Reshaping Britain's capital markets – the Hill review of the UK listing regime
The report by Lord Hill on the UK listing regime published on 3 March is a fine and early example of a realised opportunity for the UK offered by Brexit. From start to finish in just over three months, it is one of the speediest reviews of its kind, but it is no less insightful for that alacrity. It is a pragmatic response to the uncomfortable reality that the UK capital markets have become uncompetitive by comparison with those of the US and that London is conceding significant ground to other international exchanges in primary and secondary capital raising as a result of regulation which appears cumbersome and inflexible. That is partly attributable to the impact of EU legislation, but also to the stratification caused by the design and deployment of discrete solutions to specific problems without from time to time standing back to understand the impact of those solutions on the UK's overall capital markets offering to the world.
It is time for a fresh pair of eyes, backed by a Government which is committed - along with the relevant financial regulatory and taxation authorities - to delivering the appropriate changes in the shortest practicable time. The recommendations of the Hill review will need to be digested and formal consultations will be required from the Treasury, the FCA and possibly HMRC around the various changes to law, to the listing rules and the prospectus regime - but we can still expect to see a good deal of the necessary machinery in place by the end of 2021.
We know that Lord Hill's vigorous engagement with the numerous stakeholders in the financial markets ecosystem demonstrated a strong appetite for change, and that although there were predictable differences around the right solutions there was also broad agreement around key market features which presently operate as a disincentive to businesses looking to go public and which know that in the 21st century they can go to the stock market of their choice without the pressure which applied historically to “stay local”.
The recommendations propose significant changes to the current listing regime, designed to close the gap between London and other global capital markets by increasing the regime's flexibility and competitiveness, whilst maintaining high standards of regulation.
So what are the key features of Lord Hill’s recommendations?
Dual class share structures
The principle of equality of voting rights has long been enshrined in the UK listing regime, however this can leave founder-led companies which list at an early stage of their growth cycle vulnerable to opportunistic takeover bids. Dual class share structures are attractive to such companies because they give founders enhanced voting rights, enabling them to maintain a seat on the board and block a change of control during the company's growth period, maintaining the founder vision influence which typically forms part of their equity story, while they undergo the cultural transition to become a publicly quoted business. These structures are a feature of other global listing regimes and are particularly common in the US amongst founder-led tech companies. It is important that London is regarded as a suitable listing venue for a diverse range of businesses and there are already concessions built into the listing regime to cater for premium listings of certain specialist companies. Additional flexibility is required, however, to cater for those which are founder-led.
The review recommends that companies with dual class share structures are permitted to list on the premium segment, subject to safeguards to maintain high corporate governance standards including a five year maximum duration, a maximum weighted voting ratio of 20:1 and a requirement that only directors are able to hold such enhanced voting shares. English company law already permits dual class share structures, as does the regime for standard listings. If the premium segment criteria are modified it is probably desirable from a market perspective that a common approach to these structures should be encouraged. Any changes would likely also need the support of the Takeover Panel.
Historically the minimum free float threshold has been driven in part by governance concerns. Many market participants believe that this is misconceived and that the focus should be on liquidity (for which they say free float is not an accurate proxy). Certainly the listing regime already includes a controlling shareholder protocol which addresses governance aspects of majority controlled businesses.
The review identifies the current requirement that at least 25% of shares in a listed company must be in public hands (the “free float”) as one of strongest deterrents when companies consider listing in the UK, especially amongst high growth and PE backed companies. Recognising the linkage between free float and liquidity it recommends that the free float requirement is reduced to 15% and that, in line with other global listing regimes, companies of different market caps may use different measures of liquidity other than an absolute percentage. For larger companies, these measures may include a minimum number of shareholders, a minimum number of publicly held shares and a minimum share price. For smaller companies, the liquidity requirement may be met by the mandatory engagement of a corporate broker to find matching business (as is the case for AIM). The review also acknowledges that engagement with index providers will be necessary, as they have separate free float criteria for index inclusion.
