The coming into force of the Prospectus Regulation represents not just a major change in capital markets regulation, but also the most significant accomplishment to date in the EU’s Capital Markets Union reform agenda. However, reactions are mixed among market participants. Will the new framework promote broader participation in Europe’s capital markets?
Prospectus Regulation in force
On July 20, 2017 the Prospectus Regulation (EU) 2017/1129 (PR) came into force. Except for some specific provisions that applied from July 20, 2017 or will apply from July 21, 2018, the bulk of its provisions will apply from July 21, 2019, after which time the existing Prospectus Directive (PD) regime will cease to have effect.
The PR represents a complete overhaul of securities disclosure regulation in Europe, and forms a major part of the EU’s Capital Markets Union (CMU) initiative.
The new regime will not apply retroactively - securities with PD-compliant prospectuses or base prospectuses before the PR fully applies on July 21, 2019 will be grandfathered. In this briefing, we look at the areas where market participants will be most affected.
Convertibles exchangeables and tap issues
The provisions that applied immediately upon the PR coming into force relate to the exemption from the requirement to publish a prospectus for certain convertible and exchangeable securities.
Under the previous rules, the prospectus requirement for securities that are admitted to trading on regulated markets did not apply to shares resulting from the conversion or exchange of other securities or from the exercise of the rights conferred by other securities, provided that they are of the same class as the shares already admitted to trading. Under the new rules, this exemption is available only where the resulting shares represent less than 20 per cent of the shares of the same class already admitted to trading on the same regulated market.
The PR offers some carve-outs to the 20 per cent cap, including where the convertible securities were listed before the PR came into force or where they are accompanied by their own PD or PR-compliant prospectus. The PR includes a further carve-out for certain instruments issued by financial institutions for regulatory capital purposes (such as contingent convertible bonds).
Also since July 20, 2017 admitting additional securities of the same class on the same regulated market will not trigger the listing requirement for a prospectus, provided that the newly admitted securities are of the same class, trade on the same regulated market and represent less than 20 per cent of the existing ones. This change significantly broadens an old exemption that was limited to equity securities representing a maximum of 10 per cent of outstanding shares.
"Level two" technical standards
In its updated mandate to the European Securities and Markets Authority (ESMA), the European Commission requested advice in respect of possible delegated acts containing level two technical standards that will address in detail the content and procedural requirements and standards under the PR. We expect the technical standards will cover:
- Contents of the new universal registration document (URD), which will act as a new form of shelf registration document;
- Contents of the PR-compliant prospectus, base prospectus and final terms;
- Contents of the new simplified PR-compliant prospectus (to be used for secondary issues);
- Contents of the new ‘EU Growth’ prospectus;
- Criteria for the scrutiny of prospectuses and the procedures for approval of prospectuses; and
- General equivalence criteria for prospectuses drawn up under the laws of countries outside the European Economic Area (EEA).
In respect of timing, the PR requires that the Commission adopts the bulk of necessary level two measures by January 21, 2019. As a result, the Commission has requested advice in respect of third country equivalence criteria no later than 18 months and the other areas mentioned above no later than 13 months following receipt by ESMA of the mandate for technical advice. The mandates were updated on June 1, 2017, so ESMA should deliver to the Commission draft delegated acts in July and December 2018, respectively. ESMA is currently consulting on draft level two measures.
While the Commission has made an effort to lighten the disclosure requirement in some cases, some aspects of the PR are more prescriptive than the current rules. The following are some headline points in respect of the new rules:
- Bonds issued in €100,000 denominations will still be exempt from the "public offer" trigger;
- The wholesale disclosure regime is being retained, along with the €100,000 denomination distinction, and wholesale bond prospectuses will be exempt from the summary requirement;
- The scope of the wholesale disclosure regime will be widened to include issues of debt securities that are admitted to a specific segment of a regulated market where access is limited to qualified investors;
- A potentially less onerous "EU Growth" prospectus will be available for small and medium-sized enterprises (SMEs) and in certain cases non-SMEs for eligible issues up to €20 million;
- Potentially lighter disclosure requirements will apply to secondary issuers where an issuer is already admitted to a regulated market or SME growth market;
Risk factors will need to be categorized depending on their nature, with the most material risk factors being mentioned first in each category;
- Summaries may pose a challenge, as they will be shortened to seven sides of A4 sized paper and more prescriptive in content and the number of risk factors that can be included in the summary will be capped at 15
- From July 21, 2018 no prospectus will be required for issues below €1 million, which fall outside the scope of the legislation; and
- From July 21, 2018 the threshold beyond which a prospectus is mandatory is increasing from €5 million to €8 million; however, Member States will have the discretion to exempt issues of between €1 million and €8 million or establish other disclosure requirements for issues below €8 million.
