On 16 May 2014, a final package of rules (the Revised Rules) came into force (subject to certain transitional provisions) involving a number of significant changes to the Listing Rules, in particular in relation to Premium Listed companies with a controlling shareholder. At the same as the Revised Rules came into force, the FCA published its associated response statement (Policy Statement 14/8) which also appends the text of the final amendments to the rules (the Response Statement).
This follows on from the original consultation published by the FSA, the predecessor to the FCA, in October 2012 (CP 12/25) entitled “Enhancing the effectiveness of the Listing Regime” (the Original Consultation) and the subsequent feedback statement and consultation paper (CP 13/15) published by the FCA in November 2013 (the Second Consultation and, together with the Original Consultation, the Consultations).
In broad terms, the Revised Rules are intended to increase protections for minority shareholders in Premium Listed companies with a controlling shareholder by:
- imposing a requirement for such companies to enter into a relationship agreement (containing certain mandatory terms) with any controlling shareholder;
- providing additional voting power for minority shareholders of such companies when electing independent directors; and
- enhancing the voting power of minority shareholders in such companies where (in certain circumstances) the company wants to cancel its Premium Listing.
There are also provisions relating to, amongst other things, the voting rights of Premium Listed shares (including a requirement broadly to the effect that, where a vote is required by virtue of an issuer’s Premium Listing, for example in relation to significant or related party transactions, it must be approved by a vote of its Premium Listed shares) and intended to enhance transparency requirements for Premium Listed companies in certain areas as well as amendments to clarify certain eligibility and on-going requirements relating to free float and independence.
In this briefing we have summarised the main changes and consider the key implications for companies that are listed (or are considering seeking a listing) on the Premium Segment of the Official List.
Why were the rules changed?
The debate that led to the Original Consultation was based on concerns relating to the governance of certain Premium Listed companies with a controlling shareholder. In particular, there was a concern on the part of the investment community that (where the interests of a controlling shareholder conflict with those of the minority) investors may find themselves unable to participate effectively in the governance of the company. Both Consultations noted that the vast majority of companies, including ones with controlling shareholders, continue to operate without generating significant investor concerns and that there was therefore no systemic failure of the Listing Regime. However, the Revised Rules are intended to strengthen minority shareholder rights and protections where they are at risk of being abused and are particularly intended to deal with cases where a controlling shareholder does not maintain an appropriate relationship with a Premium Listed company.
What has changed for Premium Listed companies with controlling shareholder(s)?
A number of significant changes have been made to the rules applicable to Premium Listed companies with a controlling shareholder. These can broadly be broken down into three categories:
- The requirement for an agreement to be entered into with the controlling shareholder containing certain mandatory “independence” provisions.
- The process for election of independent directors.
- The process for de-listing from the Premium Segment.
Who is a ‘controlling shareholder’?
A controlling shareholder is, broadly speaking, someone who, together with persons acting in concert with them, exercises or controls1 30 per cent or more of the votes able to be cast on all, or substantially all, matters at general meetings of the company (certain voting rights are disregarded for these purposes in the same way as under the existing definition of a “substantial shareholder”). The proposal made in the Consultations that the definition should also extend to automatically aggregate interests of “associates” has not been implemented in the Revised Rules. In the Response Statement the FCA notes that associates may still be caught under the definition of “controlling shareholder” if they are in fact acting in concert, but that they will not be presumed to be acting in concert by the virtue of their associate relationship alone.
The term “acting in concert” is not defined and the FCA has been clear that it is not incorporating the Takeover Panel’s guidance on acting in concert into the Listing Rules and that it is right that neither agency should seek to fetter its own or another’s discretion. However, the Response Statement notes that (in practice) the FCA believes it is unlikely that the outcome of its deliberation on who is acting in concert would be substantially different from the Takeover Panel’s conclusion (if any) or a conclusion the Takeover Panel would have reached. The Response Statement also notes that, in circumstances where there is a shareholder who is a controlling shareholder in their own right, the FCA will still expect a company to undertake all necessary steps to identify any potential concert parties that would then also become controlling shareholders.
The FCA has noted that it would expect a Premium Listed company’s systems and controls to be capable of allowing reasonable efforts to be undertaken to identify controlling shareholders just as they would identify substantial shareholders.
What agreements are required to be put in place with a controlling shareholder?
