slaughter and may FSA Consultation Paper CP12/25: Enhancing the effectiveness of the UK Listing Regime

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1 slaughter and may FSA Consultation Paper CP12/25: Enhancing the effectiveness of the UK Listing Regime BRIEFING october 2012 INTRODUCTION On 2 October 2012, the FSA published Consultation Paper CP12/25, which: contains feedback on proposed rule changes set out in CP12/2 in January 2012; and adds a supplementary consultation on further proposed changes to the Listing Rules which the FSA believes will enhance the effectiveness of the UK Listing Regime. The final changes to the Listing Rules, Prospectus Rules and Disclosure and Transparency Rules largely reflect (with some minor changes) the proposals made in CP12/2, which were summarised in our previous briefing. The new rules came into effect on 1 October 2012, save for: changes relating to the sponsor regime, and certain sponsor-related changes regarding reverse takeovers and financial information in class 1 circulars. These will come into effect on 31 December 2012; and certain changes to the continuing obligations of existing externally managed companies with a premium listing. Under a transitional provision these changes will not apply to such existing companies until 1 January In CP12/2, the FSA highlighted the ongoing debate on the nature of the premium listing standards, made several high-level suggestions in relation to matters such as minority shareholder protection and the free float requirements, and invited feedback. These suggestions originated in part from a debate between various market participants, including the FSA, prompted by the perceived operation of the free float requirements in a number of specific high profile cases, and governance concerns held by the investment community. Some stakeholders had argued that the free float requirements should also be used for specific governance purposes (and in particular for the protection of minority shareholders), rather than just to ensure liquidity. Discussion of this issue with investor stakeholders touched on a set of related market operational concerns. In response to similar concerns, in December 2011 FTSE increased the minimum free float for UK incorporated companies seeking inclusion in the FTSE UK indices to 25%. Having received high-level feedback in response to CP 12/2, and discussed its proposals with FTSE and the FRC, the FSA is now consulting on proposed changes to the Listing Rules. PROPOSED CHANGES The key Listing Rule changes proposed by the FSA focus on: additional requirements for premium listed issuers with a controlling shareholder; modifications to the free float rules; the application of certain Listing Principles to standard listed issuers; and the introduction of additional Premium Listing Principles.

2 INDEPENDENT BUSINESS Independence from controlling shareholders The FSA has proposed a number of additional requirements for issuers with (or seeking) a premium listing which have a controlling shareholder. A controlling shareholder is a person who holds 30 per cent. of the shares or voting power in the issuer, its parent, or possibly a combination of the two. Voting power may be held indirectly, and any holdings of persons acting in concert will be aggregated. Acting in concert is not defined, but the FSA states that this may result from either formal or informal agreements or arrangements for concerted action. The FSA s stated aim is to reinstate an express requirement (removed from the Listing Rules on 1 July 2005) that a premium listed issuer must be capable of acting independently of any controlling shareholder and its associates. The proposed new rules achieve this by requiring a relationship agreement and a majority independent board, as discussed below. Relationship agreements The FSA proposes to reinstate an express requirement for an issuer to have a relationship agreement with any controlling shareholder. This would be both an eligibility requirement for new applicants, and a continuing obligation for listed issuers. The proposed new rules set out minimum content requirements for relationship agreements, including that: transactions and relationships with a controlling shareholder (and any associates) must be conducted at arm s length and on normal commercial terms; a controlling shareholder must abstain from doing anything that would have the effect of preventing the issuer from complying with its obligations under the Listing Rules; a controlling shareholder must not influence the day-to-day running of the issuer at an operational level or hold or acquire a material shareholding in one or more significant subsidiaries; the relationship agreement must remain in place for so long as the issuer s shares are listed on the Official List and the issuer has a controlling shareholder; and any material change to the relationship agreement must be approved by an independent shareholder vote. The FSA has also proposed new rules aimed at enhancing the effectiveness and transparency of relationship agreements: a company must comply with a relationship agreement at all times (although oddly this provision is labelled as guidance rather than a rule); a copy of the current relationship agreement or a link to where it may be found must be included in the annual report; and the annual report must include a statement from the company that it has complied with the relationship agreement throughout the financial year. Where the issuer has not so complied, the directors must describe the provisions breached so that shareholders can evaluate the impact on the company, and also confirm that the FSA has been informed. Majority independent board Under the UK Corporate Governance Code, at least half of the directors of FTSE 350 companies should be independent, and the Chairman should be independent on appointment. However, companies may choose to explain rather than comply with this requirement. 02

