Equity Linked Bonds and the New EU Regime

Transcription

1 Equity Linked Bonds and the New EU Regime Introduction This memorandum sets out the implications of issuing Equity Linked Bonds on an EU regulated market in light of the forthcoming implementation of the Prospectus Directive, the Transparency Obligations Directive and the Market Abuse Directive and discusses potential alternatives to listing on an EU regulated market. Key measures central to the EU regime change are: the Prospectus Directive ( PD ), and Prospectus Regulation ( PD Regulation ) which will significantly alter prospectus requirements applicable to securities being listed or offered in the EU, including the requirement that issuers follow International Financial Reporting Standards ( IFRS ) or equivalent in relation to financial information in the prospectus Contents Introduction 1 Convertible Bonds 1 Prospectus Disclosure for New Issues 2 On-going Disclosure 6 Exchangeable Bonds 9 Prospectus Disclosure for New Issues 9 On-going Disclosure 10 Impact of the New Regime 11 the Transparency Obligations Directive ( TOD ) dealing with ongoing periodic disclosure obligations of such issuers, including annual and half-yearly reports under IFRS or equivalent the Market Abuse Directive ( MAD ) requiring immediate public disclosure of price-sensitive information by issuers that have securities admitted to an EU regulated market. For a general overview of the new regime, please click here. Convertible Bonds Convertible bonds for these purposes mean bonds where the underlying shares to be delivered on conversion are issued by the issuer of the bonds or a group company of the issuer of the bonds. For disclosure purposes, the PD Regulation distinguishes between the situation where the underlying shares to be delivered are already allotted and admitted to trading on a regulated market (e.g. where the conversion rights are satisfied out of treasury shares) and where the underlying shares to be delivered have not been allotted at the time of the bond issue (as is 15 March

2 almost always the case). In the case of the former, such securities will be treated as exchangeable bonds (see below). Prospectus Disclosure for New Issues Convertible bonds (i.e. bonds convertible into newly issued shares of the issuer or of a group company) fall within the definition of equity securities in the PD. This has a number of consequences. First, unlike the position for debt securities with a minimum denomination of 1,000, EU issuers and non-eu issuers (who have already made an election in respect of their home Member State) of convertible bonds will have no freedom of choice as to the authority to which they must apply for the approval of the prospectus. This is the case regardless of the denomination of the convertible bonds being issued. Secondly, no exemption will be available in respect of the obligation to produce a summary of the prospectus, which must convey the essential characteristics and risks associated with the issuer, any guarantor and the securities in around 2500 words. Where the relevant home member state is the UK, the FSA have said they will not be religious about the word limit, recognising that in complex situations a longer summary may be appropriate. Nevertheless lengthy summaries will have to be justified. Information may not be incorporated by reference in the summary. Certain member states may take advantage of the ability to require translations of the summary into their local language, which may impose an additional burden on cross-european institutional offerings. Thirdly, convertible bond prospectuses will need to include three years of financial information prepared in accordance with IFRS or equivalent, and audited in accordance with international audit standards (although transitional relief from this requirement is available in certain circumstances) 1. In addition, interim financial information, if published, since the date of the last annual accounts, must be included in the Prospectus, also in accordance with IFRS. Where the issuer of the bonds is not also the issuer of the shares, such financial information will need to be provided in respect of both the issuer of the bonds and the issuer of the underlying shares. 1 Existing EU issuers (i.e. which have securities admitted to trading on an EU regulated market on 1 July 2005) that issue further securities, do not have to include accounts prepared on an IFRS basis until they have published their first consolidated IFRS accounts under the Accounts Regulation (Regulation (EC) No 1606/2002). For new EU issuers (i.e. which do not have securities admitted to trading on an EU regulated market on 1 July 2005) there is no obligation to restate to IFRS for any period earlier than 1 January Non EU issuers do not have to restate their accounts to IFRS in any prospectus issued before 1 January Such issuers must, however, include more detailed and/or additional information if the financial statements included in the prospectus do not give a true and fair view of the issuer s assets, liabilities, financial position, profit and loss etc March 2005

