The FCA today published its Occasional Paper No. 15: “Quid pro quo? What factors influence IPO allocations to investors?”. In this paper the regulators seeks to understand if the IPO allocation process works in the interest of issuer clients or whether conflicts of interest may result in banks favouring their highest-revenue clients when deciding on final allocations in IPOs.
Investment banks face potential conflicts of interest when conducting initial public offerings (IPOs) of shares. They work for issuing firms, and advise them on the pricing and allocation of the shares. They also have long-term relationships with buy-side investors for whom they offer trading, research, and many other services. IPOs are, on average, underpriced (i.e. the offer price is below the price at which shares trade immediately after the IPO), and investors who are allocated shares benefit from any such underpricing. Research to date into the determinants of IPO allocations has been limited by a lack of relevant data, particularly about the revenues from the buy-side clients of the book-running investment bank, and about the subsequent trading activity of investors.
This paper draws on data gathered as part of the FCA’s market study of investment and corporate banking. The paper finds evidence that syndicate banks make favourable allocations to investors who provide them with information likely to be useful in pricing the IPO, particularly investors who submit price-sensitive bids, and those who attend meetings with the issuer before the IPO. At the same time, book-runners make favourable allocations to investors from whom they generate the greatest revenues elsewhere in their business, notably through brokerage commissions. Long-only investors seem to receive more favourable allocations than hedge funds.
The FCA concludes its summary of the report that it did not find evidence that banks make less favourable allocations to investors who go on to sell those shares shortly after the IPO, nor that they favour investors who provide aftermarket liquidity.
The FCA statement and the full report are available here.