Essential Corporate News – Week ending April 15, 2016

Welcome to Essential Corporate News, our weekly news service covering the latest developments in the UK corporate world.

On April 13, 2016 the London Stock Exchange (LSE) published AIM Notice 44 in which it is consulting on proposed changes to the AIM Rules for Companies (AIM Rules) ahead of the implementation of the Market Abuse Regulation (MAR) which comes into effect on July 3, 2016. The LSE has also published a mark-up of the AIM Rules, showing the proposed amendments.

The key proposed amendments are:

• Rule 11 (general disclosure of price sensitive information) – The guidance notes to Rule 11 are being amended to clarify that AIM companies will be subject to both AIM Rule 11 and Article 17 of MAR, which provides separate disclosure obligations, and to highlight that compliance with MAR does not mean that an AIM company will have satisfied its obligations under the AIM Rules and vice versa. The LSE points out that it may take disciplinary action against an AIM company for failing to comply with AIM Rule 11, regardless of whether or not it has complied with MAR.
• Rule 17 (disclosure of miscellaneous information) – The reference to information relating to directors' dealings has been deleted from the list of information in AIM Rule 17 that an AIM company must notify without delay, and it is instead noted that Article 19 of MAR includes notification obligations for AIM companies, persons discharging managerial responsibilities and persons closely associated with them. New guidance will be added to AIM Rule 17 in respect of directors’ dealings which will signpost an AIM company’s obligations under Article 19.
• Rule 21 (restrictions on deals) – The LSE proposes removing the current AIM Rule 21 and associated guidance due to the fact that MAR will, subject to exemptions, prohibit trading during close periods. The LSE also proposes a new Rule 21 requiring AIM companies to have a dealing policy. The new Rule sets out the minimum provisions to be included in the dealing policy. It states that compliance with Rule 21 does not mean that an AIM company will have satisfied its obligations under Article 19 of MAR, that the LSE would expect an AIM company to consider its wider obligations under MAR in determining whether it is appropriate to give clearance under its dealing policy, that the LSE would expect an AIM company to appoint independent staff of sufficient seniority to grant clearance requests, and that the procedures should give consideration as to an alternate person where such person is not independent in relation to a clearance request.
• Guidance note to Rule 41 (cancellation) – AIM Rule 41 provides that cancellation of admission of AIM securities is conditional on shareholder approval unless the LSE otherwise agrees. The guidance to AIM Rule 41 includes circumstances where the LSE might otherwise agree that shareholder consent in a general meeting to cancel the trading of AIM securities is not required. The LSE proposes to clarify this guidance to make it clear that the circumstances in which it may agree that shareholder consent is not required include where an AIM company maintains or will be admitted to trading on an EU regulated market or an AIM Designated Market. For the purpose of considering this waiver, the LSE will seek assurance that the company’s admission to trading (on the other market) is not at the time subject to a suspension (or equivalent).
• Preliminary announcements - The LSE also notes that in the absence of further guidance from the European Securities and Markets Authority (ESMA), it is not clear whether an issuer is able to end its close period through the publication of a preliminary statement of its annual accounts under MAR. The LSE will consider making changes to the AIM Rules or will issue further guidance if necessary once the application of MAR in this regard is clarified.
• Nomad Rules - The LSE proposes to amend AR5 of Schedule Three of the AIM Rules for Nominated Advisers (the Nomad Rules) to remove the reference to close periods, in order to bring it in line with the proposed changes to AIM Rules 17 and 21. Other consequential changes will be made to the AIM Rules, the Nomad Rules and the AIM Note for Investing Companies where reference is made to Rule 17 ‘directors dealings’ or Rule 21 (or the terminology used for those Rules).

The LSE is requesting comments on the consultation by May 12, 2016.

Our briefing on changes for AIM companies under MAR has been updated to incorporate these proposals and can be found here. 

(LSE, AIM Notice 44: Consultation on proposed changes to AIM Rules for Companies, 13.04.16)

(LSE, AIM Rules for Companies - Consultation mark up (AIM44), 13.04.16)

On April 13, 2016 the Financial Conduct Authority (FCA) published a discussion paper (DP16/3) on the availability of information in the UK equity IPO process along with an occasional paper on the factors that influence IPO allocations to investors and an interim report on its market study on investment and corporate banking.

