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Trends In Regulations - Company Forward Looking Statements and Reducing Research Conflicts of Interest

19/12/2016

Written by: Dr Stephen Bartrop - Director, Breakaway Research.  All Company Executives understand that the only way to gain and attract investors’ attention leading to a fully valued share price in the market is to promote their story using the following methods:

  • Company Presentations
  • Roadshows
  • Research (Independent and/or Broker)
  • Conference Presentations
  • Talking to Investors

Simply relying on announcing company news in an ASX release rarely attracts any attention unless there is immediate management follow‐up, the news is absolutely stunning or you are BHP Billiton (or the like). Add to this the increasing pressure of fewer and fewer journalists covering specific areas, and there may not be any newspaper coverage – no matter how significant the announcement is to the company.

In our view, for currently listed companies, a key consideration is ASIC’s attempt to tighten up disclosure requirements.

The key regulation regarding these disclosure tightening requirements is around forward‐looking statements that must be based on reasonable grounds. Consequently, this has left many company executives pondering as to whether it was even worth being listed, let alone despairing on how to attract capital.

Two key areas where this may impact resource companies are:

1. Resources/reserve categories should be at levels that support production forecasts.

2. Any project will require financing and the impact of how this finance may occur (e.g. any dilutionary impacts on existing shareholders) have to be noted.


For Example:

A junior resource company has a small inferred resource which remains open in all directions and has the capacity to expand to more than 1 million gold ounces and produce 100,000oz pa.

All the company can potentially state is that it has a small inferred resource, which is open in a number of directions.

Taking this further, say the Company;

  • Had continued drilling to upgrade the resource to 250,000 of measured resource.
  • Has estimated that the capital cost will be $50 million.
  • Its market capitalisation has improved but is still less than half of the $50 million

It may be able to report that its anticipated production rate may be 50,000 oz pa but then to finance the plant it may need to raise $30m in equity/$20m debt, with the equity raising diluting the existing shareholders by more than 50% based on the company value at that point in time.

Historically, the approach would be to highlight the potential size of the resource and potential production rates early on so investors can factor in a risked weighted value attributed to these. As these parameters firm up (or otherwise), the risk factor diminishes and the value (share price) increases ‐ but at least it gives investors an indication of what the ‘size of the prize’ may be close to the outset. This way the share price may appreciate, and by the time an equity raising is required to build the plant, the initial investors are not confronted with a 50% dilution rate. What may happen in reality is that there would be varying levels of information in the market place, where the Company may discretely tell key investors the perceived ‘real’ potential of the project, while the rest of the market is limited to the restricted announcements.

A better and fairer outcome is the ability of investors to source research (independent and/or broker) where an analyst who compares similar projects, can assess the geology and other technical risks and then risk‐weight a project’s potential value. The role of the analyst is to provide an objective probability/risk weighted assessment of the potential of a particular project, utilising all information the analyst has at his/her disposal.

Conflicts Of Interest – Regulation Is Changing The Nature Of Broking

There has been a major thrust in both Australia and around the world at minimising conflicts of interest, particularly in the investment banks around research, corporate transactions and broking commissions.

A new development occurring in the European Union is driving a trend to unbundling commissions paid to brokers for research and execution. What this means is that traditionally a fund manager may pay commissions to brokers to transact in shares that they are buying or selling. Inherent within the commission fee may be a component fee for the research coverage provided by the broker and which finances the research department within the investment bank.

As Bloomberg reports, the proposals are part of MiFID II’s (Markets in Financial Instruments Directives) clampdown on third‐party inducements.

MiFID II proposes investment research to be paid for in one of two ways:

  • from a fund manager’s own account ‐ recoverable by raising management fees, or;
  • via a client research payment account ‐ regulators have yet to clarify the rules around using dealing commissions to fund such an account.

An unbundled model, where commission use is limited, would be most disruptive and could be

applied by the industry globally.

What Does This Really Mean?

What it means is that if a fund manager has to pay for research, it is far more likely to assess the value of the research, rather than providing a ‘lump sum’ payment. Generic research on large companies ‐ where a fund manager may receive 10 reports covering the same event ‐ may be called into question as to ‘where is the value add?’ Whereas, specific and targeted research may become the desirable focus of any expenditure.

Like many others, we believe this trend towards unbundling the price paid for research and the increasing concerns around conflicts of interest in the broking firms (whether small or large) is going to push most research to be provided by non‐conflicted external providers such as Breakaway Research. So who will pay for the research? It has to be the companies ‐ with occasional fund manager sponsored industry specific, sector or company research.

Meanwhile, broker commissions will continue to be eroded with an increasing reliance on IPO’s or placement commissions to generate revenue.

Final Words

We are experiencing a rapidly changing environment in traditional forms of research and broking. The major driver is regulation ‐ seeking to reduce conflicts of interest and providing market transparency. As a consequence, it will drive a greater dependence on independent research. In terms of forward – looking statement requirements on companies, we do find these are counterintuitive to efficient information dissemination, and to the efficient market hypothesis. At the very least, it will push companies and the markets to utilise research to a greater extent.

Breakaway Research is an independent research provider, and has a vested interest in helping Company Management understand the current global trends and regulations in the dissemination of company information. 

http://www.breakawayresearch.com

 

Disclaimer

Any observations, conclusions, deductions, or estimates of figures that have been made by Breakaway Research and the Breakaway Investment Group in this report should not be relied upon for investment purposes and the reader should make his or her own investigations. This publication has been issued on the basis that it is only for the information and exclusive use of the particular person to whom it is provided. Any recommendations contained herein are based on a consideration of the securities alone. In preparing such general advice no account was taken of the investment objectives, financial situation and particular needs of a particular person. Before making an investment decision on the basis of this advice, investors and prospective investors need to consider, with or without the assistance of a securities adviser, whether the advice is appropriate in light of the particular investment needs, objectives and financial circumstances of the investor or the prospective investor. Although the information contained in this publication has been obtained from sources considered and believed to be both reliable and accurate, no responsibility is accepted for any opinion expressed or for any error or omission that may have occurred therein.

 

Breakaway Investment Group

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