Outcome of Primary Markets review becomes effective

Summary of key issues for standard segment issuers

• In the feedback statement to DP17/2 Review of the Effectiveness of Primary Markets: the UK Primary Markets Landscape, the FCA stated that it had not reached any firm conclusions in respect of the premium/standard segment divide, but it is giving further thought to raising requirements in the standard list where these do not come from parts of EU directives that are maximum harmonising. The FCA intends to consult on this in due course.
• PS 17/22 sets out changes that remove the presumption of suspension where there is a reverse takeover save for in respect of cash shells and special purpose acquisition companies (SPACs) where this regime is retained.  This is because the FCA acknowledges that in recent years there has been a significant increase in the number of SPACs with very small market capitalisations joining the standard segment and in the FCA’s experience, there has been a lot of volatility and price spikes in those companies around the time of a proposed transaction.
• There is a new technical note entitled Cash shells and special purpose acquisition companies (UKLA/TN/420.2) which includes inter alia guidance on what ‘cash shells’ and ‘SPACs’ are.
• There are also some minor amendments to UKLA Technical Note Listing Principle 2 Dealing with the FCA in an open and cooperative manner (TN 209.2 (now 209.3), which makes clear it is mandatory to approach the UKLA in relation to reverse takeover transaction.

Background

In February 2017, the FCA published:

• a consultation paper entitled Review of the Effectiveness of Primary Markets: Enhancements to the Listing Regime (CP 17/4); and
• a discussion paper entitled Review of the Effectiveness of Primary Markets: The UK Primary Markets Landscape (DP 17/2).

The consultation paper CP 17/4 proposed a number of changes to the Listing Rules to address areas where the FCA felt individual guidance is often requested and areas where stakeholders have frequently suggested enhancements should be made including a:

• review of the concessionary routes to premium listing and the proposal of a new concessionary route for property companies;
• change to the profits test of the class tests; and
• changes to the rules around suspension of issuers in respect of reverse takeover transactions.

The discussion paper DP 17/2 aimed to prompt a broad debate about the effectiveness of UK primary capital markets and how they serve their purpose of providing access to capital for issuers and investment opportunities for investors. This discussion paper focused on the following themes:

• the split between standard and premium listing with a focus on a potential new international segment;
• how to support the growth of science and technology companies;
• the listing of debt securities and debt MTFs; and
• retail investor access to debt markets.

The CP 17/4 and DP 17/2 papers were followed on 1 March 2017 by a further consultation paper entitled Reforming the availability of information in the UK equity IPO process (CP17/5) which set out proposals for changes to improve the range, quality and timeliness of information available to investors during the IPO process with aim of:

• Restoring the centrality of an approved prospectus or registration document in the IPO process.
• Enhancing standards of conduct throughout the process, in particular in the management of conflicts of interest in the production and distribution of connected research.
• Creating the necessary conditions for unconnected IPO research to be produced.

Latest developments

On 26 October 2017 the FCA published policy statement entitled Review of the Effectiveness of Primary Markets: Enhancements to the Listing Regime (PS 17/22) which enacted many of the proposals made in CP 17/4.  The main elements of this paper are set out below.

Suspension of listing for reverse takeovers

The current Listing Rules assume that, where a reverse takeover is in contemplation (being a transaction where the target is or are bigger than the listed issuer or where the results is a fundamental change in the business, board or voting control of the issuer), there will be insufficient information in the market about the target unless the listed company can provide it.

The Listing Rules set out what information in respect of the target needs to be provided to the UKLA to avoid suspension which is broadly equivalent to the information required to be disclosed to the market on a listed company. Where the information is not provided, the FCA’s view historically has been that the market will not operate smoothly and therefore the issuer’s listing will be suspended until either the ‘information gap’ is bridged or the issuer confirms that the reverse transaction is no longer in contemplation.

In CP 17/14 the FCA proposed changing its approach as issuers as part of their compliance with existing obligations, principally the obligation to disclose inside information under the Market Abuse Regulation (MAR), needed to make public information on the target and therefore suspension was an overly draconian sanction.

In PS 17/22 the FCA has followed this approach but retained the presumption of suspension for cash shells and special purposes acquisition vehicles. For these issuers, all the rules and guidance in the Listing Rules required to rebut the assumption of suspension are retained along with the requirement to contact the UKLA as early as possible where (1) there is a reverse takeover that has been agreed or it is in contemplation to discuss whether a suspension is appropriate or (2) where details of the reverse takeover have leaked and the issuer needs to request a suspension (new LR 5.6.6R).  The Technical Note 420.2 that accompanied CP 17/4 and which was adopted under PS 17/22 also provides further guidance on reverse takeovers by cash shells and SPACs (more details of this guidance are set out below).