The discussion paper covers the following:

• Background on UK IPOs – Chapter 2 of the discussion paper draws on the evidence provided by the FCA’s investment and corporate banking market study. In particular, the FCA focusses on the aspects of the IPO process that it examines later in the paper when it considers concerns and possible interventions. The paper sets out how and where companies can come to market or ‘float’ in the UK, and details the value and volume of UK IPOs. It then sets out the role of the different participants in the IPO process and includes a description of the process, incorporating findings from the FCA’s market study on the sequencing of key sources of information and events. It ends with a brief consideration of the UK regulatory framework governing the IPO process.
• Concerns with the UK IPO process – In chapter 3 of the discussion paper, the FCA notes that the pathfinder prospectus is typically made available to investors two weeks after the intention to float announcement, and the final approved prospectus is published a further two weeks later, at the end of the book-building process. The main reason is the blackout period between the publication of connected research and the circulation of the pathfinder prospectus. The FCA considers the concerns this creates and looks at the timing of prospectus availability and what impact this has on the robustness of investors’ decision-making, concerns over how much the UK IPO process relies on connected research, why the blackout period exists, whether the timing of the circulation of the pathfinder and publication of the final approved prospectus limits the ability of unconnected analysts to publish research during the IPO process, and risks that current market practice present to the FCA’s objectives.
• Initial policy considerations – In chapter 4 of the discussion paper, the FCA notes that the UK practice of observing a blackout period means investors believe that the prospectus is available too late in the process, leaving them reliant on connected research. There is also a concern that current market practice creates barriers to the production of unconnected research which could act as a useful source of additional information for investors. The FCA considers whether intervention is warranted, or whether a solution could be market-led and sets out what improved market practice might look like and the changes a policy intervention would aim to achieve. The FCA then considers the extent to which both connected and unconnected research are a valuable feature of the IPO process, where the prospectus is available in good time, and compares regulatory and market practice in the US.
• Policy options and routes to reform - In chapter 5 of the discussion paper, the FCA sets out policy options for routes to reform. The two key measures considered are (i) a re-sequencing of the publication of an approved prospectus and connected research (which could eliminate the existing blackout periods so connected research would not be distributed by syndicate banks for a specified period after the publication of the prospectus) and (ii) allowing unconnected analysts access to the issuer’s management, creating an opportunity for unconnected analysts to produce research. The chapter then goes on to talk about a series of models, including illustrative timelines, for the IPO process (all of which include reference to the possibility of splitting the prospectus between the registration document, which is published at an earlier stage, and the securities note which is published at the end of the process).

      The three models are:

• Model 1: Requiring a blackout on connected research until seven days after an approved prospectus/registration document is published – The FCA believes this would incentivise underwriting and placing firms wishing to publish connected research to advise their IPO clients to publish the approved prospectus earlier in the process and would foster conditions for producing unconnected research (because unconnected analysts would have access to the prospectus much earlier than currently and could use it to inform their research). The FCA notes this would reduce investor reliance on connected research, reinstate the prospectus as the central information source and so increase the likelihood of better investment decisions and more efficient price formation.
• Model 2: Opening any analyst presentation to unconnected research analysts and requiring a blackout period on connected research until seven days after publication of an approved prospectus/registration document – The FCA notes that this retains the key features of Model 1 but includes a mandatory additional measure that would give unconnected analysts access to the issuer’s management (the paper notes that it could be sensible to frame this measure in a way that provides unconnected analysts with access to the issuer’s management as part of the same meeting as connected analysts). It notes that this model builds on current practice by adapting the existing analyst presentation to place unconnected analysts on the same footing as their counterparts within the syndicate.
• Model 3: Opening any analyst presentation to unconnected research analysts and prohibiting such a meeting from taking place until after publication of an approved prospectus/registration document – The FCA notes that this model would represent a significant shift from current practice and achieve the most arm’s length relationship between the underwriting firms and their research analysts. However it also notes that a potential disadvantage of this model would be the lack of opportunity for analyst feedback to inform the prospectus document which is released at the start of the investor education and marketing period.

The FCA has requested comments on the discussion paper by July 13, 2016.

