FCA publishes new consultation paper

On 01 March 2017, the FCA published a consultation paper on its proposals for improvements to the timing, sequencing and quality of information provided to market participants in the UK IPO process (CP17/5) (Consultation Paper).

The paper is based on feedback gathered from stakeholders following publication of a discussion paper on the subject in April 2016 (DP16/3) (see “FCA publishes discussion paper on the availability of information in the UK equity IPO process”) and follows up on potential remedies identified in the FCA’s report of findings from its investment and corporate banking market study in October 2016 (see “FCA investment and corporate banking market study: final report”).

What are the FCA’s concerns with the current IPO process?

The Consultation Paper identifies and expands on a number of concerns raised in DP16/3 around access to information and conduct risk in the current process for an institutional-only IPO, in which syndicate banks publish research on the IPO applicant (known as “connected” research) at the time of the “intention to float” or “ITF” announcement (around four weeks prior to admission) following which there is a “blackout period” of around 14 days before circulation of a pathfinder prospectus to potential investors, with publication of the final approved prospectus only taking place following pricing of the IPO, typically two to three days before admission.

The FCA’s view is that market integrity and consumer protection are compromised because investor information and price discovery are based primarily on connected research, which is potentially biased or perceived as biased, rather than on an approved prospectus. The FCA also considers that the current IPO process restricts competition among analysts because of the barriers that unconnected analysts outside the syndicate banks face in producing IPO research.

Specific concerns raised by the FCA include:

• The pathfinder prospectus is made available relatively late in the process to a limited group of potential investors and the final approved prospectus is only made available once the IPO has effectively closed, meaning that it does not play a proper role in informing investment decisions.

• Unconnected analysts lack access to meaningful information on issuers and are typically unable to produce good quality IPO research before publication of the final prospectus. Research from connected analysts is therefore often the only source of information available during the investor education and price discovery phase of an IPO.

• Analysts from prospective syndicate banks come under pressure from corporate finance advisers at the pitching stage to produce favourable research in order to secure their bank’s place on the underwriting syndicate. Even once a bank is mandated, favourable research can also influence its position in the syndicate later in the process.

• The process by which an issuer’s advisers review connected research creates further pressure on connected analysts to present a common view and enables issuers to control messaging during investor education.

The FCA has also identified practices on disclosure of information during IPOs that it considers are potentially inconsistent with the Market Abuse Regulation (MAR) and wants to explore these further as part of the consultation process.

What are the Consultation Paper’s main findings?

Timing of prospectus publication

The Consultation Paper notes that there is widespread support from stakeholders for publication at an earlier stage in the IPO process of an approved prospectus or registration document (i.e. a document containing disclosure on the IPO applicant but no price information which would form part of a “tripartite” document together with a summary and securities note, as permitted under the Prospectus Rules) and the FCA therefore favours making this change in order to advance its policy aims.

Connected research

While DP16/3 considered whether connected research should be permitted in view of the conduct concerns that the FCA identified, feedback from stakeholders indicates that it plays a valuable role in the IPO process, particularly due to its brevity and forecasts of company financial information. In the Consultation Paper, the FCA does not on balance favour prohibiting connected research but prefers to focus instead on mitigating the conduct risks associated with it.

Unconnected research

DP16/3 highlighted the absence of unconnected research on IPO applicants (citing only one example of unconnected research being published during the IPO process out of 169 IPOs between January 2010 and May 2015) and identified late availability of the approved prospectus and lack of access to management as the main reasons for this. The FCA notes that there are differing views on the level of demand for unconnected research, but that a number of buy-side firms have indicated they would be willing to pay for it on certain transactions.

The FCA also notes concerns expressed by investment banks and law firms over how and when unconnected analysts would be given access to management, particularly if this is to happen at the same time for both connected and unconnected analysts and before publication of an approved prospectus or registration document. There are also concerns around the potential legal risks arising from the distribution of research by unconnected analysts in jurisdictions where this may give rise to liability on the part of the issuer or its advisers, such as the US.