3 Finally, convertible bonds will, generally, be treated in the same way as shares so that a substantially greater level of prospectus disclosure will be required as compared with the current regime. Annexes 1 and 14 of the PD Regulation will need to be complied with to provide equity-style disclosure on the issuer of the underlying shares and to provide detail on the underlying shares themselves. It should be noted however that, unlike the position with shares, neither a working capital statement, nor a statement of capitalisation and indebtedness is required to be made. Set out below are some of the significant additional disclosure requirements, as compared with the current regime for convertible bonds under Chapter 23 of the UKLA listing rules. As stated above, where the issuer of the bonds is not the same entity as the issuer of the underlying shares, the information required by Annex 1 of the PD Regulation will be required in respect of the issuer of the underlying shares 2. Therefore references to issuer in I to XI below should be interpreted as references to both the issuer of the bonds and the issuer of the underlying shares. I. Selected Financial Information The inclusion of selected financial data, comprising key figures that summarise the financial condition of the issuer, is mandatory. According to Level 3 guidance from the Committee of European Securities Regulators ( CESR ) 3, the selected financial data must be extracted from the historical annual (and if applicable interim) audited information on a straightforward basis. However, figures derived from the audited figures (i.e. by way of calculation or elaboration based on the historical information) may be used provided they are clearly explained and defined, are relevant to an understanding of the issuer s business and are reconcilable with the historical or interim financial information. II. Risk Factors Prominent risk factors specific to the issuer or its industry and risk factors material to the convertible bonds (in order to assess the market risk associated with the bonds) must be disclosed. III. Business Description This must include a segmental analysis of products and sales, as well as a description of material property, plant and machinery, any security over it and any environmental issues that may affect the issuer s utilisation of those assets. Trend information must also be presented with respect to the most significant recent trends in production, sales and inventory, and costs since the end of the last 2 3 Article 17.1 of the PD Regulation. published on 10 February It is available at Equity Linked Bonds and the New EU Regime 3

4 financial year to the date of the prospectus. In addition, information on any known trends, uncertainties, demands, commitments or events that are reasonably likely to have a material effect of the issuer s prospects for at least the current financial year, must be disclosed. The issuer must also provide a description of its principal investments (both current and planned future). IV. Operating and Financial Review This is a mandatory requirement. CESR s Level 3 Guidance states that the OFR should provide investors with a balanced historical and prospective review of the issuer s performance and financial condition, including the risks and uncertainties the business faces. Amongst other things, it should not be assumed that all readers are qualified investors, so the OFR should not assume a detailed prior knowledge of the business nor of the significant features of its operating environment. V. Profit Forecasts Where a profit forecast or estimate is included, an auditor s report must accompany it. CESR s Level 3 Guidance sets out a number of factors which an issuer should take into account when preparing a profit forecast. Where an issuer has published a prior profit forecast (other than in a previous prospectus) which is outstanding, CESR considers that there is a presumption that such outstanding forecast will be material in the case of share issues (especially in the context of an IPO). It goes on to state that this is not necessarily the presumption in case of non-equity securities. It is not certain to what extent this interpretation will be extended to convertible bonds. However, it may be prudent to include any previously published, but still outstanding, profit forecast in a convertible bond prospectus. VI. Capital Resources Considerable detail, as set out in CESR s Level 3 Guidance, is required on the sources and amounts of an issuer s cashflows, the issuer s funding structure, any restrictions on the transfer of funds within the issuer s group, the issuer s treasury policies and objectives, peak borrowing requirements etc.. VII. Pro forma Financial Information This should be provided where there has been a significant gross change (i.e. a variation of more than 25% relative to one or more indicators of the size of an issuer s business). VIII. Corporate Governance 4 15 March 2005