(FCA, Discussion Paper/DP16/3: Availability of information in the UK Equity IPO process, 13.04.16)

This occasional paper, published by the Financial Conduct Authority (FCA), seeks to understand if the IPO allocation process works in the interests of issuer clients or whether conflicts of interest may result in banks favouring their highest-revenue clients when deciding on final allocations in IPOs.

The FCA assembled a detailed dataset on IPO allocations, on the revenues that banks receive from IPO investors, on meetings between issuers and investors, and on the trading behaviour of IPO investors, which resulted in the following findings:

• Determinants of IPO allocation – The FCA finds that book-runners make favourable allocations to investors with whom they generate the greatest revenues elsewhere in their business, notably through brokerage commissions, while syndicate banks make favourable allocations to investors who provide them with information likely to be useful in pricing the IPO.
• Secondary market trading after the IPO – The FCA states that book-runners sometimes justify making an allocation to hedge funds in IPOs on the grounds that they provide valuable aftermarket liquidity, however the FCA finds no evidence for this. Hedge funds allocated shares in the sample of IPOs considered provided negligible aftermarket liquidity, and those which did provide liquidity were not favoured by book-runners in allocations.
• Are allocation practices detrimental? – The FCA notes there is no unique optimal allocation or pricing policy for each IPO, and so it is difficult to quantify the extent, if any, to which allocating shares to banks’ preferred clients leads to a less favourable outcome for issuers. However, book-runners face a conflict of interest between issuers and investors when pricing and allocating IPOs. Since the revenues they earn from investors dwarf the fees which they earn from issuers, there is a risk that book-runners will resolve this conflict at the issuers’ expense, first, by allocating more shares to high-revenue investors than is optimal for the issuer and, second, by setting the price of the IPO at a lower than optimal level. In both these ways the book-runners would be maximising the value of the IPO process to their own high-revenue investor clients.

(FCA, Occasional Paper 15: Quid pro quo? What factors influence IPO allocations to investors?, 13.04.16)

This interim report, published by the Financial Conduct Authority (FCA), presents the findings of the FCA’s wholesale sector competition review which was announced in July 2014.

The interim findings are as follows:

• Choice, universal banking and cross-subsidies – The FCA did not find any compelling evidence that any particular sector or category of clients faces a lack of available suppliers for corporate and investment banking services and the analysis indicates that large and frequent issuers such as financial institutions and large corporate clients are all well served by banks and advisers. Based on its findings, the FCA does not see grounds for widespread intervention at this time, but notes that it is concerned about the practice of banks using contractual clauses to restrict client choice and proposes to address this.
• Syndication – The FCA found no clear evidence that syndicate sizes have grown. Clients rather than banks drive syndicate size and composition and the total fees a client pays do not tend to increase with the number of syndicate members. Moreover, the FCA found that, while senior syndicate roles are dominated by large banks, medium-sized banks secure junior roles and the FCA was told that they provide a potential route to entry and expansion. For these reasons the FCA does not propose to pursue issues around syndication any further at this stage.
• Reciprocity – The FCA notes that at present reciprocity does not appear to be excluding non-reciprocal banks from competing because they can win mandates and therefore it does not propose to take any further action on reciprocity at this time. Should the practice become more widespread or show signs of restricting entry and expansion or distorting competition more widely in debt capital markets, the FCA will consider conducting further work.
• League tables – The FCA has some concerns that certain practices distort league table rankings and reduce comparability, specifically that some banks engage in transactions which are undertaken with the main aim of gaining league table credit, even if they are executed at a significant loss to the bank, and that many banks routinely present league tables to clients in a way that inflates their own position. As a result, unreliable league tables are, at best, ignored by clients and, at worst, distort clients’ choices because they do not accurately signal banks’ capabilities to undertake a comparable transaction. Therefore the FCA will explore how to improve the credibility and usefulness of league tables.
• Corporate finance advisers – The FCA found no evidence of corporate finance advisers giving advice which would be against the client’s best interests or trying to unfairly influence the research on IPOs, albeit a positive research message conveyed by analysts is one of the main factors considered when advising the issuer on which banks to appoint to a syndicate. It was noted that the role of corporate finance advisers can give rise to conflicts of interest and that there is a lack of clarity over how the FCA’s rules and guidance apply to them. As such, the application of the FCA’s rules to corporate finance advisers’ activities is covered in Chapter 6 of the report.
• Transparency of scope of services and fees – During the Wholesale sector competition review, a number of concerns were raised about the transparency for clients of the scope of services and fees. The FCA’s review of engagement letters found that transparency is not a material area of concern at this time. The need for banks to ensure sufficient transparency of terms for clients is set out in the FCA Handbook and will be enhanced further by MiFID II.
• The IPO process – The current market practice for UK IPOs includes a ‘blackout’ period typically lasting 14 days between publication of research by syndicate banks (connected research) and the circulation of the pathfinder prospectus and the FCA is concerned that this approach reduces the diversity and independence of information available to investors during the investor education period. The FCA addresses these issues, and the possible improvements to the IPO process under consideration, in its accompanying discussion paper on the availability of information in the UK Equity IPO process.
• Allocation of shares in IPO book-building – The FCA found that the way in which IPO allocations are scaled back shows some patterns consistent with issuer’s interests. In particular, IPO allocations tend to favour investors who assist with the price discovery process, and long-only investors tend to receive more favourable allocations than other investors, including hedge funds. However, the FCA also found that IPO allocations are skewed towards investors who account for significant revenues to the bank from other business lines (e.g. trading commission), suggesting the allocation decision may also reflect the interest of the bank. The FCA’s analysis of IPO allocations is described in detail in its accompanying occasional paper on factors that influence IPO allocations to investors. The strength of the skew towards the bank’s favoured investors varied significantly by institution, and, as part of its supervisory work, the FCA will investigate those banks where the skew appears strongest to assess whether these outcomes align to issuing clients’ best interests.

