On 2 March 2010 the Financial Services Authority (FSA), acting in its capacity as the UK Listing Authority (UKLA), published a supplementary edition of LIST! (LIST! 24) in relation to the interaction between working capital statements and risk factors. The UKLA considers working capital and risk factors to be “two of the most important disclosures in prospectuses and circulars, especially for the types of transactions that have been common in the last couple of years”, but comments that there is the potential for overlap and inconsistencies between them. LIST! 24 seeks to clarify the UKLA’s approach to these disclosures and to set out the key principles and guidelines for issuers to take into account.

LIST! 24 refers to guidance on the preparation of working capital statements which is set out in paragraphs 107 to 126 of the recommendations for the consistent implementation of the Prospectus Directive Regulation published by the Committee of European Securities Regulators in 2005 (CESR Recommendations). The UKLA comments that its guidance on working capital statements and risk factors is consistent with the CESR Recommendations. As a result, the UKLA will pay close attention to risk factors that suggest that the issuer will or may run out of working capital in the next 12 months. In addition, where such risk factors sit alongside a clean working capital statement, the CESR Recommendations will be directly relevant in relation to both prospectuses produced under the Prospectus Rules and circulars produced under the Listing Rules.

The UKLA will have regard to the following principles in applying the CESR Recommendations to working capital statements and risk factors:

  • The document belongs to the issuer and the issuer and its advisers must be satisfied that it discloses the issuer’s position accurately

The UKLA will challenge the issuer’s document where there is inconsistency between the issuer’s risk factors and its working capital statement. The UKLA will not consider whether and how a risk factor should be disclosed. This is a question for the issuer in consultation with its advisers. However, where such an inconsistency arises, the issuer cannot merely remove or modify the inconsistent risk factor where to do so would lead to deficient disclosure in the document. Either the facts underlying the risk factor should be addressed or the working capital statement should be qualified.

  • Some risk factors are fundamentally inconsistent with a clean working capital statement

Paragraphs 125 and 126 of the CESR Recommendations are particularly relevant to a scenario where a certain risk factor disclosure cannot be reconciled with a clean working capital statement. This can occur where there is “insufficient headroom between required and available funding to cover reasonable alternative scenarios”. If the issuer is not able to arrange additional financing to cover this risk or to reconsider its business plan, it may be required to provide a qualified working capital statement instead of a clean working capital statement.

  • Not all risk factors dealing with matters of funding or finance are necessarily inconsistent with a clean working capital statement

Examples of risk factors that are not necessarily inconsistent with a clean working capital statement are where the risk factor does not necessarily suggest difficulties with an issuer’s working capital position. For example, certain covenants within an issuer’s facilities may limit its scope for expansion or force it to pass over acquisition proposals and increasing costs of capital may restrict future profitability. However, such risk factors should be “carefully and tightly drafted” such that they cannot be interpreted as qualifying the issuer’s working capital statement.

  • The document as a whole should be consistent - the risk factors, business strategy and working capital sections should all tell the same story

Issuers should aim to present a clear picture of their position that is consistent across the working capital, risk factors and business strategy section. Where, for example, the issuer’s working capital section shows sufficient working capital for the next 12 months, but calls into question the ability of the issuer to expand, make acquisitions or undertake capital projects, where such a move is intended the business strategy section should be drafted to be consistent with this.

  • Some high impact low probability risks may be consistent with a clean working capital statement

Such risks must be disclosed and should be tightly drafted to make it clear that, although the risks in question would have a severe impact on the issuer’s working capital should they crystallise, the probability of crystallisation is low. Given the low probability of crystallisation, these risks will normally be consistent with a clean working capital statement provided that they are based on reasonable assumptions.

  • Risks should only be expressed to operate ‘in the longer term’ if this is genuinely the case

This wording should not be used simply as a way of taking the risk factor outside the 12-month period of the working capital statement. The UKLA will question a disclosure using this wording to ensure that it is appropriately and accurately described.

  • Risk factors sections should be particular to the issuer and should detail a specific risk

Issuers should avoid disclosing generic or boilerplate risks. LIST! 24 refers issuers to LIST! 21 published in May 2009 for further guidance on this issue.

  • Risk factors cannot be made to be consistent with a clean working capital statement simply by using disclaimers or preambles

The UKLA will ignore any such disclaimers when assessing whether a risk factor is consistent with the issuer’s working capital statement.

(FSA, LIST! Supplementary Edition - Issue No. 24 - March 2010, 02.03.10)