FCA review of the effectiveness of primary markets: minor rule changes and further discussion

The Financial Conduct Authority (FCA) has published its final changes to the Listing Rules and new Technical Notes in response to:

• its review of the effectiveness of primary markets (PS17/22), most of which are technical enhancements rather than fundamental changes and are predominantly in the same format as in the consultation (CP17/4). These changes take effect on 01 January 2018, and
• reform of the availability of information during a UK equity initial public offering (IPO) (PS17/23). These changes take effect on 01 July 2018.

The FCA has also published its feedback statement to its discussion on the effectiveness of primary markets (FS 17/3).

This note considers the rule changes in PS17/22 and the FCA‘s response in FS 17/3. See our article “FCA rule changes alter availability of information in the UK equity IPO process” for a summary of the rule changes to the IPO process.

Background

On 14 February 2017, the FCA published two papers relating to its review of the structure of the UK’s primary markets to ensure that they continue to service the needs of issuers and investors:

• a discussion paper in which they were looking to prompt a broad discussion about the effectiveness of the UK primary markets landscape (DP17/2), and
• a consultation paper on proposed enhancements to the Listing Regime (CP17/4).

Both papers were based on initial feedback from discussions with stakeholders and other work streams which relate to this topic, such as:

• The FCA’s investment and corporate banking market study and final report (see “FCA investment and corporate banking market study: final report” for more information).
• The FCA’s work contributing to negotiation of the new Prospectus Regulation (See “Prospectus Directive”).
• Working with market participants to examine options for improving the availability of information in the UK IPO process. The FCA published a discussion paper in April 2016 and will publish a consultation paper shortly. (See “FCA publishes discussion paper on the availability of information in the UK equity IPO process”).
• Work to improve the effectiveness of the UK’s primary debt markets.

See “Review of the effectiveness of primary markets: FCA publishes two new papers” for a summary of CP 17/4 and DP 17/2).

Policy Statement PS 17/22

Most of the changes to the Listing Rules relate to the premium segment of the listing regime and are technical enhancements rather than fundamental changes. The changes are:

Eligibility requirements

Chapter 6 - has been reordered and rewritten to simplify and clarify provisions, for example:

• To state explicitly (in LR 6.2.4R) that the additional financial information (which may be required where there have been acquisitions during the three year track record period) needs to be audited. This is currently only implicit in the rules.
• To clarify that only a company that has been generating revenues in its declared line of business for the past three financial years can meet the current requirement for an applicant for a premium listing to demonstrate a three-year financial track record. The FCA has also published an additional Technical Note, UKLA/TN/102.1, with further guidance on how to interpret the track record requirements.
• To delete the guidance (currently in LR 6.1.13G to LR 6.1.15G) which explains where the FCA might waive the requirement for financial information and a track record as they do not normally waive these requirements.
• To split the existing independence rule (LR 6.1.4R) into three separate provisions: a rule on the need to carry out an independent business (LR6.4); a rule that clarifies the need to have a business independent of any controlling shareholder (LR6.5); and a rule that clarifies the issuer must control its business (LR.6); and to add further guidance and a new Technical Note UKLA/TN/103.1.
• To delete the guidance (in LR 6.1.17G and LR 6.1.18G) which states that the FCA may dispense with the requirement for an applicant (and any subsidiary undertakings) to have sufficient available working capital to meet the group’s requirements for at least the next 12 months as they have not waived this requirement since the listing function was conducted by the FCA or its predecessor, the FSA, and are unlikely to do so in future.

New concessionary route for property companies - commercial companies that apply for a premium listing are usually required to have a three year revenue-earning track record in order to be eligible. However, there are specific rules for mineral companies and scientific research based companies (SRBCs) which exempt those companies from the general requirements and enable them to gain a premium listing by instead complying with other conditions. These are the so-called "concessionary routes" to premium listing.

As originally proposed, the FCA has added a new concessionary route to premium listing for certain property companies that cannot meet the three-year revenue earning track record. This recognises that a company can use a property valuation report to show three years of development of real estate assets represented by increases of gross asset value of those assets instead of the revenue earning track record.

Additional guidance is set out in a new Technical Note UKLA/TN/426.1.

Additional guidance on the existing concessionary routes for SRBCs and mineral companies - as originally proposed, there is a new Technical Note UKLA/TN/422.3 with additional guidance on the interpretation of the concession for SRBCs (which will replace the current technical note) and a new Technical Note UKLA/TN/427.1 for mineral companies.

Class tests

Changes to the "profits test" - the rules have been amended to provide that if the profits test result is 25% or more and anomalous and the transaction is not a related party transaction, companies with a premium listing of equity shares can:

• disregard the profits test provided all of the other class test results are below 5%, or
• make certain specified adjustments to the profit figures used in the profits test.

