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It Will Take An Army
ASIC’s new guidance on sell-side research misfires
ASIC’s existing guidance on sell-side analyst research has been too principles-based to offer much practical assistance and so there is clearly a need for better guidance. Unfortunately, Consultation Paper 290 Sell-side research (CP 290) in many respects goes even further than the prescriptive international standards the global houses already comply with, requires a compliance army (which is potentially problematic for many, smaller, research providers in our market) and focuses the compliance burden on the analyst by making them personally accountable for misuse of MNPI and interference by their colleagues. Some key themes emerging from CP290 are:
- No culture of compliance, just police: ASIC assumes that existing guidance around managing conflicts is not being followed, and has outlined detailed rules which apply to ASX-listed entities and other clients, research analysts and the corporate advisory and other private-side actors of investment banks at each stage of the transaction life-cycle. Some of these rules should not be surprising, such as prohibiting analysts from being involved in transaction pitches (a position that all FINRA-regulated houses will be well familiar with) while others go much further (internal compliance to act as the middle-man in all interactions between the analyst and the issuing company if there is a capital raising or other transaction in play or contemplated). Interestingly, reliance on the integrity of individuals to comply with policies and protocols is expressly stated to be unacceptable. The result is the introduction of more oversight and involvement by compliance, which will affect the speed of publication. ASIC also proposes disclosure of the analyst’s own shareholdings (which accords to US-practice), as well as those of the licensees’ five largest share and option holders (which does not), assumes that discretionary fees reflect the content of research rather than IPO sales performance, requires prescription around the structure, funding and remuneration of research, requires public disclosure of how companies are selected for research coverage and prohibits amendments after publication of a report in an IPO context.
- “One size fits all” upsizing of the compliance function: The implementation of the guidance will require, for some houses, significant investments in compliance staff. For example, supervising analyst briefings, playing ‘go-between’ on shared work product and information, as well as real time reviews of correspondence using key word ‘hits’ and making analyst remuneration decisions will need to be undertaken by compliance staff.
- All information is MNPI: licensees will of course need to develop specific policies, procedures and training to ensure analysts appropriately manage MNPI. This is a sensible requirement. Yet the “practical” guidance is highly conservative. Analysts are, in effect, encouraged to assume all unannounced information and analyst reports / valuations constitute MNPI, which reflects a fundamental misunderstanding of the nature and value of sell-side analyst work. Where is the recognition of the analyst’s nuanced observations, opinions, models, independent analysis and industry knowledge? There are limits on what internal training can achieve and the assessment of what constitutes MNPI needs to be on issuers, who understand the materiality of information and are in the best position to control what information they give to analysts. ASIC also seeks to require analysts to certify that their research report contains no MNPI, exposing them to personal liability for a breach of section 1041H of the Corporations Act in the event they have failed to appreciate that information is MNPI. ASIC is also requiring analysts to certify that no pressure has been exerted on them in preparing their report – the result being that the burden for maintaining a culture of compliance lands on the analyst author. The draft guidance doesn’t clearly distinguish between how these rules apply to IPOs versus secondary capital raisings and other transactions and so this will need to be clarified in the final guidance if these rules are to be understood and followed, as without appropriate demarcation between offer types, the rules around MNPI cannot be practically applied in a pre-IPO scenario where an analyst cannot know what information will be included in the final prospectus. There are also limitations proposed on including in IPO research reports any information that is not in the draft prospectus – whilst any information specific to the issuer (and attributable to the issuer) should not be included in research if the same information is not included in the prospectus, it is unclear if ASIC’s guidance is intended to prohibit the analyst’s own work product, observations, research on the industry, information from third parties, etc. Similarly, there are proposed restrictions around valuations (namely that they can only be expressed as an enterprise or total value, cannot be based on any financial information not in the prospectus (what if the analyst projects their own forecast cash flows for a DCF?) and a rule against having a policy whereby the midpoint of the IPO valuation is used as the initiating coverage value).
- It could have been worse: Contrary to the US-position, ASIC has not sought to ban the use of pre-IPO research (either before the publication of a public prospectus, or completely) or even to regulate its timing (as is the trend in the UK). Note ASIC has invited submissions on contrary views. This outcome is appropriate given the extensive use of pre-deal research in Australian IPOs (perhaps as a result of our comparatively shallower market). However, other aspects of the proposed guidance may change market practice on pre-IPO research – for example, issuers will be forced to mandate banks before they can commence analyst briefings and release their research (to avoid independence issues arising for the analyst), potentially committing issuers to a fee structure (including a fee and fee tail) earlier in the process than is often the case. The practical impact of these requirements (which in respects go beyond offshore regimes) needs to be assessed by the industry. ASIC has also flagged that they are reviewing IPO practices around allocations and there may be further recommendations flowing from that that may make it difficult to use allocation preferences to encourage pricing feedback during investor education.
We welcome ASIC’s public consultation and look forward to the results of the industry engagement and to clearer guidance on MNPI and sell-side research. We will be providing feedback to ASIC in response to CP 290.