JFTC Report: Competition policy and antitrust law perspective on the initial public offering (IPO) pricing process

On January 28, 2022, the Japan Fair Trade Commission ("JFTC") published a report "Understanding the reality of the public offering price setting process in the initial public offerings (IPOs)" ("Report").¹ The Report was prepared to examine whether there are any issues under competition policy and antitrust law that may cause the opening price to substantially exceed the IPO price.

Currently Japan’s listing system is not friendly to entrepreneurs who would like to take on new challenges. Specifically in the case of IPOs, a share price on the first day of listing (opening price) tends to be significantly higher than a price (IPO price) at which the entrepreneurs sold their shares, and the entrepreneurs tend to earn less money compared to foreign countries. It is desirable from the standpoint of competition policy to make it easier for newly listed companies to raise funds necessary to grow their businesses by setting an IPO price that matches the value and demand of the newly listed companies, and to create an environment that promotes growth in the market, which leads to the revitalization of Japan’s economy as a whole.

The Government of Japan made a decision as part of "Growth Strategy Implementation Plan" on June 18, 2021² that the IPO price setting process shall be reviewed and undertaken. Further, "The Urgent Proposal – "New Capitalism" for the Future and its Launch" ("Proposal")³, announced by the Kishida administration on November 8, 2021, provided that the JFTC work on reviewing the reality of situation regarding IPO price setting process.⁴ Accordingly, the JFTC conducted research on factors that may have been causing an opening price to significantly exceed an IPO price, including about (1) IPO price setting process, (2) variety of options for listing and (3) business practices related to IPOs, and published this Report. 

The Report consists of following five sections: Section 1 - Background and purpose of the research, Section 2 – Scope and methodology of the research, Section 3 – Status of IPOs, Section 4 – Current status of transactions in IPOs and views on competition policy and Anti-Monopoly Act ("AMA"), Section 5 – Future initiatives by the JFTC. This article focuses on Section 4.

Section 4 – Current status of transactions in IPOs and views on competition policy and AMA

(1) IPO price setting process

The JFTC conducted research on factors that could cause an opening price to greatly exceed an IPO price in the following stages: (i) application for listing on stock exchange, (ii) setting a nominal price (i.e., price of share provided in a securities registrations statement), (iii) placing a tentatively set price range, (iv) setting an IPO price and getting listed and (v) others.

(i) Application for listing on stock exchange

The JFTC conducted research particularly from the point of view whether information that contributes to a selection of lead manager, such as an average initial rate of return by issue size for each securities company, may not be disclosed. One of the possible indicators of discrepancy between an opening price and an IPO price is an initial rate of return.

According to the results of written survey and interviews, the majority of newly listed companies answered that it would be useful if an average initial rate of return of each securities company by issue size were disclosed when selecting a lead manager, but in practice only a few new listed companies actually considered such factor. If an average initial rate of return by the issue size of each securities company is disclosed by a fair and neutral organization in a comprehensive manner, newly listed companies would be more interested in setting of the IPO price from an early stage, and such information would be helpful in selecting a lead manager. It would also be an incentive for securities companies to set IPO prices more in line with demand. 

Therefore, from the standpoint of competition policy it would be desirable to publish a list of information that can be used as a reference in setting IPO prices, so that newly listed companies would have more autonomy in selecting a lead manager. As to the timing of share price to be disclosed (i.e., share price at what point would contribute to the selection of a securities company with a better understanding of newly listed companies’ value), various opinions were expressed from newly listed companies and securities companies. The JFTC recommends the Japan Securities Dealers Association ("JSDA") examine whether it would be appropriate to publish an average initial rate of return as well as at what point of average rate of return would be appropriate to disclose. 

(ii) Placing a nominal price (i.e., price of share stated in a securities registration statement)

The JFTC conducted research particularly from the points of view: (a) whether a "pre-hearing" survey⁵ of prospective demand from investors prior to the submission of securities registration statements may not have been conducted sufficiently and (b) whether a lead manager may be unilaterally offering IPO discounts. 

A nominal price is a price of share stated in a securities registration statement. It is often set at a discount (i.e., IPO discount) from the theoretical price calculated by taking into consideration the financial condition of companies selected by a lead manager as the ones that operate a business similar to that of a newly listed company. IPO discount refers to a discount offered based on consultation with a lead manager and a newly listed company in order to enhance the workability of IPO, taking into account the difficulty of obtaining company information and predicting liquidity of the newly listed company.

According to the JFTC’s research, there were a certain number of securities companies that misunderstood that it was legally impossible to conduct a pre-hearing survey. The JFTC recommends the JSDA clarify and disseminate that not any type of pre-hearing is prohibited by laws and regulations, and it is desirable from the viewpoint of competition policy for securities companies to conduct a pre-hearing if institutional investors are able to respond and to set a nominal price based on investor demand. 

In addition, according to the results of JFTC’s research, IPO discounts are offered in almost all cases, but the rational may not always been fully explained to newly listed companies. It may violate the AMAwhen setting up a nominal price low without explaining the concept or without a reasonable ground, but just informing, for example, it is an IPO discount. It is desirable from the viewpoint of competition policy for securities companies to sufficiently discuss with newly listed companies and set a nominal price after the newly listed companies are fully satisfied. 

