In May 2023 the Financial Conduct Authority (FCA) published a Consultation Paper (CP23/10) in relation to its proposed reforms to the equity listing rules in the UK. The reforms have been proposed following recommendations from Lord Hill’s review of the UK listing regime with the aim of improving the UK’s framework for listing shares. A key motivation for the reforms is to try and make the UK capital markets more attractive to issuers.
The most significant reform is the proposed replacement of the current standard and premium listing share categories of the Official List with a single listing category for equity shares in commercial companies (ESCC). The requirements for listing on the current Premium Segment of the Official List are regarded as overly burdensome and are deterring some companies from listing in the UK. The intention of the new single listing category is that it will be more straightforward for issuers and advisers than the current rules-based approach and a move to a disclosure-led process is intended to encourage a more diverse range of companies to list and grow on UK markets.
However, the implications of the proposed reforms for companies currently listed on the Standard Segment of the Official List are not as appealing, particularly as they will be subject to more onerous requirements than they presently are. In our opinion, the effect of these reforms on smaller companies should not be overlooked. Market data from the Official List at the end of 2022 indicated that of the 328 Standard Segment companies at that time, 167 were commercial companies that under the reforms would need to comply with the requirements of the ESCC. There were 416 Premium Segment commercial companies on the Official List in December 2022 that under the reforms would also likely join the ESCC. Therefore, using the December 2022 figures Standard Segment companies would represent nearly 29% of the total companies listed on the ESCC.
We will explore the proposals in more detail throughout this article with a particular focus on the implications for companies currently listed, or considering a listing, on the Standard Segment of the Official List and, in particular, our view of a likely increase in costs and regulatory burden in a change to the sponsor regime for those companies.
The Proposed Reforms
- Eligibility requirements for ESCC – financial information
The FCA proposes to remove from the Listing Rules the current eligibility requirements for companies seeking a listing that currently apply to Premium Segment companies, including, the three-year historical financial information requirements and the requirement to provide a clean working capital statement. Companies listing on the Standard Segment currently have no specific eligibility requirements related to financial information or providing clean working capital statements.
Therefore, this does not make any change for Standard Segment companies for now but this may change as part of the FCA’s proposed new Public Offers and Admission to Trading Regime which is reviewing the current prospectus regime in the UK. Under the current prospectus regime which applies to both the Premium and Standard Segments, companies are required to include three years’ financial history (or a lesser period if they have not traded for three years) and a working capital statement, which can, in a limited number of circumstances, be qualified. A change to the prospectus requirement is likely to be particularly helpful to less mature, fast growth companies particularly in the tech and natural resources sectors who may have previously been unable to produce three years of results and/or do not have sufficient capital to make a clean working capital statement.
- Initial and continuing obligations for ESCC
The current Listing Rules contain initial eligibility requirements and continuing obligations that apply solely to companies listing on the Premium Segment. These rules include provisions with regards to: independence and control of business, controlling shareholders and dual class share structures. There are currently no corresponding requirements for companies listing on the Standard Segment
Independent business and control of business
The proposals include exploration of a modified approach to the independence of business and control of business for the single ESCC category. This change seems to be primarily targeted at companies that act as strategic investors in investee companies by taking non-controlling positions, but which are not diversified fund vehicles. In respect of these issuers the FCA is considering replacing the current independence requirements but requiring specific and explicit disclosure (perhaps through risk factors) or assurance by sponsors on the ability of the issuer to monitor and report on its investment(s).
The Standard Segment currently has no independence requirements and so issuers that are dependant on a parent company or have one main asset (such as a natural resources project) that they do not control and/or operate may become burdened with additional disclosures or additional requirements for a sponsor.
Controlling shareholders
The Listing Rules currently require companies on the Premium Segment to enter into a relationship agreement with any ‘controlling shareholder’. There is currently no such requirement for Standard Segment companies however in our experience relationship agreements are frequently entered into between Standard Segment companies and controlling shareholders to demonstrate good corporate governance. The proposals put forward by the FCA remove the requirement for a relationship agreement but include a ‘comply or explain’ disclosure mechanism that puts the onus on shareholders to satisfy themselves that the nature of the relationship between the company and a controlling shareholder does not pose a risk. This is more onerous than the current provision for Standard Segment companies, however, we do not see this proposed change as particularly onerous on the basis that relationship agreements are often entered into by Standard Segment companies in any event despite there being no mandatory requirement to do so.
Dual class share structures
The reforms proposed by the FCA introduce a more flexible approach to dual class share structures than those currently in place for Premium Segment companies. The proposals include enhanced voting rights that could be exercised on all matters and at all times (not just to stop a change of control or protect a founder director) and only cease to be exercisable after 10 years. This does not apply on the issue of shares at a discount of more than 10%. While these proposals are more restrictive for companies listed on the Standard Segment than the current absence of any restrictions, in our experience, dual class share structures have rarely been used by such companies so the reforms proposed provide no significant detriment.
