On 30 November 2015, the European Commission (“EC”) released a proposal (the “Proposal”) as part of the EC’s capital markets union project for an overhaul of the Prospectus Directive1 by introducing a draft new Prospectus Regulation.
The Proposal is focused on creating greater opportunities for investors as the EC continue their plans to create a more accessible and competitive public market. The proposal also recognises the need for flexibility and cost effectiveness for SMEs and smaller issuers. But how will large issuers react? This remains to be seen with a proposal that is still far from complete.
1 Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC
In the seventh edition of GFMI, we addressed the latest EC green paper and the Review of the Prospectus Directive consultation paper through which the EC sought to establish key changes to the current Prospectus Directive based on the needs of the market. The closing date for responses was 13 May 2015, with a total of 181 responses being received. The EC have focused on a number of key themes in the Proposal which stem from the responses.
This article summarises the key changes which appear in the Proposal from the perspective of investors and SMEs and other issuers, and offers some insight into the background to these changes and the potential impact they may have on the market and its participants.
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SUMMARY OF KEY CHANGES
Greater liquidity and access to the market for smaller investors through removal of wholesale exemption (for securities with a €100,000 minimum denomination) for larger issuers – although there will still be an exemption based on the minimum consideration payable per investor
Shorter, more concise prospectus summaries (maximum six pages) which will now be required for all issues with the wholesale exemption removed
More specific material and categorised risk factors with a limit on the number of risk factors included in the summary
Central electronic database for prospectuses
No requirement to produce a prospectus for offers of securities with a total value of less than € 500,000 over a 12 month period (increased from € 100,000)
‘Light’ prospectus concept for SMEs provided they have no securities admitted to trading on a regulated market, including an optional ‘questionnaire’ format
3. Other Issuers
Fast track “Universal Registration Document” for regular issuers, which allows for more concise public offer process
A new minimum disclosure regime for secondary issuances, which replaces the old proportionate disclosure regime
No prospectus requirement for an issue of new securities of up to 20% of the same class as those already issued on a regulated market
A. Removal of Wholesale/Retail distinction
The motivation for this change comes from what the EC believes are the “unintended consequences” of allowing a lesser standard of disclosure for non-equity securities with a denomination of more than € 100,000. This has amounted to “favourable treatment” for one category of issuer in the eyes of the EC, with the result that many investors are effectively locked out of some of the most financially sound bonds on the market. The result is that issuers will now have a single standard under which prospectuses must be issued – which could increase the administrative burden for some issuers in the short term. This is to be mitigated however by the suggestion of a “unified prospectus template”, to be defined through secondary legislation.
This change will be welcomed with open arms by smaller investors in the market. This is also consistent with the strategy of the Capital Markets Union (“CMU”) to make the EU financial system more competitive and also increase options for savers across the EU. However, the greater administrative burden associated with a full prospectus and also the enhanced competition for high-end investors will be looked upon with frustration by the most sophisticated market players. However if these proposals are introduced issuers would have access to a deeper and more open market for securities which could prove to be beneficial in the long term and may lead to lower interest rates which would more than offset any increase in issuance costs. The administrative burden may also be mitigated by the new Universal Registration Document, which is discussed below.
It is also worth keeping in mind that larger issuers can still rely on the other existing exemptions for a prospectus, for instance the qualified investor exemption, and also the small investor pool exemption (fewer than 150 investors who are not qualified investors).
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B. Shorter Summaries
One of the key findings from the public consultation was that prospectus summaries under the current regime are not fit for purpose. Summaries have therefore been re-designed in the Proposal in question and answer format to be a maximum of six sides of A4 paper when printed using characters of readable size. It remains to be seen how the length requirements will work in practice – they are likely to be overly restrictive for many complex issues. The new form of summary looks to align the regime with the Regulation on key information documents for packaged retail and insurance-based investment products
(“PRIIPS Regulation”). If the securities offered fall under the scope of the PRIIPS Regulation, the issuer can use the key information document required under the PRIIPS Regulation, which will avoid duplication and unnecessary delay. There is also an allowance of three supplementary pages per additional security covered in the summary – so long as that security is sufficiently similar to the others being offered.
