On 2 October 2012, the FSA published new consultation paper CP 12/25 (CP 12/25) which, amongst other things, sets out proposals for changes to the Listing Rules with a view to 'enhance the effectiveness of the Listing Regime'. The deadline for responding to the consultation is 2 January 2013.

Click here for our detailed note of the new proposals.

FSA U-turn

Market observers and in particular, "buy-side" investors would be forgiven for eagerly anticipating the response to the FSA Consultation Paper CP 12/2 in which the FSA had intimated that it would be prepared to lower the free float requirements for premium listings. Following the consultation however, the FSA, as set out in CP 12/25, has concluded that adjusting the free float requirements would not be an appropriate measure to address the underlying concerns relating to the protection of independent shareholders and the preservation of effective corporate governance in the Listing Regime.

Instead, it has announced a suite of new (and some old) measures to bolster the existing corporate governance framework of the Listing Regime which it believes will individually address such concerns.

Here is a brief outline of the new proposals:

Independence and control

The FSA has proposed two new rules to replace the current control and independence requirements in the Listing Rules. Under the new rules, a new applicant for a premium listing must demonstrate that:

  • it controls the majority of its business; and
  • it will be carrying on an independent business as its main activity.

The new independent business and control requirements will apply both to applicants for, and companies with, a premium listing at all times on a continuing basis. The new requirements will be supplemented by guidance setting out factors which may be relevant when determining whether an applicant meets the control and independence criteria. For example, a lack of strategic control over the commercialisation of a product may indicate that an applicant is unable to carry on an independent business. Furthermore, if a company is able to exercise only negative control or only has veto rights over significant decisions affecting the management of the business made by third parties, this may indicate that it does not have control of its business.

Controlling shareholders – a hint of déjà vu?

The FSA has reinstated the old 'controlling shareholder' provisions which were removed from the Listing Rules in 2004. The provisions were originally removed as it was believed that the relationship between an issuer and its controlling shareholder should be a matter for disclosure and left to the judgment of investors. In response to recent concerns that the existing governance framework for listed issuers has not been sufficiently protecting independent shareholders, particularly where there is a dominant controlling shareholder, the FSA is proposing to reinstate the express provision that a premium listed issuer must be capable of acting independently of a controlling shareholder and its associates.

A 'controlling person' will be a person who holds:

  • 30% or more of the shares or voting power in a new applicant for, or a company with, a premium listing, or its parent undertaking; or
  • shares or voting power that enable it to exert a significant influence over the management of a new applicant for, or a company with, a premium listing.

The proposed definition will also include the ability to aggregate the interests of those acting in concert.

Relationship agreement

CP 12/25 also proposes to bring back the concept of the relationship agreement to the Listing Rules for companies with a premium listing who have a controlling shareholder. In practice, the entry into such agreements has continued to be market practice as they are viewed as necessary in order to attract public investors. Consequently, the new proposals require the relationship agreement to remain in effect for so long as the shares are listed on the Official List and the listed company has a controlling shareholder.

Relationship agreements will have to comply with the proposed specific content requirements. These requirements include ensuring that:

  • a controlling shareholder abstains from doing anything that would have the effect of preventing a new applicant from complying with its obligations under the Listing Rules; and
  • a controlling shareholder must not influence the day-to-day operations of the new applicant.

Any material change to the relationship agreement will require independent shareholder approval (that is, the approval of all shareholders other than the controlling shareholders and its associates).

So that the FSA is able to monitor the correct operation of the new rules, the new proposals require a copy of the relationship agreement (or details of where it may be obtained free of charge) to be included in the company's annual report. The annual report must also include a directors' statement that the company has complied with the relationship agreement throughout the financial year, or where there has been any non-compliance, a description of the non-compliance and confirmation that the UKLA has been informed. This addresses the conundrum that breaches of a relationship agreement between a controlling shareholder and a company controlled by it may not be vigorously remedied. These proposals are a useful addition to enforcement issues and will enhance current market practice where many relationship agreements already contain provisions which enable independent directors to have the power to decide whether to seek remedies for breaches.

Make-up of the board

The FSA believes that independent directors are important for the protection of independent shareholders in listed issuers. It is therefore proposing to introduce a new eligibility requirement to govern the make-up of the board where a new applicant for a premium listing has a controlling shareholder. The applicant's board will need to have either:

  • a majority of independent directors; or
  • an independent chairman and independent directors making up at least half the board.