3 Where a premium listed issuer has a controlling shareholder, the FSA proposes a departure from this approach. Under the proposed new rules, any such issuer will be required to have a majority independent board that is, with either a majority of independent directors, or a majority comprising independent directors plus a Chairman who was independent on first appointment. Independence will be determined by the issuer s board of directors under the UK Corporate Governance Code. However, the consultation also gives the option of preserving issuers existing flexibility regarding director independence, subject to the requirement to comply or explain. This suggests the FSA expects some resistance to its proposal. The new requirement for majority board independence will be both an eligibility requirement and a continuing obligation. However, once listed, an issuer would have six months to rectify any non-compliance (for example, following the resignation of an independent director). Election of independent directors A dual voting requirement will apply when electing independent directors to the board of an issuer with a controlling shareholder. Independent directors will need to be approved by a vote of all shareholders, plus a separate vote of the independent shareholders only (i.e. excluding the controlling shareholder and its associates). If either vote is defeated, then the listed company may propose a single further vote to elect the proposed independent director after waiting for at least 90 days. This may be passed by all shareholders voting together, i.e. with no separate vote for independent shareholders. The effect is to impose a 90-day cooling off period to allow shareholders to engage in discussions and try to reach a solution acceptable to both the controlling and independent shareholders. However, if the controlling shareholder is not minded to accept a compromise candidate, then it will be able to use its voting power to support the election of its chosen independent director. Sponsor s role When the issuer floats or issues further shares, the sponsor must confirm that all of the relevant requirements of the Listing Rules have been satisfied, including these new eligibility requirements. The FSA has stated that it will draw heavily on the sponsor in assessing whether a new applicant has complied with the controlling shareholder rules. Independence in other circumstances The FSA will also retain the existing requirement that a premium listed issuer must demonstrate that it will be carrying on an independent business, both as an eligibility requirement and a continuing obligation. The FSA highlights that independence means more than simply operating independently of any controlling shareholder. Proposed new guidance on the independent business requirement indicates that the FSA is likely to be concerned where, for example, the issuer does not have strategic control over commercialisation of its product or its ability to earn revenue, or if the issuer cannot demonstrate that it has access to financing other than from a controlling shareholder (or an associate). Removal of exemption The FSA proposes to extend the requirement that premium listed issuers carry on an independent business to mineral companies and scientific research based companies. Currently such companies are exempt from this requirement. The FSA acknowledged that, even after it ceased to be a requirement on 1 July 2005, most new applicants with a controlling shareholder continued to put in place relationship agreements which enabled the issuer to act independently from the controlling shareholder. Reinstating the rule requiring a relationship agreement is therefore unlikely to have a significant impact on 03