(iii) Placing a tentatively set price range

The JFTC conducted research particularly from the points of view: (a) whether effective investor roadshows may not have been implemented, (b) desires of the interviewees at the roadshow of newly listed companies may not have been reflected and (c) there may be a standard pertaining to the size of the range of a tentatively set price range.

According to the Report, in order to be able to have a tentatively set price range accurately reflect demand, it is desirable for securities companies to receive appropriate feedback from institutional investors and strive to have an effective investor roadshow that takes into account the value and growth potential of newly listed companies. To achieve this, it is desirable to enhance transparency by disclosing the results of roadshows to newly listed companies with institutional investors’ names when they agree.

In addition, it would be desirable from the standpoint of competition policy for securities companies to provide explanations to newly listed companies about potential institutional investors to be interviewed at the investor roadshow by, for example, providing them with a list of institutional investors interested in the roadshow of the newly listed company in advance, so that newly listed companies can select interviewees with more autonomy. It is also desirable for securities companies to sufficiently discuss with newly listed companies about institutional investors to be interviewed, and select them after the newly listed companies are fully comfortable with a list of interviewees.

Further, it is desirable from the viewpoint of competition policy for securities companies not to set rigid and narrow standards for width of the tentatively set price range, but to set it more in line with demand based on the results of roadshows.

(iv) Setting an IPO price and getting listed

The JFTC conducted research particularly from the points of view: (a) an IPO price may be set within the tentatively set price range even when the result of book-building sticks to the upper limit of the range and (b) retail sales departments may be involved in the IPO pricing process.

According to the results of JFTC research, there are a certain number of securities companies that misunderstand that setting an IPO price that exceeds the upper limit of the tentatively set price range would violate law and/or regulations. In addition, there are also a certain number of securities companies that consider that revising a tentatively set price range would in practice be difficult.

The Report recommends the Financial Services Agency of Japan (the "FSA") and the JSDA disseminate that there are no systematic restrictions on the setting of an IPO price that exceeds the maximum of the tentative set price range. In order to make it possible to raise funds with IPO prices that more closely reflect investor demand, securities companies should be more flexible in setting IPO prices based on the results of book-building, including setting an IPO price above the upper limit of the tentatively set price range, and/or setting an IPO price after correcting the tentatively set price range. Needless to say, careful attention should be paid to investor protection and the impact on the listing date.

According to the results of JFTC research, the JFTC did not identify any cases where retail sales department actually influenced the IPO pricing process while some newly listed companies expressed concern that IPO pricing process may has been affected by the involvement of retail sales department, particularly retail sales department for individual investors. Securities companies are required to establish a system for managing conflicts of interest, so that reflecting the wishes of retail sales department would not unduly affect the IPO pricing process.

(v) Others

In addition to above, the JFTC conducted research (a) whether it may be difficult to add a joint lead managing securities company or change a lead managing securities company, (b) second opinions may not be sufficiently heard, (c) a lead manager may be requesting a higher underwriting ratio for newly listed shares and (d) there may be barriers to entry in underwriting lead managers. 

According to the Report, it would be desirable from the competition policy perspective that securities companies discuss with newly listed companies from an early stage of the IPO process about the level of an IPO price to be set along with providing relevant materials, and proceed with the IPO process after the newly listed companies are fully satisfied. In addition, securities companies should give consideration to newly listed companies to be able to add or change a joint lead manager(s) appropriately if the newly listed companies wish to do so.

With regard to the second opinion, the Report indicates that it would promote competition among securities companies because it would increase a possibility of changing a lead manager by newly listed companies seeking a second opinion from a non-lead manager securities company; in addition to seeking a second opinion would enable to examine the appropriateness of an IPO price from an objective viewpoint and to set an IPO price appropriately reflecting supply and demand.

According to the results of the JFTC’s research, lead managers often ask newly listed companies to underwrite 80 percentage or more of their share. If a lead manager underwrites a high proportion of newly listed shares, the number of shares that can be underwritten by other securities companies would be limited, thereby impeding the underwriting of newly listed shares by other securities companies. This may limit a number of securities companies that newly listed companies can seek a second opinion from. Therefore, it is desirable from the viewpoint of competition policy for lead managers not to request a high underwriting rate against the will of newly listed companies unless there is a particular problem.

As to the barriers to entry, it would be desirable from the viewpoint of competition policy for the Tokyo Stock Exchange, Inc. ("TSE") to clarify and disseminate the specific matters that need to be addressed under the TSE’s Rules on the System for Surveying Eligibility for Listing of Trading Participants, so that a wide range of securities companies may be able to take the role of lead manager.

(2) Variety of options for listing (e.g., book-building, direct listing or bidding process)

The Report suggests that if newly listed companies are able to choose a listing method that best suits them from multiple options (e.g., book-building, direct listing or bidding process), competition among securities in lead management business would be promoted, such as a securities company that can propose an attractive listing method to newly listed companies would be selected as a lead manager. In this regard, some securities companies expressed their concerns about adopting a bidding or direct listing process under the situation where demand for newly listed companies is unknown. From the viewpoint of diversifying the options for the listing method (such as making a bidding process one of the options), the Report recommends TSE and the JSDA should study how a bidding process should be by, for example researching similar methods overseas.