5 Detailed disclosure as to board practices, terms of employment, remuneration etc. is required. In addition, a statement as to the extent of the issuer s compliance with relevant corporate governance requirements must be given, along with information on board committees etc.. More detailed information as to the management and number of employees of the issuer is required. IX. Related Party Transactions Information must be given on related party transactions entered into between the beginning of the period covered by the historical financial information and the date of the prospectus. X. Conflicts of Interest Directors, and senior managers relevant to establishing that the issuer has the appropriate management expertise and experience, must disclose any potential conflicts of interest and, if there are none, a confirmation to that effect must be given. XI. Statement of Material Interests by Experts If an independent expert s report is included in the prospectus disclosure must be made of any material interest the expert may have in the issuer, including any compensation received from or employment relationship with the issuer and any relationship with the financial intermediaries involved in the offering. Annex 14 of the PD Regulation requires information on the underlying share such as the dividend and other rights attaching to the shares, any restrictions on the free transferability of the shares, the terms of any public takeover bids and the potential dilutive effect on shareholders of the exercise of the conversion right. Upon exercise of the conversion right and issuance of new shares, no prospectus will be required, in the same way as at present. 4 Responsibility for the Prospectus The Prospectus Regulation requires those responsible for the prospectus to give a responsibility statement, with determination of who is responsible being left to the home member state. The intention of HM Treasury, as stated in its Consultation Paper on PD implementation, is to preserve the existing responsibility regime. However, the draft Prospectus Rules and FSMA amendments appear to have left a gap in terms of determining who is required to give a responsibility statement. Under Chapter 23 of the Listing Rules, on a convertible bond issue, the responsibility statement need only be 4 Article 4.2(g) of the PD Equity Linked Bonds and the New EU Regime 5

6 given by the issuer of the bonds. 5 It is not yet known whether the draft rules will be amended to carry across the current provisions on who is required to give the responsibility statement into the new regime. On-going Disclosure Transparency Obligations Directive Convertible bonds do not fall within the definition of debt securities as set out in the TOD 6. Therefore, once the TOD is implemented 7, issuers (which, for these purposes means the issuer of the bonds) will be required to prepare annual reports in accordance with IFRS or equivalent standards 8 and will not be able to take advantage of the exemption for issuers of debt with a nominal value per unit of 50,000 or above. Many non-eu issuers of convertibles have recently included disclosure in their offering documents to the effect that, if the TOD is brought into effect as currently drafted, they will de-list their convertible securities from EU regulated markets. Issuers of shares and debt securities are obliged, under the TOD, to publish half yearly reports (also in accordance with IFRS). Issuers of shares are obliged to produce interim managements statements (or quarterly accounts). As convertible bonds are neither shares nor debt securities, it would appear that the obligation to produce half-yearly reports or quarterlies under TOD does not (in the absence of any legislative amendment) apply to issuers with only convertibles traded in the EU. Annual List Issuers of convertible bonds need to file annually, with the home state competent authority, a document that contains or refers to all information published (anywhere in the world) in compliance with regulatory requirements. This list must be filed and made available to the public, within 20 working days after publication of the annual financial statements, in the home member state. Market Abuse Directive By virtue of the MAD, issuers of convertible bonds admitted to trading on an EU regulated market will be subject to certain continuing obligations with regard to disclosure of inside information i.e. an issuer must disclose, as Listing Rule 23.11(a) modifying Listing Rule 6.H.3. Any security which is equity linked falls outside the definition of debt for these purposes. The deadline for implementation is 20 January Non-EU issuers that use US GAAP are not required to use IAS in their annual reports prior to the financial year starting on or after 1 January 2007, by which point the EU Commission will have identified what will be equivalent standards 6 15 March 2005

7 soon as possible, any inside information which directly concerns the issuer. Inside information is defined as information of a precise nature that is not generally available but, if made generally available, would be likely to have a significant effect on the price of the issuer s qualifying investments, or related derivative investments. Whether the impact on price will be significant must be assessed in the context of whether a reasonable investor would use that information as part of an investment decision. In addition, the MAD requires issuers, and those acting for them 9, to prepare and keep up-to-date lists of all individuals working for them with access to inside information 10. Insider lists should be kept for a period of five years, to be disclosed to the FSA at any time upon request. The preparation of insider lists is likely to be a considerable administrative burden for many issuers and their advisers. In addition, any transaction conducted on the account of persons discharging managerial responsibilities, or their close associates, in the shares of the issuer or in derivatives or other financial instruments relating to those shares must be notified to the issuer within five business days of the day on which the transaction took place. The issuer must then disclose the details of the transaction to a regulatory information service. This obligation should not, however, apply where the underlying shares are not issued by the issuer of the bonds and there is no trading in shares of the issuer of the bonds, since the obligation applies in respect of shares of the issuer of the bonds, or derivatives or other financial instruments relating to the shares. These issues are more relevant to a non-eu issuer whose shares are listed outside of the EU. Issuers with shares listed on an EU regulated market will need to comply with these obligations in any event i.e. their agents and advisers (for example banks, accountants and lawyers). See Article 6(3) of MAD. Equity Linked Bonds and the New EU Regime 7