4 current practice. Moreover, the prescribed content requirements broadly reflect those which issuers currently apply. In addition, a requirement to carry out transactions on normal commercial terms is policed through the related party transaction rules, and it would appear unnecessary to require a relationship agreement for this purpose. Although the requirement for the issuer to comply with the relationship agreement at all times (and associated reporting obligations) is new, it is not clear what benefits this requirement will bring. Relationship agreements tend to impose more obligations on the controlling shareholder than the issuer, so reporting on the issuer s compliance will only tell part of the story. While there is a requirement for any material amendments to be approved by independent shareholders, there is no requirement for shareholder approval at the time that a relationship agreement is adopted. The benefits of the proposed dual voting requirement for the election of independent directors are not clear: a simple requirement that an issuer with a controlling shareholder must have a majority independent board should be sufficient to address the FSA s concerns that some such issuers choose to explain rather than comply with this aspect of the UK Corporate Governance Code. There is no need to impose an additional dual voting requirement; while the dual voting requirement will significantly change the process for electing independent directors, it may have little impact in practice given that the fallback is a single vote by all shareholders (after a cooling off period); and the dual voting requirement partially disenfranchises some shareholders (albeit only for 90 days), which runs contrary to the general principle of one share one vote enshrined in company law. CONTROL OF BUSINESS Amended control requirement The FSA will amend the existing requirement that a premium listed issuer must control the majority of its assets ; the amended rule will require such an issuer to control the majority of its business. The FSA believes the amended rule will reflect a holistic view of the issuer s business. This will remain both an eligibility requirement and a continuing obligation. Proposed new guidance for this rule identifies one of its purposes as being to ensure that a premium listed issuer has an unfettered ability to implement its business strategy. The guidance identifies the following as factors that may indicate that an issuer does not have such an unfettered ability: the issuer is able to exercise only negative control or only has veto rights over significant decisions affecting the management of the business made by third parties; the issuer has precarious control of the business that relies for example on contractual arrangements that may be altered without its agreement; or the issuer has in place contractual arrangements which result, or could result, in a temporary or permanent loss of control of its business. New applicants which have undertaken acquisitions The existing rule requires a new applicant to have controlled the majority of its assets for at least its entire three-year track record period. This is inconsistent with another existing requirement that a new applicant provides three years of accounts representing at least 75% of its business. Parts of the business acquired during the threeyear track record period will not have been controlled by the issuer prior to being acquired. So, a new applicant may have three years of accounts covering 75% of its business, but be unable to show that it has controlled the majority (50%+) of its assets for three years. 04

5 The FSA states that the acquisition of entities within the three year track record period should not rule out eligibility for premium listing. However, it is concerned where entities that have formed part of the issuer s track record and upon which a new applicant is relying to establish its eligibility have not been controlled throughout the track record period and control only passes on or shortly before admission. The primary reason for the FSA s concern is that the financial information presented will generally reflect the lack of control. The FSA therefore proposes adding new guidance that a new applicant may be ineligible for a premium listing if non-controlled interests have represented the majority of its business for a significant part of the three-year track record period. Removal of exemption The FSA proposes to extend the requirement that premium listed issuers control the majority of their business to scientific research based companies. Currently such companies are exempt from this requirement. The amended rules would include two similar requirements: that an issuer controls its business, and that it carries on an independent business (i.e. free of control by others, especially a controlling shareholder). Under the changes which came into force on 1 October 2012, a third overlapping requirement was added (which will only apply to existing companies from 1 January 2014), that an issuer s board s discretion to make strategic decisions must not be limited or transferred to a person outside the issuer s group. The FSA s key concern appears to be that a person outside of the issuer s group may have, or acquire, excessive control over the issuer s business. Perhaps a single targeted rule would have been sufficient to address this concern, supplemented if necessary by another rule dealing with any unrelated concerns which the FSA may have. However, as it stands issuers will be subject to three separate, and partly overlapping, eligibility requirements and continuing obligations. It is to be hoped that the FSA will be pragmatic when considering whether a premium listed issuer has an unfettered ability to implement its business strategy. For example, loan security documentation routinely contains provisions which could result in the temporary or permanent loss of control of the issuer s business. FREE FLOAT Rationale for changes In the FSA s view, the free float requirements are aimed at ensuring liquidity, rather than ensuring effective corporate governance. (However, it notes there is considerable debate amongst market participants on this point.) This view underlies the FSA s proposals in this area. Eligibility for being considered part of the free float Under the existing rules, at least 25% of any class of shares (whether admitted to a premium listing or standard listing) must be held in public hands within the EEA. However, the FSA may accept a lower percentage in certain circumstances. When calculating what shares are held in public hands, the FSA proposes to exclude any shares held by a person subject to a lock-up period of more than 30 calendar days. Under the existing rules, public hands shares do not include any 5% or greater interest held by persons in the same group or acting in concert. The FSA proposes to create two new carve-outs to this requirement, allowing the following interests to count as being in public hands: holdings of investment managers in the same group, where investment decisions are made independently by the individual in control of the relevant fund. However, this carve-out is not automatic, and is subject to the FSA s discretion; and 05

