The UK Financial Services Authority (the “FSA”) has published a consultation paper outlining several proposed changes to the Listing Rules.1 The changes, which are significant, are intended to enhance the effectiveness of the UK listing regime and to address concerns in relation to the potential influence of controlling shareholders on listed companies while at the same time ensuring that London remains an attractive listing venue.
Over recent months the issue of how to maintain the quality of the UK listing regime and to protect investors while continuing to attract (often emèrging markets-based) companies, some of which have a controlling shareholder, has been the subject of considerable debate in the UK market. Concerns have also been expressed in relation to London's ability to continue to attract companies, and to compete with other listing venues (including, principally, the US markets), given the current requirement that not less than 25% of a listed company’s shares must be held in public hands.
This consultation represents the FSA’s response to these potentially conflicting challenges. The consultation will close on 2 January 2013. The FSA expects to publish its feedback in Spring 2013.
The key proposed changes are outlined below.
Shares in public hands
Currently, in order for a company to obtain a listing on the premium segment of the London market, at least 25% of its listed shares must be held in "public hands".2 This is known as the "free float" requirement. For this purpose, shares which are held by (among others) major shareholders or directors are not treated as being in public hands. The FSA may modify this requirement where it is satisfied that a large number of shares of the same class, and the extent of their distribution to the public, will ensure a properly functioning secondary market.3
Some, largely buy-side, market participants had argued for a significant increase in the free float threshold (to 50%, or in some cases even higher) as a way of preventing controlling shareholder-related corporate governance failures of the sort which we have seen recently in the London market. Increasing the proportion of shares held by independent shareholders would, it was argued, allow those shareholders to curb the excesses of such a shareholder.
Despite considerable pressure for it to do so, the FSA does not propose to do this. In its view, the free float requirement is intended to ensure that a company's shares are sufficiently liquid, and to use it as a way of ensuring effective corporate governance would be a "blunt tool" which could damage London's attractiveness as an IPO market. (This view is supported by the fact that the European law from which the free float requirement is derived is explicitly drawn in terms of liquidity.4)
Instead, the FSA proposes to mitigate the risk of such governance failures by introducing specific requirements in relation to (among other things) relationship agreements, board composition and appointment, and shareholder voting. These are addressed in turn below.
It also proposes to introduce greater flexibility in relation to the free float requirement, by:
- providing additional guidance on the circumstances in which it will be likely to relax the free float requirement in relation to companies seeking a premium listing; and
- removing the requirement for a minimum absolute percentage free float for companies seeking a standard listing by basing the free float requirement for such companies solely on liquidity (in light of the number, nature and diversity of holders following admission).
In relation to companies seeking a premium listing, the proposed guidance indicates that the FSA may modify the 25% free float requirement where:
- the number of public shareholders exceeds 100; and
- the expected market value of the shares exceeds £250 million.
However, the guidance makes it clear that even where these criteria are satisfied, other than in exceptional circumstances, it will be unlikely to agree to such a request where the proportion of the company’s listed shares in public hands will be less than 20%.5
The FSA also proposes to amend the Listing Rules so that:
- shares that are subject to a lock-up period of longer than 30 days will not be treated as being in public hands,
- financial instruments that give a long exposure to shares but which do not control the buy/sell decision will be excluded from the calculation of the free float; and
- holdings of individual fund managers in an organization will be treated separately provided that investment decisions are made independently.
The FSA's decision to not increase the free float requirement is to be welcomed. Any such increase would be likely to materially weaken London's attractiveness as a listing venue. The specific changes outlined below represent a more sensible and proportionate approach to the governance challenges posed by listed companies which have a controlling shareholder.
At the same time, by giving greater flexibility in relation to the free float requirement (especially for a standard listing), the FSA is going some way to addressing the concerns of the sell-side community in relation to the competitive pressures facing the London market from other major global markets (including, principally, the US markets).
Under the proposed rules, companies seeking a premium (as opposed to a standard) listing which have a controlling shareholder (which, for these purposes, means any person who, together with its associates and persons acting in concert with it, holds at least 30% of the shares or voting power of the company concerned) must be able to operate independently of that controlling shareholder. To do so:
- such companies will be required to put in place an agreement to govern the relationship between the company and the controlling shareholder and to ensure that it is able to conduct its business independently of that shareholder (a so called "relationship agreement");
- its board must either comprise a majority of independent directors or it must have an independent chairman and directors and independent directors who together comprise a majority of the board; and
- its constitution must require the election of independent directors to be approved by separate resolutions of the company’s shareholders and of its independent shareholders (i.e., excluding the controlling shareholder and its associates).
These requirements are outlined in turn below.
Until 2004, where a listed company had a controlling shareholder it was required by the Listing Rules to put in place a relationship agreement on admission. Such agreements are still generally used in that situation.
Under the proposed rules, such agreements must include provisions to ensure that:
- transactions and relationships with a controlling shareholder and its associates are conducted at arm’s length and on normal commercial terms;
- a controlling shareholder and its associates abstain from doing anything that would have the effect of preventing the company from complying with its obligations under the Listing Rules; and
- a controlling shareholder and its associates do 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 its significant subsidiaries.
Listed companies will be required to comply with the terms of the relationship agreement at all times, and the relationship agreement must remain in effect for so long as the company’s shares are listed and the company has a controlling shareholder.
All material amendments to the relationship agreement will require the approval of the independent shareholders (i.e., the shareholders other than the controlling shareholder and its associates). In that regard, such agreements will be treated in a similar way to related party transactions under the Listing Rules.
