The Markets in Financial Instruments Directive (MiFID II) has torn up business practices across the capital markets. Though the rules apply mainly to secondary markets, several aspects of the 1.5 million paragraphs of rules have forced new issue desks to change their practices.
This came sharply into focus in the first trading week of the year, as a string of deals hit screens with fee disclosures included — a first, for some areas of the European bond markets.
Disclosing fees (or allowing them to be reverse-engineered from other disclosures) is standard in some parts of the European capital markets, but it’s far from universal.
Corporates frequently mandate banks to differentiated lead manager roles, may include more complex aspects such as performance fees, and see underwriting fees as part of a broader package of payments to their relationship banks. Neither the banks nor corporate treasurers have been eager to reveal the financial details of these relationships.
The MiFID II rules make banks disclose fees because of a regime known as “inducements” — part of the same broad push which has shaken up the market in investment bank research.
The rules say that for any transaction, there must be a clear disclosure of the costs and charges provided to clients. Many bond syndicate desks have interpreted this as meaning that investor clients should therefore have a disclosure of the fees paid from issuers to their underwriters — but there, any consistency stops.
Others, such as JP Morgan and Deutsche Bank, have chosen to precisely disclose, at least on some deals, while many firms have simply agreed to provide the information bilaterally — if an investor wants to know, they can ask their sales coverage. Still others simply disclose that a fee was paid.
At least one firm, GlobalCapital understands, has taken the view that MiFID II should not apply at all — the client of the syndicate desk in a new issue is the issuer, not the investors, and the issuer already knows the fees.
“Every bank has got their own idea about how do the fee disclosure — there is no standard way,” said one head of DCM. “It’s a great shame as you might have thought the market could have got round the table on this and agreed on it. But the lawyers have had an absolute field-day with MiFID II — they have opined and opined and opined and so we have ended up with a Babel tower of opinions. The lawyers have had a very merry Christmas.”
He continued: “Some [banks] have decided to disclose fees — they’re probably doing this to try and look clever in front of clients, trying to turn this into an opportunity and get noticed.”
Competition heats up?
Fee disclosure could, in theory, change some of the competitive dynamics in the market, though just two days into the new regime, any changes had yet to emerge.
An investment grade syndicate head said that it could in theory encourage a race to the bottom, since less frequent borrowers would be unwilling to pay more than their peers, once a given fee has been disclosed.
“They certainly won’t pay more, but the question is, will they pay less?” he says. “The regulator will say ‘it’s your problem, you can choose to do that’, but the RoE of some banks isn’t looking that hot at the moment, and in the long term, reduced P&L for banks means less resource in the business, and less service for investors — a strange result for a regulation that’s supposed to protect investors.”
The DCM head said: “The worst thing that can happen is for full disclosure of exact fees. This will severely hurt all but the very largest of banks in the market as they will be able to drive everyone else out of the market by squeezing fees down towards zero. The biggest banks can cross-subsidise their bond businesses, spread the costs out across the firm and be able to live with low or zero fees longer than anyone else.”
Several bankers emphasised that bond underwriting in Europe was already a highly competitive market — in stark contrast to the US.
“US deals are almost entirely fees disclosed,” said the syndicate head. “That’s the main comparison, and the good news, from a bank perspective, is that there’s fee discipline — there’s not much debate about what the fee is for doing a deal.”
There’s also ambiguity about how to treat deals with a nominal fee of zero. Such issues may be done for league table credit, for relationship reasons, or in small size with the expectation of winning benchmark mandates later.
But with no direct charges or costs, some argue there’s nothing to disclose under a strict reading of MiFID II rules — though the spirit of transparency might suggest otherwise. One syndicate banker pointed to Daimler’s €750m five year FRN, issued on Thursday through sole lead UniCredit, as an example of a zero fee deal, but the deal announcement included no information either way.
The rules could also influence how the market treats banks that try to drastically cut prices, with sharp cuts in fees likely to earn the disdain of their peers.
One banker rejected this idea though, saying: “There’s no sense that banks are in any way engaging in uncompetitive practice around fees, it’s an absolute no go area."
The syndicate head said: “To my mind, if you have a zero fee, you have to disclose, you have to say we are not being paid a fee for this. I’m not sure that stops people going ahead and doing a trade like that, nor issuers for asking for it though. I’m not aware of any bank that will turn down trades out of principle.”
Time to agree
With a huge volume of other MiFID II details to get ready, regulators have been reluctant to offer exact guidance on every point of interpretation, while market bodies such as the International Capital Market Association have not yet reached consensus on what exactly constitutues good fee disclosure practice.
But as the market grows used to it, standard terms are likely to emerge.
“We need to discuss among ourselves, among the broader issuer community and with banks what the best practice should be, and how this should be applied across currencies,” said a funding official at a major European public sector issuer.
“It’s not a big question in the euro and dollar benchmark markets, there are agreed standard fees among the frequent borrowers, but this isn’t the case for all currencies or formats.”
The DCM head expected some consensus to emerge in two or three months — though one of the syndicate bankers noted that it would be hard to achieve agreement on how to handle deals with multiple layers of banks involved such as global co-ordinators, joint leads, joint bookrunners, co-managers, passive books and so on.
One regulator contacted by GlobalCapital refused to clarify how they would treat the issue. But, as several aspects of MiFID II are likely be having teething problems, regulators are likely to go easy at first.
The FCA's director of enforcement, Mark Steward, said in September that "we have no intention of taking enforcement action against firms for not meeting all requirements straight away where there is evidence they have taken sufficient steps to meet the new obligations"
One point which united all the bankers contacted by GlobalCapital was the lack of any real investor interest in the new disclosure regime.
The theoretical rationale for disclosing fees comes from retail-based distribution — if a retail broker or financial adviser receives a particularly juicy commission for pushing a product, perhaps the investor should be wary.
But this is unlikely to occur in wholesale markets, which are fairly tightly segregated by asset class, with fees in narrow ranges. While an investment bank certainly gets paid a higher percentage for leading an additional tier one deal than an SSA issue, the deal will be run by different syndicate officials and sold to different investors — who ought to be well appraised of the risks in any deal they’re buying.
“Investors don’t care two hoots,” said the investment grade syndicate head. “Nobody has paid any attention to fee disclosure so far. I’m not aware of any phone calls our sales have received on the subject.”
Additional reporting from Nell Mackenzie and Nigel Owen