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Playing by the new rules

Amid the arrival of myriad regulations in 2018, Harriet Clarfelt and the IC companies team explore the ways investors can capitalise on (or avoid) the changes facing multiple sectors
March 9, 2018

March 2008: The Global Financial Crisis is in full swing. British bank Northern Rock has just been nationalised. American peer Bear Stearns will soon be bought out by JPMorgan. Lehman Brothers, and many other institutions, will collapse in a matter of months. 

Blackberries ring unanswered in boardrooms as bailout talks continue. On the streets of London, black cabs sweep City workers off the kerb. Meanwhile, across schools and universities, students pore over Facebook (US:FB) – a relatively nascent platform – with few concerns about who can access their private content. As exam season approaches, some head to Waterstones to buy textbooks: quicker, and cheaper, than ordering online.

March 2018: Banks are grappling with the Markets in Financial Instruments Directive (Mifid II), the culmination of a decade of reforms and sanctions designed to avoid another disaster. But as the financial services sector has claimed authorities’ full attention, another group of companies has grown, unfettered, into a near-monopoly. Apple’s (US:AAPL) iPhones dominate the smartphone market. Uber has undercut other taxi firms, offering cheaper rides at the touch of a button. Meanwhile, Amazon (US:AZN) can deliver almost anything to your door within hours.

It’s no surprise that 2018 is set to be a major year for regulation. Governments and market authorities around the world have seemingly acted simultaneously, recognising that one of their key priorities, consumer protection, has been endangered by the rise of ‘Big Tech’, and a lack of restrictions around the sharing of personal data. But, acting ‘simultaneously’ does not always mean ‘in unison’. Indeed, in some instances, the new rules around data – specifically within Mifid II, the Open Banking regime and the EU’s new general data protection regulation (GDPR) – appear to challenge one another.

Data governance is just one among a raft of statutes affecting sectors from telecoms to energy suppliers. Some have already come into effect. Others may be delayed as lawmakers negotiate with industry leaders. But each of these changes raise questions about the purpose of regulation. What is the aim of the regulator? To protect the individual, to safeguard investors, to encourage competition, or to protect citizens from corporate giants? In our analysis, we have selected those mandates most relevant for UK investors this year.

 

1) New reporting standards (IFRS 9 and IFRS 15)

1 January 2018

Sectors affected: IFRS 9 – financial services; IFRS 15 – outsourcers, technology, software and computer services (any companies that rely on contracts to generate revenue)

IFRS 9

Banks are no strangers to regulatory complexity, but 2018 promises to be a particularly busy year, with Mifid II, data privacy rules and the latest payment services directive obliging them to open up data to third parties. The cherry on top of this regulatory trifle is IFRS 9, which alters the way that loan losses are accounted for and ultimately reported.

Under the previous ‘IAS 39’ rule, banks used so-called incurred loss models. The problems with this system were exposed during the financial crisis, when banks couldn’t report losses ahead of time. IFRS 9 compels lenders to use expected credit loss (ECL) models, predicting how much they could potentially lose on loans and making provisions for these losses.

The issue is that lending banks must also maintain common equity tier 1 (CET1) capital. The introduction of IFRS 9 could cause sudden increases in ECLs, which could in turn reduce these capital buffers.

To smooth any resultant volatility, banks have been given five years to manage the transition. Upon applying IFRS 9, if an institution’s opening balance sheet reveals a reduction in CET1 capital because of the new ECL standard, it can include a portion of the increased ECL provisions within its CET1 capital. This portion should decline to zero over the five years.

The effects of IFRS 9 are already being acknowledged. In its full-year results, Lloyds (LLOY) said that transitional relief will reduce the impact on its CET1 capital ratio from around 30 basis points to just 1 basis point. For Barclays (BARC), the effect is similar: a likely 34 basis point impact under the “fully-loaded CET1 ratio” was ultimately “negligible as at 1 January 2018”.

IC view: IFRS 9 brings greater transparency, and should help both bank customers and investors more accurately understand capital structures and exposure. The long-term impacts will become more apparent as the standard is incorporated into all financial reports. Transitional arrangements should help to mitigate initial capital fluctuations, and give stakeholders time to see how the regulation works in practice, although potential volatility cannot be ruled out.

