Streamlining IPOs – What are the Buy Side Thoughts?

A common theme amongst The Hive trading community is that the IPO process is hugely inefficient, and the sources of frustrations are multiple. The lack of standardisation probably manages to explain these multiple issues.

Initial Public Offerings (IPO’s) are the very essence of why we have the finance industry we have, so for them to be as inefficient as they are is concerning. They link the providers of capital to firms that will allocate the capital whether it be the building of a factory, digging for gold or researching a cure for a disease. 

Companies wishing to make their business publicly traded will do so usually via an investment bank. These banks will then approach their clients and the portfolio managers will decide if they are interested in investing. When a decision is made, the people who make sure that the investment process happens smoothly are the buy-side traders. 

Some of the main frustrations raised on a call that The Finance Hive hosted with a select group of members are below:

• Lack of unique identifiers for the new shares in terms of exchange codes on trading systems.
• The reflection of interest relies on informing all the brokers involved and often multiple departments within those firms. 
• Communication of interest often uses an Instant Bloomberg message (IB) which introduces operational risk and difficulties in auditing and monitoring.
• The allocation process within the investment banks who organise the IPO is a hugely opaque affair. How they decide who gets what within each IPO is a mystery to many and has many conflicts of interest possibilities.
• A recent addition to the list of issues is what timestamp is used for reporting the trading. Brokers are told to use the time of allocation which does not fit in well with the reporting of this trade to custodians/fund accountants.

The FIX Community is one of many organisations that are trying to tackle this issue and reduce the operational risk around IPO’s. Technology providers have tried to solve the problems, but none are really geared for the buy side. Perhaps it is owing to the multiple areas that need to be improved that a solution has not yet been forthcoming. A key takeaway from the call was that rather than tackling the problem as a whole, we need to identify and solve bitesize pieces. It was acknowledged during the conversation that there are systems in Fixed Income that currently work for new listings so perhaps further exploration here would be beneficial for the equities members. It is often said within Finance that equities get it last when compared to fixed income and this may prove to be another example.

But back to IPOs. In the spirit of not looking to solve all the issues in one go the remainder of this report will not look at the price formation and allocation process for IPO’s. Discussions on how much money should be left on the table for capital providers would be worthy of a report itself. For more information on both subjects a useful resource is an FCA occasional paper from 2016:

Click here to access -> FCA occasional paper

The areas that the Hive Community will specifically focus on are the earlier availability of unique identifiers and communication of interest and feedback on the allocation. 

There are genuine operational risk pitfalls around the current IPO process. Owing to the lack of standardisation there is a disproportionate amount of resources dedicated to them. Problems can occur with a miscommunication of interest in terms of size. For example confusing share amount  with the monetary amount, indicating the wrong limit or a limit when the strike price was desired will all have drastic consequences. Additionally, putting trades on dummy securities can have problems if you miss when the live security is available, and trading begins.

After an allocation has been received there will be interest in how this was decided and how an allocation ranked compared to the average. This will sometimes make a PM feel warm and loved and other times have them asking the dealing desk to side-line a broker for their perceived slight. The allocation will then need to be communicated to the custodians and valuation departments which invariably requires manual intervention when there is no ISIN or sedol available. Each firm will likely have their own way in dealing with the operational burden of an IPO, but one thing they will have in common is it will not be the most efficient process in the world. 

Any operational team member in a buy-side firm will tell you that if you need something resolved quickly you get your trader to speak to their sell-side counterpart and usually any impasse quickly evaporates. The same can be said for portfolio managers and investment bank ECM’s. The PM’s can communicate the need for joined up thinking between brokers, exchanges, and information providers so the buy-side have the tools needed to improve the process. The main tool being a unique identifier which is available on all trading systems before an IPO is launched.

The next big improvement would be investment banks allowing for interest to be communicated via execution management systems. If a unique identifier was available, it will improve the oversight and governance around IPO’s both for the buy side and the sell side. The current need to inform multiple departments within multiple firms of what you want in an IPO only adds to the opaqueness of how the allocation is determined. Some would say that a few market practitioners would not welcome such governance for the current murkiness allows some market members to benefit. This leads on to a very important point; the current system does work. Just look at the issuance in the market and the capital that is being provided and the results speak for themselves. Should we be tampering with such an important aspect of a healthy economy?

IPOs are often the largest trades for a firm and any means of moving towards STP would be welcomed by all the buy-side. Is it too much to ask to have an instrument waiting for a buy side traders trading system so they can input a proposed trade when the PM tells them what they want to do it? It should also be easier to monitor internally and communicate externally within the trading system as opposed to fragmented communication channels. Many firms currently use a spreadsheet to monitor deal interest, communication, and allocation. To put it simply, Internal compliance and operational risk departments would probably have a new anxiety dream if they realised how things were currently being managed for the largest trades most firms undertake.

If you wish to discuss this topic further, please feel free to contact Isabella Grassick, Customer Success Manager for Equities & FX