The Macfarlanes M&A weekly update is a short update on key developments relevant to M&A lawyers. It is a signpost towards matters that may be of interest, with links to more detailed information.

This week we focus on the Government’s proposals for reforming corporate governance of UK companies. We also look at some further clarifications from ESMA on the Market Abuse Regulation, and proposals by the FCA to update its guidance on the duties of listed company sponsors and on certain financial statements.

GOVERNMENT ISSUES PROPOSALS FOR CORPORATE GOVERNANCE REFORM

On 29 August 2017, the Department for Business, Energy and Industrial Strategy published the formal response to its November 2016 green paper on proposed reforms to corporate governance.

The proposals touch on executive pay, employee board representation and governance of private companies. They would be implemented by a combination of secondary legislation, revisions to the UK Corporate Governance Code (the “Code”), and industry-led action.

We have produced a separate paper on the proposed reforms, which is available here. The key proposals coming out of the response paper are as follows:

  • CEO to average pay ratios. Quoted companies will be required to state the ratio of their CEO’s pay to average workforce pay in their annual remuneration report.
  • Reporting on LTIPs. Quoted companies will be required to include in their remuneration policy a “clearer explanation” of the potential outcomes of complex, sharebased incentives.
  • Structuring LTIPs. The Government will invite the Financial Reporting Council (FRC) to introduce new Code principles on share-based remuneration. As part of this, the recommended minimum holding period for long-term incentive plans would be increased from three to five years.
  • Remuneration committees. Remcoms would be given greater responsibility for demonstrating alignment between executive pay and incentives and explaining this to the workforce. A person would need to serve for at least 12 months on a remuneration committee before chairing.
  • Shareholder opposition. Companies encountering “significant opposition” to executive pay proposals would need to take concrete steps to address this. These might include issuing a public response or submitting their directors’ remuneration policy to a binding vote at their next AGM.
  • Employee board representation. Companies subject to the Code would be required to adopt one of three models: designate existing non-executive directors to represent employees; create an employee council which the board would consult; or appoint a director from the workforce.
  • Stakeholder engagement. Companies will be required to explain how their directors have considered employees, suppliers, customers and other stakeholders when complying with their duty under section 172 of the Companies Act 2006 to promote the success of their company.
  • Corporate governance code for “private” companies. The FRC will be asked to work with various industry bodies to develop a new corporate governance code for privately-owned companies. The code would apply only to companies with more than 2,000 employees.
  • Reporting on corporate governance arrangements. Companies with more than 2,000 employees will be required to disclose their corporate governance arrangements in their directors’ report and state whether they follow a formal code. This requirement will apply to all companies (whether public or private), except for those already required to report against the Code or issue a corporate governance statement under the Disclosure Guidance and Transparency Rules (i.e. listed companies). It might also be extended to limited liability partnerships (LLPs).

The requirements to disclose pay ratios, report on LTIPs, explain compliance with section 172 and report on corporate governance arrangements will be mandatory. The first two would apply only to publicly traded companies, whereas the second two would apply to public and private companies alike.

However, the majority of the other proposals would be incorporated into the Code and so would only apply to premiumlisted companies (in practice, those with a premium listing on the London Stock Exchange Main Market). In theory, these companies would be free to diverge from these proposals provided they can justify doing so under the “comply or explain” principle.

In practice, however, both Main Market and unlisted companies (including those admitted to AIM) will need to recognise that investors will expect them to comply with these new proposals and so justify any deviation from them carefully.

ESMA ISSUES UPDATED Q&A ON MARKET ABUSE REGULATION

The European Securities and Markets Authority (ESMA) has updated its Q&A on the Market Abuse Regulation (“MAR”). The new questions address the market soundings and insider list regimes.

Market soundings

The market soundings regime is set out in article 11 of MAR. A “market sounding” is a communication by an issuer or certain other persons to gauge investors’ interest in a possible transaction. A person making a market sounding (a disclosing market participant or “DMP”) must consider whether the communication contains inside information, inform the recipient if it does, and keep certain records.

The Q&A confirm that the market soundings regime applies to a possible transaction in a financial instrument to which MAR applies. In other words, the regime applies to financial instruments admitted to (or for which an application had been made for admission to) a regulated market, a multilateral trading facility (such as AIM) or (in due course) organised trading facility (such as a private trading platform) (“primary instruments”).

