The Financial Conduct Authority (“FCA”) issued a discussion paper on the Availability of information in the UK equity IPO process on 13 April 2016 (the “Discussion Paper”). The Discussion Paper follows a number of reports into the UK equity market, including the Association of British Insurers’ study on Encouraging Equity Investment (July 2013) and the HM Government-commissioned IPOs and Bookbuilding in Future HM Government Primary Share Disposals (December 2014), which demonstrates that there has been appetite for change for some years. Whilst in principle any change which enhances the provision of information to potential investors is to be welcomed, there are a number of risks to the changes proposed.
This article is split into three sections:
- Section 1 will briefly consider current market practice in relation to the provision of information to investors in the IPO process
- Section 2 will summarise the proposed changes set out in the Discussion Paper, including the suggested “models for reform”
- Section 3 will consider the potential risks of the proposals to change current market practice.
SECTION 1 - CURRENT MARKET PRACTICE
In order to understand the potential effects of the changes proposed in the Discussion Paper, it is necessary to consider the current process of providing information to potential investors. The current process can broadly be split into seven steps:
- 3 to 4 weeks before an intention to float announcement (“ITF”) is made, the issuer will invite connected analysts to an “analyst presentation”, which includes a detailed presentation by the issuer’s management team followed by an in-depth question and answer session
- TThe connected analysts prepare connected research reports about the issuer, which contain information on the market and industry the issuer is operating in, together with profit forecasts and valuation ranges of the issuer
- The ITF is announced and connected research published
- There is a blackout period of around 14 days where no new information is published
- The pathfinder (or initial) prospectus is circulated, which includes an initial price range
- The issuer’s management go on roadshows and book-building occurs
- The final approved prospectus (including the final price) is published on the first day of trading.
SECTION 2 – SUMMARY OF PROPOSED CHANGES IN THE DISCUSSION PAPER
The Discussion Paper raises two main concerns about the current process. The first is that the prospectus should be the main document that investors rely on when making an investment decision, with the inference that current market practice dictates that too much weight is placed on the connected research reports, which have the potential to be biased. Additionally, the FCA raises concerns over the blackout period which currently occurs after the publication of connected research reports (before the pathfinder prospectus is published), particularly as it is suggested that the only reason for the blackout period is that it is to protect research analysts from liability by imposing a gap between publication and investment decision. The second concern is that unconnected analysts do not have an opportunity to produce pre-float reports and therefore investors do not have access to independent reports when making an investment decision. The Discussion Paper notes that of the 169 IPO transactions the FCA examined, only one transaction featured unconnected research published during the IPO process and that generally, unconnected analysts’ reports do not tend to appear until 6 to 12 months after a float.
In order to alleviate these concerns, the FCA puts forward three “models to reform” in the Discussion Paper. All three models require the prospectus to be published before any connected research is published, which is the approach taken in France and the US (although in the US, the publication of connected research is prohibited through the whole IPO process). Additionally, models 2 and 3 seek to provide mandatory access for unconnected analysts to any analyst presentation held by the issuer’s management. The three models are:
- Model 1 –analyst presentation takes place, followed by the publication of the prospectus. There is then a mandatory blackout on connected research for 7 days
- Model 2 – the same as Model 1, but with a mandatory requirement to invite unconnected research analysts to attend any analyst presentation by the issuer
- Model 3 – the same as Model 2, but the analyst presentation must not take place before the publication of the approved prospectus.
Whilst the aims of the regulator are understandably to ensure that investors are given as much and as accurate (and unbiased) information as possible, the proposed changes open up some potential risks that need to be considered.
SECTION 3 - RISKS OF THE PROPOSED CHANGES
All three models propose that the publication of the prospectus and analyst research reports (whether connected or unconnected) are inverted so that the publication of the prospectus comes first. There are a number of practical issues and concerns in relation to the proposals:
- Investor interest - currently, as analyst reports are released well in advance of the prospectus, the reports play a role in “warming up” the market. For smaller, less high profile IPOs which may need a longer lead in time to generate interest, the absence of research reports removes an important plank in developing the story and could impact the success of these IPOs
- Less information available to investors – the suggested changes may lead to the provision of less information or less reliable information to investors:
- The publication of analyst reports before the prospectus help issuers to refine the disclosure in the prospectus based on key points, questions and comments raised by analysts in the analyst meetings and in the reports. Additionally, the valuation ranges stated in analyst reports assist issuer’s with determining acceptable and realistic price ranges for the issue
- Research reports provide helpful information to potential investors about the issuer, the market and industry in general and without them, investors would lose all ‘colour’ to enable them to make a more informed decision about an investment. The current blackout period does go some way in protecting analysts from liability as a result of the information contained in the analyst research reports. If the order of publication is inverted, connected analysts may be wary of publishing anything which does not appear in the prospectus (unless analysts are prepared to go to the cost and expense of independently verifying any statements in their report which go above and beyond the information contained in the prospectus). This is likely to limit the value of the analysts’ reports published around the time of the IPO.
- Cost/time - Verification is the lengthy and costly process in which all statements in a prospectus are checked to ensure that all statements are accurate, true and not misleading. If the issuer/its directors make any misleading statements in the prospectus, they can face civil and criminal charges. Publishing the prospectus before the connected research will extend the IPO marketing period and will require information contained in the prospectus to remain up-to-date for a longer period of time. It is likely that during the marketing process, the information in the prospectus will need to be updated, which will require additional verification exercises, increasing cost for the issuer and extending the time of the marketing period even further.
Model 3 suggests that analyst presentations should be held post publication of the prospectus. This may devalue the analyst meetings with management, as management are likely to confine what they say to that published in the prospectus, to avoid liability.
Models two and three contain a mandatory requirement to open analyst presentations up to unconnected analysts. Concerns with this centre on increased cost and time for the issuer, for example, as a result of hiring a larger space to hold the presentations. Again, query the value of these proposals for smaller, less high profile issuers who will be most likely marketing to sophisticated investors who should be able to understand the context in which analyst reports have been written (ie the potential for bias) and understand the associated risks.
It is clear that there are a number of issues with the proposals contained within the Discussion Paper. In particular, the FCA should consider providing for more flexibility for smaller, less high profile issues where issuers are unlikely to open the issue to retail investors and where building the story pre-publication of the prospectus is more crucial to the success of the float. Responses to the Discussion Paper are required by 13 July 2016.