The purpose of the Shareholders Rights Directive II (“SRD II”) is to encourage long-term shareholder engagement and transparency between traded companies and investors. These changes came into force on 10 June 2019 and Member States have transposed the SRD II's provisions into national law. These require UK companies with shares admitted to trading on a regulated market in the UK or EU to have safeguards with respect to material transactions with related parties (SRD II, Article 9c).
As a result, both premium and standard listed companies must have in place the relevant procedures in order to comply with the new Disclosure and Transparency Rules (“DTR”) on material related party transactions (“RPTs”), including a requirement for board approval and public announcement where relevant. These requirements will apply, in addition to the Listing Rules (“LR”) for premium listed companies, to certain types of transactions entered in financial years starting on or after 10 June 2019.
Who does this apply to?
The new RPT rules apply to:
- UK companies with shares admitted to trading on a regulated market in the UK or EU (including those with a premium or standard listing of shares); and
- certain non-EEA issuers i.e. issuers incorporated overseas with shares.
DTR 7.3 does not apply to AIM companies as AIM is not a regulated market (it is an exchange regulated market and multilateral trading facility).
Issuers incorporated elsewhere in Europe with 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, and therefore may not be applied in the same manner as the UK.
How do the new RPT rules apply to premium listed companies?
Premium listed companies must comply with the new RPT rules in DTR 7.3 alongside LR 11, despite these being separate regimes. However there are some instances where DTR 7.3 would apply exclusively to a transaction by a premium listed issuer, but LR 11 would not:
- DTR 7.3 includes a different and wider definition of a related party (for example this now includes entities, or any member of a group, which provide key management personnel services to the company in question);
- DTR 7.3 rules on the aggregation of RPT transactions (for example the board approval and disclosure requirements apply to all aggregated transactions instead of the LR 11 rules which require application to only those transactions that trigger the materiality threshold along with just a description of earlier aggregated transactions); and
- DTR 7.3 adopting a different set of rules regarding transactions to which the RPT rules do not apply (see section on Exemptions below).
Premium listed companies will need to ensure that they can identify the now wider defined related parties in line with new rules and review their procedures for assessing whether transactions are in the ordinary course of business. They will now have some additional disclosure obligations and must be mindful of 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 will need to consider whether an equivalent is available under DTR 7.3 and (if not) how it will comply with the new rules going forward.
How do the new RPT rules apply to standard listed companies?
For standard listed companies, the rules are new territory and issuers will need to establish an effective process for the identification and correct treatment of RPTs, as well as ensuring that relevant transactions are approved by the independent board members and announced to the public. If a standard listed company enters into a material RPT, it must announce the name and relationship of the related party, the date and value of the transaction or arrangement and “any other information necessary to assess whether the transaction or arrangement is fair and reasonable from the perspective of the issuer and of the shareholders who are not a related party”. The rules apply with modifications to standard listed companies incorporated outside the EEA.
What is the definition of a related party?
DTR 7.3 adopts the accounting framework definition of related party in the EU-adopted International Financial Reporting Standards (IFRS) (IAS 24). Therefore it is important to note that any future change in the wider IFRS definition would result in a corresponding change in the scope of transactions subject to DTR 7.3. DTR 7.3 specifically includes transactions with related parties on non-market terms as RPTs, rather than this just being a factor to have regard to when assessing whether a transaction is in the ordinary course of business.
What is a material transaction?
A material RPT is one where any percentage ratio is 5% or more according to any one of the types set out in Annex 1 of DTR 7 (related party tests) and Annex 1 of LR 10 for premium listed companies for the transaction concerned. These tests align with the requirements for large RPTs under LR 11. The related party tests assess the size of the RPT relative to the size of the issuer. There is a requirement to aggregate all transactions with the same related party over a rolling 12 month period.
The tests are:
- Gross assets: the gross assets which are the subject of the transaction vs. gross assets of the issuer (i.e. non-current assets plus current assets). Issuers should consider, when calculating assets the subject of a transaction, whether further amounts (such as contingent assets for arrangements) should be included to ensure the size of the transaction is properly reflected in the calculation.
- Profits: the profits which are the subject of the transaction vs. profits of the issuer. Issuers should consider whether further amounts should be included in the calculation of the consideration to ensure the size of the transaction is properly reflected in the calculation.
- Consideration: the consideration for the transaction as a percentage of the market capitalisation of all the ordinary shares of the issuer.
- Gross capital: the gross capital of the business being acquired / sold vs. gross capital of the issuer.
The guidance in these related party tests is for issuers to consider the inclusion of further amounts such as contingent assets to ensure the transaction size is properly reflected in the calculation.
Where a company enters into a sequence of smaller transactions with the same related party (or its associates), it will need to take into account and plan how it will comply with the new aggregation rules. If the result is below 5% when assessing materiality (aggregating all relevant transactions over the previous 12 months), then there is no announcement obligation (however compliance with the modified requirements for a smaller RPT in LR 11 may still be required for premium listed companies).
There are exemptions from DTR 7.3’s announcement and approval requirements for some permitted types of transactions.
- Ordinary course of business transactions
These must be concluded on normal market terms. An issuer must establish systems and controls to enable this assessment to take place, ensuring the related party does not take part in the assessment.
- Transactions with subsidiary undertakings
The subsidiary undertaking must be either wholly owned or not have another related party of the issuer holding an interest in it. A comprehensive list of non-wholly owned subsidiaries where another shareholder is a related party should be maintained in order to track this.
- Transactions regarding remuneration of directors
Transactions in relation to directors’ remuneration that comply with the Companies Act 2006.
- Other transactions ensuring fairness
Transactions offered to all shareholders on the same terms. This should be available for share buybacks and rights issues, for example.
What are the rules on a material RPT?
If an issuer or its subsidiary undertaking enters into a material RPT which is not exempt:
- An announcement must be made at the time the terms are agreed; and
- Unless the issuer is incorporated outside the EEA, the board must approve the transaction before it is entered into.
Under DTR 7.3, the issuer must obtain board approval for a material RPT before it is entered into. The FCA has noted that this means decisions for material RPTs must be taken by those directly accountable to shareholders (the issuer’s directors) and cannot be delegated, although shareholder approval is not required.
The issuer must ensure that directors linked to the related party abstain from the board’s consideration of the transaction and do not vote on the board resolution. This applies where:
- The director is the related party.
- An associate of the director is the related party.
- The director is a director of the related party.
The announcement of a material RPT must set out:
- The related party’s name.
- The nature of the related party relationship.
- The date and value of the transaction.
- Any other information necessary to assess whether the transaction is fair and reasonable from the perspective of both the issuer and its shareholders (who are not related parties) including minority shareholders. However, DTR 7.3 does not require a fair and reasonable report by a sponsor or other third party.
In many of the above areas the FCA continues to monitor the market and gather research to provide updates later this year, especially regarding the impact of Brexit on the application of RPT definitions for UK companies.
As the new rules apply from the start of the next accounting period commencing after 10 June 2019, premium listed companies should update their RPT policies now to include DTR 7.3 requirements (in addition to their parallel obligations which still apply under LR 11), to enable identification of related parties as well as reporting and control systems 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. Standard listed companies will need to establish and maintain these policies and controls as well as briefing board members and considering appropriate training for internal teams on compliance.