On May 31, 2019, the FCA published its Policy Statement PS19/13 which (amongst other things) sets out the UK’s approach to implementation of the related party provisions of the revised Shareholder Rights Directive (SRD II)1.
As discussed below, the new rules will apply to (amongst others) premium and standard listed share issuers and premium listed GDR issuers. Companies will need to consider what changes may be required to their internal systems and controls in order to comply with these requirements.
Where can I find the new rules?
The new rules on related party transactions (RPTs) are set out in new DTR 7.3.
When do the new rules come into effect?
The new rules came into effect on June 10, 2019. However, transitional provisions mean that they will only apply to issuers in respect of financial years starting on or after that date. For example, issuers with a December year-end will only need to comply with effect from January 2020. However, in any event, companies should start thinking now about the updates that may be required to their internal systems and controls.
What companies are subject to the new rules?
The RPT rules in DTR 7.3 apply to UK-incorporated issuers which have shares admitted to trading on a regulated market2.
Subject to certain modifications (which are discussed further below), the Listing Rules also extend the provisions of DTR 7.3 to (a) overseas incorporated premium and standard listed share issuers (other than open-ended investment companies) and (b) premium listed GDR issuers, in each case unless they are subject to corresponding requirements imposed by another EEA State (such issuers being referred to in this briefing as ROW issuers)3. This is based on the principle that all issuers within a particular listing category should generally be required to comply with the same requirements.
Issuers incorporated elsewhere in Europe that have shares admitted to a regulated market in the UK will not be subject to DTR 7.3 but will instead be subject to the RPT provisions of SRD II as implemented in the member state where they are incorporated. There are a number of areas where SRD II gives member states choices as to the requirements to be imposed in respect of RPTs, and such issuers should not assume that the member state in which they are incorporated has implemented its provisions in the same way as the UK.
Who is a related party for the purposes of the new rules?
Under DTR 7.3 the definition of related party is the same as that which applies under EU-adopted IFRS (EU IFRS). Companies that report in EU IFRS will be familiar with this definition as they will already have to disclose transactions with such related parties in their annual accounts.
However, some ROW issuers do not report in EU IFRS but instead use a standard that has been deemed to be equivalent (for example, US GAAP). Such issuers will be permitted to use the definition of related party set out in those equivalent accounting standards rather than the definition under EU IFRS. The FCA notes that this will result in broadly similar disclosures but will avoid the need for such companies to have reporting systems that enable them to identify related parties under two different standards.
More generally, it should be noted that the definition of related party under DTR 7.3 is not the same as the definition of related party under LR 11 and the FCA has acknowledged that, as a result, there may be certain transactions that are RPTs under DTR 7.3 but which are not within the scope of LR 11.
What transactions are subject to the new rules?
So far as possible, the FCA has sought to align the definition of related party transaction under DTR 7.3 with the definition under LR 11, although the two are not identical (also see above in relation to the definition of related party and further below in relation to exclusions from the approval/disclosure requirements).
Related party transactions
Under DTR 7.3, the term related party transaction includes:
- Transactions between an issuer and a related party.
- Arrangements pursuant to which an issuer and a related party each invests in, or provides finance to, another undertaking or asset.
- Any other similar transaction or arrangement between an issuer and any other person the purpose and effect of which is to benefit a related party.
For these purposes, references to a transaction or arrangement by an issuer include a transaction or arrangement by a subsidiary undertaking. The rules will also apply to the novation or variation of an existing agreement between the issuer and a related party whether or not (at the time the original agreement was entered into) that party was a related party.
Transactions or arrangements which are in the ordinary course of business and concluded on normal market terms are specifically excluded from the definition of a related party transaction. As discussed further below, issuers must establish procedures to assess whether this is the case.
Material related party transactions
A “material” related party transaction will trigger certain approval and disclosure requirements as discussed below. For these purposes, a transaction will be material where any percentage ratio resulting from the application of the class tests in Annex 1 to DTR 7 is 5 per cent or more.
