The new Prospectus Regulation (known as PD III), which will come into effect on 21 July 2019, is intended to minimise variation in the interpretation and application of legislation across the EU with a view to improving the functioning of the internal capital markets and guaranteeing investor protection. It remains to be seen whether the intended enhancements will achieve these aims, but what is clear is that the changes will have practical implications for issuers and other market participants.
PD III applies to prospectuses where securities are being offered to the public in the EU and/or traded on an EU regulated market. The new regime introduces significant changes to risk factors and summaries and a range of changes to disclosure requirements more generally. It also broadens the scope of the existing wholesale regime governing securities with a denomination of at least €100,000, which are subject to a lighter disclosure regime, to encompass those admitted to trading exclusively on a “qualified investor” segment of a regulated market.
What will be the status of prospectuses approved before 21 July? Will they be “grandfathered”?
The majority of issuers with debt programmes will not have to comply with new disclosure requirements in their base prospectuses until 2020. A base prospectus approved before 21 July 2019, when the new requirements come into force, will continue to be governed by the previous rules until either 21 July 2020, or the expiration of its validity period, if that happens first.
This means that supplements issued on or after 21 July 2019 relating to a base prospectus approved before that date will be subject to the old rules. However, there is no “grandfathering” for any prospectuses approved on or after 21 July, even if the registration document forming one of its constituent parts was approved before that date.
The EU Commission promised a change of course on risk factors - how has this played out?
The approach to risk factors is one of the most significant areas of potential change. The EU Commission and ESMA have both indicated that a change of course is needed. As is the case under the current rules, risk factors are required to be material and specific. The most material risk factors should be disclosed first.
In addition, risks should be substantiated by the contents of the prospectus and backed by quantitative information where possible. An issuer may also disclose its assessment on a scale of low, medium or high (although this is not mandatory).
PD III introduces specific limitations on the number of categories of risk factors that may be included. Under ESMA’s new guidelines a “standard” single security prospectus should not have more than 10 categories and sub-categories of risks in total. It is not entirely clear what is meant by a “standard” prospectus, but multi-product base prospectuses could potentially contain more than this.
Moreover, competent authorities may challenge issuers, if they are not satisfied with the information provided, for example if the section is deemed to be incomprehensibly long.
ESMA’s guidelines preserve some flexibility for competent authorities when it comes to setting out risk factors. This could lead to some differences in approach between jurisdictions in terms of how much of an overhaul of risk factor disclosure they will ask to see. Indeed, some competent authorities have indicated that they believe their approach to risk factor disclosure has always been in line with these guidelines.
What are the headline points that retail issuers will need to know on the changes to the summary requirements?
Summaries will look quite different under PD III. Retail issuers should expect that this section will require significant redrafting. Summaries will no longer be subject to a disclosure annex. Instead, the annex has been replaced with specified sections and mandated sub-sections with headings, with the detailed requirements being included in PD III itself. The length of the summary has been reduced to seven pages. This is a more restrictive requirement, but it is helpful that this can be extended if there is a guarantor, or if it covers several securities.
The summary will include four parts: an introduction containing warnings; information on the issuer; information on the securities; and information on the offer/admission. A maximum of 15 risk factors will be covered across the issuer and securities sections. Tables setting out key financial information must also be included.
Under PD III, issuers can replace the securities part of their summary with the relevant information from a PRIIPs KID they are preparing for a particular issue, as long as the KID itself is included in the prospectus disclosure package. This latter requirement may present practical problems for issues done under a base prospectus since inclusion of the KID disclosure will necessitate a review of the base prospectus disclosure which may result in the need for a supplement. This will have timing implications for an issue. Although this replacement of the securities part of the summary is framed in the legislation as being optional, it is not as yet clear if this is something that competent authorities may start to require.
How have the general disclosure requirements changed?
There are a number of changes to the disclosure requirements that will need to be taken into account. PD III specifically requires hyperlinks for all documents incorporated by reference in the prospectus. These links must be functional for 10 years, which may present challenges given that websites may be updated and restructured periodically.
The list of documents that may be incorporated by reference has been extended to include elements such as corporate governance statements, although it remains to be seen how useful this change will be in the debt capital markets space. Links to external websites can be included but they need to be accompanied with a statement specifying that they do not form part of the prospectus and that they have not been approved by the competent authority.
Some definitions have been removed, including those for debt and derivatives securities, as has the table of combinations, which previously served as a helpful guide to identifying the applicable disclosure annexes. Some of the required statements (such as the responsibility and no significant change statements) have been changed. The A, B, C categorisation of some items in the annexes has also been changed, which may make it difficult to document issuance of certain types of securities (e.g. credit linked securities) using final terms.
The registration document for banks and credit institutions - which provided some relief from certain requirements of the retail regime - has been removed. This is mitigated by the removal of certain items in the revised retail annex. Requirements relating to the consistency of financial information for a particular year with that of the following year have been removed for wholesale issues and narrowed in the case of retail issues.
What is the secondary issuance regime and how might it be used in a debt capital markets context?
The regime for secondary issuances is being simplified. The aim is to reduce the disclosure requirements for issuers with equity already admitted on a regulated market for 18 months that are looking to issue further securities (including non-equity securities). Issuers need only provide financial statements for the previous 12 months but may also need to include half-yearly financial statements, which would not represent a reduction in financial disclosure for wholesale issuers. No description of the group, or indication of whether the issuer is dependent on other entities in the group, will be required.
