On 21 July 2019 the new Prospectus Regulation (Regulation (EU) 2017/1129) (the “New Prospectus Regulation”) regime repealed and replaced the previous Prospectus Directive (“PD2”) regime in all EU Member States.
In this briefing we explore the impact of the New Prospective Regulation on issuers producing a prospectus in relation to equity shares for review by the Financial Conduct Authority (“FCA”) in the UK and also provide some practical observations based on the Cooley team’s experience of advising issuers on producing prospectuses under the new regime to date.
Prospectuses in relation to equity shares published under the New Prospectus Regulation largely follow the same layout and content requirements as under the PD2 regime. There are, however, a number of changes, the more significant of which we have outlined below.
What has changed?
Under PD2 the prospectus summary encouraged overly technical and often immaterial disclosures. A stated objective of the New Prospectus Regulation was therefore to make the summary more investor-friendly by granting issuers the flexibility to include information that is material and meaningful to investors. However, the requirements under the New Prospectus Regulation are very prescriptive. Instead of the former tabular format under PD2, the summary must now be made up of prescribed sections under four main headings (introduction and warnings, key information on the issuer, key information on the shares and key information on the offer and/or admission to trading) using a Q&A format. In addition, under the new summary regime issuers must ensure that summaries are clear and concise, not least because the length of the new summary is limited to seven sides of A4 paper, with no more than 15 of the most material risk factors included in the summary. There are also detailed requirements about the presentation of financial information in summaries.
Member States have the discretion to increase the page limit and substitute content requirements for summaries. Although this could lead to an inconsistent approach in summary requirements between Member States, the option of flexibility with page limits may make some jurisdictions more responsive to market needs.
The seven page limit can prove challenging for issuers, particularly those with complex operations, in drafting a summary containing all the key information that investors need in order to understand the nature and risks of the issuer and the shares as the New Prospectus Regulation requires. Although the New Prospectus Regulation does not require the summary to be in a tabular format as was the case under PD2, the requirement to provide a selection of historical key financial information and pro forma financial information (where relevant) can themselves take up most of the allotted seven pages. Using a very small font, either generally in the summary section or specifically in the key historical financial information tables, will not be acceptable.
What has changed?
The New Prospectus Regulation requires issuers to include only risk factors that are specific to the company or their shares and which are material for taking an informed investment decision. Each risk factor must be specific, explaining how the risk affects the issuer or the securities being offered or admitted to trading. The risks must be categorised by their nature, with the most material risk presented first under each category based on the probability of the occurrence and the expected magnitude of the negative impact.
On 1 October 2019, the European Securities and Markets Authority (“ESMA”) published its guidelines on the inclusion of risk factors in prospectuses under the New Prospectus Regulation. The guidelines illustrate best practices to ensure the delivery of a clear message on the risks attaching to an issuer and its securities, and are part of the wider updates and refinements being made to the prospectus regime. The guidelines, which are addressed to national competent authorities (“NCAs”) such as the FCA, apply from 4 December 2019 and aim “to encourage appropriate, focused and more streamlined disclosure of risk factors, in an easily analysable, concise and comprehensible form, by assisting competent authorities in their review”. The guidelines encourage the NCAs, as part of their usual review processes of draft prospectuses, to challenge issuers where the principles required by the guidelines have not been met. If the issuer is unable or unwilling to make the necessary changes or to provide supplementary information, then the NCA may refuse to approve of the prospectus and terminate the review process.
There are 12 guidelines and explanatory paragraphs which give additional guidance on how the guidelines should be interpreted, spread across six categories (specificity, materiality, corroboration, presentation of risk factors, focused/concise risk factors and those risk factors in the summary). Below is a summary of the main considerations in each category of the guidelines.
Specificity – Specificity may depend on the type of entity (e.g. start-up companies, regulated entities, specialist issuers etc.). Each risk factor should identify and disclose a risk that is relevant to the issuer or its shares, rather than simply comprising generic disclosure. Issuers operating within the same industry may be exposed to similar risks and therefore disclosure related to these types of issuers can be similar. However, industry or sector specific risks may affect issuers differently depending, for instance, on their size or market shares and therefore it is expected that, where relevant, these differences are also reflected in the disclosure of a given risk factor. Merely replicating risk factors seen in prospectuses produced by similar businesses will not be appropriate unless they are relevant to the issuer and its shares. The NCAs should ensure that a disclosure establishes “a clear and direct link” between the risk factor and the issuer or its shares. The NCAs should challenge risk factors that only serve as disclaimers of liability.