 

IFRS 15 

The way in which companies recognise revenues has a serious impact on results from one year to the next, and ultimately on investors’ returns. IFRS 15 provides rules to alleviate some of the “uncertainty of revenue and cash flows from a contract with a customer”. Essentially, companies must now recognise revenues when goods or services are supplied to a customer; not just when they sign a contract. In theory, this means investors can no longer be misled by strategically-timed revenue recognition.

To recognise revenue under IFRS 15, companies must apply five steps. First: identify the contract with the customer. Second: identify the contract’s performance obligations. Third: determine the transaction price – the sum the company expects to receive. Fourth: allocate this price to each ‘performance obligation’. Finally, revenue can be recognised when the performance obligation has been satisfied by the transfer of goods or a service.

Outsourcers

Outsourcing – the business of contracting – is heavily affected by IFRS 15. Capita (CAP) introduced the standard early, in September 2017. Restating its 2016 full-year results, the group said underlying revenues would be 5 per cent lower, operating profit 30 per cent lower and the balance sheet would endure a swing to negative shareholders’ equity. IFRS 15 isn’t the only problem facing Capita, which recently suspended its dividend and cut profit expectations – but it did damage the share price.

Serco’s (SER) management does not anticipate a significant impact. The expected restatement of 2017’s numbers should reduce revenue by £3m and underlying trading profit by £0.3m. The standard will have a greater effect on new contracts if they have lengthy transition phases, which Serco says could delay profit and revenue recognition. Meanwhile, IC buy tip Babcock (BAB) seems relatively unperturbed, stating that it does not believe the adoption of IFRS 15 will require a change in profit or revenue recognition.

Other sectors have been flagged for disruption by IFRS 15. Last September, analysts at Liberum said they envisaged “more surprises in the pipeline” with particular reference to aerospace and defence, construction, software, support services and telecoms. Investors in these sectors should keep their eyes peeled. For example, we already know that 90 per cent of Meggitt’s (MGGT) revenues come from the sale of goods where revenue is recognised at the time of shipping, although the aerospace group doesn’t expect the new standard to change this significantly.

Software

Broker N+1 Singer says IFRS 15 will require many software companies “to reset their numbers”, with those using up-front licence models, and with significant hardware and professional services revenue, most affected. Cloud-based software as a service (SaaS) companies with annual subscription models should endure less change. To wit, see Fidessa’s (FDSA) recent full-year numbers. The group expects IFRS15 to have a less than 1 per cent impact on reported revenue for 2018. This appears to be because 88 per cent of the company’s top line constitutes recurring revenue.

IC view: Software companies will need to gauge whether different revenue streams, including licences, deployment and upgrades, should be bundled together as one performance obligation, or considered separately. Ultimately, the new standard should benefit investors, who will receive a more transparent and accurate insight into how and when revenues arise. HC

 

2) Mifid II

3 January 2018

Sectors affected: Financial services

Like most financial regulation, Mifid II was long in planning and delayed in implementation. It finally arrived on 3 January, in the shape of one of the EU’s most ambitious and far-reaching financial reforms, covering practically every aspect of trading and applying to all financial services companies with EU clients. It is designed to address the shortcomings of Mifid I, which focused too heavily on equities trading – a fact revealed shortly after its introduction at the onset of the financial crisis in November 2007. The updated version also now addresses the vast markets for derivatives and bonds that operate outside formal exchanges.

Mifid II has been designed to create greater transparency and resilience within financial markets, injecting more competition and protecting investors. Put simply, it means financial institutions, including investment providers, brokers and advisers, must be more up-front about when they transact and what they charge. In turn, that means creating a data trail behind traded assets. Compliance spend – principally the investment-focused variety – was estimated to be $2.1bn in 2017 alone for global investment banks and asset managers, according to research by IHS Markit and Expand.

That means additional operating costs for asset managers, although the bulk of the up-front costs were taken last year. However, judging by figures reported by UK-listed financial services companies for 2017, these costs haven’t eaten too much into the bottom line. What’s likely to have the greater impact on brokers, banks and asset managers is the requirement for the latter to pay the former two groups directly for research, rather than being bundled into the cost of buying and selling securities.

The logic is that using dealing commissions to purchase research causes a conflict of interest for investment managers, as they use transaction costs to pay for this research. That’s expected to cost between 5 and 20 basis points of assets under management, according to a survey by the CFA Institute. The question is whether asset managers pass on the cost to clients or not. Companies such as Liontrust Asset Management (LIO) have decided to absorb the charge themselves, while (in a wise PR move) Fidelity backtracked on its original decision to pass on the cost to its clients.

