Given the level of distrust about the financial sector and politicians, the Coalition must ensure that large profits from future bank sales are not creamed off by underwriters, says John Chown. In his Centre for Policy Studies Pointmaker ‘No to underwriting: How the government can avoid being ripped off,’ Chown outlines how any future distribution process must be transparent and not open to exploitation of financial intermediaries.
He explains how underwriting has become unnecessarily expensive and actively encourages the deliberate mispricing of issues, using the cases of National Grid in 2010 and Prudential as recent examples. The big danger here is underwriting fees which, particularly for companies, by deliberate under-pricing (a real cost to the vendor) to reduce the risk, are far too high. Even discounted rights issues are, these days, unnecessarily underwritten.
Using his extensive knowledge of previous privatisations, Chown sets out a process which he says will eliminate the need for expensive underwriting whilst maximising proceeds for the Treasury and could save the Treasury up to £3.3billion when reprivatising RBS and Lloyds. This includes:
1) Treating the substantial work of drawing up the prospectus as a professional assignment to be carried out for negotiated fees, handled directly by the Coalition government.
2) Taking advice on the conceptual aspects of the issue, including the capital structure, from independent fee-paid advisors, and the expertise available within the Treasury, the Bank of England and the Select Committees in both Houses of Parliament.
3) Making a political decision over how much of the issue will be offered at the maximum available price to investors, and how much would be retained on favourable terms for small investors.
4) Seeking tender offers from all investors, domestic and foreign, institutional and private, with the minimum application set above the maximum likely allocation to small investors.
5) Then allowing the general public to acquire fairly small holdings at a discount conditional upon the shares being held for a minimum period.
He concludes that the Coalition has much work to do in the banking sector to induce more competitiveness, address ‘too big to fail’ and to placate public concerns on remuneration and bankers’ bonuses. However, it should ensure that the sale of the bank shares is made transparently and cheaply by using the tender process outlined above and avoiding the unnecessary expense of underwriting fees.
Tim Knox, Director of the CPS, comments: “This paper shows that, in previous privatisations, UK governments have failed to get a good deal from their financial advisers. We cannot let this happen with Lloyds and RBS. That is why John Chown's recommendations must be heeded by HM Treasury.”
John Chown, author and principal of Chown Dewhurst LLP, comments: “As an economist, I am an enthusiastic supporter of free, competitive capital markets, but as a tax adviser, involved in many substantial financial transactions, I have noticed that intermediaries do not always act in the best interest of their clients. Privatisation, although a (generally) very successful policy, was damaged by a significant part of the potential proceeds being denied to the government by self-seeking advice from the intermediaries. The charges for underwriting new issues generally have continued to be greatly in excess of the value of the services offered, and I am very concerned that the Coalition avoids being led astray into the old trap.”
A copy of the pamphlet is available from here.
John Chown is available for comment.
NOTES TO EDITORS
1. No to underwriting by John Chown is published by the Centre for Policy Studies on Tuesday 30th August 2011.
2. John Chown is a monetary economist and an expert in international tax at both the professional and public policy level. He was a co-founder of the Institute for Fiscal Studies and has advised the Russian and other governments on capital market taxation. He has served on the Technical Committee of the Association of Corporate Treasurers, one of whose tasks was to educate treasurers in getting value for money from the financial services industry. He has been a regular reviewer for the Times Literary Supplement and Central Banking, and gave evidence to OFT enquiries in 1997 and 2010 on underwriting procedures.
3. John Chown is available for comment. For queries on Thursday 25th August and Friday 26th August, please call the Centre for Policy Studies on 020 7222 4488 (office). For media enquiries over the weekend, please contact Ryan Bourne (CPS researcher) on 07545962024.