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news and comment RIGHTS ISSUES

Ask the experts: Are fees excessive? THREE EXPERTS – ONE FROM THE ACT, ALONG WITH A CONSULTANT AND A BANKER – DEBATE THE RIGHTS AND WRONGS OF FEES, WHILE A TREASURER RECOUNTS HIS RECENT EXPERIENCE OF A RIGHTS ISSUE.

be fairly confident in advance that the rights should also ask for an itemised breakdown when issue will be successful, which in turn further the advisory and underwriting fees are bundled reduces the degree of risk they are assuming. together. Bear in mind that any bundling of charges The greater degree of confidence would seem to usually works to the benefit of the provider. merit lower fees; the fact this hasn’t happened So the message is: suggests that are being overcharged. g treat the rights issue as a serious transaction, These trends have been noticed, though – which means putting it out to competitive hence the Institutional Shareholders’ Committee tender; report on right issues in December, which urged g question whether the rights issue actually companies to be more alert and to demand a needs to be fully underwritten; and greater degree of competition. g be aware that networking is still prevalent – It was followed by an Office of Fair Trading the prospect of a rights issue often sees report in January. Since the OFT stopped short of investment buttering up the CEO and describing the banks’ fees as anti-competitive, bypassing both the treasurer and CFO. the inference is that buyers are failing to It’s good to see that shareholders have begun Martin O’Donovan, assistant director for challenge underwriters on whether their work questioning the levels of fees charged. However, technical and policy, ACT merits such high charges. while they can put pressure on management Right issues have been attracting steadily As issuers don’t usually engage in rights and raise the public debate they can’t actually increasing fees from the banks – both for issues very often, they rely on the expertise of take action themselves. underwriting and for the whole package, their advisers as to whether a rights issue is A concluding thought: given that underwriting including advice – over the past decade. Ten actually needed, when the best timing is, etc. Yet a rights issue is a major strategic activity, years ago a figure of 1.5% or 2% of proceeds they often use the same for both the companies and their treasury teams might was typical; today 3% and even 4% is common. advisory work and the underwriting – surely consider working through the various issues well Another development has been for the rights there is a conflict here even if it’s different units in advance of commencing any rights issue – on issue to be priced well below current market of the bank divided by Chinese walls. a “how would we organise it if we went ahead value. This gives shareholders more of an The size of the rights issue and the size of the with one?” basis. This process would involve the incentive to take up the issue and prevent discount rest to some extent on the adviser’s legal team and consider at what point to put it dilution, and there is less risk of the price recommendations. The underwriter wants an out to competition. Now that two recent reports sliding towards the rights issue level. There have easy life, so will tend to set both at a cautionary have publicised the issue of fees, companies also been cases of rights issue being launched level. This might have been prudent when have more ammunition to question pricing and into a weak market, with the share price falling markets were very volatile, but despite a few even whether underwriting is needed. below the rights issue level as a result. jitters during 2010 the underlying trend has been The ACT has worked with other bodies on Although underwriting fees have risen, the a return to more normal conditions. Also, although guidance to rights issues – suggesting, for level of risk taken on by underwriters has fallen. advisers would probably caution against going example, that they didn’t always need to be Another development has been the increase in ahead with a rights issue if they felt the timing to underwritten. However, we have found it impossible pre-marketing, also known as pre-sounding. be completely disastrous, they might be minded to agree a wording acceptable to everyone; the Traditionally, a would keep its plans for to recommend going ahead when conditions are projected guidance was continually redrafted or a rights issue confidential ahead of the launch, to “iffy” to avoid missing out on their fee. our radical proposals were watered down. prevent rumours from spreading – although it Yet a rights issue is a big deal for a company. The ACT is now considering reviving the would attempt to gauge likely demand. If it doesn’t work out, the outcome can be very project to issue guidance, perhaps in conjunction The increasing use of pre-sounding has seen serious, so companies must proceed cautiously. with . ACT’s technical and policy director underwriters approach investors much earlier,to Treasurers would be well advised to hold a John Grout has just issued a blog on this topic get a more accurate indication of what take-up competitive tender for the and posted it on the ACT website at of the issue is likely to be. This means they can instead of simply using their house bank. They www.treasurers.org/node/6750