Key requirements2 in respect of “relationship agreements” for Premium Listed companies include:
- Premium Listed companies will be required (both on admission and on an ongoing basis) to have a written and legally binding agreement in place with any controlling shareholder. Where there are a number of controlling shareholders, separate agreements do not need to be entered into with all of them if the company reasonably considers that one shareholder can procure compliance by any non-signing controlling shareholder(s) and their associates and provided that the relationship agreement includes an undertaking to this effect together with the names of any such non-signing controlling shareholder(s). In the Response Statement the FCA notes that it expects companies that choose to utilise this concession to exercise their judgement reasonably with the aim of ensuring that the intention of the obligation to carry on an independent business as the company’s main activity is safeguarded.
- The agreement must contain certain minimum provisions relating to independence which must be complied with at all times, namely undertakings that: (i) transactions and arrangements with the controlling shareholder and/or its associates must be conducted at arm’s length and on normal commercial terms;3 (ii) neither the controlling shareholder nor any of its associates will take any action that would prevent the company from complying with its obligations under the Listing Rules; and (iii) neither the controlling shareholder nor any of its associates will propose (or procure the proposal of) a shareholder resolution which is intended (or appears to be intended) to circumvent the proper application of the Listing Rules4 (the Independence Provisions). The requirement proposed in the Original Consultation for the agreement to include provisions to the effect that the controlling shareholder and its associates must not influence the day to day running of the company at an operational level or hold or acquire a material shareholding in one or more of the its significant subsidiaries was dropped in the Second Consultation and is not therefore reflected in the Revised Rules.5
- Companies are required to include a statement in their annual report as to whether an appropriate agreement has been entered into with any controlling shareholder and as to compliance with the Independence Provisions (and any procurement obligation in respect of non-signing controlling shareholders – see above) during the relevant accounting period. Where this statement identifies non-compliance the company must include a brief description of the background to and reasons for the non-compliance that enables shareholders to evaluate its impact and state that the FCA has been notified. Where any independent director declines to support the compliance statement, the statement must reflect this fact.
In the Original Consultation it was proposed that any material amendments to the terms of a relationship agreement would be subject to prior approval by independent shareholders, however these proposals were dropped in the Second Consultation (on the basis that the revised Independence Provisions constitute fundamental requirements that cannot be varied) and have therefore not been implemented in the Revised Rules. In the Response Statement, the FCA has noted that it would not see the amendment of an existing relationship agreement (or entry into a new one) as being a related party transaction where this is purely intended to address compliance with the relevant Listing Rules requirements.
How long will companies that are already listed have to put appropriate agreements in place?
A transitional period of six months applies from the coming into force of the Revised Rules for existing companies to put appropriate agreements in place with controlling shareholders. A six month grace period also applies to companies that acquire a controlling shareholder following listing.
What are the consequences of non-compliance?
Following a triggering event (see below) all transactions with the controlling shareholder or its associates will effectively be subject to prior approval by independent shareholders as related party transactions under Chapter 11 of the Listing Rules, even where they would normally fall within the de minimis, ordinary course or other safe harbours set out in that Chapter (although the FCA retains the ability to exempt ordinary course transactions where it considers it would be appropriate to do so and, more generally, retains the ability to dispense with or modify the enhanced oversight provisions in exceptional circumstances). The additional oversight provisions are seen by the FCA as an important protection for minority shareholders where there is a risk that the relationship between the controlling shareholder and the company may prejudice them in some way and, given their onerous nature, the FCA believes they will serve as an effective deterrent to non-compliance.
The enhanced oversight provisions referred to above will be triggered in circumstances where: (i) an appropriate agreement is not in place; (ii) any of the Independence Provisions contained in the agreement have not been complied with by the company; (iii) the company becomes aware that the controlling shareholder is not in compliance with any of the Independence Provisions; (iv) the company becomes aware that the controlling shareholder is not in compliance with any procurement obligation (in relation to compliance by other non-signing controlling shareholders/their associates) contained in the relationship agreement; or (v) any independent director of the company declines to support a statement made in the annual report as to compliance with the relevant requirements (this last trigger is intended to give independent directors the ability to effectively voice any objections). In the context of non-compliance by the controlling shareholder, the FCA noted in the Second Consultation that the nature of the Independence Provisions is such that the company would (or should) become aware of any breach by a controlling shareholder and that the company’s systems and controls should be adequate to ensure that such breaches are identified.
Once the enhanced oversight provisions have been triggered, they will continue to apply until the publication of an annual report that contains a clean statement of compliance by the board without any disagreement from independent directors (i.e. they will continue to apply beyond the point at which the issue is rectified). In the Response Statement, the FCA noted that several respondents to the Second Consultation were concerned that the time period for which a company may be subject to the enhanced oversight measures could be disproportionate to the breach. In this context, the FCA has stated that it will keep the duration of this period under review and will consider changing its approach if it seems appropriate once the new rules have had time to bed down.
