Did UBS breach its ‘Chinese Walls’?

UBS’s recent report - and its subsequent revision - on NSWs electricity privatisation illustrate that truly independent opinions are a dying breed. 

After retaining power in the recent NSW state election, Premier Mike Baird looks set to achieve his goal of selling half of the state’s electricity distribution system.

Putting aside the political arguments over privatisation, there is controversy over the report the government’s advisors, UBS, issued 11 days before the election. Although generally supportive of the deal, its title – Bad for the budget, good for the state – and conclusion that the state's budget would suffer from lost future profits raised the government's ire.

Colleague Gaurav Sodhi has previously noted that selling NSW's poles and wires now isn’t a bad idea given that earnings have likely peaked. I also disagree with the report as originally prepared (Disclosure: I’m a member of the Liberal party).

The government quickly made its displeasure known through various channels and, later the same day, the report was reissued with a new title Good for the state and with the offending political commentary removed.

While I’m not surprised at the government’s actions, I am surprised that UBS ever got itself into this mess.

UBS’s advisory team is part of its investment bank and separate to the UBS Securities research team which issued the report. The advisory business is also much more profitable than the research business, as illustrated by the $10m or so in fees that the former will receive once the electricity assets are privatised. The research team would have to sell a lot of reports to even come close to this.

As the advisory team can plausibly argue that the fees it earns help pay the salaries and bonuses of their research colleagues, there is clearly potential for the latter to be pressured to issue reports which help the advisory team.

In order to maintain the research team's independence, banks set up ‘Chinese Walls’ which limit interactions between the two groups. It is also an offence under s912A of the Corporations Act for the advisory part of a bank to influence its research division.

Yet as the AFR has been reporting, soon after the government contacted UBS’s head of investment banking Guy Fowler and head of UBS Australasia Matthew Grounds, the report was amended and republished. Head of research Chris Williams has taken responsibility for the stuff-up, saying he didn’t read the report before it was published and also apologising for the damage to the bank’s reputation as a result of having to reissue it. Mr Williams has also stated Mr Fowler was in his office ‘by coincidence’ when discussing further changes to the report with the analysts who prepared it.  

ASIC is currently investigating whether UBS breached its Chinese Walls and so potentially fell afoul of the Corporations Act.

Whatever the outcome of ASIC’s investigation – and we’re certainly not saying that any UBS employee breached the law – this saga illustrates the problems with supposedly ‘independent’ opinions.

Whether it’s your typical independent expert’s report commissioned as part of a takeover or a Mineral Council report on the Renewable Energy Target: what you’re getting is the illusion of independence.

This is because ‘independent experts’ have a vested interest in ensuring whoever is paying for their opinion is satisfied with it. It isn’t any different to the issuers of sub-prime mortgage bonds receiving AAA-ratings from the ratings agencies in the lead-up to the GFC.  

Unfortunately, with the research business becoming less profitable, genuinely independent research is becoming rarer. At Intelligent Investor Share Advisor, however, we don’t have to kowtow to investment bankers who pay our bonuses and so we can make up our own minds.

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Disclosure: the author is a member of the Liberal party and has no desire to work for an investment bank. 

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