The Q&A confirm that the market soundings regime also applies to possible transactions in instruments whose price or value depends or has an effect on an instrument of a kind described in the above categories. This wide category is particularly tricky to assess.

The Q&A state that DMPs must assess “on a case by case basis” whether there is a relationship to the price or value of an instrument subject to MAR and, importantly, must document this assessment. This appears to address the recent paper by the Financial Markets Law Committee (FMLC), which raised uncertainties over the scope of the regime (see our update here).

Although the Q&A do not address all of the specific issues raised by the FMLC, they do clarify that transactions not involving primary instruments fall outside the market soundings regime, but transactions involving instruments whose price or value depends on a primary instrument are.

Insider lists

The Q&A clarify that persons who act on behalf or account of an issuer and who come into possession of inside information have their own duty under MAR to keep an insider list. This is separate from an issuer’s duty to keep an insider list. Issuers are not responsible for ensuring that persons acting on their behalf keep their own insider lists. However, where those persons draw up and keep an insider list on behalf of the issuer, the issuer will remain primarily responsible for ensuring that the list complies with the regime.

CHANGES TO GUIDANCE ON SPONSORS’ DUTIES AND FINANCIAL STATEMENTS

The Financial Conduct Authority (FCA) has proposed various changes to the UKLA knowledge base. The proposed changes are set out in Primary Market Bulletin 18. The key points are as follows:

  • Sponsors’ duty regarding directors. Under Listing Rule 8.3.4R, if a sponsor advises an issuer on the interpretation of the Listing Rules or Disclosure Guidance and Transparency Rules, it must take reasonable steps to ensure the issuer’s directors understand their responsibilities. The FCA is proposing a new Technical Note (TN/718.1) to explain what might constitute “reasonable steps” and how active a role the FCA expects sponsors to take in this regard.
  • Sponsors’ duty regarding established procedures. Under LR 8.4.2R(3), before a sponsor submits an application for admission to the premium list, it must form the opinion that the applicant’s directors have established procedures that enable the applicant to comply with the Listing Rules. The FCA is proposing a new Technical Note (TN/719.1) to explain how far those procedures should be developed before an application is made, what sponsors should take into account when forming their opinion, and how they can demonstrate compliance with this duty.
  • Sponsors’ duty regarding adverse impact. Under LR 8.4.12R(2), if a sponsor submits a class 1 circular or a circular relating to certain kinds of transaction, it must form the opinion that the transaction will not have an adverse impact on the issuer’s ability to comply with the Listing Rules. The FCA is proposing a new Technical Note (TN/720.1) to explain how it expects sponsors to approach this duty and how the duty interacts with certain kinds of public company takeover.
  • Quantified financial benefits statements. A QFBS is a statement made on a public company takeover setting out the expected synergies between the bidder and target after the acquisition. The FCA is proposing a new Technical Note (TN/315.1) to explain that, if a QFBS is included in a prospectus, the QFBS will constitute an expert report. This would require a consent statement to be included and the reporting accountants and financial advisers to accept responsibility for it.
  • Cash-flow statements. Financial Reporting Standard 102 requires companies to produce a cash-flow statement, but certain investment funds can exempt themselves from doing so. However, the Prospectus Rules require a prospectus that contains audited financial information to also include a cash-flow statement. The FCA is proposing a new Technical Note (TN/635.1) to explain that investment companies issuing a prospectus should consider whether, in light of this, it is appropriate to take advantage of the exemption in FRS 102.
  • Profit forecasts and estimates. If an issuer has made a profit forecast or estimate (“PFE”) that is still outstanding and subsequently issues a prospectus, the prospectus must state whether the PFE is still valid. If it is not, it must explain why. In some cases, by confirming that the PFE is no longer valid, an issuer will not need to state the assumptions underlying the PFE and may be able to dispense with an accountant’s report on the PFE. The FCA is proposing to amend Technical Note TN/340.2 to clarify when an issuer is justified in stating that a PFE is no longer valid and the factors the FCA will consider when deciding whether the reasons given by an issuer are credible. The consultation closes on 11 October 2017.