The next section looks a number of these changes in greater detail.
What’s changing… and what’s not
Retained: €100,000 minimum denomination safe harbor from the prospectus requirement
Currently under the PD, a prospectus is required for offers of securities to the public (the ‘public offer’ trigger), or where securities are admitted to trading on an EEA regulated market (the ‘listing’ trigger). Debt securities issued in denominations greater than €100,000 (or the equivalent in other currencies) are exempt from the ‘public offer’ trigger, although issuers often list on a regulated market anyway, particularly where a prospectus is required under the ‘listing’ trigger. Voluntary listing may be due to investors having investment criteria that require investment in listed securities, or issuers seeking to be exempt from withholding tax in certain Member States.
The PR retains this safe harbor, in addition to other safe harbors from the ‘public offer’ trigger, such as for offers of debt securities solely to qualified investors or to fewer than 150 non-qualified investors or where the total consideration from each investor is less than €100,000.
Changed: minimum issuance thresholds where a prospectus is required
Currently under the PD, issues of securities fall outside the legislation altogether where the total consideration in the EEA is less than €5 million (calculated over 12 months). From July 21, 2018 this threshold will be reduced to €1 million.
While frequent bank issuers will still not need a prospectus for offers of unsubordinated, non-convertible/non-exchangeable debt securities below €75 million (aggregated over 12 months), they will need to rely on exemptions to the ‘public offer’ and ‘listing’ triggers rather than be carved out of the legislation altogether (as is the case under the PD).
From July 21, 2018 Member States will have the discretion to exempt from the prospectus requirement (or instead impose minimum disclosure requirements on) domestic issues of securities with total consideration over 12 months of up to €8 million (up from €5 million). Under this approach, the threshold at which an issue requires a prospectus or other disclosure document depends on whether the issue is cross border or, if domestic, in which jurisdiction, since the threshold will vary according to national law.
Retained: €100,000 distinction between wholesale and retail issues for disclosure purposes
Under the current PD regime, the level of disclosure required depends on whether the prospectus is for a retail or wholesale bond issue. Retail bonds are aimed at a wide base of investors, including less sophisticated investors who regulators consider to be in need of greater regulatory protection. Retail bond issues require a higher level of disclosure than wholesale bond issues, which are issued in minimum denominations of €100,000 and are aimed mainly at institutional investors.
The PR keeps this distinction, and expands the scope of the wholesale disclosure regime to include debt securities trading on a specific segment of a regulated market where only qualified investors can trade them.
Even though the €100,000 denomination exemption may not be strictly necessary to be eligible for the wholesale disclosure regime, issuers may decide to continue to issue in such denomination to avoid financial reporting under the Transparency Directive and registering their auditors under the Statutory Audit Directive. Higher denominations may also appeal to issuers wishing to avoid interest from retail investors (for example, when issuing certain regulatory capital instruments) or to facilitate liability management exercises that may arise later on.
Categorized: risk factors
Under the current rules, prospectuses must set out risk factors relating to the issuer's ability to fulfil its payment obligations under the securities. The threshold for including a risk factor is merely whether the risk is ‘material to making investment decisions’. This approach is also commonly used in the securities offering laws of other jurisdictions.
Under the new rules, issuers will be required to categorize risk factors according to their materiality. Multiple thresholds of risk will need to be established, with procedures put in place to determine what factors to include in each category. ‘Materiality’ in this sense will need to take into account both the likelihood of occurrence and the expected magnitude of the negative impact of such risks. This process will involve quantifying risk in a way that is novel in capital markets regulation.
Issuers are also likely to have some concerns about potential liability issues where risk factors are miscategorized. If an issuer labels a very remote risk as ‘low-risk’ and it then materializes in unusual or unforeseen circumstances, will the issuer or its officers be liable for misrepresentation?
The PR states that an issuer ‘may’ disclose its assessment of the probability of a risk occurring and the gravity of such risk using a qualitative scale of low, medium or high. While use of ‘may’ suggests that this categorization requirement is discretionary, expect issuers and underwriters to continue grappling with these concerns, at least in the short term. The PR empowers the Commission to adopt delegated acts that will hopefully provide some objective criteria for analyzing the materiality of risk factors.
