French legislative overview
Legalization of cannabis is a recurrent topic in France, which has reached a new milestone under the pressure of the changes underway in other European countries.
The European Securities and Markets Authority (ESMA) has provided guidance as to how banks will be required to disclose in their prospectuses the risks of the bail-in feature being triggered under EU legislation that takes effect on 1 January 2016. Banks are asking themselves whether their current disclosure will be enough.
On 15 December 2015, ESMA published an update to its Q&A on disclosure for debt capital markets transactions under the Prospectus Directive (2003/71/EC, as amended) (the PD). Interestingly, the update provided new guidance with respect to what level of disclosure should be included in a PD-regulated prospectus when securities are subject to ‘bail-in’ powers under the Bank Recovery and Resolution Directive (2014/59/EU) (BRRD). ‘Bail-in’ refers to powers exercisable by resolution authorities in the relevant EU Member States to rescue troubled EU banks by writing-down their debt or converting bonds into equity.
Until recently, the focus of many of our banking clients has been on ensuring that documentation complies with the specific contractual drafting requirements under article 55 of the BRRD. Now, however, attention is turning to how bail-in risk is disclosed for debt securities that are offered to the public or listed on a regulated market in the EU (i.e. where a prospectus is required). This briefing looks at what banks will need to do before January, and how it will change in the medium term when the European Commission’s Capital Markets Union (CMU) initiatives bite.
In addition to disclosing the rights, and limitations to rights, attaching to securities which must be included in a prospectus, EU banks will need to consider when issuing debt securities whether to disclose in the prospectus the risk that the securities could be subject to bail-in under the BRRD.
ESMA has advised that where the issuer considers the possibility of bail-in to be material, taking into account the possible impact on investors and the probability of bail-in occurring, this should be reflected in the risk factors section and summary of a prospectus.
ESMA considers that the risk factor should, at minimum, alert prospective investors to the possibility that, in the event that write-down or conversion powers are exercised by an EU resolution authority:
In this regard, such risk factor should also alert prospective investors to the fact that financial public support should only be used as a last resort after having assessed and exploited, to the maximum extent practicable, the resolution tools, including the bail-in tool.
It is not clear whether prospectuses will be permitted to disclose mitigating factors relating to the risk of bail-in. In the UK, the Financial Conduct Authority (FCA) has given technical guidance that it will generally not challenge risk factors that contain information on mitigating factors provided that the inclusion of such information does not confuse the nature of the risk or its materiality. Where a prospectus is specifically precluded from including information on risk mitigation – for example, due to US disclosure requirements - then this information may be better disclosed elsewhere in the document.
In determining whether the possibility of bail-in is material, the ESMA guidance looks both at the impact on investors and likelihood of bail-in occurring. With respect to the first question, bail-in will always be material since the entire face value of the securities could potentially be bailed-in under the BRRD.
The second question is not completely clear. There are two conflicting views on how the risk of bail-in should be disclosed. On one hand, all banks that are subject to the BRRD are subject to bail-in; therefore, there will always be a risk (however remote) that any securities issued by an EU bank could be bailed-in at some point. We expect that a number of banks will favour including a generic risk factor to this effect. One advantage to this approach is that even well capitalised banks will not be caught out if there is an unexpected downturn. Banks cannot ignore the fact that the possibility of bail-in will always be in the background.
As regards the generic approach, if banks’ listing authorities apply ESMA’s guidance strictly, the listing authorities may require the removal of any risk factors that do not address the likelihood of the securities actually being bailed-in (or conclude that the current risk of bail-in is low).
One response could be that the likelihood of bail-in is inherent in the underlying credit analysis that investors would need to make as part of their due diligence efforts. Arguably it should be obvious in other disclosure such as in the financial statements and general discussion of the issuer’s business whether the issuer is at material risk of bail-in.
The problem with speculating in the risk factors as to the likelihood of bail-in is that it could significantly undermine confidence in the bank as a going concern. Issuing debt securities may be part of a bank’s turnaround plan, but if the bank is forced to call attention to the possibility of regulatory intervention, it may forgo issuing altogether.
The bail-in mechanism applies from 1 January 2016, so EU banks will need to disclose bail-in risk for any issue of debt securities after this date. It would not be surprising to see a race to the bottom in terms of risk aversion and disclosing all bail-in risk, no matter how remote.
In the UK, the FCA has given technical guidance that while the current PD requirements are broadly drafted and do not prescribe the type of risk factors that should be included, they do state that the risk factors should be specific to the company and its industry, and should be relevant to the type of securities being offered. The FCA notes, however, that it is not uncommon to see risk factor sections that include more generic, standardised risk factors, which do not appear to be directly relevant for the company or the issue that is the subject of the document.
On 30 November 2015, the European Commission published its proposed Prospectus Regulation. If adopted, it will replace the PD in its entirety. This proposal forms a major part of the Commission’s Capital Markets Union (CMU) initiative, which aims to improve access to debt capital markets across Europe’s 28 Member States, and in doing so promote investment and growth in Europe (see our related briefing here).
While generic risk factors may have survived under the current rules, the new regime will be different because regulators want to eliminate non-specific risk factors in prospectuses. Once the Prospectus Regulation comes into force at the end of 2016 or early 2017, regulators will have a specific mandate to remove any generic risk factors.
The Prospectus Regulation is intended to address concerns that prospectuses are overly long documents that are neither read nor understood by investors. The Commission has said that the current approach to risk factors means that prospectuses are overloaded with generic risk factors, and the recitals to the Prospectus Regulation say that listing authorities should no longer tolerate generic risk factors when reviewing a prospectus. Further guidance will be needed to see how this should play out in practice.
Under the Prospectus Regulation, issuers will be also required to categorise risk factors according to their materiality (high-risk, medium-risk and low-risk) and limit the number of risk factors that can be included in a summary to the five most material risks.
Most likely banks will provide generic disclosure relating to bail-in risk for as long as they can. As listing authorities become more particular, issuer banks will need to provide evidence of materiality in order to keep the risk factors in their prospectuses. In cases where any issues about the drafting of risk factors are likely to arise, it is advisable for issuers to enter into early dialogue with the relevant listing authority to ensure clear and appropriate disclosure.
Alternatives exist. Where the chances of bail-in are looking likely on balance, then issuer banks will need to do a cost-benefit analysis of issuing under the PD versus the potential reputational effects of pointing out such bail-in risk. In certain cases, it may be more advantageous to issue securities on a private placement basis or list them on a multilateral trading facility (MTF) market, where a prospectus is not required.
Our dedicated banking reform group provide insight and analysis into the impact of structural banking reform on key jurisdictions across the globe. See the Banking Reform technical resource here.
Our capital markets group has substantial experience of advising banks and other financial institutions on a wide variety of debt capital markets transactions, and provides thought leadership on the impact of European CMU initiatives. See the Capital Markets Union technical resource here.
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