Blackout periods

The FCA noted the views of market participants on the importance of maintaining an appropriate gap between the publication of an approved prospectus or registration document and connected research due to the potential liability risk of investors regarding connected research as part of an issuer’s offering materials if the two documents are released close together and relying on the research rather than the prospectus when making an investment decision.

One of the main ideas proposed in DP16/3 was the imposition of a mandatory blackout period of seven days between publication of the approved prospectus or registration document and any connected research in order to restore the primacy of the approved document as a source of information, mitigate conduct risks associated with connected research and provide unconnected analysts with the information they require to produce IPO research. The FCA continues to view a seven-day blackout period as necessary to advance its policy aims and also thinks that it would help to give unconnected analysts sufficient time to prepare research prior to the commencement of investor education and price discovery if they are not able to access management at the same time as connected analysts.

What are the FCA’s proposals for reform?

The Consultation Paper proposes two key reforms:

Earlier prospectus and access to management for unconnected analysts

The first proposal is a series of new FCA Handbook rules in the Conduct of Business sourcebook (COBS) to ensure that an approved prospectus or registration document is published and unconnected analysts have access to management before publication of connected research. The FCA’s intention is that this will restore the primacy of the approved disclosure document, improve the range and quality of information available to investors and support more balanced investor education and price discovery.

The proposed rules would give issuers and syndicate banks a degree of flexibility on how and when unconnected analysts are given access to management. If unconnected analysts are provided with access to management on equal terms at the same time as connected analysts, then publication of connected research would be permitted one day following publication of the approved document.

Alternatively, if issuers and syndicate banks want to provide management access to unconnected analysts at a later stage, this would be permitted provided that (i) communication with unconnected analysts is substantially completed by the time connected research is released; and (ii) connected research is not published until at least seven days after publication of the approved document.

The proposed rules would require syndicate banks to provide an opportunity for access to management to a range of unconnected analysts which, in their reasonable opinion, creates a reasonable prospect of enabling investors to make a better-informed assessment of the issuer. The rules would also require the engagement of unconnected analysts to be on "reasonable terms" (with restrictions in line with prevailing UK market practice and geographical restrictions on the distribution of research deemed to be ‘reasonable’ under the rules).

To help facilitate these proposals, the FCA envisages working with industry bodies to develop an industry-standard set of research guidelines to specify ‘reasonable’ terms of access and assist in determining an appropriate range of unconnected analysts.

Stricter guidance on interactions by connected analysts

The second main proposal is new FCA Handbook guidance in COBS to clarify that any interaction between a bank’s analysts and issuers or their corporate finance advisers would be treated as participation in pitching efforts (and therefore inconsistent with maintaining the analyst’s objectivity) until the bank has accepted an IPO mandate and its position in the syndicate has been agreed. The FCA’s intention is to reinforce the existing COBS framework on conflicts of interest and mitigate the risk of bias in connected research, in conjunction with the proposed new rules described above.

The FCA has also left open the possibility of extending its COBS guidance to any interactions between analysts and corporate finance advisers during the production of research if this is considered necessary to address concerns around the current practice of reviewing draft connected research.

MAR considerations

The FCA is also seeking further evidence from stakeholders on how disclosure of information in analyst presentations is justified as being in compliance with MAR, and in particular whether any inside information is disclosed to analysts or their audiences in the normal exercise of an employment, a profession or duties in accordance with Article 10 of MAR. The FCA notes that issuers with debt securities admitted to trading on either a regulated market or a multilateral trading facility (MTF) would fall within the scope of MAR, and that first-time issuers would otherwise fall within the scope of MAR when making a request for admission to trading on a regulated market or MTF.