Tightened: prospectus summaries
Transaction summaries were an attempt by PD II to make prospectuses more accessible to investors, but the effect was that the prescribed format was even more difficult to understand. The PR keeps the concept of summaries, but they will be shortened and more prescriptive (subject to extension in certain circumstances).
In terms of when a summary is required, the PR does not require a summary for debt securities trading on a regulated market that either have minimum denominations of €100,000 or are traded on a specific segment of a regulated market that is limited to qualified investors. For note programmes, the obligation to draw up a summary of the base prospectus when the final terms are not included is removed, so that only the ‘issue-specific’ summary is required to be produced and annexed to the final terms when they are filed.
Summaries are changing in terms of content and format. While the page limit is being reduced to seven sides of A4 sized paper, the PR grants discretion to Member States to increase the page limit and substitute content requirements for summaries. This could lead to a patchwork of summary requirements that vary between Member States. On the other hand, some flexibility with respect to page limits may make some jurisdictions more responsive to market needs.
Summaries will need to contain four sections, including:
- An introduction containing warnings;
- Key information on the issuer;
- Key information on the securities; and
- Key information on the offer of the securities to the public and/or admission to trading.
Controversially, the PR requires that summaries set out the 15 most material risk factors specific to the issuer, and the guarantor (where the securities are guaranteed). Limiting the number of risk factors in the summary to an arbitrary number is arguably one of the less helpful changes introduced by the PR.
Civil liability will arise in respect of a summary that is misleading, inaccurate or missing material information only when read together with the other parts of the prospectus. Requiring all parts of the prospectus to be read together only protects issuers for claims arising within the EU. There are concerns that issuers could potentially be liable in jurisdictions outside the EU where a material risk factor is in the main prospectus but not the summary.
The format and length are intended to mirror that of ‘key information documents’ (KIDs) that will be required for packaged retail and insurance-based investment products (PRIIPs) under the PRIIPs Regulation from January 2018. In the event that an issue of debt securities is accompanied with a KID, then a prospectus summary will not be necessary. In addition, the PR grants ‘discretion to individual Member States to require a KID in lieu of a prospectus summary.
Introduced: shelf registration disclosure
The PR adopts a disclosure process similar to the North American concept of ‘shelf registration’, which will allow issuers that are listed on a regulated market or multilateral trading facility (MTF) to file an annual URD to be approved even where they do not intend to immediately offer or list securities. URDs will set out all relevant information on the issuer and its business, including some on-going transparency disclosure. Once an issuer has had a URD approved for two years consecutively, it will no longer need prior approval for filing subsequent URDs.
Following acceptance by competent authorities of a URD, approval of prospectuses will be ‘fast-tracked’ for approval by national supervisors. The aim is to shorten approval time for frequent issuers from ten to five working days. In certain circumstances, issuers will be able to fulfil some of their on-going disclosure obligations under the Transparency Directive by integrating their annual and half-yearly financial reports into a URD.
We expect debt issuers to continue using the existing base prospectus format, which acts as a shelf disclosure document for issuance under a note programme. While URDs will be available to use for nearly any kind of debt securities (not only for those issued under an offering programme or in a continuous and repeated way), URD disclosure requirements will be based on the share registration documents plus additional items. As a result, we expect that URDs will be used primarily for equity issuance.
Will it work? This new ‘tripartite’ regime may have teething problems. While a key aim of shelf registration is to allow issuers that have filed URDs to tap the market more quickly, the URD and its amendments need to be usable in prospectuses without further approval steps, which is unclear at the moment. Issuers will be able to take advantage of the fast track approval process, but regulators may still be able to comment on the URD content itself when an issuer files a prospectus.
As long as amendments to the URD filed by frequent issuers can still be reviewed by regulators when a URD is included in a prospectus, the main potential benefit of the URD is negated. In addition, the ability to only file the URD after having had it approved for two consecutive years becomes meaningless if the resulting updated URD cannot be directly used for prospectuses without further approval.
In addition, the PR does not expressly say that URDs also can be passported independently across the EEA. Issuers that decide to file a URD will be required to file it with the competent authority of their home Member State, so it is unlikely that issuers will have URDs filed and approved by multiple competent authorities (as a number of big international banks currently do with base prospectuses). If an issuer were to file a prospectus outside of its home Member State, it is unclear whether the host Member State will be able to comment on the URD separately as part of its prospectus review.