What additional requirements apply in relation to election of independent directors?
In the Original Consultation, the FCA consulted on whether additional requirements should be introduced requiring Premium Listed companies with a controlling shareholder to have a majority of independent directors on the board (as opposed to the current requirement to comply or explain against the UK Corporate Governance Code). This proposal was dropped in the Second Consultation where the FCA explained that, whilst it continues to place great importance on the independent members of the board where there is a controlling shareholder, it considers that it is the quality, not the number, of independent directors that is important. It was, however, noted that this was a finely balanced result and that it will therefore revisit this topic in the future if necessary.
As proposed in the Consultations, the Revised Rules impose a dual voting process on the election or re-election of independent directors at general meetings for Premium Listed companies that have a controlling shareholder.6 This is on the basis that independent directors act as an important source of challenge and control and the FCA therefore sees it as essential that minority shareholders have a proper say in their election. The dual approval process requires such appointments to be approved by independent shareholders as well as by shareholders as a whole (in the Response Statement the FCA notes that the requirement can be met through holding a single vote or proposing a single resolution provided that the votes of independent shareholders can be identified by the company). Where the two votes conflict, a further vote may be held not less than 90 days (and not more than 120 days) later on a simple majority basis (i.e. the majority vote will ultimately prevail, but independent shareholders will have had an enhanced opportunity to register a “protest” vote). The Revised Rules include guidance clarifying that, where the necessary approvals are not obtained at the first vote in respect of an existing independent director who is being proposed for re-election (including any such director who was appointed by the board until the next AGM), the relevant director can remain in office until the second vote is undertaken.
The company’s constitution must allow for the election and re-election of independent directors in accordance with these requirements. In the Response Statement the FCA notes that the use of “allow” means that companies will not be required to amend their constitution so long as it does not prohibit elections from taking place in accordance with the dual approval structure.
Enhanced disclosure requirements also apply to circulars relating to the appointment of independent directors by Premium Listed companies with controlling shareholders, including disclosure of any previous or existing relationships, transactions or arrangements with the controlling shareholder or its associates. A description must also be included covering why the company considers the relevant individual will be an effective director, how it has determined their independence and the process it has followed in selecting them for the role.
Transitional provisions apply in relation to companies that are already listed or that acquire a controlling shareholder following listing.
What additional requirements apply in relation to cancellation of listing?
Enhanced approval requirements apply where a Premium Listed company with a controlling shareholder wants to cancel its listing or transfer its listing category. These include:
- A requirement that, where such a company proposes a shareholder vote to cancel its Premium Listing (including where it wishes to transfer to a Standard Listing), it must obtain approval (by simple majority of those voting) from its independent shareholders as well a majority of not less than 75 per cent. of the total votes cast. The FCA intends to leave it to the company’s discretion as to whether this is achieved through one or two votes.
- A requirement that, where such a company wants to de-list following a takeover offer and the offeror (or any controlling shareholder who is an offeror) was interested in more than 50 per cent of the company’s voting rights before it announced its firm intention to make an offer, the offeror must obtain acceptances from (or acquire shares from) independent shareholders that represent a majority of the votes held by independent shareholders at the date its firm intention to make an offer was announced as well as reaching the overall threshold of 75 per cent. However, this is subject to the caveat that, where the offeror has acquired or agreed to acquire issued share capital carrying more than 80 per cent of the voting rights of the issuer, no further approval or acceptance from independent shareholders is required to cancel the Premium Listing.
Is a Premium Listed issuer still required to control the majority of its assets?
Under the Revised Rules, Premium Listed companies are not subject to a separate requirement to demonstrate that they control the majority of their assets (as was the case under the previous rules) or the majority of their business. Instead, the FCA has implemented an approach that sees control of business as only one aspect of a broader principles-based assessment of whether an independent business is present.7 The FCA believes that this will give applicants flexibility in the way they structure their business (whilst still ensuring they maintain a sufficient level of control) and enable sponsors and the FCA to exercise judgement over whether the business is genuinely independent.
The Revised Rules set out various factors that may indicate a company will not be carrying on an independent business as its main activity. These include (amongst other things):
- Where the company does not have strategic control over the commercialisation of its products and/or its ability to earn revenue and/or freedom to implement its business strategy.