In its original consultation, the FCA had proposed that the materiality threshold should be set at 25 per cent or more. However, the FCA noted that it received substantive disagreement from the investor community who considered the proposed 25 per cent threshold to be too high. The FCA agreed with feedback that materiality should not depend on the issuer’s listing category and that a better approach would be to apply the same materiality threshold for all related party transactions. As a result, the threshold was lowered to 5 per cent in the final rules (which is consistent with the threshold for shareholder approval under LR 11 in the case of premium listed issuers).
The class tests to be used when calculating materiality are set out in Annex 1 to DTR 7. They relate to gross assets, profits, consideration and gross capital and are very similar to the class tests that apply for the purposes of LR 10 and LR 11. As discussed further below, issuers must aggregate transactions entered into with the same related party (or its associates) in any 12 month period when assessing materiality.
What are the key requirements of the new rules?
Systems and controls
Issuers must establish and maintain adequate procedures, systems and controls to enable them to assess whether a transaction or arrangement with a related party is in the ordinary course of business and has been concluded on normal market terms. They must ensure that the related party (and any person who is an associate, director or employee of the related party) does not take part in this assessment.
Approval and disclosure
Where the related party transaction is “material” (see above) the issuer is required to:
- Obtain the approval of its board for the transaction or arrangement before it is entered into and ensure that any director who is (or an associate of whom is) the related party, or who is a director of the related party, does not take part in the board’s consideration of the transaction/arrangement and does not vote on the relevant board resolution (although note that the requirement for board approval does not apply to ROW issuers)
- Announce certain information via RIS by no later than the time the terms of the transaction or arrangement are agreed.
If (after obtaining board approval/announcement but before completion) there is a material change to the terms of the transaction or arrangement, the issuer must comply again separately with the disclosure and (where applicable) approval requirements. Amongst other things, the FCA would generally consider an increase of 10 per cent or more in the consideration payable to be a material change to the terms of the transaction.
Certain transactions are specifically excluded from these approval and disclosure requirements, namely:
- Transactions or arrangements between an issuer and its subsidiary undertaking provided (a) the subsidiary undertaking is wholly owned or (b) no other related party of the issuer has an interest in the subsidiary undertaking.4
- Certain transactions or arrangements regarding remuneration of directors of the issuer where these have been disclosed and approved in accordance with the UK Companies Act 2006.
- Transactions offered to all shareholders of the issuer on the same terms where equal treatment of all shareholders and protection of the interests of the issuer is ensured.
The FCA notes that the exemption in the second bullet point above cannot be extended to ROW issuers as they are not subject to UK domestic company law requirements and that they will therefore need to consider whether they are required to comply with the disclosure requirements of DTR 7.3 in relation to directors’ remuneration.
See also below in relation to the interaction between disclosure/approval under DTR 7.3 and the requirements applicable to premium listed issuers under LR 11.
As noted above, issuers must aggregate transactions or arrangements entered into with the same related party (and any of its associates) during any 12- month period. Where any percentage ratio is 5 per cent or more for the aggregated transactions/arrangements, the issuer must comply with the approval and disclosure requirements of DTR 7.3 (which refers to approval before the transaction or arrangement is entered into and to announcement “no later than the time at which the terms of the transaction or arrangement are agreed”) in respect of each of the aggregated transactions or arrangements.
This is different from the approach under LR 11 where issuers are only required to comply with the approval requirements (or, in the case of smaller related party transactions, the requirement to obtain a fair and reasonable confirmation) in respect of the transaction that results in the threshold being crossed but not in respect of the other transactions included in the aggregation (albeit disclosure of those transactions is required).
The FCA recognises the challenge for issuers in complying with the approval and announcement requirements of DTR 7.3 in respect of previously completed transactions included in the aggregation. However, it notes that these provisions flow from SRD II which does not provide alternative options on this matter. The FCA makes the point that where an issuer is proposing to enter into a sequence of smaller transactions with the same related party (or its associates), it will need to take into account and plan for how it will be able to meet its future obligations for those individual transactions under the aggregation rules.
How do the new rules interact with the existing provisions of LR 11?
In addition to DTR 7.3, premium listed issuers will continue to be subject to the requirements of LR 11 and in many cases a related party transaction may fall within the scope of both regimes.
