Prospectus Regulation: ESMA publishes final guidelines on format and disclosure of risk factors

Background

The Prospectus Regulation (2017/1129) was published in the Official Journal on 30 June 2017 and came into force on 20 July 2017, though most of its provisions will not be applicable until two years later - 21 July 2019. It repeals the Prospectus Directive with effect from that date.

Under the new Prospectus Regulation, risk factors in a prospectus will be limited to risks which are specific to the issuer and/or the securities and which are material for taking an informed investment decision, as corroborated by the rest of the prospectus. Article 16(4) of the Prospectus Regulation gives ESMA a mandate to develop guidelines to assist national competent authorities (NCAs) in their review of the specificity and materiality of risk factors.

ESMA published a consultation on 13 July 2018 containing draft guidelines on risk factors which NCAs should incorporate as part of their review practices when scrutinising a prospectus. ESMA has now published its final report providing an overview of the feedback received from stakeholders during that consultation. Its final guidelines on risk factors are attached to the report (at Annex II) with examples of specific and material risk factors included at Appendix I.

The final guidelines become effective two months after their publication on ESMA’s website in all of the official EU languages.

Guidelines on risk factors

As stated in the recitals to the Prospectus Regulation, the primary purpose of including risk factors in a prospectus is to ensure that investors can assess the relevant risks related to their investment and can, therefore, make informed investment decisions in full knowledge of the facts.

ESMA’s guidelines aim to encourage appropriate, focused and more streamlined disclosure of risk factors, in an easily analysable and concise form by assisting NCAs in their review of the specificity and materiality and of the presentation of risk factors across categories. They are not limited to the risk factors of any particular type of entity or prospectus. The criteria of specificity, materiality and corroboration are cumulative and it should be clear that all criteria have been fulfilled where a risk factor is included in a prospectus.

Although addressed to NCAs, issuers and other persons responsible for a prospectus should consider the guidelines when preparing a prospectus for submission to the relevant competent authority.

The guidelines on risk factors include the following:

• Specificity: The NCA should ensure that specificity of the risk factor is clear from the disclosure. In this regard the NCA should challenge the persons responsible for the prospectus where the disclosure of a risk factor does not establish a clear and direct link between the risk factor and the issuer, guarantor or securities or if it appears that risk factor disclosure has not been drafted specifically for the issuer/guarantor or the securities. The NCA should also challenge the inclusion of risk factors that only serve as disclaimers.

• Materiality: It is the responsibility of the issuer to ensure that the disclosure of a risk factor clearly demonstrates that a risk is material and the NCA should challenge the inclusion of a risk factor where that materiality is in doubt. The NCA should also challenge the persons responsible for the prospectus where the potential negative impact of the risk factor on the issuer/guarantor and/or the securities is not disclosed. Providing quantitative information within the disclosure helps to demonstrate the materiality of a specific risk factor. Where this information is not available or appropriate, however, the description of the potential negative impact of a risk factor should be described using a qualitative approach (e.g. by using the scale of low, medium, or high risk.) Where a qualitative approach is undertaken, the impact of the risks should be adequately explained and be consistent with the order of the most material risk factors within each category (pursuant to Article 16(1) of the Prospectus Regulation.) NCAs should challenge the inclusion of excessive or inappropriate mitigating language which compromises understanding.

• Corroboration of materiality and specificity: Where the NCA considers that the materiality and the specificity of a risk factor is not corroborated by a reading of the prospectus, the NCA should challenge the inclusion of the risk factor. While clear corroboration of the materiality and specificity of a risk factor is normally demonstrated via the inclusion of specific corresponding information elsewhere in a prospectus, this is not always necessary. In certain cases, it is sufficient that materiality and specificity is identifiable by reference to the overall picture of the issuer/guarantor and the securities presented in the prospectus.

• Presentation of risk factors across categories: Risk factors should be presented across a limited number of categories based on their nature. A risk factor should only appear once, in the most appropriate category and the most material factors should be presented first in each category (though it is not mandatory for all the remaining risk factors within each category to be ranked in order of materiality.) Risk factors which are specific and material to the issuer/guarantor could, for example, be divided into the following categories:
  • risks related to the issuer’s financial situation
  • risks related to the issuer’s business activities and industry
  • legal and regulatory risk
  • internal control risk, and
  • environmental, social and governance risks.

NCAs should challenge the presentation of risk factors across categories when more than 10 categories and sub-categories are included in a standard, single-issuer, single-security prospectus. This figure can be extended in other circumstances depending on the type of prospectus (e.g. more categories/sub-categories may be appropriate in a multi-product base prospectus.) Sub-categories should only be used where they can be justified based on the particular circumstances of the case.

• Focused/concise risk factors: The disclosure of each risk factor should be presented in a concise form – the materiality and specificity of the risk factor should be clear and its presentation appropriate and focussed.

• Risk factors in the summary: The presentation of risk factors in the summary should be consistent with their presentation based on materiality in the risk factor section. This does not mean, however, that the summary must include risk factors from all of the categories included in a prospectus.