FCA investment and corporate banking market study: final report

On 18 October 2016, the Financial Conduct Authority (FCA) published its final report of the findings from its investment and corporate banking study (see FCA investment and corporate banking market study: interim report, our article on its interim findings from April 2016).

The report largely confirms the FCA’s findings from its interim report, namely that:

• clients are not always free to award primary market mandates to banks that best suit their needs, particularly as a result of contractual clauses in client engagement letters by banks, restricting a client’s future choice of supplier
• league tables that rank banks by transaction activity can be misleading where banks carry out loss-making transactions (for example, block trades) just to improve their ranking, and
• the IPO process, both with regard to the “black out” period and because allocations of shares, are skewed towards buy-side investors from whom banks derive greater revenues (eg trading commission).

Ending the use of restrictive contractual clauses

In its interim report, the FCA noted that consumer choice could be limited by a number of different practices.
One of these was the use of restrictive contractual clauses in client engagement letters, which the FCA states are used by banks to restrict their client’s choice of banking services supplier in the future.

In particular, the FCA was concerned about:

• "Right of first refusal" clauses that prevent clients from accepting a third party offer to provide future services unless they have first offered the mandate to the bank or broker on the terms proposed by the third party, and
• "Right to act" clauses that prevent clients from sourcing future services from third parties, regardless of any potential third party offers.

In its final report, the FCA noted that these types of clauses were not particularly common, often negotiated by clients and rarely enforced by the banks proposing them. However, despite these factors and the potential consumer benefits outlined by several consultation respondents, the FCA stated that it believed that “…there is no justification for continuing to allow the practice of using restrictive contractual clauses in the market.”

Several banks noted that a ban on use of these types of restrictions could lead to increased costs to clients and banks, when responding to the FCA’s interim report findings. Other potential negative consequences of a ban could include lead to fewer banks competing to provide the same services to clients and a reduction in services that banks are able to offer (as some services are no longer viable, as a result of the decrease in expected revenue).

The FCA is currently consulting on whether to ban “contractual clauses that restrict competition without being clearly beneficial to clients” of the two types listed above, by including a restriction in the COBS handbook. The consultation closes on 16 December 2016.

Cross-selling

Cross-selling/cross-subsidisation is linked to the use of restrictive clauses in contracts, as the clauses are used as a way of securing future business, making certain services viable or even profitable when they otherwise would not be.

In its interim and final reports, the FCA considered this practice of "cross-subsidisation", whereby banks tended to offer lending and corporate broking services at low or below cost to clients, in exchange for a more profitable flow of transactional business (known as universal services). Typically higher returns were made on transactional business which would subsidise the lending/corporate broking businesses, with the expectation that a client would provide enough transactional business to warrant continuing the relationship. Ultimately, the FCA did not consider taking remedial steps in this area to be appropriate.

The FCA also conducted analysis on innovators in primary market services and found that innovation was occurring, but nothing that fundamentally challenged the role of banks and that it would continue to monitor the role of start-ups in the provision of banking services.

Ultimately, the FCA found that there was...”sufficient evidence of entry to show that such barriers [to entry and expansion in the banking services market] are not insurmountable.”

Next steps

As well as consulting on a proposed ban of restrictive clauses in engagement letters (please see above), the FCA noted in its final report that it is also:

• working with BBA and AFME to develop industry guidelines on the use of league tables in client pitches and with league table providers to reduce incentives for banks to conduct league table trades, and
• considering changes to the IPO process and it expects to publish a separate consultation paper with policy proposals in late 2016/early 2017.

The final report comes 17 months after the market study was launched, a longer timetable than originally anticipated by the FCA. There is no doubt that the FCA has had a good look, through its competition lens, at what is going on in the investment and corporate banking space. Broadly, on this basis, the final report should be seen as a clean bill of health for this part of the industry. However, this should not preclude the FCA from taking more focused enforcement action under the concurrent competition law powers which it obtained in April 2015, where it considers if appropriate.

If you would like further information or advice in respect of the FCA’s competition agenda and the consultation process on contractual clauses, please contact your regular regulatory contact at Simmons & Simmons.