19 May 2017

Financial Times: Mifid II threatens to turn bond allocation into a minefield

Under Mifid II, bankers must provide a justification for the final allocation made to each investor in a bond sale. This piece of the regulation attempts to address complaints from small investors that banks managing bond sales favour the world’s largest asset managers, handing them more debt as a quid pro quo for fees provided from other business. But Mifid also has rules designed to protect retail investors that could stop bankers allocating bonds to the smallest investors entirely. Ruari Ewing, a senior director at capital markets trade association ICMA, said that these “product governance” rules are “the single biggest challenge Mifid poses to bond syndication”.

The problem is that Mifid II requires the creation of a three page information document for retail investors, summarising the potential risks of a deal. But an offering memorandum for a corporate bond usually runs to hundreds, and sometimes even thousands of pages, in an attempt to cover all potential legal liabilities. Cramming this into a few pages would be impossible, leaving banks open to lawsuits if a deal goes wrong.

In European investment grade bond syndications, the bookrunners all take orders and then collate them at the end, removing any duplicated orders in a process called “reconciliation”. They then host an allocation call to debate and decide which investor gets what. But the high-yield market largely follows a US convention whereby a “left-lead” bookrunner effectively controls the deal. Their bank is listed first on the left in the bookrunner list, with the remaining banks “on the right” listed in alphabetical order.

Perhaps the biggest problem with the new regulation is that it fails to recognise a fundamental fact of the bond market — that syndicate bankers do not have the final say on allocation, the issuers themselves do. “Most treasurers took a quick look at the final book and sign off on it,” said the corporate bond banker. “But some really do get involved in the allocation process. And it is the issuer’s book at the end of the day.”

Full article on Financial Times (subscription required)

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