A glimpse at the future of the UK’s capital markets

Following its recent announcement (see our previous Corporate Law Update), the Financial Conduct Authority (FCA) has published four engagement papers setting out proposals for the future of the UK’s regime for bringing equity and non-equity securities to market in the UK.

The UK’s current regime is set out in the UK Prospectus Regulation (inherited from EU law) and in rules made by the FCA (most notably, the Prospectus Regulation Rules).

Under UK law, a public company is free to offer securities to the public. However, unless the offer falls within one or more specified exemptions, the company is required to publish a prospectus in connection with the offer.

In addition, a company must publish a prospectus if it is proposing to admit securities to a regulated market, such as the London Stock Exchange Main Market. Again, there are certain exemptions from this requirement.

The Government has previously published a draft illustrative statutory instrument, to be made under the Financial Services and Markets Act 2000, setting out proposed reforms to this regime.

In broad terms, under the reformed regime, offering securities to the public would be prohibited unless the offer benefits from one or more “exceptions”. Many of these mirror the current exemptions from publishing a prospectus under the UK’s current regime, although some are new or have been modified.

The exceptions include where a company is proposing to admit securities to a securities exchange. In those circumstances, the FCA would have power:

• for regulated markets, to require the company to publish a prospectus as a condition to admission; and
• for so-called primary MTFs (such as AIM), to require the exchange operator to make publication of a prospectus a condition to admission.

Given these exemptions, the “stand-alone” requirement for an issuer to publish a prospectus on admission of its shares to a regulated market would be removed.

The FCA has now published four “engagement papers”, each of which deals with a different aspect of the FCA’s role in the reformed regime, designed to provoke discussion by raising specific questions.

The FCA has asked for responses to the questions by 29 September 2023.

We’ve set out the key points from each below, along with our thoughts at the end. We begin with the second of the four papers, which contains perhaps the most significant proposed changes, designed to implement recommendations from the Secondary Capital Raising Review (SCRR) (see our previous Corporate Law Update).

Further issues of equity on regulated markets (Paper 2)

Once an issuer has admitted their securities to a regulated market, it may wish to carry out further admissions later down the line to raise further equity capital (“secondary issuances”). This will commonly take the form of a rights issue, open offer and/or placing.

Engagement Paper 2 seeks views on when a prospectus should be required for a secondary issuance.

The FCA’s starting assumption is that no prospectus should be needed for a secondary issuance unless there is a clear argument that one is required for investor protection. This is because the information asymmetry that exists between an existing listed company and its shareholders is not as stark as that between a new issuer and potential investors.

As a result, Engagement Paper 2 concentrates on ways that the current regime could be scaled back to achieve this aim.

Questions on which the FCA has invited comments include:

• whether to set a minimum threshold above which a prospectus will be required based on a percentage of the issuer’s existing share capital (noting that the SCRR recommended a threshold of 75% and the European Commission has floated a threshold of 40%);
• if so, whether issuances above that threshold should require only a simplified prospectus;
• whether the FCA should require a different kind of document to be published on a secondary issuance (below any minimum threshold, if one is introduced) instead of a prospectus; and
• whether an issuer needs to have been admitted to a regulated market for a minimum period of time to benefit from not needing to publish a prospectus.

Admission to trading on a regulated market (Paper 1)

As noted above, under the new regime, a public offer would be permitted if, at the time of the offer, the securities in question will be admitted to a regulated market.

In connection with this, the FCA would have power to require the issuer to publish a prospectus, as well as to set the content of the prospectus and exemptions from publishing a prospectus.

Engagement Paper 1 seeks views on how the FCA should exercise this power.

In short, the FCA is not proposing to make any significant changes to the current framework, but it has asked for views on several core concepts.

Exemptions

The FCA is proposing to retain the current exemptions from publishing a prospectus when admitting securities to a regulated market that are set out in the Prospectus Regulation. These include where securities are admitted following a conversion of existing admitted securities (such as warrants), under a scrip dividend and/or to existing or former directors and employees.

It is also proposing to keep the exemption for securities admitted in connection with a takeover, merger or division. In this case, an issuer can publish an “exemption document” instead of a prospectus. However, in practice, this document is a prospectus in all but name and still requires FCA approval.The FCA is asking whether the content of this document should be aligned more closely to the UK Takeover Code and whether the requirement for FCA approval should be removed.

Content and format

The FCA’s starting assumption is that the content and format of a securities prospectus should remain the same, including (in particular) the financial information to be included in it. However, it has put forward several considerations for reform.

For example, it notes that the summary in a prospectus can be unduly concise (being limited to seven sides of A4 and 15 risk factors) such that it does not provide enough detail to investors, or (conversely) unduly long or duplicative, such that it unnecessarily lengthens a prospectus.

It is seeking views on whether the content requirements for a prospectus summary could be relaxed (such as by allowing cross-referencing to parts of the main body of a prospectus), or whether prospectus summaries should be abolished completely.

Assuming the prospectus summary remains, however, the FCA is not proposing at this point to change the current “tripartite” format of a prospectus.

Other points on which the FCA has invited comments include:

• whether quarterly financial information should be required in a prospectus, as this might “act against investors taking a longer-term view of securities”;
• whether to make incorporation by reference to certain documents (such as annual reports) mandatory or to extend the ability to incorporate by reference beyond base prospectuses;
• whether to provide further guidance or content requirements for ESG-related disclosures;
• whether to abolish growth prospectuses, given low take-up and the fact that, under the reformed regime, operators of MTFs would determine their own admission content requirements;
• whether to allow issuers to publish a voluntary prospectus, even where an exemption applies;
• whether to shorten the period during which a prospectus must be available from six to three working days, in line with the recommendations of the SCRR; and
• whether to extend the validity period of a prospectus beyond the current 12 months.

