The Financial Conduct Authority (FCA) has scrutinised investment and corporate banking services of late, focusing on primary market and related activities provided in the UK. The question of how UK primary capital markets can most effectively meet the needs of issuers and investors is a very big one. So since 2015, there has been a wholesale sector competition review, market study, interim report, discussion papers, consultation papers – and more.
During this, the FCA identified an area of the UK equity initial public offering (IPO) process that needs improvement: the range, quality, timeliness and sequencing of information available to investors. “The prospectus, which should be the primary source of information on companies seeking to raise finance through the IPO process, is currently made available very late,” says Christopher Woolard, FCA executive director of strategy and competition.
The FCA also identified opportunities to improve negative perceptions of bias and conflicts of interest in analyst research. Woolard noted, during a speech at Bloomberg in March 2017: “Only analysts employed by the book-running syndicate can access the information they need to produce research on an offering.” As a result, this so-called “connected research” is the main source of information available to investors during a crucial stage of the process and third-party research providers are shut out.
Reforms on the horizon
FCA Policy Statement 17/23: Reforming the availability of information in the UK equity IPO process (PS17/23) is effective from 1 July 2018. It introduces rules to ensure that before connected research is released, a prospectus or registration document is published and providers of unconnected research are given access to the issuer’s management. PS17/23 also sets out new guidance that aims to address underlying conflicts of interest that can arise if analysts in prospective syndicate banks interact with the issuer’s representatives, for example, during float pitches and vetting meetings.
The move stems from a package of measures set out by the FCA on 26 October 2017 designed to ensure that the UK’s primary capital markets remain effective. The measures include new Conduct of Business Sourcebook (COBS) provisions, and a series of new COBS rules is being introduced; they seek to restore the centrality of a prospectus or registration document and enhance overall standards of conduct in the IPO process.
The FCA reforms have been welcomed by many. “ICAEW supports the creation of a level playing field between connected and unconnected research,” says Katerina Ioannou, manager, capital markets policy, in the Corporate Finance Faculty. “Perceptions of bias and conflicts of interest are not good for the markets and it makes sense for unconnected analysts and connected analysts to have the same access to information and management,” she explains.
Galina Dimitrova, director of investment and capital markets at the Investment Association, also sees benefits in the FCA reforms to remove the current information asymmetry between issuers and potential investors and improve the range, quality and flow of information available at IPO. She says: “This will ensure that the London market continues to attract high-quality and well-run companies and that investors can make informed investment decisions, assisting both parties in the funding journey.”
However, there are some who are not convinced that bringing forward the publication of the prospectus (in a registration document) and giving unconnected firms access to the issuer’s management will necessarily lead to the FCA’s desired outcomes. “I don’t expect there to be a raft of unconnected research published on every IPO,” says Julian Stanier, equity capital markets expert and partner with law firm Pinsent Masons LLP, who cites a lack of financial incentives for unconnected analysts.
The new FCA rules seem flexible enough to allow new market trends to develop. “This will shake up long-followed timelines, particularly given the huge changes that are already going on in the research industry as a result of the forthcoming implementation of MiFID II,” says Nick O’Donnell, corporate finance partner at law firm Baker McKenzie. From January 2018, MiFID II requires fund managers to pay banks and brokers directly for analyst research, which may also help to diminish demand for it.
In contrast to Stanier and O’Donnell, Arzish Baaquie, UK head at Smartkarma, predicts new opportunities for independent analysts and potential investors in UK IPOs: “I see a good understanding of unconnected research coming in the future,” he says, thanks to the FCA reforms and platforms such as Smartkarma. By providing infrastructure to connect its institutional investor clients with independent providers of research, online platforms have the potential to unite a fragmented research industry.
Tinkering with timing
How much FCA reforms affect the timing of available information remains to be seen. “I think information will be available earlier in the IPO process, but it is likely to be slightly earlier not significantly earlier,” says Delphine Currie, a partner in the corporate group at law firm Reed Smith. From 1 July 2018, timings around available information will reflect decisions about if and when unconnected analysts get access to management.
The new FCA rules will require companies to publish an FCA-approved “registration document” before any connected research is released. Many expect this registration document to be what is now the first part of the UK IPO prospectus, minus the securities note containing information about the price or size of the fundraising, or the summary. This is an area where the FCA reforms will give reporting accountants plenty of commercial, technical and practical issues to think through over coming months.
“Early in the IPO process, a registration document will not create prospectus liability under UK securities law, because it is not being used for the sale of securities; the FCA will not require the sponsor to sign off on it,” says Kevin Desmond, senior director and capital markets expert at PwC. What this means for the opinions and other things in that registration document (such as a reporting accountant’s report on historical financial information, or proforma financial information) is more technically complex.
Questions for reporting accountants
Who are these accountant’s reports addressed to? Who is responsible? And who is liable? “These are some of the questions the profession will be discussing with the FCA over coming months as we try to work out quite how it will all work,” says Desmond, adding: “Reporting accountants will deal with the situation, as and when, depending on how things play out.” The reporting accountant’s opinion may need to be accompanied by an explicit disclaimer as to who can rely on it and who cannot.
The gap between producing the registration document and the prospectus may increase costs, because a lot of the reporting accountants’ work is front-loaded and some may need to be repeated. “Reporting accountants may need to refresh and update their work to reflect events that have happened in the intervening period and the scale of this work could vary,” says Desmond. Reporting accountants will also need to consider their interactions with sponsors during the IPO process: “That needs to evolve.”
Additional costs may not be a barrier for larger companies on UK primary markets, but if the new rules are applied to multilateral trading facilities (MTF) they could be a barrier. Desmond says: “I think it’s good news that the FCA has not sought to extend the new rules to AIM.”
But the FCA is encouraging brokers and nomads on AIM IPOs to follow the new rules and it will review their application to MTFs after July 2019 – just in time to factor it into considerations for a post-Brexit capital markets regime.
More information on PS17/23 and other associated documents can be found on the FCA website at tinyurl.com/FCA-PS1723 while tinyurl.com/FCA-PS1723-news has details on the preceding consultation process and the entire package of measures (which also include clarification and enhancements to some elements of the Listing Rules).