Last December, Euromoney wrote of the threat posed by automation to those who make their livelihood from the primary debt capital markets. An industry drive for lower cost and greater efficiency is coupling with regulatory pressure for transparent allocations to make change inevitable.
Innovative mechanisms are now popping up that threaten the traditional methods of borrowing money. Disintermediation is suddenly all around, whether it is Uber’s no-banks loan or Verbund using a new online platform in March for its latest Schuldschein.
So what of ECM? Surely Spotify’s move to forego a traditional IPO and choose a direct listing demonstrates the direction of travel, even if the destination remains some way off?
Not so fast. Bonds are frequently issued, often highly technical in pricing and often easily interchangeable. If I have a series of bonds outstanding with three-, five- and seven-year maturities, I do not need to be a rocket scientist to price a six-year. If an investor wants to switch out of the five-year and into the six-year, he can do that without breaking a sweat.
There is clearly a distintermediation play possible here. For most conventional credits and structures, you don’t need an investment bank to structure and price a deal. Big issuers have teams with the expertise to do this.
Investors don’t need sophisticated means of accessing new primary deals if they are already familiar with the credit. Aggregators already exist for institutional investors, and have been helped by Mifid rules on legal entity identifier numbers. Familiar names can tap retail distribution platforms.
Regulators don’t like the black-box element of allocation. Bankers talk of art versus science – regulators want to cut out the art.
But the capital and liquidity that banks provide to the buy side still matter. Ask any account about the risks they face when a star manager quits and they will tell you that a counterparty prepared to take paper off their hands at 100 is worth a lot. For issuers, it is obvious that if banks earn less from DCM, the cost of loans will rise.
For straightforward credits there is little about the mechanics of debt issuance that couldn’t be disintermediated away. But banks still want to do it and they provide services to the buy side and the sell side that haven’t yet been fully replaced.
Why is ECM different? Corporate executives worry about their share price. No chief executive has their salary pegged to their CDS spread. And who really remembers how an IPO priced relative to its peers or even its own range? But you can bet on a decent number being able to tell you that Google traded up a bit more than 15% on its first day, back in 2004. Performance is the only metric that survives.
Mistakes can have long-term costs, particularly as most companies go public to provide a platform for future fundraising. Even owners who are cashing out usually have to have an eye on at least one follow-on deal to complete the exit.
It is never plain sailing, even when it looks like it should be. In March, UBS and Credit Suisse couldn’t convince Swiss investors that the price range for the IPO of Swiss company Gate Gourmet was the correct one. It’s no surprise that issuers are unwilling to trust listings to luck and automate the whole process.
Investors are making a similar risk calculation. An IPO that is a dud can collapse. A corker can double your money – or at least bring you the 15% pop that institutions pretty much expect as payment for backing a debutant. They also want aftermarket liquidity – for some issuers it can be the most important requirement of their underwriting bank.
The Google example is instructive. That company chose an auction method for its IPO, a route that has not exactly taken off in the 14 years since then. The stated aim was democracy, but greater efficiency in pricing was the hope. Fat chance: the price was still dropped to $85 at the last minute to match institutions’ demands, despite an open of $100 showing where the deal could have cleared.
If you are not raising money and have a big brand – like Spotify – then an unconventional method might work. Other than that, the complexity and high stakes of an IPO make the possibility of disintermediation smaller. Regulators might attempt to force the issue; that will be a tough battle.
The same vested interests that hold sway in fixed income are also there in equities. It is amusing to see the exceptionalism argument used by both: debt bankers reckon selling listed equities is child’s play against their expertise; equities bankers see debt pricing as an Excel function.
But the idea that the kind of transformation that seems inevitable for DCM must also be so for ECM looks fanciful. Debt bankers might not like it, but their equity colleagues seem able to argue for the human touch for some time to come.