2016 Global Trends in IR

BNY Mellon Depositary Receipts group has very recently published their annual report on global trends in investor relations. With 550 companies surveyed from 54 countries, it is probably the most comprehensive barometer of the current themes in our industry. The report provides large amount of comparative information on how listed companies are adapting to the changing marketing condition, touching on topics such as budgets, allocation of management’s time for buy side meetings, reporting lines, use of sell-side, measuring team effectiveness as well as insights into evolving areas such outreach to ESG investors and the use of technology.

Firstly as a qualifier, lets consider the demand side dynamics for global issuers. Despite the inevitable short and medium term swings in investor appetite for a given asset class, market or industry evidence that investors all around the world are diversifying and are increasingly adding a global component to their portfolios. Our own analysis point to over 4,000 institutional investors who hold emerging market securities, versus only 400 in early 20oo’s. BNY Mellon’s own estimates point to number of investors that hold DRs (or, roughly translated as those with global mandates) has increased from from 3,261 in 2Q10 to 4,533 in 2Q15. This figure will, we believe,  continue to grow, and present opportunities in areas where a- investors previously held most domestic bias and b- have considerable assets under management in active management and c- see diversification opportunities globally.

With this backdrop, a couple of things to note from the survey:

  • IR teams are working harder to address the growing global investment opportunity.  This is evidenced by 1- investor meetings taken by C-suite executives and IROs inside and outside their home markets have increased by 12.6% compared to 2013 (from 250.6 meetings in 2013 to 282.3 meetings in 2015). 2- companies almost doubling their IR budget allocation to travel, from 12.8% in 2013 to 24.3% in 2015, which in turn is interesting to contrast with the slight decrease in companies holding analyst/investor days (63% to 59%).
  • Top 10 sources of new investor demand in five years time, according to surveyed companies, will split evenly between emerging and frontier market. US, UK, China, Germany and Singapore lead the pact.
  • Technology tools, such as  conference call/webinar and video conference calls has been increasingly used in toolkit of a global IR officer (72% in 2015 vs. 63% in 2013 and 41% in 2015 vs. 34% in 2013). With the management and IR team time relatively fixed, and the buyside universe expanding – there is no element of a doubt that tools that help reach new investors can increase reach and efficiency, at a fraction of a price. We are strong advocates of using new tools to tell a company story . Can any one see how virtual reality or 360 videos can be applicable to the world of investor relations?
  • Despite the wave of regulations on how investors will pay for research and cooperate access, brokers continue to dominate the company non-deal roadshows arena, however with some signs of this changing. 10% of companies have organised NDRs themselves, up from 5% the previous year. Interestingly, companies rely a lot less on brokers nowadays to provide them with post meeting feedback, and rate quality targeting and introductions at upmost importance.
  • Growing ESG focus – The survey notes that there has been a strong increase (from 37% to 46%) in companies who have strategies in place to communicate with key investors on corporate governance issues on a regular basis, with top issues addressed being Board composition (76%), Transparency and disclosure (71%) and Remuneration (60%). Despite that the actual number of investors who reach out to ESG focused investors is still low (30%), however likely to rise. There is evidence to suggest that institutional investors are increasingly committing to ESG-focused principles in their strategies — whether that be through a more active engagement as shareholders or divestment strategies. 

Source: BNY Mellon Depositary Receipts Market Review 2015, BNY Mellon Global Trends in Investor Relations 2015

State of Corporate Access

Last week Ipreo published the fifth edition of its Global Corporate Access Survey where it monitors various elements of interactions between the company and the investment community.  At the heart of the survey is the ever changing relationship between the company and the sell-side, and its role in providing a crucial service that in the investment making process. Sample size for the survey was 400 issuers with a heavy US component (58%).

So, what do companies value most from their brokers?

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Source: Ipreo

A Brief History of Dealing Commission

The practice of investors using their own clients’ trading commissions to pay for research and corporate access has been under scrutiny for some time by regulators in Europe. To better understand the current wave of regulations and assess their impact on the market, it helps to take a step back and look closely at the economic models of both the buy- and sell-side, particularly the evolution of the commission structure. In this blog we will attempt to put the discussion in context and get to grips with how it affects the relationship between the sell-side and their clients on the investment management side.


