Banks Brace for European Crackdown on Corporate-Bond Allocations

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  • Commission completing rules intended to make process fairer
  • Banks face requirements to record, justify allocations

European regulators are preparing to deliver a message to banks that have been underwriting record amounts of corporate bonds: Don’t treat it as an opportunity to reward your most-favored clients.

As part of an effort to boost transparency in the region’s corporate-bond market, the European Commission is finishing up rules aimed at giving borrowers greater control over who buys their debt. The problem? The same banks that distribute the bonds also stand to profit when investors come back to trade them, and regulators are concerned that allocation decisions can be influenced by the latter.

While the concern isn’t new, the stakes have multiplied during a debt binge in which companies worldwide have issued an unprecedented $11.9 trillion of bonds since 2008 as central banks suppressed borrowing costs and investors gobbled up anything with a yield. For investors, access to bond sales has become increasingly important because the securities are typically sold at a discount to market rates, generating additional gains.

“Fundamentally, it should be a fair process and not be selective,” said Ivo Kok, treasurer at Arnhem, Netherlands-based energy network company Alliander NV. Borrowers have also been listening to concerns raised by investors, seeking a greater role in allocations, said Kok, citing discussions with treasurers at other companies.

The rules, proposed by the European Securities and Markets Authority in December and being considered by the commission for adoption by year-end, would require banks to detail to the issuers how they allocate the securities before they’re sold. Underwriters also would have to obtain the borrower’s consent on how the bonds are distributed, then ultimately record each one and provide a justification.

The European Commission is considering the recommendations and is due to finalize new measures within the next few months, according to Vanessa Mock, a spokeswoman for financial services, taxation and customs at the commission.

The U.K.’s Financial Conduct Authority has also been reviewing the potential conflicts of interest that exist for underwriters. It’s now collating commentary from market participants as part of a broader review of investment and corporate banking. Such conflicts “could result in banks who manage new issuances showing preference to their favored investor clients when deciding on final allocations” for debt and equity offerings, the FCA said in a market study it published in May.

The proposed rules have drawn complaints from debt underwriters that they will be arduous. Deciding allocations could take longer and require banks to hire additional staff, the cost of which may be passed on to borrowers, said Ruari Ewing, senior director for primary markets at the International Capital Market Association.

“If you have 300 investment accounts on a trade and if you’ve got to individually record the investment justification for each, that could potentially be unworkable,” he said. “Issuers are the ones who are potentially going to be bearing the consequence.”

Similar concerns over allocation practices were raised in the U.S. as bond deals grew bigger and demand for a piece of them intensified. The U.S. Securities and Exchange Commission began investigating whether banks there were giving preferential treatment to certain clients after several high-profile offerings, including Verizon Communications Inc.’s record $49 billion sale in 2013, for which money managers put in orders of as much as $100 billion.

After the European Central Bank embarked on a 1.1 trillion euro ($1.23 trillion) stimulus program this past March, euro-denominated issuance boomed, with a record amount of sales by companies outside the region.

Coca-Cola Co. sold 8.5 billion euros of bonds in February, the largest offering ever by a U.S. issuer in the single currency. Investors put in orders for 20 billion euros for those, Brendan Hanley at Bank of America Corp., one of the arrangers on the deal, said at the time.

“We see a lot of value in an issuer knowing where their bonds are being placed and who their creditors are,” said Pamela Gachara, manager of the markets team at The Investment Association, which represents more than 200 asset managers. “Our members are looking to invest in the long term so it can only work for the better of the market.”