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news and comment RIGHTS ISSUES

which broadly indicate there is little competitive Lately we have seen several examples of that tension between investment banks during the kind of pressing need emerging, as the entire raising process and that issuers raising banking industry has taken the reputational hit equity capital are not focused principally on for the high-profile failures of a few. Project reducing underwriting fees. It also found that Merlin was an attempt to provide reassurance there had been a significant increase in fees that the banks were committed to supporting the since the start of the financial crisis and those economic recovery. The Business Finance fees have not since fallen in line with the Taskforce is the banks’ joint initiative to provide reduction in risk. firm, deliverable commitments to businesses However, the OFT has provisionally concluded seeking financial support for the recovery. that it is not appropriate to refer the equity Competition is a good thing – indeed, it is vital underwriting market to the Competition to functioning markets – and the British Bankers’ Commission for investigation as the market has Association always welcomes the emergence of just been through an exceptional period following new entrants in the market (and not simply the crisis. Instead, it believes the issues because they swell our membership). But the Stephanie Maguire, professional support can be addressed most effectively by issuers and market does not necessarily need an abundance consultant, Herbert Smith institutional shareholders negotiating harder over of different companies in order to work. During the banking crisis, many rights issues fees and taking other steps to help reduce fees. Nevertheless, we have seen new entrants to the took place in the UK under challenging market At a practical level, the OFT report, like the IIC market in recent years and conditions, and the level of fees charged by inquiry, suggests that issuers should, among there is increasing competition among the big underwriters was seen to reflect the increased other things, seek more advice about the process global investment banks in the world’s biggest risks at that time. However, as market conditions from their institutional shareholders, non- financial markets, including our own. have improved there has been no corresponding executive directors and legal advisers, and put The Office of Fair Trading’s recent reduction in underwriting fees. greater pressure on fees by asking for a costs investigation into investment banking fees Given this, in July 2010 the Institutional breakdown. It also recommends that issuers charged by UK banks – which it ultimately Council (IIC) announced that it was improve the competitive tension for the decided not to refer to the Competition conducting an inquiry into underwriting practices underwriting business by, for example, inviting Commission – did level criticism at the industry, on rights issues in the UK. In the course of its banks with which they have existing relationships which is currently being discussed across the review, it looked at the role and selection of to compete for different aspects of the City with a view to improving banking services to advisers and underwriters, the pricing and underwriting, and by increasing the number of customers. But it also pressed customers to be structure of capital raising, the level of banks they have relationships with. more alert to the deals available. Specifically, it underwriting fees relative to changing risk The OFT believes that institutional urged companies and institutional shareholders exposure, the transparency of underwriting fees, shareholders should put greater pressure on to push hard for the best deals in equity and sub-underwriting practices. issuers to reduce fees. It suggests that they underwriting fees – and correctly so. Competition Following its review, the IIC inquiry issued a should discuss the principles for any future works best when customers hold out for the detailed report and made a number of equity raisings with the issuer and, where optimum deal. recommendations to improve the equity possible, commit to sub-underwriting before the But decisions on matters that can be vital to a underwriting process for issuers. While some of announcement of the rights issue, thereby company’s future are rarely made solely on price. the proposals would require regulatory changes reducing the underwriting risk and, potentially, And that price must reflect the inherent risk in (for example, the recommendation that the the fees. the transaction. It is a regulatory obligation that Listing Rules require issuers to disclose in detail Looking forward it will be interesting to see all banks must now seek to manage their all fees paid on a rights issue, to whom they are how market practice on these points develops. exposure to risk more carefully, and, as with all paid and for what services), there are some more At the very least, issuers are likely to have regulations, this has an impact on the wider straightforward suggestions in the report that further pressure placed on them by institutional economy as well. Too often in public debate we issuers considering an equity capital raising investors to negotiate underwriting fees and hear banking regulation referred to as if it has no could follow now. These include seeking banks should expect to be having more heated impact on the economy beyond the way that independent advice, not automatically assuming debates on fees. banks conduct their business. In fact, capital that the rights issue must be fully underwritten, and risk controls in particular have a and always putting the primary underwriting fundamental impact on the availability of banks contract out to tender. Issuers concerned about The British Bankers’ Association to support businesses. the expectations of their investors should look at The argument persists across public debate that The banks carry special responsibilities here, the draft generic guidance relating to the for there to be effective competition in banking both in the wake of the economic crisis and as expectations of institutional shareholders in an there needs to be a significant number of players engines of the economy. We have all been issuer conducting an equity capital raising. in the market. Yet evidence abounds that the through very turbulent times and banks must The rights issue fees inquiry is not, however, banks remain in aggressive competition with take their share of the responsibility for what the end of the story. Not long after the IIC each other for customers, in international happened. We now need to work together to launched its inquiry into underwriting, the Office commerce as in the high street. They only ever ensure Britain’s businesses can be assured of of Fair Trading also launched a market study in come together, with some reluctance, in times of the support and the services they need in order this area. It has recently published its findings, pressing need. to restore lasting stability to our economy.