Fixed Commissions

The era of fixed commissions began with the Buttonwood Agreement in 1792 in which 24 brokers meeting under a Wall Street buttonwood tree agreed to trade with each other using a basic commission rate of 0.25%. Over the years this loosely organised group evolved into the New York Stock Exchange.

The original Buttonwood Agreement housed in American Finance Museum in New York

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With no differentiation in price, brokers competed to outdo each other in areas such as research, technology and other non-product related services to win business. These non-execution, ‘soft dollar’ services were ‘bundled’ together with ‘hard dollar’ services paid for separately and explicitly by the fund manager. ‘Bundling’ became standard industry practice.

In the 1950s approximately 25% of trades in the US were executed through brokers by institutional investors. During the 60s and 70s this number rose to more than 75%, giving the small consortium of brokers unprecedented revenues and power, and bringing their activities to the attention of the US regulator, the SEC.

The SEC was interested in 3 main areas:

  • Price fixing: collusion between brokers setting prices
  • High fees: unreasonable pricing
  • Exclusivity: brokers would only trade amongst each other

As a result of the SEC’s investigation, on May 1st, 1975, the era of fixed commissions for stock transactions ended in the US. The same practice was finally abolished in the UK following the ‘Big Bang’ of 1986. However soft-dollar purchase of research and other services continued in both markets.

In the UK, the lifting of restrictions on the amount of international equities investors could hold led to a surge in demand for equity research, corporate access and other services from fund managers.

While soft-dollar services continued to attract the attention of regulators on both sides of the Atlantic, they were generally considered to be fair game in a free market economy. It was largely left to investors to decide whether the commission they were paying was value for money.

1990s

Throughout the late 80s and early 90s the use of soft commission agreements continued to grow.  90s regulation centred more on incremental tightening than structural reform, with much of the focus on disclosure to customers, the obligation to provide best execution and a specific prohibition on soft commission arrangements for certain un-related services.

The Myners Report and the pass-through of broker commissions

A reported delivered by Paul Myners (then chairman of Gartmore Investment Management) in 2011 titled ‘Institutional Investment in the United Kingdom’ addressed the question of bundling and ‘softing’. Myners pointed out that the costs for services provided by the sell-side were not being paid directly by fund managers out of their own pockets, but were being passed through to their own clients (e.g. the pension fund).

The Myners Report prompted action by the FSA (now the FCA) resulting in publication of consultation paper CP176 in April 2013. The report concluded that there was an incentive for fund managers to direct business to certain brokers to obtain additional services, rather than to seek the most favourable trade execution terms for their customers, which the FCA deemed unacceptable.

The Myners review recommended that fund management fees should factor in all additional costs (i.e. for soft services) rather than passing them on to the client, particularly as these additional services directly affect the performance of the fund itself.

Two categories of fees paid to asset managers by their clients

Screen Shot 2015-04-15 at 16.24.29Soft Commission Arrangement vs. Bundled Model

The main difference between the soft commission arrangement and bundled model  is whether it is the broker providing the ‘soft’ service, or another third party provider. Under both arrangements, the costs of the services are included in the commission rate (not in the management fee) and are therefore borne by the fund manager’s client and not by the fund manager.

In a soft commission arrangement (prevalent in the US), a fund manager agrees to send trades to a broker and receives, in addition to ‘pure’ trade execution, credits (soft dollars or soft money) which can then be used to purchase services such as research and information, usually from third-party service providers. With a bundled model, the broker offers the additional services (e.g. research or corporate access) themselves.

Commission costs depend on the rates negotiated by the fund manager and the broker, and the volume of trades undertaken on behalf of the pension fund. The fund manager’s client (e.g. the pension fund) has no direct control over either factor.

Soft commission Arrangement

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Commission Sharing Arrangements (CSA) 

The European unbundling mechanism was the Commission Sharing Arrangement (CSA). In the CSA the execution commission would be retained by the broker handling the trade, while the (larger) non-execution component would be kept on the asset manager’s behalf.  As trades accumulated the balance in the CSA account would rise.

How are things looking today

The regulatory debate over dealing commissions that followed CP176 in 2013, has been revived and scrutinised by both UK and European regulators.

