Out-Law Analysis | 04 May 2021 | 4:00 pm | 8 min. read
The UK government is set to press ahead with reforms designed to attract a greater number of high growth companies to float on UK public markets.
However, chancellor Rishi Sunak’s announcement that the government will consult on the implementation of all of the recommendations made in Lord Hill’s review of the listing regime means there will be an opportunity to reconsider some of the planned changes and preserve the UK’s reputation for strong corporate governance.
Lord Hill, who formerly served as EU commissioner for financial stability, financial services and capital markets union, opened his review with stark statistics about the UK IPO market – between 2015 and 2020, London accounted for only 5% of IPOs globally and the number of UK listed companies has fallen by 40% since 2008. He also posited a theory that the make-up of companies listed in the UK is reflective of what it calls the "old economy", and noted that at one point in the summer of 2020, Apple was worth more than the combined value of the entire FTSE 100.
With that in mind, part of the review aimed to address the issues which are thought to be driving companies to list on other venues or not list at all. The starting assumption was that these trends are more evident among founder-led tech and high growth companies, as well as SPACs. The review outlined a number of suggestions to reinvigorate the IPO market.
The review’s first technical recommendation is to facilitate dual class share structures (DCSS) within the UK listing regime. Under a dual class structure some shares are given higher voting rights than others. In the light of the publicity around The Hut Group's 2020 IPO, this recommendation is perhaps unsurprising.
The review recommended that DCSSs should be allowed in the premium-listing segment of the market, but subject to certain corporate governance controls, being a maximum duration of five years, maximum voting ratio of 20 to one, requirement for the holder to be a director, voting matters limited to remaining as a director and blocking a change of control and limitations on transfer). The idea is to provide a "transition period" for founder-led businesses to move to the public markets.
It appears that some UK investors at least may not be prepared to accept the level of founder control DCSSs facilitate, irrespective of which listing category the issuer finds itself in
Whilst this proposition will no doubt be welcome in some quarters, putting London on equivalence with the US where such structures are already permitted, corporate governance advocates will be nervous. They may suggest there is inherent confusion in the idea that it is acceptable for a premium-listed company to have such a structure for a period of five years, but that after that it must either move segment to retain it, or lose it and become subject to the "proper" rules.
However, there appears to be another solution, within the review’s own recommendations, to address the risk of companies choosing to list on other public markets – which ultimately is what the introduction of DCSSs in the premium-listed segment would be designed to combat. The relaunch of the standard segment to make its participants eligible for indexation, as the review has suggested, could address the flight to other venues, whilst at the same time retaining the principles of "one share one vote" and independence from controlling shareholders.
Since the review was published, Deliveroo has endured what one banker is reported to have described as "the worst IPO in London's history". It has also been reported that at least part of the problem was a “rebellion” from several British fund managers in relation to the DCSS which is perceived to have impacted pricing of the IPO. Deliveroo's DCSS contained many of the protections suggested by the review and the government’s upcoming consultation is likely to provide more detail. However, in light of the Deliveroo saga, it appears that some UK investors at least may not be prepared to accept the level of founder control DCSSs facilitate, irrespective of which listing category the issuer finds itself in.
The current free float regime requires 25% of a listed company's equity to be in public hands. According to the review, this dissuades certain companies from listing, particularly those which are private equity backed or high growth. The proposed amendments are two-fold:
Changes such as these are likely to be well received by investors and founders looking to hold on to shares at the point of an IPO, where the rigidity of the current rules can force earlier sell-downs, sometimes at lower valuations, than would be desirable. The counterpoint is that companies without sufficient independent shareholders risk becoming effectively listed closed shops, where smaller shareholders do not have the numbers to hold management to account.
In one of the review's more straightforward recommendations, Hill suggested that the three-year track record requirement for a premium listing is retained after finding insufficient evidence that it dissuades companies from listing, but that existing provisions related to scientific research based companies are broadened to include other sectors. This would allow a wider pool of companies without revenue records to demonstrate eligibility for listing by other means and is likely to be a welcome move.