The FCA also sets out a package of potential measures designed to be effective and proportionate and to ensure that competition takes place on its merits by reducing artificial incumbency advantages, improving clients’ ability to appoint banks that best suit their needs, ensuring that conflicts are properly managed and improving the IPO process. The potential remedies are as follows:

• Universal banking and cross-subsidies – At this stage the FCA is not satisfied that the detriment arising from universal banking and cross-subsidisation is sufficient to warrant highly interventionist measures and therefore will therefore focus on lowering barriers to entry and expansion for non-universal banks and other service providers. The FCA is aiming to remove the practice of banks using clauses that restrict choice in engagement letters, although it is interested in receiving evidence as to whether contractual clauses that restrict choice on future transactions lead to more favourable terms for clients. The FCA is also seeking views on whether there are proportionate ways in which it can reduce barriers to competition for non-universal banks and other service providers without undermining the efficiency benefits of cross-selling.
• IPO process – In order to address its concerns regarding the availability of information during the IPO process, the FCA is considering three main models for reform, specifically, re-sequencing the publication of an approved prospectus and connected research, which is intended to make the approved prospectus the primary source of information available to investors, and providing unconnected analysts with an opportunity to have access to the issuer’s management.
• Allocations – The aim of any wider remedial action would be to reduce the incentive for banks to reward favoured investor clients, where this is not necessarily in the issuing client’s interests, which the FCA found to be of concern. This would help protect issuing clients and reduce competition concerns for buy-side investors that are less important in revenue terms to the banks. However, any consideration of remedies in this area needs to be made in the light of the requirements expected to be introduced under MiFID II. As such, the FCA will focus on ensuring compliance with its existing rules and guidance and helping banks prepare for the requirements that will be introduced under MiFID II.
• League tables – The FCA is interested in whether there are remedies that could help to increase the credibility of league tables by exploring ways in which they could be better presented so that they are more meaningful for clients and remove incentives for conducting trades carried out at a loss purely for the purpose of gaining league table credit. The FCA suggests options such as criteria for the presentation of the scope of deals covered by a league table, league tables presented to clients being based on data that is consistent with the type of transaction the client is undertaking, league tables presented to clients being the same as the ones used internally by banks, and the proportion (by value and volume) of an individual bank’s transactions that exhibit characteristics that are consistent with a league table trade being declared when presenting league tables to clients. However, the FCA believes this issue is likely to be best achieved through an industry-led solution.

The FCA is requesting views on the interim report and potential remedies by May 25, 2016 and expects to publish its final report in summer 2016, and consult on any proposed interventions.

(FCA, Market Study MS15/1.2: Investment and corporate banking market study - Interim report, 13.04.16)