- Significant Transactions
The proposed reforms include an amended form of the significant transactions regime that currently only applies to Premium Segment companies. The proposals remove the current requirement for mandatory shareholder approval on certain transactions meeting the relevant test, but certain disclosure elements of the current Premium Segment regime will be retained, although the UK Market Abuse Regulations (MAR) will still be relevant for ongoing disclosures of transactions and material events.
The FCA’s proposals are to remove the more onerous obligation of the existing rules in respect of class 1 transactions and replace them with the class 2 requirements which it is proposed at the former class 1 threshold of 25% rather than the current class 2 threshold of 5%. The proposals provide that issuers it must obtain the guidance of a sponsor if they are planning to enter into a transaction that may be required to be announced under the proposed ESCC significant transaction rules due to its size and type. Previously issuers needed to consult with sponsors on potential class 1 transactions. However, sponsors will not be required to ‘sign off’ the announcement as compliant with the rules and the FCA will not need to pre-approve it. This is a change from the previous regime where sponsors were obliged to provide a ‘Sponsor Declaration for the Production of Circular’ under LR 8.4.12R(1) and means the regime will much more similar to the Nomad regime on AIM.
The proposals reduce the regulatory burden for Premium Segment companies looking to enter significant transactions however they increase the burden for Standard Segment companies who are not currently subject to a significant transaction regime, although the class 2 obligations cover the ground that would most probably be required under MAR in any case. The key change is that Standard Segment companies will need to retain a sponsor to advise them on such transactions. Although often Standard Segment companies do retain financial advisers to assist with such matters that is not always the case and, given that a large number of the Standard Segment companies are smaller than the companies on the Premium Segment, the announcement obligations are much more easily triggered. This is a key consideration for Standard Segment companies as many of them opted for this market rather than AIM due to the lower ongoing compliance costs. This reform is likely to result in Standard Segment companies needing to retain financial advisers on a retainer basis which is likely to increase their cost base as there are currently only a very limited number of sponsors that service the requirements of smaller cap companies.
The FCA’s consultation paper seeks input on whether additional disclosures and increased engagement with shareholders may be appropriate before formal completion of a significant transaction. We oppose this, on the basis that the proposed new regime is already more onerous and costly for Standard Segment companies. In addition, the advisory role of the sponsor should be optional rather than mandatory in assessing whether a potentially significant transaction meets the proposed disclosure threshold.
- Related Party Transactions
Currently, Standard Segment issuers of equity shares are required to make disclosures regarding transactions with related parties under the DTRs and Listing Rule 14, whereas related party transactions conducted by Premium Segment companies are subject to a broader set of provisions requiring FCA approved circulars and shareholder votes.
The proposed new rules remove the current requirement for Premium Segment companies:
- For related party transactions at or above 5% value on the class tests to publish FCA approved shareholder circular and obtain mandatory independent shareholder approval.
- For related party transactions above 0.25% and below 5% value to obtain a sponsor fair and reasonable opinion and announce the transaction.
The proposed new rules create one requirement for all Main Market equity issuers where related party transactions are at or above 5% on the basis of the class tests and this is to announce the transaction no later than the time when the terms are agreed including full particulars of the related party transaction and a statement by the board that the related party transaction is fair and reasonable so far as the security holders of the company are concerned and that the directors have been so advised by the sponsor. For the purposes of the fair and reasonable statement, any director who is the related party should not take part in the board’s consideration of the matter.
The proposed changes are welcome news for current Premium Segment companies however they are more onerous for Standard Segment companies as these companies will need to pay a sponsor for guidance and this approval will mean such transactions take longer to conclude. This is especially the case as the FCA is proposing that sponsors should first consult with the FCA to agree any potential modifications to the class tests and resulting classification of the proposed related party transaction.
Although there have been only 19 instances of related party transactions at 5% or over in the period 2017-2022, announcements of related party transactions by Standard Segment companies are much more frequent. Related party transactions tend to be more common for smaller companies as there is often a small number of individuals who are responsible for driving growth and they often enter transactions with the company in an effort to support it and given the small size of the companies the 5% threshold can be easily reached. This can mean that the fee a sponsor would charge to opine on a transaction may be a relatively large proportion of the value of that transaction. As small issuers are less mature businesses their options are more limited than large companies and they may have to accept such fees as they have fewer alternatives. The FCA feels that the potential benefit to investors and market integrity outweigh the increased regulatory burden. The FCA has not yet been clear on what transitional period will apply to Standard Segment companies to allow them time to adjust.
- Shareholder approval for cancellation of listing
The proposed reforms are similar to the existing provisions for Premium Segment companies and require a shareholder vote to cancel listings of shares in the single ESCC category, including a 75% majority requirement and additional provisions where a controlling shareholder is involved. It is proposed that an FCA approved circular will be required and the existing notice period of 20 business days following shareholder approval will be retained. This is similar to the requirements of AIM but will be more onerous for Standard Segment companies who are currently only required to give 20 business days’ notice of the intended cancellation of their listing.