Those potentially hurt the most by the unbundling of research costs are brokerages, with institutional investors becoming pickier about the analyst coverage they consume. Numis (NUM) said it was too early to assess the eventual financial impact. The regulation also reduces the incentive for brokers to produce research on companies, given they will need to bear the cost of producing it without any guarantee of selling it. The consensus among analysts is that this will lead to a decline in coverage of certain stocks – small-caps, in particular – and therefore a reduction in liquidity in equity markets and bigger swings in share prices. This may be one of the most significant impacts on retail investors, most of whom have limited (or no) access to professional research.

IC view: Some companies thrive on regulatory complexity, and we think there could be a few winners as the changes bed in. At the end of last year, Nex (NXG) increased investment in sales and marketing initiatives around its Abide Financial regulatory reporting service, to take advantage of a bump in work for companies that had still not got their compliance in order. Financial consultancy groups Sanne (SNN) and Alpha Financial Markets Consulting (AFM) have both attributed rising profits during the past year partly to an increase in demand from financial institutions for compliance services ahead of the regulation. In finance, as in trading, volatility and disruption will almost always be good for at least one group. EP

 

Software and Mifid II

Mifid II has driven demand for regulatory software, as clients seek precision, efficiency and in some cases automation to ensure full compliance.

  • Trading software specialist Fidessa (FDSA) believes Mifid II will lead to “a long tail of work” this year, due to some delayed elements. Moreover, the directive’s January launch has freed up financial capacity, meaning there’s room for investment in new opportunities – or indeed margin expansion. Perhaps this bright outlook explains why Fidessa may be off the market soon: Swiss software group Temenos (SW:TEMN) recently launched a £1.4bn bid for the UK company.
  • First Derivatives (FDP) said in its half-year report that regulation and compliance – including Mifid II – “remain key drivers of its business”.
  • Small-cap StatPro (SOG) offers cloud-based portfolio analytics tools to investors, and helps asset managers improve client service while complying with regulations. Analysts at Stifel say Mifid II is acting as a tailwind alongside the company’s own product refresh cycle. HC

3) Second Payment Services Directive (PSD2) and Open Banking

13 January 2018

Sectors affected: Financial services, technology, software and computer services, ‘Big Tech’, retailers, media

The payments industry is one good example of a business line that has transcended the boundaries of historic regulation. The EU’s first Payment Services Directive (PSD) was incorporated into UK law in 2009. Since then, technology has driven a global shift in how we transact – epitomised by our dwindling usage of coins and notes over the past decade. Electronic and mobile payment methods have both facilitated and been spurred on by the stratospheric rise of global e-commerce.

Until this year, banks continued to enjoy exclusive access to customers’ account data – the very fuel that could enable newer market entrants to offer competitive products and services. This data monopoly ended on 13 January 2018, with the introduction of the second payment services directive (PSD2). The revised regulation aims for “more competition, greater choice and better prices for consumers”, while seeking to better integrate the internal market for electronic payments within the EU. Because of PSD2, customers can now open up their payments accounts to organisations ranging from challenger banks to start-up financial technology businesses, as long as they give consent.

Open Banking

In the UK, PSD2 has been implemented as ‘Open Banking’, under the watch of the Competition and Markets Authority. The move forces the country’s nine largest retail banks to share customer data securely with third parties, via ‘application programming interfaces’ (APIs) – software based on a standardised set of rules.

From an investment perspective, various listed tech, software and retail companies stand to benefit from the new regulatory environment. There are also opportunities for the incumbent banks, if they can adapt and innovate. However, some fear that new participants in the financial services sector will undermine banks’ trusted client relationships.

Account aggregators

Under the new rules, businesses can become regulated Account Information Service Providers (AISPs), acting as central hubs for data from various bank accounts – ‘account aggregators’ in the jargon.

Digital banks are one group competing to act as account aggregators. UK start-up Monzo provides aggregation and spend-tracking software, and it is now working with Moneybox, an app that allows users to invest extra change from purchases into tracker funds. Such alternative savings and investment vehicles should proliferate as Open Banking takes off.