In both cases the company will still need to obtain guidance from a sponsor but will not need to consult the FCA. The FCA chose not to reduce the percentage below 25% in response to feedback as this would have required it to extend sponsors’ requirements. It has also not provided any guidance on the meaning of anomalous as it considers that sponsors are used to making and able to make that judgment.

The FCA also sought views on (i) whether there were there any other possible enhancements to the calculation of the profits test that could be made; and (ii) whether there were any alternative profit measures that should be used either in conjunction with or in place of the current profits test. The FCA received different suggestions on enhancements and will analyse them and decide whether they need to consult on them. As there was no agreement on alternative measures to use, the FCA is not making further changes at this stage.

Adjustment to figures used to classify assets and profits - currently, the figures that must be used are those in the latest published audited consolidated accounts or preliminary statement (or subsequently published interim balance sheet), which are adjusted to take account of subsequently completed transactions that meet or exceed the threshold for a class 2 transaction. The rules have been amended to require those figures also to be adjusted for transactions completed in the period to which the figures relate, which reflects guidance currently set out in Technical Note UKLA/TN /302.1 and that technical note will be deleted.

Reverse takeovers

The Listing Rules currently assume that when a proposed reverse takeover becomes public the market in the acquiring company’s securities will not be able to operate smoothly because there will be insufficient information about the proposed transaction for proper price formation to happen. Therefore, in order to prevent a disorderly market, the FCA will often suspend the issuer’s listing unless specified information on the proposed target company (broadly equivalent to the information required for a listed company) is publicly available.

The FCA has amended the rules to remove:

• the presumption of suspension for reverse takeovers for all issuers with a premium or standard listing of securities, other than shell companies - see below. The FCA stated (in CP 17/4) that their general power to suspend, combined with the existing disclosure obligations, should be enough to ensure that the market operates smoothly, without the need for additional specific guidance under the Listing Rules. They also consider that proper price formation can take place based on information disclosed to the market by the issuer to comply with its obligations under MAR even when the class test result is over 125%, and
• the obligation for all issuers with a premium or standard listing of securities, other than shell companies, to contact the FCA as early as possible to discuss whether a suspension is appropriate before announcing a reverse takeover which has been agreed or is in contemplation and to request a suspension where details of the reverse takeover have leaked.

By shell companies, the FCA mean issuers whose assets consist solely or predominantly of cash or short-dated securities, or whose predominant purpose or objective is to undertake an acquisition or merger (eg special purpose acquisition companies (SPACs)). The existing Technical Note on SPACs (UKLA/ TN/420.2) has been amended to include cash shells and provide further guidance.

The FCA will consider the suggestion that shell companies should have to put acquisitions to a shareholder vote before they can proceed to completion as part of its further work on the standard segment as set out in its feedback statement to DP17/2 - see below.

Feedback Statement FS 17/3

Of the various issues considered in DP 17/2, the FCA has decided to give further consideration to the following topics:

• Current split between standard and premium listing and how to make a standard listing more attractive and possibly raising some of the standard listing requirements which are not subject to maximum harmonisation in the EU Directive they are derived from. The FCA will not, however, take forward its original proposal of creating of a new international segment as there was not support for treating international and UK issuers differently.
• Supporting the growth of science and technology companies - the FCA sought views on (i) how effective the UK’s primary equity markets are in providing capital to science and technology companies in the scale - up phase; and (ii) how the primary market structure and regulation might better support patient capital (investment based on long term considerations). The FCA will give further consideration to the provision of patient capital to those science and technology companies that require long-term investment. The FCA will also consider what steps can be taken on any points made which relate to the regulatory framework but many of the concerns raised in the responses do not relate to the regulation of capital markets and are not areas the FCA can address.
• Retail investor access to debt markets - the FCA will continue to consider the case for identifying circumstances in which standard bond documentation should in principle be enough to meet prospectus requirements with the focus likely to be on large premium-listed companies. This will also have to take into account the wider regulatory framework such as PRIPS and MIFID product governance requirements that could dis-incentivise corporates from issuing or marketing directly to retail investors.

The FCA will discuss possible reforms with stakeholders and may present further ideas for discussion or consultation in due course.

Wholesale bond market: the FCA is not proceeding with a listed wholesale bond Multilateral Trading Facility (MTF) as a result of the London Stock Exchange launch of the new debt MTF (the International Securities Market) earlier in 2017.

ETFs: in relation to the FCA’s proposal to move open-ended investment companies from the premium listing segment to the standard listing securities category, the FCA will prepare rules for consultation to move exchange traded funds to the standard listings category.