A new report by the Association of British Insurers (ABI), “Encouraging Equity Investment”, looks at ways to facilitate efficient equity capital-raising in the UK market. The ABI sees maintaining a competitive and attractive environment as critical to London’s future as an international financial centre.
Following the financial crisis, there have been expressions of discontent in the market about both the IPO process and the system for secondary offerings. The ABI has had discussions with a large number of institutional investors and also a wide range of other market participants and interested parties, including issuers, vendors, investment banks, lawyers, accountants, independent advisers, providers of independent research and regulators. Overall, market participants do not believe that the UK model is fundamentally broken, but there are some areas where the efficiency of the process and the attractiveness of the London market could be improved. The report sets out a number of recommendations.
INITIAL PUBLIC OFFERINGS
Information asymmetry/price discovery
The ABI believes that an information asymmetry exists in favour of issuers and vendors at the expense of investors, and that it is crucial that the IPO process addresses this imbalance so that investors can understand the investment case. Market participants believe that the current IPO process simply does not allow potential investors enough time to consider properly whether to invest.
The ABI encourages early engagement by issuers and vendors with investors up to a year or more before a planned IPO. A prospectus approved by the Financial Conduct Authority, which is complete apart from pricing or price range and related information, should be issued at least one week earlier than the pathfinder or price range prospectus is issued in current practice. This will require eliminating the delay between publication of connected research and the offering document. The FCA will need to clarify that they will not regard connected research, if prepared and identified appropriately, as part of a prospectus. This could have the effect of shortening the typical timetable for an IPO (once the intention to float announcement has been made) by one week, from four to three weeks. Regulatory clarification by the FCA will mitigate risks in the UK that companies may be liable for the content of this research. However, the risk will remain of liability in jurisdictions outside the UK - most notably in the US.
The report states that there are disadvantages in having large bank syndicates on IPOs. They can be difficult to manage. Often, the respective roles of syndicate members are not clear and there is suspicion that vendors/issuers use the IPO process as a way of paying their advisers for unpaid past advice, or because they need to maintain relationships (particularly lending relationships). The report recommends that, as a rule of thumb, no more than three bookrunners should be appointed for large transactions (i.e. above £250m), excluding any over-allotment option. Below this size, there should generally be no more than two bookrunners.
The report recommends companies - with the assistance of independent advisers where appropriate - to study allocations carefully to ensure that shares are being distributed to those most likely to be long-term shareholders. Issuers and vendors are encouraged to include a retail tranche when listing in the premium segment of the Main Market.
There is significant concern about the overall level of fees on IPOs and the need for greater transparency on fees. The report recommends that the prospectus should contain a break down of fees as a percentage of the size of the offering, and fees that are not related to size, such as, for example, independent advisers’, lawyers’ and accountants’ fees, should be disclosed. Syndicate members’ individual fees should also be disclosed. The final determination and payment of incentive fees in an IPO should be made at the later of the release of the first quarter results of the issuer as a listed company and three months after listing. The amount paid should be disclosed in the market at the time of award.
The report says that the following criteria should be taken into consideration when awarding the incentive fee:
- the stability of the share price in the newly listed environment
- the allocation of the shares of the issuer to a predominantly long-term shareholder base, as evidenced by the stability of the share register in the aftermarket
- the extent and quality of the syndicate research, both during and after the IPO, in the eyes of the investors
- the continuity of research coverage post-IPO.
Free float and corporate governance
Although some market participants think that the current minimum of 25% in public hands is a barrier to listing on the Main Market, the report says that the minimum free float for premium and standard listings should be maintained at 25%.
There is strong support from all parties to strengthen the corporate governance standards of companies that have controlling shareholders. This would include requiring controlling shareholders to make a responsibility statement in the prospectus covering certain statements in the prospectus about the future conduct of the business, including their future relationship with the company, if the company is seeking a premium listing, and requiring them to enter into a publicly available relationship agreement with the company obliging them to comply with the statements included in the prospectus for which they have accepted responsibility (and any material changes to the agreement would require a shareholder vote). A controlling shareholder would include a shareholder or shareholders acting in concert with holdings of 50% plus 1 pre-IPO, and any pre-IPO shareholder who will be party to a relationship agreement post-IPO. Controlling shareholders would have liability to the same extent as the company unless they could show that they had acted in good faith and had not directly or indirectly induced the company’s default.
The report says that there should be a phased appointment of independent directors in the months leading up to an IPO. An independent board should be in place, at the latest, one month ahead of the announcement of intention to float. The requirement for an independent board should be a continuing obligation under the Listing Rules once the company is listed.
All market participants agree that the current regulatory regime has resulted in prospectuses that are too large. The report encourages issuers, their sponsors and lawyers to work with the FCA to provide a document that is more succinct in providing the important information relevant to an investment decision.
The report finds that investors remain concerned about the potentially dilutive effects of non-pre-emptive issues, and that there is a need for greater clarity about what is acceptable to investors in relation to non-pre-emptive placings. The ABI intends to clarify its existing guidance on non-pre-emptive placings, open offers and rights issues, and the report recommends that the Pre-Emption Group should be reconvened with a view to assessing the scope and suitability of their Statement of Principles in the light of market practice. The revised ABI guidance and Statement of Principles should aim to provide clarity on:
- the limit for placings for cash, including aggregate issuance over a time period longer than one year, and associated discount
- the limit for vendor placings conducted on a non-pre-emptive basis and associated discount
- the acceptability or otherwise of cash box placings when not used as directly acquisition-linked financing
- acceptable levels of capital raised and associated discounts for open offers
- the reference price when calculating discounts, and whether fees associated with such issues should be included
- the application of the Principles or guidelines for the standard segment and AIM.
The report says that major existing institutional shareholders should be consulted in advance of non-pre-emptive placings.
Underwriting capacity, fees and discounts
The report finds agreement among most parties that the split of risk and the reward for taking such risk between primary underwriters and sub-underwriters could be improved. Deep discount rights issues should be encouraged as a way to lower fees.
The report also encourages companies to reduce primary underwriting fees where possible by getting firm undertakings from sub-underwriters prior to announcement of the transaction. The gross spread for rights issues and open offers should be unbundled, so that the amounts for advice, including document preparation, primary underwriting and sub-underwriting are shown separately. These unbundled fees should be fully disclosed in the offering documents, along with disclosure of other rights issue-related fees, including, but not limited to, fees payable to lawyers, accountants and independent advisers.
It is recommended that both buy side and sell side should work to develop standard sub-underwriting agreements. The aggregate fees charged and the discounts to the mid-market price at the time of agreeing the placing should be disclosed in the pricing announcement for non-pre-emptive placings.
The report says that efforts should be made to shorten a pre-emptive offering timetable further by examining ways to eliminate the physical distribution of documents and reduce the time needed by custodians to act on their clients’ instructions. The FCA is urged to look into whether a fast-track review process could be introduced for time-critical offerings. Issuers would be expected to pay higher fees for this service.
You can access the report here.