market participants that the prospectus, which should be the primary source of information on companies seeking to raise finance through the IPO process, is currently made available very late. And only analysts employed by the book-running syndicate are able to access the information they need to produce research on an offering, while third-party research providers are being shut out.

The result is that so-called ‘connected research’ written by analysts within the book-running syndicate is the dominant source of information available to investors during a crucial stage of the process.

This is of particular concern given the conflicts of interest and associated conduct risks that arise during the production of ‘connected research’. This includes analysts coming under pressure to produce favourable coverage of the issuer in order to secure a place for their bank on the book-running syndicate.

This state of affairs presents fundamental risks to the objectives I laid out earlier:

  • Market integrity is jeopardised if investors and issuers lose confidence in the UK IPO market because pricing is based on connected research rather than a timely prospectus and a wider range of objective research.
  • Effective competition is inhibited because third-party research providers are shut out, preventing investors from accessing competing views on the offering and the issuer’s prospects.
  • Consumer protection is weakened when prospective investors are forced to rely on connected research that is potentially biased or perceived as biased.

To tackle this, we published a discussion paper in April last year through which we began to explore ways to improve the range and quality of information available to investors during the IPO process.

And today we have launched a consultation on a package of policy proposals intended to reform the IPO process in this way.

These include a re-sequencing of the process so that a prospectus or registration document is published, and third-party analysts have access to the issuer’s management, before connected research is released. 

We are also looking to prevent analysts within prospective syndicate banks from interacting with the company’s management and advisers around the time pitching efforts are taking place.

Ultimately, we want to see an IPO process: 

  • where a prospectus plays a more central role
  • with enhanced standards of conduct by analysts on the book-running syndicate during the production of their research
  • where conditions exist for the emergence of third-party research coverage

This will benefit both issuers in their fund-raising efforts and investors who, crucially, will be better protected.

Making markets work well

But today’s IPO Consultation Paper isn’t the only recent demonstration of the FCA’s intent in primary markets.

We’ve also published two more papers in the last couple of weeks which seek to improve the effectiveness and efficiency of the sector. These are a discussion paper that aims to prompt a conversation about how the UK’s primary markets can better meet the needs of issuers and investors. And a consultation paper which considers clarifications and changes to certain key areas of the Listing Rules.

The intentions of the two papers are slightly different. In the case of the discussion paper, our focus is to provoke broad debate on a few key areas of discussion.

We’re looking for views on:

  • Whether the current boundary between the standard and premium listing categories is appropriate, particularly as it relates to overseas issuers and exchange traded funds. We’re also looking more broadly at the role that standard listing plays in practice.
  • The effectiveness of UK primary equity markets in providing capital for growth, particularly for early stage science and technology companies.
  • Whether there is a role for a UK primary debt multilateral trading facility and what its potential structure might be.
  • And measures that could be introduced to support greater retail participation in debt markets.

The consultation paper on the other hand is more technical, considering specific enhancements to make certain areas of the Listing Rules easier to understand and more proportionate.

Though distinct in their intentions, all these papers speak to our overarching ambition, that is, effective primary markets that enjoy the confidence of market participants of all levels.

Closing remarks

We’ve seen that wholesale markets are dynamic, fluid and of deep consequence to the whole economy and millions of consumers. There is no clearer example of this than primary markets providing the mechanism by which companies raise IPO capital.

This has huge real world impacts, supporting prosperity and providing investment opportunities, in turn leading to job creation and a wider range of products and services available to consumers.

The transparency and integrity of a strong regulatory regime is crucial for the continued success of this sector and the wider UK economy.

But in order to work well, these markets must meet some basic tests: integrity of the market, effective competition and protection for consumers and users. These are the same as the FCA’s core objectives. 

The transparency and integrity of a strong regulatory regime is crucial for the continued success of this sector and the wider UK economy.

In periods of uncertainty as we face together now, it is only on this basis, by meeting these tests, that the UK can continue to consider itself a global centre for the issuance of securities.

We believe strong markets are firmly in the interests of UK consumers, and we will innovate and take action to ensure those markets remain open for business.

So the FCA’s commitment to ensuring the efficiency and effectiveness of primary markets will not waver. But while it is up to the FCA to create the conditions in which good outcomes are delivered for end users, it is up to firms to work together with us within the framework we set, acting responsibly and with integrity.

This is what, ultimately, will guarantee the long-term effectiveness and efficiency of the UK’s primary markets.