SPACs – special purpose acquisition companies – are cash shell companies formed with a view to making an acquisition. For potential IPO candidates, acquisition by a SPAC may in many cases be an easier route to market than undertaking an IPO themselves. SPAC listings are particularly popular in the US and have gained recent traction in Amsterdam – however main market SPAC listings in the UK are rare. The UK/EU SPAC model has significant structural differences from that which is used in the US, especially around the ability of investors to trade in SPAC shares, including exiting their investment by resale to the SPAC itself, once a proposed acquisition is announced to the market. The review considers that a key factor in the unpopularity of SPACs in the UK is the listing rule requirement for suspension of trading in a SPAC on the announcement of a potential acquisition, meaning that investors are locked into the company for an uncertain period. The review recommends this suspension requirement is removed and replaced with rules and guidance around the information to be disclosed about the acquisition at the time of announcement and additional shareholder protections such as a shareholder vote and an ability to redeem shares on completion of the acquisition.
The review considers that the standard listing segment is suffering from an identity and branding crisis and recommends a rebrand of the segment focusing on its flexibility and suitability for all types of company. It also encourages investor groups to develop guidelines on areas they see as particularly important to allow for standard list companies to be index eligible – as currently this is a key obstacle to the segment's success. Some respondents made a case for merging the premium and standard segments into one, noting that in practice similar pools of capital access both segments, although this is not proposed in the review.
Rather than piecemeal changes to parts of the current regime such as prospectus exemptions, the review proposes a fundamental overhaul of the prospectus regime, in effect to remove some of the onerous and inflexible requirements of the current EU-based regime which respondents to the review considered to be of little value to investors. In particular, it recommends that the contents of a listing document should be tailored to the type of capital raise, with minimal requirements applicable to secondary issues extending perhaps to a full prospectus exemption (while recognising that documentation may still be required for international investors under their domestic securities laws).
The review considered the regulation of forward and backward looking financial information, taking account of the widely held belief that the balance between the two is wrong, bearing in mind the criteria sought by investors in assessing new issuers.
In relation to forward-looking financial information, the review notes that although this information is valued by investors (particularly those in high growth companies) issuers feel constrained by the current liability regime when including it in prospectuses. The review recommends a safe harbour from liability for forward-looking statements if the director/issuer can demonstrate the exercise of due care, skill and diligence and has an honest belief in the truth of the statements. If this recommendation is adopted it is likely also to remove the incentive for issuers to communicate views on future outturn in and around analyst presentations in place of the formal and quality controlled context of prospectus disclosure, which would certainly be a positive change.
Additionally, the review recommends reforms to the current requirement to demonstrate a three year revenue-earning track record as part of the listing process, for example by broadening the application of the relaxations for scientific research-based companies to companies across a wider variety of sectors.
The review encourages the further development of technology which can encourage retail investor involvement in capital raisings, including IPOs. It also suggests revisiting the recommendations made at the time of the 2008 financial crisis to facilitate retail involvement in secondary capital raisings and make the process quicker and easier to execute.
The review recommends that the recently introduced rules in relation to the involvement of unconnected analysts in the IPO process are reviewed by the FCA. Feedback given to the review suggests these rules have in practice added seven days to the IPO timetable without significantly increasing engagement by unconnected analysts, therefore increasing execution risk without tangible benefits for issuers or investors.
Annual City report to Parliament
In order to ensure that London’s capital markets remain competitive over time and are not prejudiced by the creeping regulation which contributed to the current competitive gap, the review proposes a continual appraisal in which the Chancellor presents to Parliament a report on the state of the City which would provide commentary on the effectiveness of changes to the listing regime and which anticipates areas for its further enhancement. It is recommended that the first such report be published in early 2022.
What are the next steps?
Although the Government has broadly welcomed the report, the next step will be for it to consider which of the recommendations it wants to take forward into legislation – the changes to the prospectus regime for example will require primary legislation and the associated Parliamentary time. The FCA has however stated its intention to publish a consultation paper by the summer of 2021 with a view to making relevant rules by late 2021.