UK SPACs: could changes to the UK Listing Rules spark an increase?
Special purpose acquisition companies (SPACs) have recently experienced a general increase in popularity. In its 2021 SPAC Market Study, the research firm Deal Point Data notes that the level of SPAC activity has accelerated to unprecedented levels in the initial public offering (IPO) and merges and acquisitions (M&A) markets. The 2020 explosion in SPACs transactions resulted in a 320% increase in the number of SPAC IPOs compared to 2019, with the US being the main market leader. This popularity is also spreading to Europe, with notable SPAC listings on the Amsterdam and Frankfurt stock exchanges in the first few months of 2021. During 2020 to the end of Q1 in 2021, US SPACS had raised on average more than $300m. On the other hand, the UK SPAC market was dormant during 2020, raising only £30 million.
The low number of UK SPAC listings, coupled with many leading UK companies seeking a US or EU SPAC route, naturally leads to the impression that the UK is not a viable location for SPAC listings. In light of this, and the willingness to amend listing rules following Brexit, on 3 March 2021 the UK Listing Review led by Lord Hill (the Hill Review) published a report making wide-ranging recommendations for changes to the UK listing rules and, more specifically, the current rules governing SPACs. The Hill Review underlines the need for loosening such rules to make sure the UK becomes an attractive market for domestic and oversea SPAC listings, ensuring adequate protection for investors.
SPACs are new companies formed for the sole purpose of identifying and acquiring suitable business opportunities. Once incorporated, the SPAC undertakes an IPO of its shares on a public stock exchange to raise the funds it will need to identify and acquire another company. SPACs are considered “cash shell” companies as they have no commercial operations and their only assets consist wholly or predominantly of cash. Investors buying into the SPAC effectively invest in the reputation and experience of its founders and the ability of the SPAC’s management to find suitable targets within a reasonable period of time.
SPACs are considered to be an attractive alternative to accessing equity capital markets through the more conventional route of a traditional IPO. Companies going public via SPACs need only to be acquired and do not have to undertake the burdensome listing process that a traditional IPO requires, thus reducing the usual IPO timeline. Further, the significant amount of cash available to the SPAC for the specific purpose of making an acquisition takes away the uncertainty associated with a failure to raise the required funds and the risk that the investors disagree with the SPAC management’s valuation of the target.
The differing approach to SPACs in the US and UK
In the UK, the acquisition will be treated as a fundamental change to the nature of the business of the SPAC and thus be classed as a reverse takeover (RTO). A RTO requires a relisting of the enlarged entity, which includes the cancellation of the existing listing and the need to go through the usual eligibility process to achieve re-listing and the Financial Conduct Authority (FCA) approval of the re-listing prospectus. Under Listing Rule 5.6, because the buyer is a SPAC rather than a commercial company, the shares of the SPAC will be suspended until the re-listing occurs.
For investors who are used to the US SPAC model, the suspension of the shares is a problem, because the ability to trade the shares in the SPAC during the acquisition process is a key investor protection.
The irony here is that the suspension of shares is seen in the UK as a protective measure, as it reduces the risk of a disorderly market and shareholders not having a clear idea of how to trade their shares. In the FCA consultation paper referred to below, suspension is “to protect investors from disorderly markets as a result of incomplete information being available on the announcement of an acquisition, which could impair the process of proper price formation”. The reference to a SPAC being a “bet and future option on a management team finding an attractive takeover target” is indicative of the FCA’s concern.
As a matter of principle, the US regulations do not distinguish between a commercial company and a SPAC whereas the UK regulations do. In the UK, the judgment is that it is better to suspend the shares of the SPAC so as not to allow anyone to be able to trade in the shares, than to allow trading in circumstances were the market is not completely and accurately informed about the SPAC and its prospective acquisition.
It is worth noting that, because a UK SPAC inevitably acquires the target in consideration for new shares, shareholders in UK SPACs gain additional protection because the RTO inevitably triggers a Rule 9 bid, which can only be waived if the terms of the deal are approved by the Takeover Panel. This waiver requires competent and independent advice on the implications of the deal for shareholders and a vote on the deal by independent shareholders. Equivalent regulations do not apply in the US.