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news and comment RIGHTS ISSUES

Case study: National Grid

MALCOLM COOPER, GROUP AND TREASURY DIRECTOR OF NATIONAL GRID, RECOUNTS HIS RECENT EXPERIENCE OF A £3.3BN RIGHTS ISSUE TO GRAHAM BUCK.

would coincide with the release of the results for the year to 31 March 2010, which were “IT PROVIDED AN scheduled for release on 20 May. “There was some concern that the news POLICY might leak ahead of this date, but fortunately it AGAINST UNEXPECTED remained confidential and we avoided any uncertainty caused by and also any EVENTS. HAD THE share overhang,” says Cooper. ISSUE FAILED, THEN National Grid announced that the issue would raise gross proceeds of £3.3bn and a net figure THE FEES WOULD of £3.2bn, with the difference consisting of HAVE BEEN WORTH the fees for underwriters Morgan Stanley, Bank of America-Merrill Lynch and Deutsche Bank. EVERY PENNY.” “Yes, it’s debatable whether such a level of fees was justified,” Cooper says. “With National One of the more unexpected market Grid behind the offering, you can argue that The share price also traded much in line with announcements of 2010 came in May, when the degree of risk taken on by the underwriters the treasury team’s expectations, despite the fact National Grid used the release of its full-year was minimal. that on 3 June – 12 days before trading in the results to launch a rights issue involving the sale “But at the same time, it provided an new shares commenced – the shares went ex- of 990 million shares in a two-for-five placing at insurance policy against unexpected events; had dividend. By 17 June, the share price was at 335p a share. the issue failed, then the fees would have been 514p and in line with the theoretical ex-rights The plan by the UK’s largest utility group worth every penny. And it was a tough market price (TERP), which carried a discount of 35.7%. caught many investors off-guard, but appears last May, with Greece’s sovereign debt crisis The other key metric, the bonus element from less surprising in retrospect. National Grid needs creating uncertainty and much volatility in the the dilution, was 1.1426. to upgrade the UK’s power infrastructure over the equity markets.” “So in retrospect, the timing proved very next five years and estimates that the total cost Fortunately, although the market’s initial satisfactory,” Cooper says. “The transaction went will come in at £22bn. The news was also response was unenthusiastic – the share price very smoothly and we successfully got funding in sweetened by the group announcing a 12% rise fell 43p to 577p on the day of the announcement place towards our five-year plan. I also believe in pretax profits, and an 8% increase in the – the issue was highly subscribed, with a take- that it represented the largest rights issue to dividend, which it pledged to maintain over two up rate of around 95%. date designated for organic growth.” further years. “We knew beforehand it was National Grid’s rights issue also differed from inevitable that a rump of most others in being specifically allocated for shareholders, mainly our smaller organic growth, rather than to fund an acquisition shareholders, wouldn’t be able to or provide an injection of capital to a business in take up the rights,” says Cooper. “So trouble. Many of those announced during 2009 all in all we were very pleased with and the early months of 2010 fell into the latter the outcome.” category, says its group tax and treasury director Malcolm Cooper. The group’s treasury team was informed early in the year of plans to step up its investment programme and worked on the issue over several months, with progress periodically reviewed at board level, he says. “It was evident the sum involved meant that it wasn’t fundable internally and we would need to seek equity from Power points: some of National the outside.” Grid’s electricity transmission Cooper admits that choosing the right timing infrastructure in the UK was difficult, particularly when a general election was confirmed for early May. It was eventually decided that the rights issue announcement

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