Widened: the range of information that can be incorporated into a prospectus by reference
The PR should reduce duplication of disclosure by widening the range of information that may be incorporated by reference, including:
- Information in existing prospectuses, supplements and final terms;
- Regulated information under the Transparency Directive and Market Abuse Regulation;
- Annual and interim financial information, audit reports and financial statements;
- Asset valuation reports; and
- Memoranda and articles of association.
When incorporating by reference, issuers will need to include in the prospectus a checklist that cross-refers to such information. When in electronic format, prospectuses will also need to contain hyperlinks to all documents containing information that is incorporated by reference.
Updated: prospectus publication process
Once approved, the prospectus must be made available to the public before the offer to the public or admission to trading takes place. The PR is prescriptive as to what is sufficiently ‘public’. For example, the prospectus must be published on a dedicated section of an easily accessible website, downloadable, printable and searchable in electronic format. Where there is a summary, it must be accessible separately from the prospectus. Access to the prospectus cannot be subject to the completion of a registration process, acceptance of a disclaimer limiting legal liability or payment of a fee.
While arguably this may make publication simpler, it could lead to problems in complying with the offering regimes of third countries. Third countries such as the US, Canada and Australia may take the view that such publication means an offer to the public has been made in that jurisdiction without a listing or registration having been obtained from regulators in that jurisdiction. The effect of this may be to drive some listing activity to MTFs or non-EEA exchanges, where issuers need a listing but not wish to make an offer to the public.
One practical change is the introduction by ESMA of a free and searchable online database containing all prospectuses approved in the EEA and related documents. The intention is to assist consumers in making investment decisions by allowing them to make a more thorough comparison of investment products. Issuers will still be required, however, to provide a free paper copy of the prospectus to anyone who requests it.
Expanded but not simplified: SME disclosure regime
Reforms introduced in 2010 under PD II were intended to increase SME participation in the capital markets by creating a ‘proportionate disclosure’ regime. The alternative disclosure rules were rarely used, however. The PR expands on this concept with a new ‘EU Growth’ prospectus, which targets SMEs that do not have securities trading on a regulated market.
SMEs (i.e. companies with a market capitalization of up to €43 million, turnover of up to €5 million or less than 250 employees) and mid-sized companies with a market capitalization of up to €500 million will be able to take advantage of the lighter disclosure rules, and in either case the maximum size of eligible issues will be €20 million. Larger companies with market capitalizations over these thresholds but that have 499 employees or fewer and are not listed on an MTF will also be able to use an ‘EU Growth’ prospectus for issues up to €20 million.
SMEs that already have securities admitted to trading on a regulated market will not be eligible to use the lighter disclosure rules, in order to avoid a ‘two-tier’ disclosure standard. In other words, investors should be able to review one set of disclosure documents without worrying that there is more comprehensive disclosure available elsewhere. Currently, a prospectus is not required for securities listed on MTFs, provided that they are not offered to the public. This exemption has been retained in the PR.
What information will be required in these minimum disclosure regimes will not be fully known until the draft technical standards (currently under consultation) are finalized. The PR states that at minimum an ‘EU Growth’ prospectus will include a summary, registration document and securities note. The Commission will be empowered to calibrate the growth prospectus disclosure requirements depending on the size of the issuer.
The Commission believes that the ‘EU Growth’ prospectus will be more attractive to SMEs than the proportionate disclosure regime under PD II, because SMEs will be able to passport an approved ‘EU Growth’ prospectus into all EEA Member States. While the ‘EU Growth’ prospectus may be more accessible, it remains to be seen whether a new set of prescriptive rules and prospectus summaries with their tight page limits are in fact ‘user friendly’. Whether the new rules encourage SMEs and others to issue more will depend ultimately on whether the disclosure is in fact lighter.
Simplified: retail cascades and secondary issues
Like the current PD regime, under the new PR a prospectus (or base prospectus) will be valid for up to 12 months for retail cascades provided that it is supplemented and the issuer consents in writing to its use by financial intermediaries for resale.
Issuers will have the discretion to draw up a lighter registration document (called a ‘simplified prospectus’) and securities note for secondary market issuances where its securities have been admitted to trading on a regulated market or SME growth market continuously for at least 18 months and it issues more securities of the same class. Other parties offering existing securities that have traded continuously on a regulated or SME growth market for at least 18 months may also use a simplified prospectus.