Forward-looking statements (Paper 3)

Currently, an issuer can include forward-looking statements (FLSs) in its prospectus. However, a person who is responsible for a prospectus may be liable for an untrue or misleading FLS if they were negligent in preparing the FLS. The burden is on the issuer to show that the FLS was not included negligently (sometimes described as a “reverse burden of proof”).

Under the reformed regime, the FCA would have the power to designate certain types of FLS as “protected forward-looking statements” (PFLSs). Provided a PFLS is labelled as such, a person who is responsible for a prospectus would be liable for an untrue or misleading PFLS only if they knew, or were reckless as to whether, it was untrue or misleading. In addition, the burden of proving inaccuracy would be shifted to the investor.

This is designed to make it easier for issuers to include FLSs in prospectuses, in turn providing investors with more useful information for making investment decisions.

Engagement Paper 3 seeks views on the types of FLS that could qualify as PFLSs and how PFLSs should be produced, presented and labelled.

In general terms, the FCA has floated three potential options:

• Define PFLSs by reference to specific categories of FLS.
• Define PFLSs by reference to broad, minimum criteria, but not specific categories. Potential criteria could include intelligibility, reliability, relevance and the ability to compare against historical financial information.
• State that all FLSs automatically amount to PFLSs, other than certain excluded categories. For example, the FCA is proposing that the new PFLS regime will not apply to working capital statements, which would remain subject to the existing “negligence standard”.

Non-equity securities (Paper 4)

The proposed reforms to the prospectus regime would also affect admissions of non-equity securities (principally, debt securities), such as bonds and notes, structured finance products, commodities and Islamic finance instruments.

Engagement Paper 4 seek views on how changes could be made to improve admissions in the context of the wholesale, debt capital markets. The paper notes that non-equity securities currently make up 89% of all securities admitted to the Official List maintained by the FCA.

The FCA’s preliminary view is that no major overhaul is required. However, it raises for discussion various possible changes that could improve the process for admitting non-equity securities.

• Stating that financial information released after a base prospectus is published would be automatically incorporated by reference into the prospectus, without the need to publish a supplementary prospectus. This would mean, however, that investors would lose withdrawal rights when new financial information is incorporated into a prospectus.
• Removing the need to publish a supplementary prospectus unless an issuer wishes to issue further securities under the relevant base prospectus.
• Extending the validity period of a base prospectus beyond the current 12 months. (The paper notes that US shelf registration statements are valid for three years.)
• Removing the current dual standard of disclosure, under which greater disclosure is required for non-equity securities with a denomination below €100,000, applying the current, less onerous standards for securities with a denomination of €100,000 or above for all securities.
• Introducing different disclosure requirements for securities that embody financial services products, such as exchange-traded funds (ETFs), notes (ETNs) and commodities (ETCs) and securitised derivatives. This might include disclosing the credentials of the promoter/organiser and the fees involved.

The FCA is also seeking views on making tap issuances (i.e. issuances of further debt securities that are fungible with existing issued securities) easier. This might include raising the threshold above which a prospectus is required or permitting a simplified form of prospectus, or allowing issuers with equity securities admitted to trading to issue low-denomination non-equity securities under a reduced disclosure regime.

Finally, the FCA is proposing to cease new listings on the Professional Securities Market (PSM) as a consequence of the changes involved in the reformed regime. The London Stock Exchange could continue to operate the PSM for existing listings if it so wishes.

Our thoughts

Prospectus reform has long been on the agenda of the UK Government and the FCA and the discussion has now hit the corporate finance mainstream.

Efforts have been made to manage the increasing length of prospectuses, such as placing limits on prospectus summaries and allowing information to be incorporated by reference.

However, despite these measures, prospectuses remain long and unwieldy documents and involve significant cost and management bandwidth by issuers to produce them. There is also an ongoing question over how many investors engage with a prospectus in depth.

The proposed dramatic increase in the threshold for when a prospectus is required for existing issuers – from the current 20% of issued share capital to a proposed 75% – on a secondary issuance is especially promising. Investors can already review issuers’ public periodic financial announcements and disclosures of significant developments under the UK’s market abuse regime.

The proposal to harmonise disclosure standards for non-equity securities, in effect alleviating the disclosure burden for smaller-denomination securities, is also particularly welcome.

In our experience, this problem is not helped by the liability that can currently be imposed on persons who assume responsibility for a prospectus

The need to protect against liability can result in expansive risk factors the main purpose of which is merely to act as a shield against legal action. And the existing standard to which forward-looking statements need to be prepared can deter issuers from including the very information that is arguably most useful to prospective investors.

Shortening prospectuses (such as by allowing more expansive incorporation by reference to existing published material), or removing them in some cases, is likely to help both issuers (by removing the significant time and cost involved in preparing and verifying the prospectus) and investors (by streamlining the information they need to review and removing duplicative diligence).

A number of questions remain over striking the right balance between investor information and issuer disclosure throughout the prospectus regime. The proposed changes are welcome, yet critics may argue that they replicate too much of the existing regime. The debate over the coming months will be an opportunity for all market participants to have a say.