Materiality – The level of materiality of a risk factor should be clear from the disclosure provided. ESMA believes that providing quantitative information within the disclosure of risk factors helps to demonstrate the materiality of specific risk factors. However, it may not always be appropriate for quantitative information to be included. Where this is the case, the disclosure should be described in qualitative terms (e.g. by using the scale of low, medium or high risk). Whichever approach is taken, the impact of the risk factors must be adequately explained and be consistent in presentation, with the most material risk factors appearing first in each category. Issuers should ensure that any mitigating language used should not compromise the clarity of the messaging regarding the materiality of the risk factor; where mitigating language is included in relation to a risk factor, it can only be used to illustrate probability of occurrence or expected magnitude of negative impact. If the issuer determines that the mitigation in place reduces the risk to such an extent that the risk is no longer material, it should either remove the risk factor or remove the mitigating language.
Corroboration – The specificity and materiality of a risk factor should be corroborated by the overall picture presented by the prospectus. While direct and clear corroboration of the materiality and specificity of the risk factor is normally demonstrated via the inclusion of specific corresponding information elsewhere in a prospectus, this is not necessary in all circumstances. In practice, it may be helpful to include cross-references to specific corroborating sections of the prospectus to the extent possible.
Presentation – The categorisation of risk factors and the ordering of risk factors within each category should support their comprehensibility. Both should assist investors in understanding the source and nature of each disclosed risk factor. A risk factor should only appear once, in the most appropriate category. In accordance with Article 16 of the New Prospectus Regulation, the most material risk factors have to be presented first in each category, but it is not mandatory for all the remaining risk factors within each category to be ranked in order of their materiality. Issuers should use as few categories as possible in order to present the risks factors in a comprehensible manner. NCAs should question the use of more than 10 categories for most standard prospectuses.
Focused/concise – Risk factors should be presented in a concise form. NCAs should challenge the length of the risk factors disclosure to ensure that the materiality and specificity of the risk factor is clear and its presentation is appropriate and focused.
Risk factors in summary – Presentation of risk factors in the summary of a prospectus should be consistent with the presentation based on materiality in the risk factor section. This, however, does not mean that the summary must include risk factors from all of the categories included in a prospectus.
In practice, the guidelines should merely serve as a reminder to practitioners and issuers of best practice and ensure that only the most specific and material risks to an issuer and its shares are disclosed, rather than necessitate wholesale changes to the drafting process.
The requirements under the New Prospectus Regulation and the recommendations under the ESMA guidelines are generally consistent with the FCA’s historic approach to risk factors, for example not including generic or boilerplate disclosure and including disclosure that explains the risk in the context of the issuer’s business, although in some instances there will be changes to the layout and categorisation of risks under the New Prospectus Regulation. Issuers can expect the FCA to challenge risk factors if they are not consistent with the New Prospectus Regulation or the principles set out in the ESMA guidelines.
Profit Forecasts / Estimates
What has changed?
Under the New Prospectus Regulation, where a profit forecast or estimate has been published by the issuer and is outstanding it will need to be included in the prospectus. However, in a change from the PD2 regime an accompanying auditor’s report will no longer need to be included in the prospectus in respect of the profit forecast or estimate.
We would expect issuers (and their sponsors) to still seek reports from their reporting accountants to mitigate the risks associated with including a profit forecast or estimate in a prospectus. However, this will be a private report, similar to the approach that has historically been taken on Class 1 transactions by premium listed issuers.
Other Key Changes
The New Prospectus Regulation introduces several other changes to the content requirements for the prospectus, including:
- Significant change – The required “significant change” statement in the prospectus has changed slightly from detailing any significant changes in financial or trading position under PD2 to detailing any significant changes in financial position or financial performance under the New Prospectus Regulation.
- Selected financial information – The requirement to include a “selected financial information” section that was contained in PD2 has not been carried over into the New Prospectus Regulation.
- Incorporation by reference – There is a significant increase in the scope of information that may be incorporated by reference into a prospectus under the New Prospectus Regulation as compared to under PD2. In addition to historic financial information, an issuer will be able to include other documents that have been published electronically, including corporate governance statements, asset valuation reports and management reports. When in electronic format, a prospectus will need to contain hyperlinks to all documents containing information that is incorporated by reference.
- Display documents – The documents that the issuer needs to put on display no longer need to include the historical financial information. However, the display documents must be made available for inspection on a website, which is a change from PD2.
Finally, what about Brexit?
In the event of a “no-deal Brexit”, the UK prospectus regime is expected to continue broadly unchanged, at least for the time being, and the FCA will have the discretion to regard the ESMA guidelines on risk factors summarised above as relevant guidance for the UK prospectus regime then in force. However, it will no longer be possible to passport a prospectus approved by the FCA to another EU member state or vice versa.
If the UK leaves the EU with a withdrawal agreement in place, the New Prospectus Regulation will continue to apply in the UK until the end of the transition period under that agreement.