- Annual Reporting Requirements
It is proposed that the existing Premium Segment provisions relating to the UK Corporate Governance Code (UK CGC) will apply to companies in the single ESCC category. Companies incorporated in the UK will be required to include additional items in their annual financial report. It is common practice for smaller Standard Segment companies to adopt the Quote Companies Alliance Corporate Governance Code as that is more proportionate to its size that the UK CGC. The requirement to report against the UK CGC will be burdensome and costly for smaller companies listed on the Standard Segment. In our opinion, an optional rather than mandatory approach to UK CGC reporting would be more appropriate.
- Sponsor regime
On the Premium Segment, sponsors perform a similar role to a nominated adviser in respect of AIM companies with sponsors advising on the initial listing and then supporting and advising in relation to certain transactions and corporate actions specified in the Listing Rules. However, the retention of a sponsor post listing was not mandatory unlike AIM. The sponsor regime does not currently apply at all to Standard Segment companies pre or post listing.
In DP 22/02 published in May 2022 the FCA asked for feedback on proposals to expand the sponsor regime to all companies in the single ESCC category if it was implemented. It was clear from this paper that the FCA was keen on this expansion as this would mean that the sponsor would be the issuer’s first port of call, rather than the FCA, for guidance and that sponsors would interrogate transactions and provide comfort to the FCA rather than the FCA needing to do this on its own account.
So it was not a surprise that in the Consultation Paper the FCA has proposed that the sponsor regime will apply to all companies within the new single ESCC category. The role of sponsor would largely mirror the role sponsors currently have at IPO stage for Premium Segment companies (providing key assurances at the listing gateway), however, the sponsor’s due diligence would need to extend to take account of the new eligibility requirements that have been proposed as part of the consultation. In the new regime the sponsor would have fewer obligations post listing than is currently required on the Premium Segment.
The current list of sponsors includes most (but not all) nominated advisers, a number of larger financial institutions that would not normally serve small companies and other professional services firms. Only a handful of these firms are currently active at the smaller end of market and are likely to have fee structures that might be acceptable to small companies. A number of these are relatively small and are currently likely to lack capacity to take on significantly more clients. Therefore, unless more firms apply for sponsorship status, or those firms at the smaller end increase in size, then the pool of advisers from whom small companies can choose a sponsor is relatively restricted. This is likely to result in higher fees for those companies. As these companies are small, they are inherently less likely to have the resources to pay such fees and so we think it is important for there to be a sufficiently long transition period to enable the sponsor market to adapt.
- SPACs
A new category for shell companies, including Special Purpose Acquisition Companies (SPACs) has been proposed. The Consultation Paper does not provide much detail on the proposed rules for this category however the FCA does suggest that it may propose extending the sponsor regime to this category so that companies would be required to appoint a sponsor to assist with applications to list and reverse takeover transactions thereafter. However, these SPACs would need to meet the £30 million market capitalisation requirement and so are likely to be relatively rare as other markets have more flexible SPAC regimes that make SPACs more attractive to investors.
- Transitional arrangements
The Consultation Paper includes high-level proposals for transitional arrangements however it does not detail the process for existing listed companies to transition to the new single ESCC category. The FCA has requested input on the length of time issuers will need to prepare for and implement the various changes proposed in the consultation. Current Standard Segment companies will need sufficient time to transition to ensure they can meet the additional obligations proposed under the single ESCC listing category such as those relating to significant transactions and related party transactions.
Conclusion
The proposed reforms and the creation of the new single ESCC category will disproportionately increase the regulatory burden and cost for smaller companies currently listed on the Standard Segment. Companies have often sought to list on the Standard Segment as an alternative to AIM because AIM is deemed overly burdensome and costly, particularly its requirement to maintain a Nomad. The proposed new single ESCC category appears very similar to AIM particularly given the level of sponsor involvement and therefore may no longer offer an attractive alternative to AIM for Standard Segment companies.
Companies currently listed on the Standard Segment of the Official List will need to explore their options and decide whether the new single ESCC listing category is appropriate for their company particularly considering the likely increase in costs and regulatory burden in complying with the sponsor regime and additional obligations. Some Standard Segment companies may choose to cancel their listing rather than transfer to the single ESCC category or list on an alternative market such as AIM or Aquis.
Comments on the Consultation Paper are requested by the FCA by 28 June 2023. The FCA intends to issue a further consultation paper in the autumn which will include the proposed draft instrument. The transitional arrangements are still to be formulated however it is possible that the new single ESCC category could be established in 2024. This needs to be viewed against the backdrop of the Financial Services and Markets Bill, which is working its way through Parliament and is currently in the report stage and expected to conclude in mid-June. This bill, when it becomes law, is likely to creating a new legislative framework that will give powers to the FCA to set rules for what disclosures companies need to provide when seeking to admit securities to a regulated market. In May 2023 the FCA published a number of engagement papers to seek views on how the FCA might make such rules. These include the admission requirements and further issuances of equity on regulated markets and how the current prospectus regime (which is based on the EU prospectus regime) may be amended.
If you would like to discuss this topic further, please get in touch with us at Hill Dickinson LLP.
For further information, please contact:
Jonathan Morris, Partner, Hill Dickinson
jonathan.morris@hilldickinson.com