Meanwhile, proving it can stay in the game even if the rules change, larger and more traditional bank HSBC (HSBA) will launch its ‘Beta’ app this year – allowing customers to monitor various bank, transactional and investment accounts from multiple institutions. By offering spend analysis and advice, HSBC hopes to improve customer loyalty, and may even poach customers from rivals. Netherlands-quoted ING (NTH:INGA) operates ‘Yolt’, an aggregation platform offering spend-tracking. Both Lloyds and RBS are reportedly developing apps with Open Banking capabilities, and others are expected to follow. And as banks open up, security is another key theme to monitor; which should play well to the strengths of Eckoh (ECK), a specialist in secure payments (and IC buy tip).

Retailers

PSD2 and Open Banking represent a boon for retailers. Once authorised, these businesses can accept payments directly from customers’ bank accounts without an intermediary. Open Banking allows retailers to offer greater flexibility, faster refunds, and – according to Jeremy Light, head of Accenture’s (US: ACN) European payments practice – “to increase cash flow by bypassing card networks and fees and reducing fraud and chargebacks”.

For banks, however, this could mean fewer debit card transactions. Generally speaking, as Open Banking welcomes new competitors, we may see more mergers & acquisitions (M&A) among both banks and long-established payments institutions, seeking greater scale and tech expertise. To name but one example, Worldpay (WPY) has already merged with US-based Vantiv, in a £9bn deal which also attracted early-stage interest from JPMorgan.

To date, just a few fintech businesses have floated. We may well see a spate of initial public offerings (IPOs) in due course. That said, Augmentum FinTech – a private fund – plans to list on London’s main market on 13 March 2018, sized at around £100m on admission. With the financial services sector “being revolutionised by technology”, Augmentum intends to acquire a seed portfolio of high-growth assets valued at £33.3m, including investments in BullionVault, Interactive Investor, Seedrs, SRL Global and Zopa.

‘Big’ fintech

It might feel like fintech firms and retailers have reasons to celebrate in 2018. However, some believe ‘Big Tech’ giants will emerge the true winners of PSD2. They already hold heaps of customer data – bank information and the ability to initiate payments could be the final pieces of the puzzle.

Francisco González, executive chairman at Spanish bank BBVA (SP:BBV), recently warned that companies including US-listed Facebook and Amazon, and China’s Alibaba and Tencent, will “replace many banks”; only this week, Amazon has fulfilled the prophecy, revealing that it’s in talks with JPMorgan to provide its customers with bank accounts. Referencing uneven regulation between banks and techs, he said: “If I need capital to lend then let’s have the same rules for everyone — for the internet giants too.”

IC view: PSD2 and Open Banking are landmark regulations, democratising transactional data to give challengers – and banking customers – more choice. A likely increase in switching activity could benefit listed price comparison sites such as Moneysupermarket (MONY). Quoted retailers may improve sales by circumventing card payments. Meanwhile, to preserve client relationships, banks must prioritise digital services. This means competing – or indeed partnering with – the new kids on the block. In doing so, they may also uncover serious growth opportunities. HC

4) Crunch time for cryptocurrencies: G20 forum

19-20 March 2018

Sectors affected: Cryptocurrencies, financial services

The IC does not approach cryptocurrencies from the perspective of an investment. But it would be remiss to omit cryptocurrencies from an article on regulation. Indeed, there is still a general lack of consensus on whether cryptocurrencies should be deemed a proxy for money, commodities or an entirely new asset class altogether.

As the most popular of its peer group, bitcoin’s share price rose stratospherically last year. At its peak, on 16 December, one bitcoin was worth around $19,000, a figure at least in part down to its lack of regulation, and representation of a decentralised, peer-to-peer traded medium of exchange (albeit one prone to serious volatility).

Cryptocurrencies have generally fared less well this year; the price of bitcoin fell below $7,000 on 5 February. This decline both drove, and was driven by, governments turning up the volume on their concerns about virtual cash, highlighting its danger to inexperienced investors and emphasising the need to crack down before it threatens financial systems.

Various economic leaders see the G20 summit, taking place later this month, as an opportunity to discuss worldwide crypto-regulation. The head of the Bank of International Settlements, Agustín Carstens, has been particularly vehement about the importance of asserting control. “Novel technology is not the same as better technology or better economics,” he said. Bitcoin “has become a combination of a bubble, a Ponzi scheme and an environmental disaster” – the latter point referring to the amount of electricity used to “mine” new coins.

Moreover, one of the greatest concerns about cryptocurrency is its anonymity, rendering its origins – and potential facilitation of crime – difficult to trace.

