PRIMER: the Prospectus Regulation

Author: IFLR Correspondent | Published: 28 Sep 2017
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What is it?

The Prospectus Regulation (PR) is the latest attempt by the EU to regulate how issuers of capital markets instruments in the EU and the European Economic Area prepare their prospectuses. Its aim, as with most initiatives these days, is investor protection.

Adopted in June 2017 as part of the Capital Markets Union Action Plan, the PR aims to it make easier and cheaper for companies to access capital and improve the user-friendliness for investors of SME prospectuses. It also seeks to make a distinction between the sorts of prospectuses provided to retail clients with those given to institutional investors.

Have we been here before?

Yes, many times. The prospectus regime has been constantly evolving since it came into effect in 2003 and reviewed in 2008, but the regime for wholesale investors remains broadly unchanged.

The first Prospectus Directive went into effect on December 2003, with each state needing to implement by July 2005. This latest iteration will repeal and replace the Prospectus Directive (PD) and the existing PR.

It’s fair to say many in the industry have prospectus rules fatigue by now. "I have been looking at these rules for the best part of 18 years now," says Lachlan Burn, partner at Linklaters and member of the International Capital Markets Association’s legal and documentation committee. "It would be nice to have a few years of the status quo now, and stop tweaking. The low levels of securities litigation suggest the current framework is working."

Where are we now?

On July 6, the European Securities and Markets Authority (Esma) published three consultation papers containing draft technical advice on the format and content of the prospectus, with a view to delivering technical advice to the European Commission by March 31 2018.

At an IFLR Prospectus Rules conference on September 26 Johan van Gruijthuijsen, policy officer of the prospectus team at the  Commission confirmed that once Esma’s technical advice has been received in March, the Commission will draft a delegate act that will be prepared and discussed with member states.

Its intention is to draft one single delegated act rather than multiple delegated acts, according to the official. The delegated act will be part of Esma’s feedback mechanism, allowing stakeholders the opportunity to comment on the final draft before it is adopted.

Once in place the new regime will not apply retroactively. Securities with PD-compliant prospectuses or base prospectuses before the PR fully applies on July 21 2019 will be grandfathered.

When will compliance requirements start to bite?

  Some already have. Implementation has been staggered, with the first set of requirements kicking in from July 20 this year. These include an increased threshold for issuers with existing securities admitted to trading on a regulated market.

They can take advantage of an exemption from the requirement to publish a prospectus in connection with new securities that are fungible with securities already admitted to trading on the same regulated market, if the new securities represent less than 20% of the existing listed securities for a 12-month period. This is an increase from the last threshold of 10%.  

""It would be nice to have a few years of the status quo now, and stop tweaking"

It’s not all good news though. Under the previous rules, the prospectus requirement for securities admitted to trading on regulated markets didn’t apply to shares resulting from the conversion or exchange of other securities or from the exercise of the rights conferred by other securities, as long as they are the same class as the shares already trading.

Under the new rules, this exemption is available only where the resulting shares represent less than 20% of the shares of the same class already admitted to trading on the same regulated market.

Other measures kick-in in the following year. From July 21 2018, no prospectus will be required for an offer of securities with a total consideration in the EU of less than €1 million ($117 million) over a period of 12 months. And at same time in 2018, a universal registration document (URD) - fast-track approval and reporting substitutes for frequent issuers will be introduced.

Fast-track - that sounds good. But is it?

  It could be, but the URD has received a mixed response from national competent authorities at the level 2 consultation stage.

It is initially a French concept and has been in place there for more than a decade. The URD is an optional, specific registration document that contains legal, financial accounting information. It is intended for frequent issuers admitted to trading on regulated markets or multilateral trading facilities.  Every year an issuer would complete a registration document.

The aim is that once an issuer has gone through the work of putting one together they can re-use it for future issuances. While popular in France, other panellists questioned its applicability across non-equity instruments.

How are wholesale and retail investors separated?

Under the regime, the level of disclosure required depends on whether the prospectus is for a retail or wholesale bond issue. Retail bond issues require a higher level of disclosure than wholesale bond issues, which are issued in minimum denominations of €100,000 and are aimed mainly at institutional investors.

The PR keeps this distinction, and expands the scope of the wholesale disclosure regime to include debt securities trading on a specific segment of a regulated market where only qualified investors can trade them.

How does PR treat risk factors?

Risk factors have, by most accounts, got out of hand. Many prospectuses feature reams of boilerplate statements displaying an unpleasant mixture of cautious or lazy drafting.

Under the new rules, issuers will have to categorise risk factors according to their materiality. Different thresholds of risk will need to be established, with procedures put in place to determine what factors to include in each category.

'Materiality’ in this sense will need to take into account both the likelihood of occurrence and the expected magnitude of the negative impact of such risks. This process will involve quantifying risk in a way that is novel in capital markets regulation.

Although risk factors undoubtedly need to be improved, some are concerned about liability issues if they’re miscategorised. If an issuer labels a very remote risk as 'low-risk’ and it then materialises in unusual or unforeseen circumstances, will the issuer or its officers be liable for misrepresentation? This still needs to be grappled with at level 2 by Esma.

Who is overseeing this?

Until recently, the National Competent Authorities (NCAs) were the obvious candidate to enforce much of the PR at a national level. But in September 2017, the Commission published its proposal to amend the regulations dealing with the functions of European Supervisory Authorities.

Clearly inspired by Brexit and a push to give Esma greater powers within the remaining EU markets and avoid regulatory arbitrage, the changes could move powers for approving prospectuses away from the NCAs and into the hands of the already overworked Esma.

This move is unpopular. One senior figure at a European stock exchange views it as a solution to a problem that doesn’t exist. "NCAs in Europe concerned with the debt capital markets have built up experienced and competent teams that allow them to respond quickly to market needs," they said. "This won’t help issuers or investors."


See also

EU Prospectus Regulation Conference: key takeaways

For more primers, click  here.




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