Ontario Liberals keep promise on low Hydro One IPO fees

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By keeping its pledge to minimize underwriting fees for Hydro One's initial public offering, the Ontario government is helping set new commission expectations for future large IPOs.

Advised by former federal auditor-general Denis Desautels, the Ontario Liberals inked a deal with Canadian investment banks to pay the IPO's lead managers a 1-per-cent fee for stock sold to institutional investors, and 3 per cent for shares sold to retail investors. "This fee structure is significantly lower than industry norms," the Liberals said in a release. IPO fees generally range from 5 per cent to 7 per cent.

The government also named Scotia Capital and RBC Dominion Securities as the deal's lead underwriters, which means the two investment banks will manage the sale to public investors.

Two months ago, former Toronto-Dominion Bank chief executive Ed Clark, who led the Ontario government's giant asset sale process, sounded off about how little the Ontario government was likely to pay Bay Street to underwrite Hydro One's IPO.

"We are quite determined that when we do go public, you will see a fee structure that the industry has never seen before," he said at the time.

"There is not going to be a lot of money made off this" on Bay Street, he added.

Finance Minister Charles Sousa echoed that sentiment a month later, saying investment banks were so hungry for deals they would take a 75-per-cent cut on fees for selling 15 per cent of the utility to the public.

The underwriting terms announced by the government largely deliver on that promise, despite some doubts the government could pull it off. Canada had three major IPOs in 2014 – PrairieSky Royalty Ltd. raised $1.67-billion, Seven Generations Energy Ltd. raised $932-million and Northern Blizzard Resources Inc. raised $519-million – and the fee paid to the underwriters in each deal amounted to 5 per cent of the total offering size. Combined, the dealers earned $157-million in fees by selling the deals.

Commissions for government-asset IPOs have also historically been higher. When Canadian National Railway Co. went public in 1995, the underwriters earned a 3.75-per-cent fee; when Petro-Canada went public in 1991, they were paid a 4.75-per-cent fee.

However, there is a wrinkle with the Hydro One deal. It appears one faction of Canadian capital markets is taking less of a haircut on the fees. Retail advisers typically get half of the commission for any shares they place in their clients' accounts. If that rule stands for the Hydro One IPO, it means they will still get a 1.5-per-cent commission – which is likely why Hydro One's retail fee is much higher than that paid for institutional orders.

While the overall fees are low for Canada – although not unheard of globally, as Facebook paid dealers a 1.1-per-cent commission on its IPO three years ago – Bay Street dealers are unlikely to grouse. After all, the government plans to sell another 45 per cent of Hydro One in stages over the coming years, promising more fees.

In total, the provincial government plans to sell 60 per cent of Hydro One, which is estimated to earn $9-billion for the government. Of that, $5-billion will be to pay down debt and $4-billion will go toward transit. Mr. Clark advised the government to start selling assets and persuaded Premier Kathleen Wynne to do so by warning that her party cannot keep adding to its debt.

Although the banks will have to accept a lower fee, they absorb minimal risk in an IPO. Unlike a bought deal, in which the underwriters buy shares from an issuer and are then liable for reselling them to investors, their role in an IPO is more of a marketing one.

The banks were warned about their expectations as they submitted their proposals to lead the deal. Even though they always compete against each other to win all IPO mandates, they typically abide by a floor fee, so no one bids with a fee below 5 per cent. This time around, they knew the government – which must answer to taxpayers – needed to pay the lowest commission possible.