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08 February 2019

Corporate Law Update

A round-up of developments in corporate law for the week ending 8 February 2019.

This week:

FCA discloses EEA stock exchanges applying for recognition

The Financial Conduct Authority (FCA) has published a list of operators of European Economic Area securities markets that have applied to become “recognised overseas investment exchanges” (ROIEs).

The ROIE regime has been set up by the FCA to allow European market operators to continue to offer market access to UK-based members if passporting ends when the UK leaves the European Union.

To date, applications have been made by (among others) Deutsche Börse AG, which operates the Frankfurt Stock Exchange. Euronext, which operates in Amsterdam and Paris, and operates the Irish Stock Exchange, has also notified its intention to apply for recognition.

ESMA clarifies position of prospectuses following Brexit

The European Securities and Markets Authority (ESMA) has updated its Q&A on prospectuses to add two new questions regarding the position if the UK leaves the European Union without a withdrawal agreement. The new questions confirm the following:

  • A non-EU issuer which has currently chosen the UK as its “home state” for prospectus approvals will need to choose another EU, EEA or EFTA member state as its new home state. This would include all UK issuers on “exit day” because, from that date, the UK would become a “third country” and any UK issuers would become “third country issuers”.

    These issuers would be able to choose any EU, EEA or EFTA member state in which they make an offer to the public or in which their securities are admitted to trading after exit day. However, an issuer could not choose a state in which it made and closed an offer entirely before exit day.
  • Following exit day, it will no longer be possible to passport a prospectus that was approved in the UK by the Financial Conduct Authority (FCA) into an EU, EEA or EFTA member state. This is the case even if the prospectus was approved before the UK leaves the EU.

    What is more, where a UK-approved prospectus has been passported into the EU before exit day, it will no longer be possible to use that prospectus to offer securities to the public or admit securities to a regulated market.

    This differs from the likely position for passporting prospectuses from the EU into the UK. In those cases, the UK Government has confirmed that a prospectus approved in the EEA before exit day will continue to be valid in the UK until it expires.

    The overall effect of this would appear to be effectively to nullify the use of UK-approved prospectuses throughout the EU, EEA and Switzerland following Brexit.

    ESMA has confirmed that this will not affect any current listings in other EU, EEA or EFTA states. However, an issuer that wishes to continue an existing public offer, make a new public offer or apply for a new admission to trading will need to get its prospectus re-approved in its new home state. (Usefully, ESMA states that the issuer could submit its existing prospectus, rather than drawing up an entirely new one.)

    This is particularly problematic for issuers that wish to continue an existing public offer, because they will not be able to apply for “re-approval” until the UK actually leaves the EU. There would therefore need to be a “hiatus” in the offer while the issuer seeks re-approval.

FRC consults on changes to its Stewardship Code

As we noted last week, the Financial Reporting Council (FRC) has launched a consultation on changes to its Stewardship Code. The FRC says the purpose of the changes is to set out more rigorous reporting requirements and to focus on how stewardship activities deliver outcomes against objectives.

In particular, in a substantial enlargement of scope, the FRC is proposing to extend the Code beyond merely UK listed equity investments to encompass private equity and infrastructure investments.

What is the Stewardship Code?

The Code sets out what the FRC considers best practice for institutional investors when exercising their stewardship responsibilities in relation to UK listed companies. Like the FRC’s UK Corporate Governance Code, it operates on a “comply or explain” basis. Certain asset managers are required to report against the Code under the Financial Conduct Authority’s Conduct of Business Sourcebook. Other institutional investors can apply to become “signatories” to the Code and adopt it voluntarily.

What is the FRC proposing?

The key proposed changes coming out of the consultation are as follows:

  • The Code would be restructured to follow a format similar to that of the new UK Corporate Governance Code. It would be split into five sections for asset owners and asset managers (each divided into Principles, Provisions and guidance), with a separate section for service providers.
  • The revised Code would require signatories to establish an organisational purpose, strategy, values and culture to fulfil their stewardship objectives. The FRC believes this focus on purpose would align the Code with the UK Corporate Governance Code.
  • The Code would impose higher standards on asset owners and managers when integrating stewardship responsibilities into investment decisions.
  • The revised Code would no longer apply just to UK listed equities. Instead, it would apply to all asset classes, “no matter how capital is invested”. This would include private equity holdings, bonds, infrastructure and “alternatives”.
  • Reflecting an on-going trend, the Code would place greater emphasis on material environmental, social and governance (ESG) factors. This includes climate change.
  • Signatories would report on a two-stage basis. They would publish an initial “policy and practice statement” when signing up to the Code, followed by an annual “activities and outcomes report”.

The FRC has asked for comments by 29 March 2019.

PLSA publishes new Voting Guidelines for 2019

The Pensions and Lifetime Savings Association (PLSA) has published its Corporate Governance Policy and Voting Guidelines for 2019.

The Guidelines are designed to assist the PLSA’s members with promoting the long-term success of the companies in which they invest and holding the management of those companies accountable. In particular, they contain a series of recommendations for voting on particular resolutions at AGMs.

