The FCA’s review of the effectiveness of the UK’s primary markets and proposed enhancements to the Listing Rules
On 14 February 2017, the FCA published a discussion paper (DP17/2) and a consultation paper (CP17/4) (both of which are available here) which relate to the effectiveness of the UK’s primary markets and include specific proposed changes to the Listing Rules.
In overview, in the discussion paper the FCA asks:
- whether the current division between standard and premium listing is still relevant (especially in relation to overseas issuers and ETFs)
- whether the current regime is effective in supporting the growth of science and technology companies, and
- whether there is a role for a debt MTF in the UK, and whether measures should be taken to support greater participation in retail debt markets.
In the consultation paper the FCA proposes:
- to clarify the premium listing eligibility requirements for commercial companies in Listing Rule 6
- to change the concessionary routes to a premium listing
- to modify the profits test in the context of classifying transactions for premium listed issuers, and
- to change its approach to the suspension of listing for reverse takeovers.
We highlight below some of the key issues raised by the two papers.
Reviewing the UK’s primary markets landscape (DP17/2)
The FCA’s discussions with stakeholders revealed that a standard listing was generally regarded as an unattractive option because there is a lack of clarity about its purpose and lower standards.
The FCA seeks comments on whether the rationale for the market (i.e. treating UK and non-UK companies equally and offering a choice in terms of listing standards) is still valid.
The FCA notes that the name 'standard listing' has frequently been questioned, since it implies a ‘second best’ option which is unattractive to issuers. It invites suggestions for alternative names.
There is no specific suggestion in the paper that the FCA intends to amend the listing requirements for a standard listing or even get rid of the segment entirely. Indeed, there is currently no scope to do so as the requirements derive from the EU Prospectus Directive. However, following Brexit it is logical to assume that the issue could be revisited. Whilst there are legitimate concerns expressed by market participants about the segment (e.g. insufficient liquidity, a perception of less stringent regulations and a lack of indexation) it is worth noting that there are several examples of significant issuers choosing the segment, including experienced entrepreneurs using SPACs for very large fundraisings and significant commercial companies. The availability of the segment therefore provides some flexibility in the UK’s primary markets. If the segment was removed completely, it is possible that issuers may prefer to list in EU member states that offer an “EU directive minimum” regime.
The FCA notes that the number of traditional secondary listings by large, established overseas companies with a primary listing in their home jurisdiction is declining. Few new international issuers are seeking a standard listing of equity shares because issuers typically favour a listing of global depositary receipts (GDRs) if a premium listing is not appropriate. However, GDRs are targeted at sophisticated investors and so are inaccessible to many retail investors who might wish to invest in mature and successful overseas companies.
The FCA is consulting on creating a distinct international segment for large overseas companies that wish to access UK markets and observe higher standards of conduct, but for which the current UK listing requirements are not fully appropriate.
Investor protections would be key to the success of an international segment, and the FCA welcomes views on what such a package might contain. The FCA notes the package is likely to be a middle ground between standard and premium listings and would include a requirement to appoint a sponsor, give an unqualified working capital statement, satisfy a minimum market cap, have a 3 year revenue track record and comply with related party rules. Other features of the premium segment will apply on a “comply or explain” basis.
Whilst the rationale for the FCA’s proposed creation of a distinct international segment is clear, there is nevertheless a concern that the segment may overcomplicate the range of markets, and the corresponding levels of regulation, available to issuers and investors. It may also undermine the advantages and prestige of seeking a listing on the premium segment. For example, if the new segment allows overseas issuers to be eligible for inclusion in the FTSE index it may reduce the number of issuers wishing to list on the premium segment. If the intention is for the new segment to require lower standards on overseas issuers than currently imposed on premium listed issuer, but more than the EU-minimum requirements which standard listed issuers are subject to, that could create a situation where overseas issuers have an easier route to the market than UK issuers. This in turn could create an incentive for UK issuers to incorporate a new overseas holding company which would allow them to take advantage of the overseas segment.
Exchange Traded Funds
The FCA has identified ETFs as an area in which the listing regime applies investor protections that may be unnecessary and which investors may not value.
The FCA remains of the view that investment trusts and investment companies should only be able to list on the Premium segment, however, they recognise that the application of the premium listing rules to ETFs could be revisited, since ETFs are regarded as very different vehicles from most companies subject to the listing regime.
The main source of investor confidence in open-ended investment companies (OEICs) comes from the specific financial services regulations to which they are subject in addition to the listing regime (i.e. listing regime requirements may be an unnecessary overlay). The requirement to appoint a sponsor for the listing and various ongoing obligations imposed on premium-listed companies are all perceived as adding no value to an OEIC.
The FCA is seeking views on whether the super-equivalent premium listing obligations should be removed from OEICs (except for the requirement to be authorised). I.e. OEICs would be repositioned as a standard listing securities category, reserving the premium segment for commercial companies and closed-ended investment funds.
Science and technology companies and the effectiveness of UK primary markets
The UK is perceived by many market commentators as providing a supportive environment for companies at a very early stage of growth. However, the FCA recognises that the UK's primary equity markets may not be effectively supporting the science and technology companies (STCs) in the subsequent stages of growth.
Two challenges are particularly relevant to early-stage STCs: (i) securing capital for the 'scale-up' phase and (ii) securing long-term “patient capital”.
The FCA seeks comments on, among other things, what enhancements to the primary market regulatory framework could contribute to improving the provision of scale-up capital, and whether STCs should have reached a certain stage of business maturity before accessing public equity markets.
The FCA notes there are concerns that the UK's primary equity markets may be ineffective in providing patient capital, and seeks views on the extent to which current market structures and regulation reinforce a short-term focus in issuers and investors.