(3) Business practices related to IPOs

(i) Request for a specific securities company to serve as lead manager; unjust interference with the underwriting of other securities company as lead manager

The JFTC did not find any clear evidence of undue interference with the underwriting of lead managers by other securities companies in its market research. However, if a securities company improperly interferes with another securities company from taking over the role of lead manager, such as by exerting influence on banks and venture capital companies affiliated with the securities company, it could violate the AMA as an interference with competitor’s transaction (Article 14 of the Designation of Unfair Trade Practices).⁶

(ii) Exchange of information between securities companies regarding underwriting fee rates

The JFTC did not find any clear evidence of undue exchange of information between securities companies regarding underwriting fee rates. However, if multiple securities companies agree on an underwriting securities rate, it would violate the AMA as an unreasonable restraint of trade (Article 2, Paragraph 6 of the AMA).⁷

(iii) Unreasonable disadvantage to newly listed companies due to unilateral setting of an IPO price by a lead manager with strong bargaining power

The JFTC did not find any clear evidence that lead managers with strong bargaining power unfairly disadvantages newly listed companies, for example, by setting IPO prices unilaterally. However, if a lead manager with strong bargaining position is found to have unfairly disadvantaged a newly listed companies in light of normal business practices, for example, by unilaterally setting an IPO price, it would violate the AMA as an abuse of superior bargaining position (Article 2, Paragraph 9, Item 5 of the AMA). For example, it would be an abuse of superior bargaining position if such a lead manager set a nominal price low, for example under the name of IPO discount, but without explaining the concrete concept and without a reasonable basis. In order to avoid violating the AMA, securities companies need to be careful not to unilaterally set an IPO price, such as by (i) discussing with a newly listed company sufficiently and setting a nominal price after the newly listed company is fully satisfied, (ii) making it easier for a newly listed company to add a joint lead manager or change a lead manager, and not impeding the addition of a joint lead manager if the newly listed company wishes, (iii) not impeding a second opinion when a newly listed company wishes to hear it, and (iv) not requesting a high underwriting rate from a newly listed company against the will of the newly listed company, unless there is a particular obstacle.

**********

Prior to the release of the Report, the JFTC submitted the views expressed in this Report to the FSA and the TSE. In addition, it explained about the Report at the JSDA’s working group on an ideal process for setting IPO prices, which was held on January 31, 2022.⁸ The JFTC expects that the stakeholders such as the FSA, the TSE, the JSDA and securities companies toconsider and take appropriate measures in the future to promote fair and free competition in the IPO pricing process, thereby creating an environment that encourages growth in the market by diversifying the choices of newly listed companies and making it easier to raise funds, which in turn will lead to the revitalization of the economy as a whole.

_{1 The JFTC press release of January 28, 2022 is available in Japanese at https://www.jftc.go.jp/houdou/pressrelease/2022/jan/220128_IPO.html; the Report is available in Japanese at https://www.jftc.go.jp/houdou/pressrelease/2022/jan/220128_IPO/220128_report.pdf; summary of the Report is available in Japanese at https://www.jftc.go.jp/houdou/pressrelease/2022/jan/220128_IPO/220128_summary.pdf. 
2 The "Growth Strategy Implementation Plan" of June 18, 2021 is available in Japanese at https://www.cas.go.jp/jp/seisaku/seicho/pdf/ap2021.pdf. 
3 The Proposal is available in Japanese at https://www.cas.go.jp/jp/seisaku/atarashii_sihonsyugi/pdf/kinkyuteigen_honbun_set.pdf.
4 Please also refer our previous Client Alert "New Capitalism in the Kishida Administration and Competition Policy in Japan" at https://www.whitecase.com/publications/alert/new-capitalism-kishida-administration-and-competition-policy-japan.
5 Pre-hearing survey is a survey in which investors are asked about the expected demand before the submission of a securities report. Certain pre-hearings are prohibited. For example, a pre-hearing in relations to the domestic public offering accompanied by the underwriting shall not be conducted (Article 9 of the JSDA’s internal Rules concerning Proper Handling of the Pre-Hearing by Association Members). English translation of the rules is available at https://www.jsda.or.jp/en/rules-guidelines/E07.pdf. 
6 JFTC’s English translation of the Designation of Unfair Trade Practices (Fair Trade Commission Public Notice No. 15 of June 18, 1982) is available at https://www.jftc.go.jp/en/legislation_gls/unfairtradepractices.html. 
7 JFTC’s English translation of the AMA is available at https://www.jftc.go.jp/en/policy_enforcement/21041301.pdf. 
8 The Secretary General of the JFTC’s briefing on January 2, 2022 is available in Japanese at https://www.jftc.go.jp/houdou/teirei/2022/jan_mar/220202.html.} 

_{White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities.}

_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}

_{© 2022 White & Case LLP}