Some countries and institutions are already taking restrictive steps. Among them, China is banning all domestic and foreign cryptocurrency trading platforms, and ‘initial coin offerings’ (ICOs) – the way in which companies raise digital money. South Korea will allow trading only via real-name bank accounts. Meanwhile, US banks including JPMorgan (US:JPM) and Citigroup (US:CITI), and Lloyds (LLOY) in the UK, have blocked cryptocurrency purchases on credit cards.

But for all Bitcoin’s risks, advocates clearly perceive benefits beyond historic price appreciation. Some may liken it to gold, deeming it a ‘safe haven’ asset that could help to diversify a portfolio. It also enables immediate payments, while normal transactions can take longer. Most importantly, blockchain – the technology underpinning cryptocurrencies – has been hailed as world-changing. By providing a distributed ledger of transactions or records, blockchain could improve the way that data is registered and shared securely across multiple industries in future. That said, it is questionable whether buying bitcoin really represents an investment in blockchain.

IC view: The G20 summit could inspire a global regulatory framework for cryptocurrencies. As with many regulations in 2018, authorities will seek a compromise between preventing irresponsible practices and encouraging innovation. A regulated environment might lead more crypto-related businesses to consider an IPO, rather than the legally ill-defined ‘initial coin offering’. For better or for worse, there’s already hype among retail investors: last October, shares in minnow Aim company On-line (ONLY) soared simply on the news it would incorporate ‘blockchain’ into its name. HC

 

5) Broadband wholesale local access: 1 April 2018 (Megan Boxall)

Sectors affected: British telecoms

To cut prices or not to cut prices? That is the question Ofcom has been toying with for the past couple of years. The price in question is what BT (BT.A) charges its wholesale customers – including Sky (SKY), Vodafone (VOD) and TalkTalk (TALK) – to use its Openreach broadband infrastructure.

For many years, BT has enjoyed a near monopoly in UK broadband. Aside from the smaller networks owned and run by Virgin Media and CityFibre (CITY), it is the only company that owns the infrastructure needed to deliver internet to homes and businesses. Sure, consumers can buy their internet from other telecoms companies, but these are all required to rent the cables off BT.

The problem with this lack of competition is that BT has had very little reason to invest in Openreach, leaving the UK’s broadband speeds trailing far behind those in Europe. Less than 2 per cent of UK homes have access to full fibreoptic broadband, which offers speeds up to 10 times faster than the copper cables most homes and businesses currently rely on. All the while, BT has been reaping the rewards of the comfortable cash profits that flow through its Openreach subsidiary.

Ofcom initially proposed aggressive cuts to the wholesale prices, but this met with outcry from peers who worried it would stifle competition. Instead the regulator has forced BT to make minor cuts to its wholesale charges over a three-year period, banned the group from making selective price cuts in areas where it knows it will soon face competition and has allowed its peers to tack their own cables onto the existing Openreach infrastructure.

BT thinks the cost cutting will cut Openreach’s sales by £80m to £120m in the 2019 financial year. What’s more concerning is that the proposals might speed up the arrival of competition. Already CityFibre has teamed up with Vodafone to provide full fibre broadband to 1m homes in secondary cities in the UK, TalkTalk is planning its own broadband investment with M&G Prudential, and Virgin Media is mid-way through a major investment programme, which will expand the reach of its own fibre network.

IC view: For most parties involved, this regulation is very welcome. Telecoms companies should soon reduce their reliance on Openreach, while consumers will have a greater choice of internet provider. For BT, Ofcom’s decision is yet another blow. The telecoms giant has a huge number of cost pressures and an increase in competition to its cash-generative Openreach subsidiary is likely to damage the outlook further. MB

6) General data protection regulation (GDPR)

25 May 2018

Sectors affected: Technology, software and computer services, financial services, retailers, media, utilities (the list goes on)

 

The UK’s existing data protection rules were introduced in 1998. Suffice to say, technology has been transformed since then. We live our lives increasingly online, from researching, to shopping, to connecting with friends. This momentous shift has been facilitated by the widespread adoption of smartphones, and the rise of the Internet of Things – whereby all devices, from TVs to toasters, are connected.

In turn, the internet’s near-ubiquity has given rise to a swirling mass of personal data. Each time we browse the web or make a transaction, we hand over swathes of information about ourselves – from addresses, to restaurant preferences, to medical histories. This might be processed, stored or sold on by the recipient for numerous purposes.