6 interests through financial instruments providing a long economic exposure to shares, but not giving control over decisions in respect of those shares (especially buy/sell decisions), so long as the provider of the instrument does not itself acquire a 5% or greater interest in those shares. Modifying the free float requirement for premium listed issuers Existing guidance gives the FSA the ability to accept a free float of less than 25% if it is satisfied that there will nonetheless be a properly functioning secondary market in the shares. The FSA has proposed adding details of the criteria that it will apply in reaching such decisions. Specifically, a lesser free float may be accepted where the number of public shareholders is more than 100 and the expected market value of the shares in public hands at admission exceeds 250 million. The FSA also proposes amending its guidance to clarify that, other than in exceptional circumstances, it will not consider requests to reduce the free float requirement at admission to less than 20%. As the free float requirement is also a continuing obligation, presumably the same thresholds (100 shareholders/ 250 million, and 20%) would also apply going forward. Modifying the free float requirement for standard listed issuers For standard listed shares and depositary receipts, the FSA proposes to change its interpretation of the current guidance regarding when it will accept a free float of less than 25%. These changes will allow the admission of shares and depositary receipts with a very small percentage of free float in absolute terms, provided that there will still be sufficient liquidity. In assessing whether sufficient liquidity is present, the FSA proposes to have regard to the number, nature and diversity of holders post-admission. The FSA s proposed guidance in relation to the circumstances in which it may agree to modify the 25% free float requirement for premium listed issuers, and the 20% absolute minimum threshold, will be useful in providing clear benchmarks to market participants. The flexibility which the FSA proposes in relation to free float requirements for standard listed issuers is also welcome. OTHER CHANGES TO CONTINUING OBLIGATIONS There have been a number of proposed changes to ensure that the various requirements which apply at the eligibility stage also apply to premium listed issuers on a continuing basis. The FSA also proposes certain other amendments to the continuing obligations of premium listed issuers, including: a new requirement that all shareholder votes which the Listing Rules require a premium listed issuer to undertake (e.g. to approve a class 1 transaction) must be decided by holders of shares that are premium listed. Proposed guidance allows the FSA to modify this requirement in exceptional circumstances, such as to accommodate special share arrangements designed to protect the national interest and duallisted company voting structures; a new requirement that a premium listed issuer must notify the FSA without delay if it no longer complies with any continuing obligation set out in LR 9.2 (which obligations include compliance with the premium listing eligibility requirements on an ongoing basis and taking steps to secure the compliance of PDMRs with the Model Code); new guidance that where a premium listed issuer is unable to comply with any continuing obligation set out in LR 9.2, it should consider applying for a 06

7 cancellation of its listing or a transfer of its shares to a standard listing. However, under existing rules, shares cannot be transferred from a premium to a standard listing unless 75% of shareholders vote to approve the transfer; a new requirement that certain matters which the Listing Rules require to be disclosed in the annual report and accounts are presented in a single identifiable section; new minimum requirements for the disclosure of smaller related party transactions in the annual report and accounts, including comparative information for the previous two financial years; and making the eligibility requirement that limits the total of all warrants or options to subscribe for equity shares to 20% of the listed company s issued share capital at the time that the warrants or options are issued a continuing obligation as well or, alternatively, removing this eligibility requirement. The new requirement that only holders of premium listed shares may vote on certain matters will potentially cause difficulties for any premium listed issuers with multiple classes of voting shares, where some of those classes are only standard listed or unlisted. However, this is only likely to affect a small number of premium listed issuers. At present, a premium listed issuer is only required to notify the FSA if it ceases to comply with the free float requirement. This distinction between shares in public hands, and shares which are not, is fairly objective and reasonably easy for companies to monitor (as they will have access to information regarding their shareholders). However, under the proposed new rules, issuers would be under an obligation to notify the FSA of breaches of requirements which are far more difficult to monitor. For example, the rule requiring an issuer to control the majority of its business is accompanied by lengthy guidance setting out (apparently non-exhaustive) factors which the FSA will take into account when applying it. It will be difficult in practice for issuers to determine how the FSA would exercise its discretion in applying such rules. Moreover, save for the requirement for a majority independent board, the FSA has not provided any grace period for premium listed issuers to rectify any noncompliance. THE LISTING PRINCIPLES Application to standard listed issuers At present the Listing Principles only apply to the premium listed issuers. The FSA has proposed drawing a new distinction between Listing Principles and Premium Listing Principles. As a result, two of the existing Listing Principles will apply to all listed companies, including those with only standard listed securities (e.g. bonds): existing Listing Principle 2, which requires a listed company to take reasonable steps to establish and maintain adequate procedures, systems and controls to enable it comply with its obligations; and existing Listing Principle 6, which requires a listed company to deal with the FSA in an open and cooperative manner. Premium Listing Principles The FSA has proposed that six Premium Listing Principles will apply to premium listed issuers only. Four of these are restatements of existing Listing Principles, with two new principles being introduced: Premium Listing Principle 3: introduces a one share, one vote principle for premium listed classes of shares. 07