The FCA is also interested in whether alternative market structures might better support a more patient, long-term approach, in light of suggestions that a transitional stage between a fully private and a fully public market might provide an environment more supportive of patient capital. The FCA seeks comments on the relative importance to long-term investors and to early-stage issuers of a number of features of the current equity capital market model. It also asks what features a long-term capital market would need to have, and to avoid, in order to be effective.
The issues raised in this part of the paper are wide ranging but identifying specific reasons for the perceived ineffectiveness of UK primary markets is very difficult as the issues are complex. One significant factor which often comes up in discussions with issuers who are choosing a destination for their listing is the current free float requirement (i.e. that at least 25% of a company’s listed shares must be held in public hands). There have been several UK and overseas issuers which have decided to list overseas because they are unable or unwilling to comply with the free float requirement. Relaxing the free float requirement could be a key means of enhancing the attractiveness of the UK’s primary markets. Another key factor could be the UK markets’ rigid adherence to certain shareholder protections including the rules preventing different share classes with different voting rights. In many other jurisdictions investors are comfortable with lower free float requirements and dual share structures which can put UK primary markets at a disadvantage.
The big elephant in the room when considering these issues is Brexit. Any discussion regarding the UK primary markets landscape, including maintaining the attractiveness and competitiveness of the markets, will inevitably need to factor in the position of the UK after it has left the EU. For example, Brexit could present an opportunity to revisit the free float requirement. The challenge is that the outcome of the Brexit negotiations is extremely difficult to predict.
Listed debt securities and debt MTFs
The FCA explores measures that might be taken to improve the effectiveness of UK-listed primary debt capital markets. In particular, it focuses on the question of whether there is an opportunity in the UK for a new primary wholesale bond MTF (similar to the Irish GEM & the Luxembourg and EuroMTF markets).
The FCA seeks comments on this question and, among other things, on whether a specialist wholesale bond MTF could be a commercially viable option without regulated stock exchange status, whether the creation of a wholesale bond-focused MTF would be in the wider interests of investors, and on what the key elements of a listed wholesale bond MTF might look like.
Retail access to debt markets
The FCA notes there are concerns about how the current prospectus regime addresses retail participation in debt markets, and in particular whether the FCA's existing approach to the scrutiny of debt prospectuses intended for retail investors constitutes a form of over-regulation. The application of different standards to a retail bond means that issuers who have used the wholesale bond markets have to reformat their institutional documents extensively for a retail audience which has the effect of deterring large, high quality debt issuers from offering debt to retail investors. The FCA seeks comments on, among other things, whether there are forms of issuance which could be issued to retail investors without the need for the intensive scrutiny currently set out in the existing guidance on retail bonds.
Enhancements to the Listing Regime (CP17/4)
Clarifications to Listing Rule 6
The FCA proposes clarifications to the premium listing eligibility requirements for commercial companies in Listing Rule 6. The proposals also include the introduction of two new technical notes on the eligibility for premium listing relating to financial information and the track record requirements as well as the independent business requirements for issuers.
The proposals are a helpful simplification and clarification which is in line with existing policies and practice.
Concessionary routes to premium listing
The FCA has proposed changes to the concessionary routes to premium listing. Companies in certain sectors (e.g. minerals companies and scientific research based companies) are currently exempt from having to satisfy the 3 year track record for a premium listing if they meet certain criteria.
The proposals include a new concessionary route for certain types of property companies and a new technical note. The FCA notes that the following types of property companies will be most likely to use the proposed concession:
- Those that have been established for fewer than three years and hold predominantly mature, let assets that generate revenue.
- Those that have been developing assets for three years but which focus on long-term projects that may be revenue generating only after many years.
To take advantage of the concession, a property company would need to demonstrate:
- that it has three years of development of its property assets represented by increases of the gross asset value of its property assets (evidenced by the company’s historical financial information and supported by a property valuation report), or
- that 75% of the gross asset value of the company’s property assets, as supported by a property valuation report, are revenue generating at the time when it applies to list.
The proposals also include new technical notes for mineral companies and scientific research based companies.
Class tests for premium listed issuers
The FCA is proposing to change the profits test in the class tests regime for premium listed issuers which would allow issuers, after consultation with their sponsor, to disregard anomalous results or make certain adjustments for class 1 transactions. Currently issuers can ask the FCA to disregard anomalous results.
In parallel with the specific proposals on the profits test, the FCA is also consulting on whether it should include further adjustments to the profit test results, or alternative measures of profitability in the classification rules.
Whilst the proposed relaxation above is welcome, it would not appear to apply to all situations where the profits test produces an anomalous result (e.g. when applying the tests to determine whether a related party transaction falls within the exemption relating to an ‘insignificant subsidiary undertaking’ as defined in LR 11 Annex 1).
Suspensions of listing for reverse takeovers
The FCA will no longer assume, where a reverse takeover (RTO) is in contemplation, that there will be insufficient information in the market about the target, with a resulting suspension of listing.
Instead, the FCA will assume that proper price formation can happen on the basis of the information that listed companies already make public as part of their compliance with other existing obligations (especially disclosing inside information under the Market Abuse Regulation).
The removal of the presumption of suspension for RTOs will extend to all issuers with a premium or standard listing of securities but not to specials purpose acquisition companies (SPACs).
The FCA also proposes to delete its current technical note on RTOs, update its existing technical note on SPACs, which it will present in a new note on SPACs, and also update its technical note on Listing Principle 2.
Responses to the papers were due on 14 May 2017. As regards the discussion paper, if the FCA decides to take forward any specific policy proposal, it will issue a further consultation paper, taking into account any amendments that may be required in the event of changes in the UK regulatory framework, including as a result of Brexit negotiations. As regards the consultation paper, the FCA plans to publish its amended rules in a policy statement in the second half of 2017.
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