The new rules recognise that where an issuer has complied with the requirements of LR 11 for shareholder approval of a transaction it will be treated as having satisfied the disclosure and approval requirements of DTR 7.3. Likewise, where an issuer has complied with the requirements of LR 11 in relation to a smaller related party transaction it will be treated as having satisfied the disclosure (but not the approval) requirements of DTR 7.3.
Where an exemption takes a transaction outside the scope of LR 11, compliance with the requirements of DTR 7.3 will still be required (unless an exemption also applies under DTR 7.3).
As noted above, the definition of related party under DTR 7.3 is different to that under LR 11. As a result there may also be certain transactions which do not fall within the scope of LR 11 but which are subject to the requirements of DTR 7.3.
There are a number of practical considerations for companies to consider in order to comply with the new requirements, some of which are summarised below.
It will also be important to ensure that directors and other relevant individuals are briefed on the new rules and, in the case of premium listed issuers, understand the differences between the LR 11 and DTR 7.3 regimes and how these interrelate.
As discussed, issuers that are incorporated in a member state other than the UK will not be subject to DTR 7.3 but instead to the implementing provisions in the Member State where they are incorporated. Where this is the case, it will be important for the company to understand how the relevant SRD II provisions have been implemented in their jurisdiction of incorporation, as this may differ from the UK approach.
Identification of related parties
Issuers will need to identify their related parties for the purposes of DTR 7.3. Given the definition of “related party” is taken from EU IFRS (or, in the case of ROW issuers that do not report in EU IFRS, the equivalent standard used by them) a good starting point may be to look at any related parties identified in relation to the last set of accounts. Once a list has been produced, arrangements should also be put in place for its periodic review and updating going forward.
Although premium listed issuers may already have a list of related parties in place for the purposes of LR 11, they will still need to review this in light of DTR 7.3 given the differing definitions of “related party” used in the two sets of rules.
Approval and disclosure
Issuers will need to work with their advisers to assess to what extent their existing systems and controls will need to be amended to enable them to comply with the approval and disclosure requirements of the new regime.
As discussed above, ROW issuers are not subject to the requirement for board approval of material related party transactions. However, they are still subject to the requirement for these to be disclosed to the market and will therefore need to ensure that they have systems in place to ensure that any relevant transactions are identified and disclosed as required by DTR 7.3.
Although premium listed issuers will already have procedures in place for compliance with the related party rules under LR 11, these will need to be revisited in light of the new regime. In particular, care will need to be taken around any transactions falling within an exemption to LR 11 that is not replicated under DTR 7.3 – for example, the insignificant subsidiary exemption. Where an issuer regularly relies on a particular exemption under LR 11, it should be considered whether an equivalent is available under DTR 7.3 and (if not) the implications of complying with the new rules going forward.
More generally, issuers should keep in mind the overlay of disclosure obligations under the Market Abuse Regulation (MAR). Where the transaction amounts to inside information it will (subject to the rules on delayed disclosure) need to be announced in accordance with MAR, regardless of the analysis under the related party rules.
Ordinary course transactions
Issuers will also need to engage with their advisers in relation to procedures for assessing whether transactions involving related parties are in the ordinary course of business and concluded on normal market terms (and do not therefore fall within the DTR 7.3 definition of “related party transaction”).
Although premium listed issuers may already have procedures in place for assessing whether a transaction is ordinary course (as ordinary course transactions are also excluded from the definition of related party transaction under LR 11) it will need to be considered whether these also meet the requirements of DTR 7.3 – including the requirement to assess whether the transaction is concluded on normal market terms. This language is not specifically replicated in LR 11, although guidance in that chapter does note that one of the factors the FCA will have regard to when assessing whether a transaction is in the ordinary course of business is whether its terms and conditions are unusual.
As noted above, the position on aggregation under DTR 7.3 is unhelpful as once the materiality threshold is reached the approval and disclosure requirements apply not only to the transaction which crossed the materiality threshold but also to previous transactions forming part of the aggregation. Other than in the rare situation where an issuer knows that it will be entering into a series of transactions which will result in the rules being triggered as a result of aggregation, it is difficult to see how an issuer can do much more than make notification of the historic transactions at the time the aggregation threshold is crossed and, potentially, ratify the previous entry by the company into those transactions. It is to be hoped that the FCA will take a pragmatic approach in this area given that it recognises the challenge which the rules present for issuers.