The proposed rules also require that the relationship agreement, or a link to where it may be found, must be included in the company’s annual financial report. Such reports must also include a statement that the listed company has complied with the relationship agreement throughout the financial year, or, if it has not, a description of the provisions of the agreement that have not been complied with and a confirmation that the FSA has been informed of the non-compliance.
Under the proposed rules, where a company which is seeking a premium listing has a controlling shareholder, its board must:
- comprise a majority of independent directors; or
- have an independent chairman and directors and independent directors who together comprise a majority of the board.6
This would be a continuing obligation (i.e., it would apply both on and after admission). If the company ceased to comply it would be required to notify the FSA and would have six months in order to do so. This requirement represents a material departure from the "comply or explain" principle in relation to board composition and in relation to corporate governance more generally under the UK Corporate Governance Code.
Appointment of independent directors
Under the proposed rules, where a company which is seeking a premium listing has a controlling shareholder, its constitution must require the election of independent directors to be approved by separate resolutions of the company’s shareholders and of its independent shareholders (i.e., excluding the controlling shareholder and its associates). If either of those resolutions is not passed, the company may propose a further resolution. That resolution may be passed by a vote of the company’s shareholders as a single class. With this “dual vote” director appointment mechanism, a controlling shareholder may still have the ability to block the appointment of an independent director.
Again, this would be a continuing obligation.
While the requirements in relation to relationship agreements and the proposed “dual vote” construct in relation to the appointment of independent directors cannot fully address the governance challenges posed by controlling shareholders they represent a material step in the right direction.
Nature of business
Currently, a company seeking a premium listing must demonstrate that it controls most of its assets and that it will be carrying on an independent business as its main activity.7 The “independent business” requirement is a continuing obligation but the “control” requirement is not.
The FSA proposes to restructure these rules and to provide guidance on the factors that it will take into account in considering whether a company is capable of meeting these requirements8, and to make the “control” requirement a continuing obligation.
The proposed guidance makes it clear that a company may be regarded as not being independent for these purposes if:
- most of the revenue generated by its business is attributable to business conducted with a controlling shareholder (or any of its associates);
- it does not have strategic control over commercialization of its product(s) and/or its ability to earn revenue from it/them;
- it cannot demonstrate that it has or has had access to financing other than from a controlling shareholder (or an associate of a controlling shareholder); or
- if it has granted or may be required to grant security over its business in connection with the funding of a controlling shareholder (or a member of that controlling shareholder’s group).
Control of business
Under the proposed rules, a company seeking a premium listing will be required to demonstrate that it controls the majority of its business rather than (as currently) its assets.
The control requirement is intended to ensure that the company is able to comply with its obligations in relation to the timely announcement of inside information in relation to the company (under the Disclosure and Transparency Rules) and to significant transactions (under the Listing Rules), and to drive forward the company’s agenda. In that context, the factors which the FSA will take to indicate that the company is not able to do so (i.e., so that it does not control its business for this purpose) include where it:
- is able to exercise only negative control or only has veto rights over significant decisions affecting the management of its business made by third parties;
- has precarious control of the business that relies, for example, on contractual arrangements that may be varied without its consent; or
- has in place contractual arrangements that result, or could result, in a temporary or permanent loss of control of its business.
The proposed guidance is helpful and is to be welcomed.
The reference to negative control may, however, pose issues for those UK listed defence companies whose US operations are operated by a proxy board.
It is proposed that where a premium listed company is required by certain provisions of the Listing Rules to obtain the approval of its shareholders, including to approve a significant transaction or a related party transaction in accordance with the Listing Rules, this should be decided only by holders of shares that are themselves premium listed. This is intended to prevent the use of share structures that allow such matters to be decided by the holders of an unlisted share class.
It is proposed that this requirement would be subject to the following exceptions:
- special share arrangements designed to protect national interests;
- dual listed company voting arrangements; and
- voting rights attaching to preference shares or similar securities that are in arrears.
Breach of continuing obligations
Premium listed companies will be required to inform the FSA without delay of any breach of any of their continuing obligations.
Currently, they are only required to notify the FSA when they do not comply with the free float requirement.
Currently, premium listed companies are required to comply with the listing principles set out in Chapter 7 of the Listing Rules.
The FSA proposes to make premium listed companies subject to two additional listing principles. These require that:
- equity shares in a class that has been admitted to premium listing must carry an equal number of votes on any shareholder vote; 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.
These principles support, and should be seen in conjunction with, the specific requirements in relation to shareholder voting described above.
The FSA also proposes to require standard listed companies to comply with two of the Listing Principles. These are:
- the requirement to take reasonable steps to establish and maintain adequate procedures, systems and controls to enable it to comply with its obligations under the Listing Rules and the Disclosure and Transparency Rules (i.e., the current Listing Principle Two); and
- the requirement to deal with the FSA in an “open and cooperative” manner (i.e., the current Listing Principle Six).
The application of the current Listing Principle Two to standard listed companies is potentially significant. As the guidance in the Listing Rules currently makes clear, Listing Principle Two is intended to ensure that listed companies have adequate procedures, systems and controls to enable them to comply with their obligations under the Listing Rules and the Disclosure and Transparency Rules, including, among other things, obligations in relation to the timely announcement of inside information.
Compliance by some standard listed companies with their obligations in relation to company announcements has been an area of concern for the FSA.
This change should result in increased focus by standard listed companies on compliance with those rules, including, particularly, issuers of depositary receipts.
If so, this would represent a welcome (and necessary) development.