8 Securities with right to physically acquire shares Yes No Are underlying shares issuer s or group shares AND NOT already listed in EU or equivalent? DEBT Yes No Full equity disclosure: Annexes 1 & 14 plus relevant debt or derivative Securities Note Debt Disclosure: Relevant debt or derivative Registration Document and Securities Note plus of Annex March 2005

9 Exchangeable Bonds Exchangeable bonds for these purposes means bonds where the underlying shares to be delivered on conversion are issued by an entity other than the issuer of the bonds or a group company of the issuer of the bonds. In addition, convertible securities where the underlying shares to be delivered are already allotted and admitted to trading on a regulated market (e.g. where the conversion rights are satisfied out of treasury shares), will be treated as exchangeable bonds. Prospectus Disclosure for New Issues Under the PD, exchangeable bonds will be treated as debt. Therefore debtstyle disclosure on the issuer and only two years worth of financial information is required. Exchangeable bonds with a minimum denomination of 50,000 or equivalent will qualify for the special regime for high denomination debt. This means that issuers of such high denomination exchangeable bonds can avoid the requirement for IFRS accounts and international audit standards in their prospectuses. In addition, issuers of exchangeable bonds will have freedom of choice as to the authority to which they have to apply for approval of a prospectus. There will be no obligation to produce a summary where the denomination is at least 50,000 (unless a member state requires a translation of a summary into the local language under its national law). Minimal information is required to be given on the underlying shares to be delivered on exchange. This comprises (i) the name of the issuer of the security, (ii) the ISIN or other such security identification code and (iii) an indication of where information about the past and further performance of the underlying and its volatility can be obtained. This contrasts with the current regime where the information to be disclosed on the underlying shares includes a summary of the articles of association of the issuer of the underlying, the name of exchange on which underlying shares are listed, details of share price and dividend history, a brief description of activity of underlying issuer and summary financial statements for past 3 years (plus summary of interims if data on the last financial year pre-dates the prospectus by more than 9 months - the full financials would also be incorporated by reference) in addition to any major public information on the issuer of the underlying since the date of its last published accounts. It may be, however, that good practice and the overriding obligation to disclose to investors all information as is necessary to enable them to make an informed assessment, would require such information to be disclosed. Equity Linked Bonds and the New EU Regime 9

10 Responsibility for the Prospectus Similar concerns apply to exchangeable bonds as regards the responsibility statement. Currently, the issuer of the bonds may take responsibility for the information in the Prospectus, except for information which relates to the issuer of the shares into which the bonds may be exchanged. In that case the bond issuer states that it has accurately reproduced such information from information published by the underlying share issuer. It is hoped that the current position, will be maintained. On-going Disclosure Transparency Obligations Directive The position as regards exchangeable bonds and the TOD is somewhat intriguing. Despite the fact that exchangeable bonds are treated as debt securities for the purposes of prospectus disclosure, they do not fall within the definition of debt securities as set out in the TOD. Therefore, as with convertible bonds, once the TOD is implemented, issuers of exchangeable bonds (which, again means the issuer of the bonds, rather than the issuer of the underlying) will be required to prepare annual reports in accordance with IFRS 11 or equivalent and will not be able to take advantage of the exemption for issuers of debt with a minimum denomination of 50,000 or above. As with the position on convertible bonds, it would appear that issuers of exchangeable bonds will not be obliged to produce half yearly or quarterly reports for the purposes of the TOD. Annual List Issuers will be able to avoid the obligation to file the annual list with their home member state where the bonds have a minimum denomination of 50,000 or above. Market Abuse Directive In the case of exchangeable bonds, where the issuer is not the issuer of the underlying shares, the MAD should have little impact, since the issuer of the bonds is only required to make continuing disclosure of information directly concerning itself that may be relevant to investors in its listed securities. Where the bonds are issued by the issuer of the underlying shares and the conversion rights are in respect of treasury shares, the obligations under the MAD will apply. 11 Non-EU issuers that use US GAAP are not required to use IAS in their annual reports prior to the financial year starting on or after 1 January 2007, by which point the EU Commission will have identified what will be equivalent standards March 2005