This is a sensible solution and along with the shortening of summaries is an important step in making the market more user friendly. However, it remains to be seen if six pages will be sufficient for the issuer to cover the necessary information “that investors need in order to understand the nature and risks of the issuer, the guarantor and the securities being offered” and that “aids investors when considering whether to invest in such securities” (Article 7(1) of the Proposal). Closely linked to this will be the requirement under the Proposal to include only the five most material risk factors in the summary – which may be extremely challenging with regard to the most complex securities. It will also raise challenges for issuers who also intend to offer their securities in other markets (such as the capital markets of the United States) where longer form documents are usual – even if such issuers resort to separate documents for issues in other markets, questions around adequate disclosure will arise in the event of investors suffering a loss for a reason described in a document in one market but omitted from documents in the European market.
C. More specific risk factors
The Proposal suggests that risk factors which are included in the prospectus should be “limited to risks which are specific to the issuer and/or the securities and are material for making an informed investment decision”. The aim here is that issuers spend more time thinking about the key risks of the securities, instead of effectively covering all known risks, however remote, by a great number of broad risk factors in the prospectus. Interestingly, risks shall also be allocated across a maximum of “three distinct categories” based on probability and magnitude of impact.
On the one side, this is great news for investors who, in theory, will no longer have to sift through countless risk factors in order to establish key concerns. However, it is difficult not to have sympathy for an issuer who must weigh up probability against magnitude in order to categorise each risk. There is an inherent risk here itself in both overvaluing or undervaluing a particular risk factor which in any event may never occur. Under the Proposal, the European Securities and Markets Authority (“ESMA”) is tasked with developing guidelines on assessment of materiality and the categorisation of risk factors; a document which should make for interesting reading when published. Ironically, in moving towards a more universal market and removing the wholesale exemption, it is more likely that less sophisticated investors will participate in issues and such investors would be the most likely to benefit from some of the “boilerplate” risk factors which are currently commonplace in offering documents.
D. Central Electronic Database for Prospectuses
It is proposed that ESMA shall publish all prospectuses through a storage mechanism, and shall provide the public with free access to this database. This would negate the need to publish a prospectus in a newspaper or store a printed prospectus at the offices of the issuer, which are now outdated options and have been removed in the Proposal.
These changes will again be welcomed by investors and align with the objectives of the CMU in making the markets work more effectively, making connections between issuers and investors more efficient and effective.
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A. No prospectus for offers under €500,000
Issuers will not be required to produce a prospectus if the total value of the securities on offer are below €500,000 over a 12 month period. Member states are then given freedom to further exempt the prospectus requirement for domestic offers with a total value between €500,000 and €10,000,000.
This again is a sensible move by the EC and recognises the cost benefit argument against producing a prospectus for very small offers. The effect here is that SMEs will view the bond market as a more attractive and accessible option for financing, which again increases competition and liquidity in the market. There is also more than enough flexibility for member states who may have different views on the threshold for an exemption based on local market sentiment.
However, it must be remembered that SMEs will not be exempt from producing adequate disclosure for any offering which is exempt from the requirements for a prospectus; this will depend on the size and nature of the offering and the regulations of the home member state.
B. Light Prospectus for SMEs
There will be an option for SMEs to follow minimum disclosure rules for the drawing up of a prospectus provided that they have no securities admitted to trading on a regulated market. The exact information and nature of the disclosure will be set out in secondary legislation, but the Proposal does provide that the information shall be adapted to the size and track record of the issuing company. There will also be an option for SMEs with certain securities to draw up a prospectus in the form of a questionnaire with standardised text. ESMA will also produce a set of guidelines for issuers who elect for the questionnaire format.
It is clear that access to financing for SMEs has been seen as being of fundamental importance to the EC in developing the Proposal. This is another change which is designed to make the bond market more appealing to smaller issuers, especially in light of the low-cost questionnaire format of prospectus. In order for this to be successful however, it will be crucial that standardised questions are clear, easy to follow and at the same time capture the level of detail required for investors. ESMA will have a difficult task in constructing guidelines which will have the aim of making a very complex process relatively simple. The ideal scenario will be the creation of a low cost, simple disclosure mechanism which works in practice. This will probably take some trial and error on the issuer side, however it is a concept which will certainly prove popular among smaller and first time issuers.
A. The Universal Registration Document
The EC and the capital markets union project have also recognised the administrative burden imposed on issuers who are required to draw up a new prospectus on an annual basis for issuing securities – referred to in the Proposal as “frequent issuers”. Under the Proposal, an EU issuer can file a “Universal Registration Document” – akin to a US shelf registration – which includes a description of the “company’s organisation, business, financial position, earnings and prospects, governance and shareholding structure”. This is then submitted to the competent authority for approval and once approved, only a securities note and summary are required to be submitted for any offer of securities to the public.
Furthermore, once an issuer has had a Universal Registration Document approved by the competent authority for three consecutive financial years, subsequent Universal Registration Documents may be submitted without prior approval.