Proposed Changes to UK regulations
In the consultation paper published by the FCA at the end of April on SPACs, the main themes were (i) discussing changes to the Listing Rules so that US style SPACs would be possible on and attracted to, the London market, and (ii) the protection of investors who invest in these SPACs. The implication was that two types of SPACs would be possible: the US style SPAC, which raises a lot of cash to enable the acquisition of the target for cash, and the old UK SPAC, which raises only enough cash to get listed and pay expenses and acquires the target for shares (with a working capital placing to fund the enlarged group). The US style SPAC raises concerns referred to below which need to be addressed, and, whilst the same issues arise for the old style UK SPACs, at least investors have the protection of the Rule 9 waiver process referred to above.
The concern expressed by the FCA is that the US style SPAC might encourage the listing of “low quality” or “less mature “companies on the LSE through the SPAC route”. The reason for this concern is the inevitable pressure on the “sponsors” of the SPAC to spend the newly raised cash on a deal, especially given the limited time available in which to find the deal or repay the cash to investors. The danger is simply that the SPAC will overpay for the chosen target or not carry out sufficient due diligence on the target, which in truth turns out to be of “low quality”.
The FCA addresses these risks by reference to the size of the SPAC. The assumption is that, if the SPAC is of a minimum size, it is likely to attract more experienced management and advisers who will be better able to avoid risks of overpayment and poor quality in the target, than a smaller SPAC. If the SPAC is of the minimum size and subject to other conditions, then the suspension of its shares is no longer required to protect investors. If the suspension of shares is no longer required, then US style SPACs will be more likely to want to list on the London markets.
For present purposes, the size threshold is defined by reference to the funds raised by the SPAC (excluding funds raised by the SPAC sponsors) and the proposed amount is £200m. The additional conditions which the SPAC must satisfy to avoid suspension of the shares are:
- The SPAC must ring-fence, via an independent third party, the funds raised so that they cannot be spent other than on the chosen acquisition, the redemption of shares referred to below, or the repayment of capital if the SPAC should fail to find a target or complete an acquisition within the required timetable;
- Shareholders must have the ability to redeem their shares at a predetermined price out of the ring fenced funds if they do not wish to remain a shareholder after the announcement of the proposed acquisition;
- The funds raised must be returnable to shareholders if the SPAC fails to find and acquire a target within 2 years of admission to listing (extendable by a further 12 months if the public shareholders so approve);
- The proposed acquisition must be approved by the board (excluding any conflicted directors);
- Where any of the SPAC’s directors are connected to the target or a subsidiary of the target, the board must publish a statement that the proposed transaction is “fair and reasonable” as far as the public shareholders of the company are concerned. This statement should reflect the advice by an appropriately qualified and independent adviser;
- The proposed acquisition must also be approved by the shareholders other than the sponsor and any shareholder connected with the target. To ensure that shareholders can properly exercise their voting rights, shareholders must be provided with sufficient disclosure on the target and the terms of the acquisition, as well as how the board has assessed the value of the target, to allow them to make a properly informed decision; and
- Clear disclosure about the structure and arrangements of a SPAC must be made, including the incentive and remuneration of the sponsors.
Prior to announcing the proposed acquisition, the SPAC must consult with the FCA and confirm in writing that it fulfils all the conditions to avoid a suspension of its shares, and that it will continue to do so post announcement until the completion of the RTO. In addition, where details of the proposed transaction have leaked, the presumption that the SPAC will be initially suspended remains unchanged.
Existing rules on eligibility, listing requirements and continuing obligations will continue to apply.
We welcome the possibility of US style SPACs in the London market as it gives investors greater choice and helps to keep London competitive with other stock markets.
We welcome also the focus on investor protection. However, although the figure of £200m reflects US market experience, it is an arbitrary figure. The rationale for this figure is that, if such an amount is being raised, it will attract institutional investors who will carry out a greater level of due diligence than might otherwise be the case on the SPAC, its prospects and its management team, and the SPAC is more likely to attract experienced management and supporting advisors. In this way, there is a connection with good governance and investor protection, and the protection arising from the suspension of the shares in the SPAC is no longer necessary.
We look forward to the results of the consultation (which ends on 28 May) and whether alternative ideas emerge. One possibility is that the amount of funds raised becomes only one item within a list of indicators of good governance, which is supported by independent advice to the board similar to that required for the Rule 9 whitewash (which includes a review of the valuation of the target by the SPAC). In discussions with the FCA prior to announcement of the acquisition, the SPAC would then have an opportunity to rebut a presumption of suspension if less than the agreed threshold amount were raised.