Review of the effectiveness of primary markets: FCA publishes two new papers

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 are 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 are 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
• The FCA’s work contributing to negotiation of the new Prospectus Regulation
• 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
• Work to improve the effectiveness of the UK’s primary debt markets

Responses are due by 14 May 2017 and the FCA will publish rules in response to its consultation paper in the second half of 2017.

Discussion paper

This paper provides a broad overview of the UK’s current primary markets, the listing regime, the FCA’s regulatory role and data that the FCA has collated relating to those markets.

The FCA state in the discussion paper that it is their view “that the data do not point to obvious, wide-ranging changes which should be made to the regulatory regime in the primary equity markets. Coupled with the anecdotal evidence that the premium listing regime operates well, we see no reason to open a wide-ranging discussion on whether premium listing should change.” As a result the only changes to the premium listing segment that the FCA is proposing are the technical enhancements set out in the Consultation Paper - see below

The Discussion Paper therefore focusses on the standard listing segment and certain specialist categories within that segment. The FCA is seeking views on:

• Standard listing - whether the original rationale for the standard listing is still valid (namely to offer a listing regime which was open to both UK and non-UK companies but which would be attractive to overseas companies which might find the more onerous obligations under the premium listing unattractive). This is because stakeholders generally regarded the standard listing as an unattractive option because it lacks clarity and the name implies second best.

• International segment - whether a new distinct international segment should be developed as the evidence suggests that few overseas issuers seek a standard listing of equity shares - where a premium listing is inappropriate they generally opt for a standard listing of GDRs.

  This would be a standard listing aimed at large overseas companies but with additional investor protections - these would, however, be less onerous obligations than for a premium listing. Some of the investor protections suggested are:

  • a requirement for a sponsor when listing
  • substantive eligibility conditions, such as unqualified working capital statement, minimum market capitalisation, and financial information which has been audited without qualification and supports a three-year revenue earning track record, and
  • application of the related-party rules, with other features of the premium listing regime applying on a "comply or explain" basis.

• Exchange traded funds (ETFS) - whether open-ended investment companies should be moved from the premium listing segment to the standard listing securities category. Stakeholders felt that the additional premium listing obligations were not necessary as open-ended investment companies are subject to regulations outside the Listing Rules, such as the undertakings of collective investment in transferable securities (UCITS) framework, and COLL, the FCA’s specialist sourcebook for certain types of collective investment.

• Science and technology companies - the FCA is seeking 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).

• Debt securities - whether there is a role for a UK primary debt MTF market similar to those in Luxembourg and Ireland and measures to support greater retail participation in debt markets.

Consultation paper

As noted above, most of the changes to the Listing Rules proposed in this consultation paper relate to the premium segment of the listing regime and are technical enhancements rather than fundamental changes. The changes proposed are:

Eligibility requirements

• Chapter 6 - will be 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 will also provide an additional Technical Note, UKLA/TN/102.1, with further guidance on how to interpret the track record requirements.
  • To delete the guidance (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; a rule that clarifies the need to have a business independent of any controlling shareholder; and a rule that clarifies the issuer must control its business; 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 concession 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.

  The FCA is proposing a new concessionary route to premium listing for certain property companies that cannot meet the three-year revenue earning track record. This would recognise that a property valuation report might be more appropriate to judge the maturity of the property company for eligibility purposes.

  The consultation paper states that:

  • "Companies that have been established for less than three years, but predominantly hold mature, let assets that generate revenue. The track record of these companies as the current "holding vehicle" of the assets is arguably less important than the performance of the assets themselves. An example may be a spin out of a mature portfolio. For such companies, property valuation reports will provide key information for assessing the value of the company.
  • Property companies that develop assets, and have done so for three years, but focus on long-term projects that may only be revenue generating after many years, if not decades. For these companies, the issuer’s ability to demonstrate successful development activity representative of its long-term strategy through several years of increases in the value of the assets on its balance sheet, and supported by the property valuation report, will be much more informative than revenue figures."

There will also be additional guidance in a new Technical Note UKLA/TN/426.1.

Additional guidance on the existing concessionary routes for SRBCs and mineral companies - the FCA is proposing 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" - stakeholder feedback and the FCA’s own experience suggest that the current profits test often produces anomalous results. The FCA is therefore proposing that premium listed companies will be allowed:
  • to disregard the profits test where its result is anomalous, the result is 25% or more and all of the other class test results are below 5%, and
  • in certain limited circumstances - where the profits test result is 25% or more and is anomalous - to make specified adjustments to the profit figures used in the profits test.

In both cases the company would still need to obtain guidance from a sponsor but would not need to seek the FCA’s agreement.

The FCA is expecting the sponsor to take the decision as to when it is appropriate to regard a profits test result of 25% or more as anomalous when the other class test results are below 5%. The CP notes that “there may be some limited situations where, in the sponsor’s view, regarding the profits test as anomalous would not be appropriate because the sponsor considers the profits test reflects the true size of the transaction under consideration. This could occur, for example, where an issuer is due to acquire a loss-making entity and the relative size of the target’s losses will have a significant effect on the issuer’s medium term prospects. In these circumstances, the sponsor may consider that a class 1 or reverse takeover result appropriately represents the size of the proposed transaction, or may contact the FCA for guidance as they would currently.”

The FCA is also seeking views on (i) whether there are there any other possible enhancements to the calculation of the profits test that could be made; and (ii) as an alternative to their proposals, are there any alternative profit measures that should be used either in conjunction with or in place of the current profits test.

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 FCA is proposing to require the figures used for classifying assets and profits to be adjusted for such transactions completed during the last financial year, which reflects current guidance in Technical Note UKLA/TN/302.1.

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 is proposing 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 state 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.
• 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 wholly or predominantly of cash or short dated securities, or whose predominant objective is to undertake an acquisition or merger (eg special purpose acquisition companies (SPACs)). The existing Technical Note on SPACs will be amended to include cash shells and provide further guidance.

The proposals do not include (i) changing the premise in LR 5.6.19G that the FCA will generally seek to cancel an issuer’s listing when it completes a reverse takeover; or (ii) changing or removing the FCA’s general power to suspend listing in LR 5.1.1R and the related guidance in LR 5.1.2G.