As a result of this change, companies will not have to 'comply or explain' with the UK Corporate Governance Code in this area. However, the FSA appreciates that there is wide support for the 'comply or explain' approach and is therefore consulting on whether stakeholders would prefer to proceed with the new proposals or keep the 'comply or explain' approach and retain flexibility for board composition in all circumstances. Given the flexibility of the 'comply or explain' approach, it will be interesting to see whether stakeholders will favour a shift towards a more prescribed route which may involve a significant shake-up of an issuer's existing board to favour the 'greater good' (that is, the independent shareholders). It is likely that the responses which the FSA receives will diverge upon the buy-side / sell-side divide. The FSA may be none the wiser at the end of the consultation period as to a consensus of market views on this point.

Election of independent directors

Currently, a director may be elected or dismissed by approval of the majority of all shareholders who vote. In a company with a controlling shareholder, independent shareholders may not hold enough shares to influence the outcome of the vote. The FSA has proposed therefore, a dual voting structure for the appointment of independent directors of a premium listed company with a controlling shareholder. Such appointments must be approved both by the shareholders as a whole and also by the independent shareholders. If the result of these two votes conflict, a further vote may take place not less than 90 days later on a simple majority basis of all shareholders. This seems to strike an appropriate balance between enabling the independent shareholders to have a vote without ceding control of the company to a group which has only a minority economic interest.

Continuing obligations

The FSA is also proposing a number of additional amendments to the continuing obligations of companies with a premium listing, including the following:

Voting by premium listed shares. The FSA is seeking to tighten the rules so that the investor rights and protections arising from the premium listing segment only attach to premium listed shares and not to any other securities on the grounds that the absence of such controls presents an opportunity for circumventing the protections which the super-equivalent provisions are intended to afford. The proposed new rule provides that all shareholder votes that are required to be undertaken by a premium listed company should be decided by the holders of premium listed shares unless there are exceptional circumstances (such as where there are voting rights attaching to unlisted preference shares which are in arrears or where there are dual listed company structures).

Non-compliance with continuing obligations. The FSA is proposing that issuers should be subject to an obligation to notify the FSA of non-compliance with any of the continuing obligations set out in LR 9.2 (and not just the free-float requirements as currently provided). It is also proposed that, where a company is not complying with any of these obligations, it should consider applying for a cancellation of its listing or a transfer of its listing category.

Listing Principles

Currently, the Listing Principles apply to premium listed companies but the FSA proposes to extend the scope of certain principles to standard listed companies. As a result, the following changes are proposed:

  • Principle 2 (systems and controls) and principle 6 (open and co-operative dealings with FSA) of the existing Listing Principles will be applicable to all listed companies. One would hope that this amendment would be non-controversial.
  • The remainder of the existing Listing Principles (principles 1 and 3 - 5 (inclusive)) will be re-categorised as Premium Listing Principles that apply to companies with a premium listing only.

Two new Premium Listing Principles will also be introduced requiring that:

  • the voting power of each share within a premium listed class should carry an equal number of votes (new Premium Principle 3); and
  • where a company has more than one class of equity shares admitted to premium listing, the aggregate voting rights of the shares in each class should be broadly proportionate to the relative interests of those classes in the equity of the company (new Premium Principle 4).

Free float

Premium listing. As mentioned above, the FSA does not believe that increasing the current level of the free float requirements would be sufficient to ensure effective governance in a listed company, particularly in relation to the premium listing segment.

The FSA has, however, announced proposals to clarify the operation of the free float provisions for companies with a premium listing. These proposals include:

  • excluding shares subject to a lengthy lock up period (that is, longer than 30 calendar days) from the free float calculation on the basis that such shares do not provide any liquidity; and
  • specifying the criteria that the FSA will apply in determining whether to modify the 25% requirement for shares in public hands. The proposed criteria include companies where the number of public shareholders exceeds 100 and the expected market value of the shares in public hands at admission exceeds £250 million.

Even where these two criteria are met, other than in exceptional circumstances, the FSA is unlikely to agree to a request where the number of shares in public hands will be below 20%.

Standard listing. The FSA notes that there may be room for increasing flexibility in the standard listing segment. No rule change is being proposed but the FSA is seeking views on admitting securities which have very low free floats in percentage terms provided that there is sufficient liquidity.

A step back into the future?

Whilst some market commentators may be disappointed with the FSA's apparent U-turn in its approach to modifying the free float requirements, CP 12/25 explains the rationale behind why adjusting the thresholds may act as a "blunt tool" which may not fix the underlying concerns relating to appropriate governance and maintaining the "gold standard" quality attached to the UK's premium listing brand.

Rather, a package of measures, some of which have already been tested in the market in previous years, may provide a more pragmatic solution to the recently raised concerns of stakeholders. The return of the 'controlling shareholder' provisions is a step back in time, however, their re-instatement may be a step forward in the current era, where prescribed rules and controls may provide comfort to investors, rather than act as a barrier to future investments.