11 Impact of the New Regime For current EU issuers with convertible or exchangeable bonds listed on an EU regulated market, there will be little or no change. These issuers will, in any event, most likely be subject to regular reporting and annual update requirements in connection with their listed shares. On new issues of convertible bonds by EU issuers the main implications will be (i) the additional level of disclosure which, even on an offering not sold into the US, will be more akin to the type and level of disclosure seen on 144A and registered offerings into the US and (ii) the inability to choose the authority who must approve the prospectus. Consideration may be given to ways of structuring convertibles so as to avoid some of these effects, for example satisfying conversion rights from treasury shares or those held by a non-group company under a synthetic treasury structure, which may qualify the bonds as exchangeables rather than convertibles, or at least reduce the disclosure burden imposed upon issuers. For non-eu Issuers, with only convertible or exchangeable bonds listed in the EU, the most significant change will be the requirement for annual reports containing IFRS accounts audited in accordance with international audit standards, both in the prospectus and, on an on-going basis, under TOD. The cost of compliance with this may make it appropriate for non-eu issuers who otherwise do not have to produce IFRS accounts to consider de-listing from EU markets or to transfer over to an Exchange Regulated Market. Both the London Stock Exchange and the Luxembourg Stock Exchange have expressed an intention to establish a market platform or segment (each an Exchange Regulated Market ) that is not a regulated market for the purpose of the EU regime (and therefore will fall outside the ambit of the directives) but will be regulated by the relevant exchange (and in the UK, by the UKLA which grants the listing). The Luxembourg Stock Exchange has stated that the operating rules of the Luxembourg Exchange Regulated Market will be almost identical to the current rules. We await further details from the Luxembourg Stock Exchange on this. The FSA in the UK has published a consultation paper 12 setting out the proposed details of its Exchange Regulated Market for listed specialist securities 13 (including convertible and exchangeable bonds). Issuers of convertible or exchangeable bonds (irrespective of the denomination of the bonds) will be required to prepare listing particulars containing the same Financial Services Authority Consultation Paper 04/06 October 2004 The Listing Review and implementation of the Prospectus Directive Draft rules and feedback on CP203. Specialist securities are those that comply with Chapter 23 of the Current UK Listing Rules and are sold to persons who may be expected normally to buy or deal in securities of that kind (see section 82(c) of FSMA). Equity Linked Bonds and the New EU Regime 11

12 disclosure as is required for wholesale debt under the PD Regulation 14 and the information required to be disclosed in the underlying share building block (i.e. Annex 14). Therefore IFRS is not required to be included in the listing particulars and considerably less disclosure need be made. The FSA has clarified that issuers of specialist securities will not be required to report historical financial information in IFRS or an equivalent GAAP either in listing particulars or as a continuing obligation requirement. The FSA expects to follow that approach following implementation of TOD. The FSA has, however, proposed to apply certain of the MAD obligations (including the obligation to prepare and maintain insider lists) to issuers on its Exchange Regulated Market. It remains to be seen what other regulations the Exchange Regulated Market will be subject to. Given that these markets are within the jurisdiction of the EU, it is not inconceivable that they could also be subject to future EU legislation. Another alternative for issuers for which the new EU regime is inappropriate is to list their convertible or exchangeable bonds on exchanges outside the EU such as the Switzerland, Singapore or Hong Kong exchanges, each of which is developing processes to enable issuers with securities admitted to trading on EU regulated markets to transfer those securities and their listings. For further information on these alternatives please click here 14 i.e. Annexes 9 and 13 of the PD Regulation. For further information on the issues discussed in this article, please contact your usual Linkaters contact This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts at Linklaters, or contact the editors. Linklaters. All Rights reserved 2005 Please refer to for important information on the regulatory position of the firm. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. London One Silk Street London EC2Y 8HQ Tel: (44-20) Fax: (44-20) We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com 12 A /0.1/16 Mar 2005