Our view

Timing of prospectus

It is clear that the FCA intends to bring forward the publication of an approved prospectus or registration document in the IPO process to enhance its status as a source of information for investors. We think this can best be achieved, as the Consultation Paper suggests, by requiring the publication in the first instance of a registration document as part of a “tripartite” document, which is then supplemented with a summary and securities statement (including a price range) prior to the commencement of marketing and the investor roadshow. This approach is already permitted under the existing prospectus regime and has been used in some UK IPOs offered to retail investors, including Royal Mail. This approach is also used in France and was highlighted by Lord Myners in his Review of IPOs and bookbuilding in Government Primary Share Disposals in December 2014.

Access for unconnected analysts

We think that, in practice, the option under the proposed new rules for management to communicate with connected and unconnected analysts at the same time would be used rarely, if at all, for the following reasons:

• The single-day gap between publication of the registration document and connected research permitted under the proposed new rules where equal access is provided would present potential liability risks associated with "overlap" between research and disclosure documents. We do not think syndicate banks will want to adopt a blackout period of less than seven days in these circumstances, particularly given the 14 day blackout period typically observed under current market practice.

• Issuers and syndicate banks may have concerns around the practicalities and potential risks of granting access to unconnected analysts at the same time as connected analysts and before publication of a registration document, and it may not be possible to fully address these concerns by adopting an industry-standard set of research guidelines for unconnected analysts as the FCA proposes.

• With the exception of larger IPO transactions, we think it is unclear that sufficient demand for unconnected research exists, or that investors will be willing to pay for research at a level that can sustain a significant number of unconnected research providers.

We think it is more likely that issuers and syndicate banks will continue to follow a process for connected analysts that is as close as possible to current market practice and will accept the seven-day blackout between publication of the registration document and connected research, offering unconnected analysts the opportunity to attend a separate analyst presentation during this period.

The FCA has left open the possibility that management access for unconnected analysts could take place via webcast, conference call or email exchange, rather than a physical meeting. Given the likely uncertainty around the number of potential attendees, cost of venue hire and the relatively short timeframe, we think an online meeting format will be the preferred option for issuers.

There is a further potential concern around the volume and timing of follow-up questions from unconnected analysts. The proposed rules in the Consultation Paper stipulate that unconnected analysts must be able to make enquiries of the issuer’s management team to enable them to form a substantiated opinion on the issuer and that the communication process must be substantially completed before any research is published. Unless there is a clear pre-agreed Q&A process with strict deadlines for the submission of questions, there is a risk that publication of research could be delayed beyond the anticipated seven-day blackout period. The Q&A process with unconnected analysts could also place a significant additional burden on the issuer’s management team in the context of the overall IPO timetable.

MAR considerations

Other than the example of issuers with debt securities admitted to trading identified by the FCA in the Consultation Paper and potentially in the case of spin-off transactions, we do not think that information provided to analysts will fall within the scope of MAR for the majority of IPO applicants given that the formal application for admission is made much later in the process following the investor education phase. In the event that MAR does apply to an issuer at the time it is in communication with analysts, it is likely that the type of information provided to analysts would be more restricted and the issuer’s disclosure obligations would need to be considered carefully.

Other practical issues

It is common for banks to involve analysts at the pitching stage to get their views on whether or not they would be willing to cover a particular company. The FCA’s proposal that engagement letters must be signed and syndicate positions confirmed before any interactions with analysts can take place would remove the ability of banks to vet potential issuers in this way. We think the FCA’s concerns on this point could also be addressed by restricting corporate finance advisers and issuers from soliciting valuation feedback from connected analysts at the pitching stage, rather than banning interactions altogether until an engagement letter is signed;

The introduction of a tripartite prospectus requirement is also likely to result in greater costs for issuers, with additional comfort letters and legal opinions being required at the time of publishing the registration document. The longer time period between publication of the registration document and the final prospectus will also increase the likelihood of a supplementary prospectus being required.

Next steps

Responses are due by 01 June 2017 and the FCA expects to publish a policy statement outlining any changes to its Handbook later in 2017.