The FCA’s reason for retaining these provisions in respect of cash shell and SPACs is that in recent years there has been a significant increase in the number of SPACs with very small market capitalisations joining the standard segment of the Official List, as opposed to in the past where SPACs were usually led or backed by a high-profile entrepreneur or promoter and were raising significant amounts of capital.

The FCA has also noted that that many of these small companies have a very broad acquisition strategy and their share prices can experience high levels of volatility around the time of a proposed transaction. This volatility may be because the market has priced the transaction with incomplete information, suggesting the smooth operation of the market has been disrupted, and this may be detrimental to investors. As a result, the FCA still considers that a presumption of suspension is appropriate to protect investors and avoid a disorderly market in respect of cash shells and SPACS.

There are also some minor amendments to UKLA technical note entitled Listing Principle 2 - Dealing with the FCA in an open and cooperative manner (TN 209.2 (now renumbered 209.3). The only main change is that the FCA have made clear that where there is a prospect of a reverse takeover, contact with the UKLA is mandatory under LR 5.6.6R. The guidance continues to specify that issuers need to deal with the UKLA in an open and cooperative manner and that issuers should consider contacting the UKLA where there is a significant transaction and provide some guidance as to when transactions that could be considered significant.

Special purpose acquisition companies (SPACs) and cash shells

In CP 17/14 the FCA proposed updating its existing technical note on SPACs (UKLA/TN/420.1) with a new technical note entitled Cash shells and special purpose acquisition companies (UKLA/TN/420.2). This new note:

• includes guidance on what  ‘cash shells’ and ‘SPACs’ are (as these terms were not previously defined in the Listing Rules) which was required in order to implement the changes to the presumption on suspension on reverse takeovers (referenced at paragraph 4.2 above).
• reminding certain issuers (such as cash shells whose shares have previously been admitted to a premium listing) of the provisions in LR 5.4A.16G, which mean where the issuer no longer meets the requirements of the applicable listing category against which it was initially assessed for listing, the UKLA may consider cancelling the listing of the equity shares or suggest to the issuer that, as an alternative, it applies to transfer its shares to a different listing category;
• incorporates elements of the previous guidance in Technical Note – Reverse Takeovers (UKLA/TN/306.3) that has been deleted as the content also applies to cash shells; and
• has some further changes for readability and clarification purposes.

The definitions created for cash shells and SPACs are not mutually exclusive. Cash shells are issuers whose assets consist wholly or predominantly of cash (or potentially short dated securities), which may fall within this definition as they have disposed of all, or a majority of, its assets and also may, or may not, have a strategy to seek an acquisition opportunity or to develop a business as a start-up.

SPACs are a new company incorporated to identify and acquire a suitable business opportunity or opportunities. It may also be referred to as a ’search fund’. Its initial funds are usually raised through an initial public offering (IPO) on a stock market or through a fundraising undertaken before the IPO. After the IPO, its cash resources are used to identify acquisition opportunities, finance the due diligence costs and potentially fund or part fund the acquisition of a suitable business to invest in.

A cash shell or SPAC can list under LR 14 provided it is not an ‘investment entity’ i.e. an entity whose primary object is investing and managing its assets with a view to spreading or otherwise managing investment risk.

Premium segment admission requirements

The FCA broadly adopted the changes they proposed in CP 17/4 in respect of Chapter 6 of the Listing Rules (Additional requirements for premium listing (commercial company)) with some minor changes. These included:

• Reordering of LR 6.1 which has now become LR 6.1, LR 6.2 and part of LR 6.3 with the additional requirement that where there have been acquisitions during the three year track record period that the additional financial information on those acquisitions be audited (See new LR 6.2.4) and the provision regarding the financial track record covering 75% of the business have been amended slightly;
• Inserting a clear reference to historical financial information needing to demonstration a revenue earning track record as a new LR 6.3.1R which currently appears only in the associated guidance.  The UKLA have also provided an additional Technical Note UKLA/TN/102.1 which includes further guidance on how to interpret the track record requirements and removed the guidance note;
• Amending the independence requirements so that it is split into three elements. These are (i) independence from a particular person or group (ii) independence from a controlling shareholder and (iii) control of the issuers business.  The FCA did not intend to change the requirements but to clarify what was required. TN 103.3 sets out guidance in respect of each of the three elements on what indicates the requirements are not met; and
• Removal of the reference to UKLA being able to waive the need for a clean working capital statement as the UKLA “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.”

Concessionary route to premium listing

Applicants for premium listing are usually required to have a three-year revenue earning track record in order to be eligible for premium listing. However, the existing rules contain specific exemptions for companies in some sectors. Companies in those sectors are able to gain a premium listing by complying with other conditions. These are the “concessionary routes” to listing.

