Capital raising since the financial crisis

Author: | Published: 1 Apr 2010
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Since the beginning of the financial crisis, capital markets in Germany have been mixed. While there were hardly any initial public offerings (IPOs) in Germany, equity markets have seen a high number and volume of rights issues. Even more active than the equity markets were corporate bonds. Unlike most other countries, during the financial crisis German banks rarely raised equity but relied on other forms of financing, in particular participations by individual investors, including the state, in the form of silent partnerships. German companies traditionally also rely on debt financing from banks and even though the German banks have tightened their credit requirements, many companies continue to do so.

There have been no substantial changes to the legal and regulatory environment for the raising of capital in Germany in connection with the financial crisis (other than the rescue scheme for banks in autumn 2008). Regulation of German capital markets is strongly influenced by legislation on the European level. Thus, many rules will be comparable to those of other EU/EEA states.

Structure of the capital markets

From a legal point of view, Germany's capital markets are divided into the regulated market, with a high level of transparency and investor protection, and the unregulated market, to which only basic rules apply. At the Frankfurt Stock Exchange, Germany's main capital market, the regulated and the unregulated market are further divided: the regulated market into the Prime Standard segment and the General Standard segment, the unregulated market into the Entry Standard segment and the Open Market segment.

Germany's main regulatory financial authority is the Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). Its responsibilities include the combating of insider dealing, tracking down market manipulations, enforcement of transparency rules and the review of securities prospectuses. Supervision of the stock exchanges is primarily the responsibility of the stock exchange supervision authorities of the federal states (Länder).

IPO of ordinary shares

A listing of shares on the regulated market, in particular in the Prime Standard segment, ensures the best visibility and access to investors but is also the most costly due to the enhanced transparency requirements, such as the obligation to publish financial reports based on IFRS as applicable in the EU and immediately publish all price-sensitive information (ad-hoc publicity). In contrast, there are shares of about 10,000 issuers listed in the Open Market segment, which is not connected with any continuing obligation for the issuer. The Entry Standard segment (and its equivalent of the Munich Stock Exchange: m:access) has been created to provide issuers with a less costly alternative. Transparency requirements are less strict here, but it appears that the segment has been well accepted by issuers and investors alike.

Requirements

The requirements for a listing of shares on a German stock exchange depend on whether listing is sought in the regulated market or in the unregulated market.

In both, German companies must be incorporated as a stock corporation (Aktiengesellschaft), a partnership limited by shares (Kommanditgesellschaft auf Aktien) or a Societas Europaea, but comparable foreign corporate bodies are permitted as well. Both in the regulated and the unregulated market public limited companies under English law and corporations incorporated in the US as well as Dutch NVs and French SAs can be found.

A further similarity between the regulated and unregulated market is that ordinary as well as preferred shares may be listed. However, the concept of preferred shares in a German stock corporation differs from that of many other countries. Preferred shares carry no voting rights and no priority over ordinary shares upon liquidation, but receive higher dividends than ordinary shares.

For a listing of shares on the regulated market of the Frankfurt Stock Exchange the total market value of all shares to be listed must be at least €1.25 million and a free float of at least 25% must be reached immediately after the listing (but may later fall). The issuer must have existed as a business and published its annual accounts under IFRS as applicable in the EU for at least three years. Exemptions from these requirements may be granted by the stock exchange in certain cases.

Requirements for listing in the unregulated market are substantially lower, for example there are no requirements for trading record, working capital or free float.

A listing of shares on the regulated market and any public offering (including one of shares to be listed on the unregulated market) requires a prospectus. Incorrect information or the omission of material facts in the prospectus may result in prospectus liability. In this case, anyone that acquires the new shares within six months may request a refund of the subscription price from the issuer as well as from any other person that has taken over responsibility for the prospectus, that is, usually the global co-ordinator.

For issuers incorporated in Germany the prospectus must be approved by BaFin. For issuers incorporated in another member state, the prospectus must be approved by the component authority of the issuer's home state and notified by such authority to BaFin. For issuers incorporated outside the EEA, the competent regulatory authority is the authority of the EEA state in which for the first time within the EEA either the shares are offered to the public or an application for admission to trading is filed.

Process

An IPO can be structured as an offer of new shares resulting from a capital increase as well as an offer of existing shares from selling shareholders. However, the usual structure in Germany is a combination of primary and secondary offer. It is common practice to place the shares with institutional investors as well as with private investors through a public offering in Germany, accompanied by a private placement with institutional investors abroad (including an offering to US investors under Rule 144A of the US Securities Act of 1933).