It remains to be seen whether there will be much uptake for this regime in the debt capital markets space, particularly as there are some potential barriers. For example, disclosure requirements around the type, class and amount of an issue have been designated as Category A, meaning the information must be in the base prospectus (rather than final terms), although there may be a way around this in most cases (the exception being the amount of a wholesale issue).
The prospectus must also include a concise summary of the information disclosed by the issuer under MAR over the past 12 months. This is not required in the retail or wholesale debt annexes, and will add to rather than simplify disclosure for debt issuers.
Will the format of the prospectus change?
The requirement under a programme for a base prospectus summary has been removed although the requirement for issue specific summaries remains. Provisions are unclear, however, on whether the base prospectus should include a form of the issue specific summary. It is likely that a form will have to be drawn up for operational purposes, even if it is not included in the base prospectus. In general, the current market approach to segregating information on the different securities in the base prospectus should satisfy the new requirements. A new “Universal Registration Document” format is available, but it seems likely that the market will continue to use the existing base prospectus and final terms structure in relation to debt programmes.
Will there be any changes to scrutiny and approval by competent authorities?
New scrutiny and approval provisions have been designed to drive convergence of competent authorities' approaches. The focus is on the "three Cs": completeness of information; comprehensibility (disclosure must be clearly structured, legible and free from unnecessary reiterations); and consistency (disclosure must be free from internal material discrepancies).
There are helpful provisions that allow a competent authority to take a proportionate approach to scrutiny. For example, the first draft of a prospectus that is substantially similar to a previously approved prospectus should take less time to scrutinise.
Are there any operational issues that may arise once the new legislation comes into effect?
Competent authorities will have to provide ESMA with around 30 items of data once a prospectus has been approved to allow ESMA to classify it in its storage mechanism and to produce its annual report on prospectuses. Competent authorities are likely to pass the burden of this requirement on to issuers. In some instances, such as the requirement for details of “consideration offered”, it is not clear what ESMA is asking for, making this issue one of the most potentially problematic elements of the new rules from a practical perspective.
How have the publication requirements changed?
Most of the publication requirements are broadly the same. But new rules specify that publication must be in electronic form on a dedicated section of a website. As most prospectuses for debt instruments are published on a regulated market website, issuers may not have direct control over where a prospectus sits after it is published.
Competent authorities must also publish approved prospectuses and it will be important to ensure that the timing of the publication by competent authorities aligns with the timing of publication by issuers.
Prospectuses will have to remain publicly available for at least 10 years, which will result in the same issues as mentioned in relation to hyperlinks to documents incorporated by reference above.
Has the supplements regime changed?
As noted above, changes to the supplements regime will only apply to supplements to prospectuses approved on or after 21 July 2019.
The application of withdrawal rights is broadly unchanged. These will be available to investors that have already agreed to purchase securities before the supplement was published and where the securities are not yet delivered.
New investor notification requirements apply to financial intermediaries in relation to supplements, which may present challenges. The term "financial intermediaries” is not defined. Banks that are dealers on an issuer’s programme may well be caught by this term, although they will not always have sight of when an issuer is producing a supplement.
Helpfully, the market view that withdrawal rights are do not apply in a wholesale debt context (i.e. where a prospectus is only prepared for admission to trading purposes as the offer side of the equation is exempt from a prospectus requirement), has been endorsed by ESMA.
The triggers for preparing a supplement are broadly unchanged. As before, a supplement is required in the following circumstances in a debt capital markets context:
where there is an increase in the programme amount; and
when a new public offer jurisdiction or admission venue is added.
In addition, a new mandatory requirement to produce a supplement has been introduced where there is an amendment to, or a withdrawal of, a profit forecast or estimate contained in a prospectus.
Are there any changes to the advertisements regime that market participants should be aware of?
There is no grandfathering arrangement for advertisements, even where an advertisement relates to a prospectus that has been grandfathered. There are ongoing efforts at an industry level to develop language that may be used to streamline compliance with the new advertisement requirements.
The definition of advertisement has been expanded to refer to "communication" rather than announcement, so that a wider range of disclosures, including bilateral communications, could be caught. Term sheets, screen announcements and roadshow materials will continue to be considered advertisements.
The range of items that is caught under the new regime is helpfully still limited by the test of whether a communication relates to a specific offer or admission, and is aimed at specifically promoting the subscription or acquisition of securities.
As before, an advertisement will need to be consistent with the prospectus and will have to be updated if a supplement is produced. It must not present things in a materially unbalanced way, or include alternative performance measures not contained in the prospectus.
Oversight of compliance with the advertising requirements is the responsibility of each competent authority in any jurisdiction where the advertisement is disseminated. This may result in a fragmentation of compliance requirements. However, it is worth noting that scrutiny of advertisements by a competent authority is not a precondition to the offer or admission taking place.
Conclusion: Will PD III achieve its intended goals?
It is too early to say whether the Prospectus Regulation will improve the functioning of the capital markets in the EU and improve investor protection. There is still some level of uncertainty regarding how the PD III regime in its entirety will ultimately play out. The changes are not entirely straightforward or unambiguous, meaning that market participants will have to tolerate a period of adjustment before the dust settles on PD III and a verdict on it can be reached.