In PS 17/22 the FCA has make some small amendments to the existing concessionary routes to a premium listing for mineral companies and scientific research-based companies by reordering and amending Chapter 6 of the Listing Rules. The FCA has also followed through on its proposed new concessionary route to the premium segment for some property companies to enable the listing of asset rich property companies that do not have the required financial track record.

Profits class test

Currently premium listed issuers are obliged under the Listing Rules to provide certain disclosures, or seek shareholder approval, for large transactions that are outside the ordinary course of business. These transactions are classified according to a number of tests of relative size. These tests are known as the ‘class tests’.

In CP 17/4 the UKLA noted that stakeholder feedback and its own experience (from providing guidance to issuers and their advisors) indicated that the application of the ‘profits test’ of class tests often produces anomalous results. Therefore the UKLA proposed two changes to the profits test set out in LR 10 Annex 1 (Significant transactions: Premium listing). The changes proposed in CP 17/4 were adopted in PS 17/22 with minor amendment and now LR 10 Annex 1G makes clear that where a profits test produces a result which is (1) anomalous and (2) produces a result of 25% or more then provided it is not a related party transaction the premium listed issuer:

• can where all the other applicable class test results are below 5%, without consulting UKLA in advance (although sponsor advice will be needed on the application of the test under LR 8.2.2R) disregard the test; or
• may make adjustments to the figures used in calculating the profits test, without consulting the UKLA in advance (although again sponsor advice will be needed) with the permissible assumptions being set out in the Listing Rules and including certain one off costs and the deduction of interest charges related to pre –iPO period (see new paragraphs 12R and 13R of LR 10 Annex 1).

The UKLA resisted calls to define what “anomalous" means and is leaving this up to the sponsors who will need to seek UKLA guidance if they are not sure.

The UKLA have also amended LR 10 Annex 1G to incorporate guidance that was in Technical Note 302.1 and reissued a very slightly amended Classification Test Technical Note (now 302.2).

FS 17/3 - Feedback on Effectiveness of Primary Markets: The UK Primary Markets Landscape

This paper further develops the proposals in respect of the areas raised in DP 17/2 and in particular the FCA wants to consider further:

• the current split between standard and premium listing, and in particular the scope to raise minimum requirements in the standard list where these do not come from parts of EU directives that are maximum harmonising.
• ways in which the Listing Rules can be adjusted to enhance science and technology companies access to patient capital.
• retail access to debt markets.

Standard/premium listing 

In terms of the premium/standard segment divide, the FCA did not reached any firm conclusions but it is giving further thought to raising requirements in the standard list where these do not come form parts of EU directives that are maximum harmonising. The FCA intends to consult on this in due course. However, the idea of a separate international segment has been discontinued for the time being as feedback did not support the differential treatment of international and UK issuers because an additional segment was perceived to add a further level of complexity that was possibly confusing.

Primary markets facilitation of access to patient and scale up capital

The feedback from DP17/2 suggested that mid and small cap science and technology companies are having difficulties accessing institutional investment due to their risk profile, which is incompatible with the solvency and prudential regulatory requirements of such institutional investors. It seems science and technology issuers are also being tempted to list on US markets as they are perceived to have better pricing due to the US having a more developed expertise networks. There is also a perception that the involvement of US backers at IPO, or in later funding rounds, is driving these companies to US rather than UK markets.

Lack of liquidity was also perceived to be an issue with UK primary markets, with periodic trading being mooted as a solution to encourage patient capital. However, where trading is limited this raises the issue of corresponding disclosure around the trading periods, which is regulated by MAR and MiFID II that FCA have limited scope to adjust.

Retail access to bond market

The feedback noted there appeared to be interest in facilitating the issue of bonds in retail size tranches by listed entities without going through all the current requirements. However, the ability to facilitate this is limited by the Prospectus Regulation (which has been recently introduced and therefore unlikely to change) and by Packaged Retail Investment and Insurance Products (PRIIPs) and MiFID product governance requirements.

Although the FCA we will continue to consider the case for identifying circumstances in which standard bond documentation rather than a prospectus should be enough to meet prospectus requirements for a retail offering, it seems this will be focused on large premium-listed companies only. Therefore retail investors will continue to gain exposure to corporate bonds through funds, the London Stock Exchange’s Order book for Retail Bonds market (ORB) or through unlisted mini bonds offered by crowd funding platforms or otherwise.

Other issues

In terms of other issues touched upon in DP 17/2 the FCA noted that the LSE had created the MTF market to deal with the perceived lack of a listed wholesale bond MTF and that the feedback supported ETFs being standard rather than premium listed.