The future of UK equity markets: what’s over the Hill?
Lord Hill’s review on UK listings (produced at the behest of the UK Treasury) makes suggestions to help ease these pressures along with proposed solutions around other structural weaknesses that we can’t help but sympathise with:
- overly complicated processes; documents that are duplicative, and lengthy timescales;
- unnecessary and burdensome regulatory requirements; and
- a lack of flexibility in the premium listed segment that can serve to deter high-growth companies.
In this context, the suggestions made in the UK Listing Review are very welcome and might just represent the turning point that we need. For everyone involved in corporate finance, and indeed for the wider UK economy, we very much agree with Lord Hill’s assertions that we need strong public markets to help companies fund growth and investment and spread wealth and investment across the UK.
The Review makes 15 recommendations to improve the competitiveness of the UK equity markets. We agree with many of them. Of those recommendations, the 5 key proposals we want to discuss here are:
- permitting dual class share structures in the premium listed segment;
- improving the marketability of special purpose acquisition vehicles (SPACs);
- facilitating the provision of forward-looking statements;
- changing free-float requirements; and
- a redesign of the prospectus regime.
Dual class share structures
The ability for newly listed companies to give “outsize” voting rights on certain matters to founder shareholders (or “dual class” structures) is something we advocated for 3 years ago. What is proposed strikes a sensible balance between accommodating the concerns of founder-backed, high-growth businesses with the UK’s high corporate governance standards. These structures will be permitted within the premium listed segment for a maximum duration of five years (following which the outsize voting rights must cease or the issuer move listing segment). During this time, the founder would be able to block a change of control of the company. By providing founders with a transition period during which they are able to ensure control is retained, it is hoped that concerns relating to early opportunistic takeover bids will be avoided.
We think that this flexibility is welcome and will be embraced by certain companies looking at a UK listing. It is no coincidence that on the day after the publication of the Report, one of the UK’s most famous and valuable tech start-ups, Deliveroo, announced that “it is expected to adopt a time-limited dual-class share structure to provide Will Shu, founder and CEO, with the stability to take decisions to enable the company to execute on its long-term strategic vision in order to create long-term shareholder value”. Let’s hope there are many more Deliveroos to come.
SPACs are the current craze of global capital markets, accounting for more than 20% of overall deal activity in the first two months of 2021. Whereas there have been 248 SPAC vehicles listed in the US in 2020, raising £63.5bn in aggregate, London has largely missed out on this SPAC revolution (only four SPACs were listed in the UK in 2020, raising an aggregate total of £0.03bn).
SPACs are cash shells formed with a view to making one or more acquisitions based on a stated investment policy. The speed of fundraise is the key advantage for a SPAC, principally because, prior to acquiring assets, a SPAC is a simple business to list.
As we have previously identified, the key deterrent to SPACs listing in the UK is that trading in the SPAC’s shares is suspended at such time as it identifies an acquisition target. That leaves investors potentially locked into their investment for an uncertain period. The Review suggests that the FCA should remove this requirement (as it has done for commercial companies).
There are very valid concerns that SPACs might be seen as a way of circumventing the traditional method of listing a company, resulting in unsuitable companies coming to market which runs the risk of damaging corporate failures. The Review addresses this point to a certain extent, suggesting that the FCA develop appropriate rules and guidance further to increase investor confidence in SPACs, including on:
- the information which SPACs must disclose to the market upon the announcement of an acquisition;
- the right of investors to vote on acquisitions prior to their completion;
- the right of investors to redeem their initial investment prior to the completion of an acquisition; and
- if necessary, to safeguard market integrity, the size of SPACs below which the suspension requirement may continue to apply.
We agree that the proposals remove a significant barrier to SPACs listing in London, and that some well-developed additional safeguards should enable a deeper UK SPAC market to develop.
Issuers have traditionally avoided making forecasts in their prospectuses because it can significantly increase the liability for those responsible for the prospectus, due to the simple fact that no company has complete control over what happens in the future. In addition, forecasts need to be formally reported upon by accountants, which is an expensive and time-consuming process. But the Review recognises that investors are very keen to receive such information and that the gap has traditionally been filled by connected research analysts providing forecasts in their research. It sees that process as highly inefficient and unsatisfactory. We agree. In particular, it can lead to a position where information that is plainly material to an investor is not included in a prospectus, which must be a weakness.
The Review proposes that the issue could be solved by reforming the liability regime for the company and its directors. Its tentative suggestion is that this could be achieved by directors having a defence to liability provided that they could demonstrate that they had exercised due care, skill and diligence in putting the information together and that they honestly believed it to be true at the time at which it was published.
In our view, that defence is not very different from the existing defences for a claim for prospectus liability set out in the Financial Services and Markets Act 2000. We would like to see a more radical solution (defending directors against other heads of liability, such as the law of negligent misstatement and statutory and common law misrepresentation) in order to substantively reduce the risk profile. The requirement for accountants to report on profit forecasts should also be reviewed or modified.
Market participants providing evidence to the Review said that the existing FCA Rules on free float are one of the strongest deterrents to listing in London, particularly for high growth and private equity backed companies. Analysis conducted by the London Stock Exchange referred to in the Review shows that, in the US, there is no significant drop in secondary market liquidity until below a 10% free float.
The two key changes proposed by the Review are to:
- widen the definition of what counts towards the free float; and
- reduce the required free float from 25% to 15%.
Investment managers and other institutional shareholders are currently excluded from the free float calculation if they hold 5% or more an issuer’s shares. It is proposed this is increased to 10%. The Review also suggests that test is further refined to take account of holdings that are diversified across fund managers within the same investment house who are making independent decisions.
The Review adds that companies of different market capitalisation could use alternative measures to the absolute percentage of 15% to demonstrate that there will be sufficient liquidity in their shares following listing.
We generally welcome these changes but think that, on the margins, it will make the analysis of the free float a more complicated exercise. While the Review considers the FCA’s confirmation of alternative criteria ought to be confirmatory in nature rather than involving inherent discretion, that might be difficult to achieve in practice.
A redesign of the prospectus regime
This is perhaps the most intriguing but least well-developed of the areas of the Review. At the heart of the proposal is the idea that, rather than using prospectus requirements to limit access to capital raising, the prospectus regime should be tailored to the circumstances of the transaction that is being used to raise capital.
While a laudable aim, there is considerable work to be done in defining those circumstances. We agree with the Review’s comment that for existing listed issuers the reporting requirements and market abuse rules mean investors receive information on a regular basis, and that a prospectus adds little.
We think that there is at least a case for removing some of the meaningless disclosure that has built up over the years in prospectuses. In addition, we think that a short form disclosure document may be appropriate for certain types of secondary issues.
It is exciting to think that we may be on the cusp of a complete redesign of the prospectus regime, which could help propel the UK capital markets to greater relevance. We will watch the developments with interest.