There are a number of major benefits to the Universal Registration Document. For instance, issuers who have an approved Universal Registration Document will benefit from a fast-track approval mechanism (five working days instead of ten). The new system is also expected to be much lower cost, more efficient and could allow frequent issuers to take advantage of changes in the market by preparing offering documents in a much shorter timeframe. The issuer may also, under certain circumstances, fulfil their disclosure obligations under the Transparency Directive2 at the same time as submitting their Universal Registration Document, so long as they include their annual and half-yearly financial reports in the submission. Larger issuers may be concerned that they will lose submission privileges in the event that they do not file a Universal Registration Document in any financial year, however aside from this, issuers will welcome this initiative.
“Universal Registration Document and Base Prospectuses”
Under the Proposal, all non-equity securities can now be issued through a tripartite prospectus (i.e. a separately drafted registration document, securities note and summary, which can be drafted at different times). The Universal Registration Document can also be used in conjunction with all prospectuses. This is good news for financial institutions, who will be one of the main groups taking advantage of “frequent issuer” status and who often utilise base prospectuses when offering securities to the public.
2 Directive 2013/50/EU of the European Parliament and of the Council of 22 October 2013 amending Directive 2004/109/EC of the European Parliament and of the Council on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market.
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Once a frequent issuer has a Universal Registration Document approved, this will reduce the time and cost for that issuer to produce a base prospectus. However, there is one other important change to the base prospectus: the issuer will be required to produce an “issue specific” summary for each issue of securities, to be annexed to the final terms when those are filed. This does entail slightly more administration for the issuer, however it is probable that one issue summary will form the basis for subsequent summaries. Moreover, the requirement to draw up an initial summary of the base prospectus (if the final terms are not contained therein) is removed, meaning again more efficient access to the market. Overall therefore, issuers using the base prospectus regime are also likely to benefit from the Proposal.
B. Minimum disclosure regime for secondary issuances
Like the minimum disclosure rules for SMEs, the Proposal offers a specific form of disclosure for companies undertaking a secondary issuance, provided that the issuer’s securities have been admitted to trading on a regulated market or an SME growth market for at least 18 months. Like much of the new Proposal, the EC will adopt secondary legislation which will set forth the minimum disclosure regime for secondary issuances. However, at this stage the EC have suggested that the document will contain financial information from the last financial year and they have recognised the need for investors to be provided with sufficient information on the terms of the offer, use of proceeds, risk factors, board practices, remuneration, shareholding structure and related party transactions.
This amendment is a sensible one – the EC have commented that around 70% of prospectuses approved annually are drawn up by companies who would qualify for the lighter prospectus approach set out in the Proposal. The balance to be struck will be the creation of a regime which provides real financial and administrative efficiency for issuers, whilst providing enough disclosure to satisfy investors. We have already witnessed a hiccup with the old proportionate disclosure regime (which is to be abolished under the Proposal) and unless the benefits are clear, issuers may decide to stick with the full disclosure programme. This may be the most difficult task for the EC under this Proposal but there is certainly no doubt that there is a huge appetite for minimum disclosure, provided it works in practice.
C. No prospectus for supplementary issues below 20% of existing securities
The Proposal specifies that a prospectus will not be required for securities fungible with securities already admitted to trading on the same regulated market, provided that they represent, over a period of 12 months, fewer than 20% of the number of securities already admitted to trading on the same regulated market (increased from 10%). This amendment could represent significant cost savings for issuers, and will again be conducive to the creation of a more effective and efficient securities market.
However, the existing exemption for securities issued following conversion of convertible securities will also be capped at 20% of the class already admitted to trading which may impact on the size of convertible issues possible without a prospectus.
In short, it seems that the initial draft of the Proposal has been prepared to provide advantages for each major category of market participant, with the intention that an initial reaction should be positive from all sides. However, it is clear that smaller investors and SMEs benefit the most from the initial proposals which, given the key objectives of the CMU project to create a more liquid, versatile and competitive market, hardly comes as a surprise.
It remains to be seen how large and frequent issuers will seek to address some of the main changes in the Proposal, but the new Universal Registration Document and the re-worked minimum disclosure regime should reduce the impact of a reform which looks out largely for the smaller investor.
Overall, the changes proposed seem well calculated and a regime akin to that in the Proposal should lead to a more liquid and diverse market but, as mentioned above, we have yet to see the final detail of the proposals. It will be interesting to see whether the secondary legislation succeeds in treading the fine line between more accessible documentation