The PLSA has made the following changes to the Guidelines for 2019:

  • The Guidelines now focus more on developments in corporate governance in the UK. They cite the Principles from the new UK Corporate Governance Code and relate the PLSA’s guidance to those Principles. This is designed to help pension schemes, asset managers and proxy voting agents interpret the Code and express their view on how well a company has applied it.
  • When taking capital structure decisions, companies should balance their financing needs with the interests of broader stakeholders. In particular, they should strike a balance between paying dividends to shareholders and reducing deficits in defined benefit pension schemes.
  • Pension schemes that outsource their stewardship activities should set out their expectations of asset managers and service providers. This ties in with the FRC’s proposed new Stewardship Code (see above), which sets out separate guidance for asset managers and “service providers”.
  • The board should scrutinise the language of the company’s public statements to decide whether they give a clear sense of the company’s corporate purpose, culture and values.
  • A company’s chief executive should not become chair except in “exceptional circumstances”. There should be significant and timely engagement with shareholders before doing this.
  • Companies should have a clear sense of demands on directors’ time. The directors’ other appointments should be set out in the company’s annual report.
  • Shareholders should understand relationships between a company and its independent non-executive directors that could compromise their ability to hold management to account.
  • Shareholders will expect organisations that carry out external board reviews to take an “independent and rigorous approach”.
  • Shareholders should pay close attention to the composition of audit committees to ensure that committee members have the appropriate expertise and that any connections with the company’s auditor are clearly disclosed.
  • Significant pay discrepancies between executive management and the workforce, or based on gender or ethnicity, may be indicative of wider problems with a company’s workplace culture.
  • Investors should continue to press companies to clearly explain the reasons for increases in the fixed pay of senior executives. The company’s executive pay policy should incentivise behaviour that is consistent with the company’s purpose and values.

FCA and FRC consult on improving corporate stewardship

As we noted last week, the Financial Reporting Council (FRC) and the Financial Conduct Authority (FCA) have published a joint discussion paper on building a regulatory framework for effective stewardship.

The purpose of the paper is to advance debate and gather views on how best to encourage institutional investors to engage more actively in stewardship of the assets in which they invest.

In particular the FRC and FCA are seeking input on the following:

  • Whether the FRC/FCA’s interpretation of “stewardship” is appropriate or if it should be defined differently. The FRC and FCA define “stewardship” as “the responsible allocation and management of capital across the institutional investment community, to create sustainable value for beneficiaries, the economy and society”.
  • Any areas that effective stewardship should focus on. The paper lists environmental, social and governance (ESG) matters, innovative research and development, sustainability in operations and executive pay as examples.
  • Whether the key attributes of stewardship proposed by the FRC/FCA capture the concept of “effective stewardship”. The paper lists four key attributes: clear purpose; constructive oversight, engagement and challenge; institutional culture and structures; and disclosure and transparency.
  • How firms with different objectives and strategies approach stewardship. The FRC and FCA are particularly interested in how stewardship practices differ across active and index-tracker funds and how stewardship activity is integrated into investment decisions.
  • The key barriers to achieving effective stewardship. The paper suggests that barriers might arise from cost pressures, misaligned incentives, discrepancies across different investment strategies, and inadequate information flow between issuers and asset owners and managers.
  • The balance between regulation and codes of practice. To this end, the paper sets out key areas of stewardship and how these are dealt with by regulation and the Stewardship Code.

The FRC and FCA have asked for feedback by 30 April 2019.

FCA consults on changes to Handbook to implement SRD II

The Financial Conduct Authority (FCA) has published a consultation on proposed changes to its Handbook to implement certain provisions of the Second EU Shareholder Rights Directive (SRD II).

SRD II is designed to promote effective stewardship and long-term shareholder engagement by enhancing transparency between issuers and investors and by requiring investors to disclose their investment and stewardship strategies.

EU Member States have until 10 June 2019 to implement SRD II in their domestic law. The FCA’s proposals are predicated on the UK and the EU reaching an agreement under which the UK will remain obliged to implement SRD II. If no agreement is reached, the FCA will return with new proposals.

The key proposed changes are as follows:

  • FCA-regulated asset managers and life insurers would need to disclose details of their stewardship policies. This includes arrangements for engaging with certain investee companies and how they exercise their voting rights. This change would build on the current requirements in the FCA’s Conduct of Business Sourcebook, which requires FCA-regulated firms managing investments for non-individual professional clients to comply or explain against the FRC Stewardship Code.
  • UK companies with shares admitted to a regulated market would need to seek and disclose board approval for related party transactions (RPTs). For premium-listed issuers, which are already required to obtain independent shareholder approval before entering into an RPT, this new requirement will impose little additional burden.
  • A requirement for life insurers and asset managers to provide greater disclosure over their investment and asset management arrangements.

The FCA has asked for responses by 27 March 2019.

Other items

  • Corporate governance. Following AIM Rule 26 (which requires AIM companies to identify and report against a “recognised corporate governance code”) coming into effect in September 2018, the Quoted Companies Alliance (QCA) has analysed the websites of 927 AIM companies to see which codes companies are adopting. The analysis showed an overwhelming preference for the QCA’s own Corporate Governance Code (826 companies), with the UK Corporate Governance Code a distinctly second choice (55 companies).
  • ESMA clarifies position for issuers on home state under Transparency Directive. The European Securities and Markets Authority (ESMA) has published an updated version of its Q&A on the Transparency Directive. A new question clarifies that an issuer on a regulated market which has currently chosen the UK as its “home state” will need to choose a new home state, and explains how to do this.
  • FCA gives hints on LIBOR. Edward Schooling Latter, Director of Markets and Wholesale Policy at the Financial Conduct Authority (FCA), has given a speech on the impending transition away from the London Interbank Offered Rate (LIBOR) as a benchmark. Many commercial contracts currently use LIBOR as a reference point when stipulating interest rates for late payment. Mr Latter has suggested that contract parties may wish to move away from LIBOR towards near risk-free rates (RFRs).
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