In the UK, the FCA’s Policy Statement (PS14/7) published in 2014 created a narrower perimeter for the services and goods permissible under the current regime. The FCA also excluded “corporate access” from the list of services that could be purchased with dealing commission.

In Europe, in late 2014 the European Securities and Markets Authority (ESMA), adopted an equally rigorous approach to the purchase of research as part of the MiFID II inducement provisions. As with corporate access, the message is that fund managers should be paying for research out of their own pockets or charging up-front fees to their clients for the service.

The path from here is perhaps best summarised in last summer’s discussion paper by the FCA:

Overall, we conclude that unbundling research from dealing commissions would be the most effective option to address the continued impact of the conflicts of interest created for investment managers by the use of a transaction cost to fund external research. We believe it would drive more efficient price formation and competition in the supply of research, removing the current opacity in the market. It would be particularly effective if this reform can be achieved on an EU-wide basis.

The final regulations around research continue to be a hot topic and are expected to come into force in Europe by 2017. In addition to the regulatory developments outlined here, other factors such as electronic, off-exchange and intra-buy side trading have continued to eat away at the market share of the traditional broker, resulting in falling commissions and challenging the existing model more than ever.

 

Sources and additional references:

‘The Myners Report’

Museum of American Finance: Original Buttonwood Agreement 

OXERA’s “An Assessment of Soft Commission Arrangements and Bundled Brokerage Services in the UK”

FCA’s Consultation Paper : CP 13/17 Use of dealing commission

FCA’s Consultation Paper 176: Bundled Brokerage and Soft Commission Arrangements

Ashurst’ “New regime for the use of dealing commissions – impact on managers and brokers” 

Ashurts’ “Softing and bundling – where are we now?”

Ashurts’ “Dealing Commission: A History”

Investment Management Association: The Use of Dealing Commission to Purchase Research

Frost Consulting

Flash Update: UK Corporate Access Shake-up

Corporate Access, a service usually offered by investment banks / brokers that brings investors and corporate management teams together, is going through a radical shake-up in the UK. These developments could potentially impact not just UK-based companies but any listed company with an investor base in the UK.

Update:

After a period of lengthy consultation, last Thursday the UK’s financial regulator, the FCA, has issued its final say on the use of dealing commissions, previously used by investors to pay for research, corporate access and  trade execution. As of the 2nd of June, UK investment managers should only use client dealing commission to pay for ‘substantive research’ and costs related to executing trades. Using dealing commission to pay for access to senior management at companies they invest in will now be explicitly banned.

The FCA estimates that up to £500 million pounds of dealing commissions were spent in 2012 to arrange such meetings. The new rules emphasize that costs for research can only be passed on to clients if they lead to a “meaningful conclusion”. Naturally, nothing is stopping investors from paying brokers for corporate access themselves from their own management fees (rather than passing it on to their clients), or organizing their meetings themselves without a broker.

Impact:

These current developments have been widely expected by the market and its participants. It is too early to assess the precise impact on the industry however we can anticipate a few emerging trends.

  • Institutional Investors will place a greater scrutiny on how they organize their roadshows and most importantly, the business model behind it. We would not be surprised to see investors setting up their own Corporate Access departments to facilitate dialogue between companies they are interested in.
  • Brokers will most likely continue to offer corporate access service to investors, however the nature of the services is likely to change. Focus will be on access to new, unique, and valuable investment ideas priced at a point which investment managers are prepared to pay for themselves. As a consequence of this, and looking on the other side of the coin,  brokers will likely be more selective of which companies they offer this service to.
  • From a company’s IR perspective,  the magnitude of the impact will certainly depend on both macro and company specific factors, as well as the size of company’s investor base in the UK. Broadly speaking, we expect companies assuming more responsibility for investor targeting and engagement, and over the longer term expanding the resources of their IR teams, to accommodate new requirements.
  • We expect the regulation to present opportunities for independent providers of corporate access. The challenge those companies will face is access to investors, comparatively weak relationships, and perhaps access to resources to provide ‘seamless logistics’ which play an important role in any meeting.

Further reading: New FCA rules on use of dealing commissions