8 Premium Listing Principle 4: requires that where an issuer has more than one class of equity shares admitted to premium listing, the aggregate voting rights of the shares in each class should be broadly proportionate to the relative interests of those classes in the equity of the issuer. Under proposed new guidance, in assessing whether the voting rights are proportionate, the FSA will have regard to factors including the commercial rationale for the difference in voting rights. Additional disclosure The FSA proposes that premium listed issuers be required to disclose in their annual report how they have applied Premium Listing Principle 1. Premium Listing Principle 1 (restating existing Listing Principle 1) requires an issuer to take reasonable steps to enable its directors to understand their responsibilities and obligations as directors. Issuers with only standard listed securities may wish to consider whether their existing procedures, systems and controls are sufficiently robust to satisfy their obligations under the new Listing Principles. The new requirement for premium listed issuers to disclose information regarding the application of Listing Principle 1 in the annual report is of questionable value to shareholders. The introduction of a one share, one vote principle presents a potential issue for some premium listed investment companies which have multiple classes of premium listed shares with different voting rights. This may be the case where different share classes track different pools of assets (with voting rights weighted to reflect the net asset value underlying each class), or where different share classes are denominated in different currencies, and so were issued at different prices (with voting rights weighted to reflect the prevailing exchange rates at that time). However, such share structures should comply with the new principle, given that the voting rights of each class are broadly proportionate to the relative interests of those classes in the equity of the issuer. CONSULTATION PERIOD AND TRANSITIONAL ARRANGEMENTS The FSA has requested comments on the proposed amendments by 2 January 2013, and intends to publish its feedback in the spring of The proposed continuing obligations as regards controlling shareholders will impact existing premium listed issuers. Presumably they will be given a transitional period to satisfy the new requirements. This could require entering into, or amending, relationship agreements and, more significantly, changing the composition of the board, as well as introducing a dual voting regime for the election and re-election of independent directors. POSTSCRIPT Information on ex-dividend dates In its recent Market Watch publication, the FSA has warned issuers to consider, before disclosing information, whether that information could have a significant effect on the price of either the issuer s shares or related derivatives or both. The FSA has identified instances where derivative traders have traded shortly before FTSE 100 issuers have announced ex-dividend dates. The FSA believes that in some cases investor relations departments have informed these traders of the ex-dividend date before the relevant announcement. Although information about the ex-dividend date may not have a significant effect on the price of the issuer s shares, it may in some cases have such an effect on related derivatives. In these cases, selective disclosure should not be made before the relevant announcement is made. 08

9 UKLA Helpdesk Since 1 October 2012, the UKLA Helpdesk no longer addresses queries on a no names basis. All queries are required to identify the relevant issuer. In addition, generally, requests for guidance must be made in writing. Oral queries may be submitted in cases of exceptional urgency and by sponsors during the provision of a sponsor service on a transaction. A number of proposals in the FSA s consultation paper involve extending principles-based eligibility requirements to become continuing obligations for issuers, and expanding the broadly-worded Listing Principles. This is likely to increase issuers need to consult with the UKLA. Without the Helpdesk for general queries, interpreting these rules will be more difficult and (if it is necessary to write to the FSA for guidance) more time-consuming. Slaughter and May 2012 This material is for general information only and is not intended to provide legal advice. For further information, please speak to your usual Slaughter and May contact. scqm7.indd1012