Data sharing has brought many benefits to consumers, but it has also prompted global concerns about privacy. In May 2018, the EU will introduce its general data protection regulation (GDPR). Under GDPR, businesses must prove that they have a lawful basis for processing personal data. The rules encompass some core principles. Companies must ensure customers give their full consent for data processing. A pre-ticked box is insufficient. Individuals also receive various new rights. Among others, these include the right to be informed how their data has been processed, the right to rectification, if data is incorrect, and the right to data erasure.

GDPR also gives rights to consumers regarding automated decision-making, including profiling. The impact of this could be significant, given the proliferation of artificial intelligence. Companies must now inform people about automated processing of their information, and introduce ways for them to request human intervention or challenge an automated decision.

The penalties for non-compliance are severe. Perpetrators could pay up the greater of €20m or 4 per cent of their annual global turnover; potentially crippling for smaller companies, and a severe financial and reputational blow for large players too.

What does this mean for investors? GDPR poses a challenge for many listed businesses, which must spend more on compliance. However, it also presents some exciting opportunities, if companies can comply effectively – or indeed provide the technology to help other organisations fulfil their regulatory obligations.

Big Tech processors

The UK’s current Data Protection Act applies to data controllers; those determining the purposes and means for processing personal data. GDPR puts data processors under the spotlight too. Alongside smaller peers, this change affects the likes of Amazon and Alphabet. While this super-sector is largely headquartered in the US, any company with operations in the EU must play by the European rulebook. All will have to comply, to avoid a billion-dollar sales hit.

Identity specialists

For the incumbent data specialists, the new rules should enhance the competitive advantage of those with large existent databanks. Examples of UK-quoted data giants include Relx (REL), which elevated its barriers to entry via its acquisition of ThreatMetrix – a digital identity specialist – for £580m in January this year. We also expect GDPR bodes well for information services provider Experian (EXPN). Like Relx, Experian’s scale should facilitate its own compliance, and enable it to help customers with theirs. As May approaches, data intelligence specialist GB Group (GBG) also looks well-positioned.

Market research and data analytics

YouGov (YOU) already holds vast quantities of data. In January this year, the market researcher said it would overshoot previous trading expectations thanks partly to its higher-margin data products and services. The company also recently launched its digital advertising platform, YouGov Direct, which uses blockchain technology to verify data sharing between consumers and advertisers – acknowledging that consumers currently have little say in how their data is exchanged.

Protecting against breaches

GDPR’s fines provide a strong incentive to protect against privacy breaches. Various high-profile attacks in recent years – ‘WannaCry’ and ‘Petya’, to name but two – revealed just how damaging hacks can be. That backdrop should continue to play to the strengths of cybercrime-focused Sophos (SOPH) and NCC (NCC), although we are neutral on the prospects for both. The former saw various director share sales last year, and recently reported a slowdown in billings growth. Meanwhile, Softcat (SCT) spies “a good opportunity” in GDPR, given the challenge it poses to the security firm’s clients.

IC view: All companies managing personal data must prepare for GDPR. This means most PLCs. Non-compliance could lead to customer law-suits, not just fines. Establishing consent is essential for retailers and marketers among other consumer businesses. In complying with GDPR, the Financial Conduct Authority (FCA) believes there is regulatory alignment. And the UK government has proposed a national Data Protection Bill, which would help GDPR to survive Brexit. HC

7) Domestic Gas and Electricity (Tariff Cap) Act 2018

Possibly the end of 2018

Sectors affected: Energy suppliers

For years, regulation of the UK’s energy supply market has oscillated between two driving principles. The first was that customers would be best served by measures to improve competition. The second – that it would be better to restrict pricing. Limited steps have been taken in both directions with the introduction of a price cap for prepayment meters and efforts to make switching to a new supplier easier, but in recent months political pressure from both sides of the aisle has meant suppliers are once again looking at a cap on the prices they can charge their customers.

The Domestic Gas and Electricity (Tariff Cap) Act 2018 was introduced in October last year and temporarily limits the amount that can be charged to consumers on the standard variable tariff (SVT). The cap level itself will be set by Ofgem, the market regulator, and will last until at least the end of 2020, with the potential for extension out to 2023. In February, MPs from the business, energy and industrial strategy select committee called for the cap to be brought into effect in time for the end of 2018, so as to protect vulnerable customers during the winter months. Analysts at RBC Capital Markets described this as “an ambitious target”.