Depending on the overall structure of an IPO, marketing and advertising will take place with different intensity during the different stages of the process. In any case, it is strongly advisable for the issuer and the accompanying banks to issue and enforce publicity guidelines to ensure that any marketing, which may even include research reports that do not fulfil certain requirements, is identified as such and does not contradict the information given in the prospectus. Failure to comply with these rules may result in prospectus liability.

Rights issues

As noted above, Germany has seen a number of rights issues with a considerable volume. Following the financial crisis and the increased volatility of the markets, the use of backstop-investors has become more common. As a new development, Germany has even seen an advance placement to several investors prior to offering the shares to the existing shareholders coupled with a claw-back mechanism (such as Continental).

Other than in an IPO, under the current practice of the German regulators, a rights issue can be done without the prior publication of a prospectus if the offer is only to existing shareholders and if the issuer does not organise a trade in subscription rights. In this point, German practice under the Prospectus Directive differs from other European countries and the situation is likely to change with the upcoming reform of the Directive as proposed by the EU Commission.

However, a prospectus might still be necessary for the admission to trading of the new shares. Admission to trading is mandatory within one year from the rights issue for all new shares if similar securities are already admitted to trading on the regulated market. Further, a delay of the admission to trading may make a rights issue less attractive to investors. The obligation to publish a prospectus may be avoided completely if the rights issue amounts to less than 10% of the total share capital of the issuer or if the issuer is able to demonstrate that shares were only issued to existing shareholders.

For German stock corporations, the most effective rights issue is a capital increase from authorised capital. However, the articles of association need to provide for authorised capital and, in addition, that capital may only amount to 50% of the total share capital. Therefore, Germany has seen a number of rescue rights issues directly approved in the general meeting, which adds a great level of complexity to the process.

Issuing of bonds

The German market has a wide variety of bonds, including stand-alone bonds, medium-term note programmes, subordinated capital bonds and, as a German speciality, covered bonds (Pfandbriefe). The new Bond Act (Schuldverschreibungsgesetz), which came into effect on August 5 2009, brings comprehensive changes to the legal regime for bonds, both for the issue of new bonds and, if the issuer elects, amendments of the terms and conditions of existing bonds. It strengthens the position of bondholder representatives compared to the old Bond Act, in which transparency issues and trustee provisions lacked clarity. Further, the procedural provisions for bondholder meetings have been modernised.

A bond can be issued as a private placement or public offer. The issued bonds may or may not be listed on an exchange.

The admission of securities other than shares to any of the regulated German stock exchanges is subject to a minimum aggregate nominal value of €250,000. In addition, the denomination of the issue must reflect the needs of the investors and must be suitable for trading purposes. In relation to the unregulated market segment, there are no size limits for debt instruments.

For securities that are intended to be offered for sale to the public or admitted to trading on a regulated market, a securities prospectus, previously approved by BaFin, must be published. As with equity prospectuses, there are detailed statutory requirements in, for example, the Prospectus Regulation. These are supplemented by international and German market standards. For issues of non-dividend securities and derivatives, there is the possibility of drafting a base prospectus, under which the issuer can issue securities regularly for a period of 12 months, without being obliged to draft a separate prospectus for each issue. The base prospectus is supplemented by final terms for each separate issue, conducted under the base prospectus regime.

Exemptions from the obligation to publish a prospectus apply if the offer is only addressed to qualified investors, if it is addressed to fewer than 100 natural or legal persons (other than qualified investors) per member state, if it is addressed to investors that acquire securities for a total consideration of at least €50,000 or if the nomination per unit amounts to at least €50,000 or if the total consideration for all offered securities is less then €100,000 over 12 months.

Equity-linked bonds

German stock corporations may issue two main types of equity-linked bonds – convertible bonds and bonds with warrants attached – and increasingly made use of this possibility since the beginning of the financial crisis.

Convertible bonds are bonds which, during their term, can be converted into shares of the issuer. While the option usually lies with the bondholder, sometimes the issuer is given the option to force conversion. Upon conversion, the debt obligation of the issuer is redeemed in consideration for the issue of the new shares.

In a bond with warrants, the warrant that confers the right to acquire shares at a certain price may be detached from the bond and traded separately. The issuance of so-called naked warrants, without attachment to a bond, is not permitted under German corporate law.

Future changes

Changes to the legal environment for raising capital in Germany can be expected from the reform of the Prospectus Directive, which is under discussion on the European level and is likely to come into force in summer 2010, but would still require implementation into German law.