The review was relatively scathing of the premium listing requirement for historical financial information to cover 75% of an issuer's business, calling it a "blunt instrument" and "unhelpful". In another straightforward recommendation, the review recommended that the 75% test is applied to only the most recent historical financial period within the three-year track record requirement.
Such an amendment has the potential to open up a premium listing to companies that have grown significantly by acquisition, and could facilitate an IPO as a realistic exit proposition for more private equity buy-and-build platforms that may have otherwise struggled to satisfy this requirement.
The review proposed a "re-examination of what a UK prospectus regime should look like". The effect of this re-examination may impact existing listed companies more than prospective listing candidates. The review noted that very little feedback on the contents of prospectuses in relation to IPOs was received, aside from respondents' desire to include forward-looking guidance and that the regime is "cumbersome" for smaller issuers.
Regarding forward-looking information, the review addressed the prospectus liability regime and the resulting impact on directors' willingness to put such information in prospectuses. It said the market-practice of companies and their advisers reviewing connected analysts' reports for factual accuracy, and the interaction of that information with the prospectus itself is inefficient and unsatisfactory. The review proposed the Treasury should consider amendments to the Financial Services and Markets Act to adjust the liability associated with forward-looking financial and other information.
The detail of these legislative amendments will be of keen interest and will begin to emerge in the consultation this summer. One of the proposed solutions is a defence for directors who are able to show that they had exercised due care, skill and diligence in putting together the information and being able to demonstrate an honest belief that it was true. The practical implication would likely be further advisory cost in connection with the preparation, verification and justification of the information included in prospectuses. It may be that companies feel this is a price worth paying for the ability to communicate their business plans directly to their investors.
Hill did not expressly seek feedback on rules around the provision of information to unconnected analysts and the changes to the IPO timetable introduced in 2018. However, his review noted that "numerous market participants and advisers" gave the feedback that these rules place London at a disadvantage when compared with other listing venues, because of increased execution risk due to a longer public phase, increased cost and practical issues, whilst providing little practical benefit.
The review recommended that the FCA should be charged with improving the competitiveness of the London market. Such a duty may impact regulation. For example, in introducing the 2018 rules, the FCA's aims may well have been well-intentioned but it is possible to imagine that the changes would not have been implemented if the FCA had been challenged on the implications of a longer deal timetable.
In addition, the review also makes the case for a re-brand of the standard listing segment alongside a re-working of the indexation criteria with the aim of developing a rejuvenated and flexible regime which has real appeal.
The lack of index-eligibility is a material factor mitigating against a standard listing which we see in practice, but Lord Hill was relatively vague in describing what this new segment would be, other than "flexible". The aim appears to be to create a viable alternative to the cost and rigidity of the premium segment which will develop its own best practice depending on the context of the company in question and its investors, subject always to the FCA's minimum standards for eligibility. This is an interesting proposition but one which, at least in the short term, would create some uncertainty as those market practices bed in.
There is no doubt that the post-Brexit world offers an opportunity to diverge from previous practices, but such developments must also protect the reputation the City has earned for promoting high standards of corporate governance
The review was only a first step, and we now know the consultation process will kick-off this summer. Changes to the Listing Rules take some time and legislative changes potentially even longer, so changes are unlikely to materialise before the end of 2021. However, the review does signal a direction of travel: the City, with its history and tradition, needs to be higher on the government's agenda.
There is no doubt that the post-Brexit world offers an opportunity to diverge from previous practices, but such developments must also protect the reputation the City has earned for promoting high standards of corporate governance.
On one read, Deliveroo's travails could suggest that enabling founder-led and high growth businesses to have a "transition period" is not going to work in the UK where institutional investor sentiment seems sceptical. However, that might be to over-read general trends from one particular example: Deliveroo is a loss-making business and there are concerns about the impact of the gig-economy on its business model. Nevertheless, there is a danger that Deliveroo's bruising experience will act as a disincentive to the very type of companies the review aims to attract to London.