The energy suppliers have already started to look at ways to prevent or minimise the damage of any cap. Centrica (CNA) led the charge late last year with a raft of proposals both for how it would reform (eg by withdrawing the SVT for new customers) and how the government should adapt (eg by funding renewable subsidies through general taxation rather than through bills, as it is currently). SSE (SSE) took a different approach, proposing to demerge from its household energy supply business, combining it with rival NPower and listing it as a new company, thereby exiting the market.

IC view: There is a real possibility the cap will not come into effect until 2019, meaning it could potentially last less than two years. Despite this, the impact of this legislation is already being felt, as the share prices of Centrica and SSE demonstrate. Both can be expected to suffer once a cap is in place, unless SSE manages to leave the household supply market as it plans to. Approach the sector with caution. TD

 

8) Antitrust: 2018 and beyond

Sectors affected: Big Tech

There is certainly something dystopian about corporate giants that provide everything we eat, read and watch; own all our data; navigate our journeys and even have a semi-conscious presence in our homes. The investor George Soros fears conglomerates, particularly in the tech space, could facilitate “totalitarian control the likes of which not even Aldous Huxley or George Orwell could have imagined”. In 1984, Big Brother was always watching. In 2018, Big Brother’s name is Alexa.

And it is not just their dominance which has critics worried. US tech firms have been accused of being anti-competitive and stifling fair trade. Amazon is a retailer and a marketplace. Google makes money by publishing content while determining the position of that content on its own search engine. Facebook doesn’t need to make money from WhatsApp and Instagram because its newsfeed shares a duopoly in the digital advertising market with Google.

In the past few decades these companies and their peers have tiptoed from start-ups to corporate behemoths. Their growth has been largely organic, they have mainly made small acquisitions and they have refrained from engaging in mega-mergers. By and large, they have avoided the critical eye of competition laws.

US corporate antitrust law is governed by three statutes that are more than a century old. They restrict the formation of cartels which could hold back trade, limit M&A and prevent the creation of monopolies. And yet today in America a handful of companies control the same proportion of their respective markets as Standard Oil did when it was chopped up in 1911.

For years, these companies have been heralded as pioneers of digital America. But now – with Amazon raising the price of its books, Google increasingly embroiled in unsavoury ad campaigns, and Facebook facing calls to prevent interference on its platform by nation states – regulators have had enough. In 2017, the European Commission fined Google €2.4bn (£2.14bn) for prioritising its own shopping site. Germany’s cartel office accused Facebook of unfairly using its position to track internet users. France has threatened to fine Facebook for sharing data between its apps. Australia’s competition authority has launched an investigation into the market power of Facebook and Google. And even former US antitrust officials acknowledge that their approval of Google’s acquisition of YouTube and Facebook’s acquisition of Instagram looks naive in hindsight.

Dealing with tech dominance is no mean feat. As former US federal judge Richard Posner wrote, about an earlier chapter in the internet revolution: “This problem will be extremely difficult to solve; indeed, I cannot even glimpse the solution.” The difficulties lie in the fact that antitrust laws exist not to protect small businesses but to maximise consumer welfare, or what Robert Bork in 1978 dubbed “the antitrust paradox”. Forty years on and Mr Bork’s theory is starting to bite. Companies that try to team up to take on the might of the FANGs (Facebook, Amazon, Netflix (US:NFLX) and Google) are being regulated, while the giants can keep growing.

To avoid the dystopian future predicted by Mr Soros, global governments perhaps need a fundamental rethink of competition laws. After all, the world has changed a lot since the existent antitrust statutes were inscribed.

IC view: The 100-year-old US anti-trust laws are not going to be rewritten in 2018, but the fact that they are even being talked about should arouse concern for big tech monopolies. In the short-term FANG company shareholders should perhaps be wary that their uncontested days are coming to an end. The debate is also relevant for investors in the wider marketplace, as the rise in monopolistic corporate power may be an important factor behind elevated levels of profitability. That means changes in anti-trust laws could have a real, albeit slow, impact on equity market returns. MB

***

More regulations can be expected in due course. IFRS 16, governing how companies recognise and measure leases, will be introduced in 2019. Regulation around advertising is also high on the international agenda. Arguably, as technology comes to underpin every industry, those regulating each sector will need to work hand in glove to prevent dangerous scenarios – all the while encouraging innovation. Ten years ago, we endured the global financial crisis. Today, perhaps, we must try to stave off a global technology crisis.