- Where (except in the case of a mineral company) the business consists principally of holdings of shares in entities that the company does not control – this includes where the company is only able to exercise negative control or where its control is subject to contractual arrangements which could be altered without agreement or result in a temporary or permanent loss of control (the FCA has clarified that the latter provision is not intended to capture security that may be granted to third party providers of finance). In the Second Consultation the FCA noted that the level of non-controlled stakes at which an applicant appears to lack independence will depend on the specific circumstances of the case and the other evidence regarding independence viewed as a whole, rather than a percentage figure that can be applied in all cases.
- Various circumstances in the context of the relationship with any controlling shareholder, including (amongst other things) where a majority of revenue is attributable to business conducted with a controlling shareholder, where the company cannot demonstrate it has access to finance other than from a controlling shareholder, where the company has granted (or may be required to grant) security over its business in connection with the funding of a controlling shareholder or where a controlling shareholder (or any of its associates) appears to be able to influence the operations of the company outside its normal governance structures or via material shareholdings in one or more of its significant subsidiary undertakings.
In the Original Consultation, guidance was proposed that a company may not be suitable for a Premium Listing where non-controlled assets represented a majority of its business for a significant part of the financial record period - this proposal was dropped in the Second Consultation and is therefore not reflected in the Revised Rules.
Have the free float requirements changed?
A major area of debate in the context of the discussions that led to the Original Consultation was whether the free float requirements should be adjusted. In particular, certain market participants saw free float as a tool for achieving good corporate governance (by ensuring minority shareholders controlled sufficient shares to guarantee their views were heard) and therefore believed that the required free float for Premium Listed companies should be increased above the current 25 per cent. minimum.
In the Consultations the FCA took the view that the free float requirements were intended to ensure sufficient liquidity rather than operating as a governance tool and it did not therefore propose any significant changes to the minimum free float requirements for Premium Listed issuers. However, it has clarified the criteria that it may take into account when deciding whether to modify the minimum free float requirement for a particular Premium Listed issuer – in particular factors that the FCA may take into account (in addition to shares of the same class that are held, even if they are not listed, in non-EEA states) include:
- The number and nature of public shareholders – whilst the 100 person minimum proposed in the Original Consultation was dropped in the Second Consultation (and is therefore not included in the Revised Rules), the FCA has noted that it will closely scrutinise cases where a derogation is sought and there are fewer than 100 public shareholders.
- Whether the expected market value of shares in public hands at admission will exceed £100 million (as part of the Second Consultation this figure was adjusted from the £250 million value originally proposed in order to address a concern that, having compared it to recent examples of IPOs, the figure had originally been set too high). The FCA has stated that, depending on the other criteria, there may however be cases where it will want to see a free float value significantly in excess of £100 million.
Whilst the wording of the minimum free float rules for Standard Listed issuers has not been amended, it was noted in the Consultations that the FCA intends to change its approach to modifying the requirement for a particular Standard Listed issuer and, in this context, to focus on anticipated liquidity following admission rather than necessarily looking at a strict percentage free float.
The Revised Rules include guidance that, in circumstances where the FCA has agreed to modify the free float requirements (whether for a Premium or Standard Listed issuer), it will consider withdrawing that modification if sufficient liquidity is not evident.
Certain changes have also been made to the way in which the free float is calculated for both Premium and Standard Listed companies. In particular, shares will not count towards the free float requirement if they are subject to a lock-up of more than 180 days. In many cases this will not have a significant impact as a shareholder subject to lock-up arrangements will often hold 5 per cent. or more of the issued share capital meaning that its shares will not be treated as being held in public hands in any event.
What are the other key changes in relation to the Premium Segment?
Voting power of Premium Listed shares
The Revised Rules implement certain changes relating to the voting power of Premium Listed shares, namely:
- A requirement to the effect that, where a vote is required by virtue of a company’s Premium Listing, it must be passed by the holders of its Premium Listed shares.8 The FCA retains power to modify this requirement in exceptional circumstances (for example in the case of companies with “golden share” structures designed to protect the national interest or dual listed company voting arrangements). A transitional period of two years applies for companies admitted to Premium Listing on or before 15 May 2014.
- The introduction of two new Listing Principles for Premium Listed companies to the effect that: (i) each Premium Listed share in a class must have equal voting power; and, (ii) 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 (the rules include a non-exhaustive list of factors the FCA will have regard to when assessing whether voting rights are proportionate for these purposes, including the extent to which the rights of the classes differ other than in their voting rights and the extent of dispersion and relative liquidity of the classes).
Notification of non-compliance with ongoing obligations9
In the Original Consultation, a new requirement was proposed that Premium Listed issuers would have to make immediate notification to the FCA where they failed to comply with any of the continuing obligations set out in Listing Rule 9.2 (historically this only applied in relation to failure to comply with the free float requirement). In the New Consultation, this approach was modified to cover only those eligibility requirements that also have continuing effect (for example, free float or the requirement to be carrying on an independent business) and this is the position reflected in the Revised Rules. Whilst the question of whether a company continues to meet the free float requirement is typically relatively clear cut, assessment of some of the other requirements, for example whether it is carrying on an independent business, can be more complex and involve a number of subjective judgements. Premium Listed issuers will therefore need to consider how they will approach assessing this in the context of the new notification requirements.
Annual report disclosure
Premium Listed companies are now required to disclose (in a single, identifiable section of their annual report) all of the matters required to be disclosed under Listing Rule 9.8.4 (information to be included in annual report and accounts), although the rules permit this to be achieved by including a table cross-referencing the relevant disclosures. A transitional period applies for companies with a financial year ending on or before 31 August 2014.
Disclosure of smaller related party transactions
The Listing Rules historically only required smaller related party transactions (as defined in Chapter 11 of the Listing Rules being transactions where each of the class test ratios is less than 5 per cent. but one or more of the ratios exceeds 0.25 per cent.) to be disclosed in the company’s next published annual report. Under the Revised Rules certain specified details must be disclosed via RIS as soon as possible on entering into the transaction or arrangement. In addition the previous requirement for companies to provide certain notifications and confirmations to the FCA prior to entering into such transactions has been removed, although the company is still required to obtain a written “fair and reasonable” confirmation from its sponsor.
What are the other key changes in relation to the Standard Segment?
The only material change in relation to the Standard Segment (other than the in relation to the free float requirement referred to above) is the extension of two of the current Listing Principles (adequate systems, procedures and controls and open and co-operative dealing with the FCA) to apply to Standard Listed issuers.
What do the proposed changes mean for existing Premium Listed issuers?
Premium Listed issuers with a controlling shareholder will need to review their existing arrangements to determine whether they comply with the new requirements. Whilst, in many (but not all) cases, such companies will have an existing relationship agreement in place, this is likely to need to be amended in order to ensure its terms appropriately track the new minimum content requirements. Companies with a controlling shareholder where a relationship agreement is not in place will need to approach the controlling shareholder with a view to an appropriate agreement being entered into (assuming the controlling shareholder is willing to do so). In terms of any such agreement covering more than the new basic mandatory terms, where companies only acquire a controlling shareholder following listing or now need to put an agreement in place, they are likely to have more limited negotiating power than a company that puts arrangements in place as part of its IPO process. Where the controlling shareholder holds shares through persons acting in concert with it, it will also be necessary to consider whether additional agreements need to be entered into with those other shareholders or whether one shareholder can procure compliance by the others.
Companies will also need to consider whether their constitutional documents permit the dual voting structure required in relation to the election of independent directors.
More generally, where Premium Listed companies have share or voting structures that are (or may be) inconsistent with the new requirements relating to the voting power of Premium Listed shares, consideration will need to be given as to whether these structures can be changed or whether moving to an alternative market (for example, the Standard Segment) may be more appropriate. However, this will have other implications which may make it an unattractive option including lack of eligibility for inclusion in the FTSE UK indices (which require a Premium Listing as one of the eligibility criteria) and lesser protection for shareholders in terms of various ongoing obligations (for example, related party and significant transactions).
Internal procedures will also need to be updated to ensure that smaller related party transactions are promptly notified to the market via an RIS announcement.
What do the proposed changes mean for companies that are considering a Premium Listing?
The FCA’s move away from imposing a stand-alone requirement for issuers to control the majority of their assets to looking at control of the business as one part of a broader assessment of whether an independent business is present is helpful, as it recognises that there are a range of factors that will be relevant to this determination and this will give applicants greater flexibility in the way that they structure their businesses. However it also means that the decision as to independence is more subjective, which has the potential to result in a lack of clarity in some cases.
The proposed changes in relation to voting rights of Premium Listed shares re-enforce the view expressed in the Consultations that issuers should not be eligible for a Premium Listing where they have a share structure that allows holders of an unlisted share class to decide matters where a Premium Listing requires a shareholder vote. This means that companies using classic “US style” dual class share structures10 are unlikely to be eligible for a Premium Listing.
As with existing issuers, companies seeking a Premium Listing that are expected to have a controlling shareholder on IPO will need to ensure that an appropriate agreement is put in place with effect from admission.