Would US listing rules save Europe ECM?

Author: | Published: 4 Sep 2012
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With European and UK equity capital markets moribund, lawyers are calling for the adoption of a US-style regulatory regime to ensure they remain competitive.

Lawyers in the UK have warned the European initial public offering (IPO) model is completely broken. They argue a shift to the US’ more efficient IPO execution and marketing practices is the only way to encourage more start-ups to list in London and the EU.

The UK government last week revealed plans to relax listing rules to encourage fast-growing technology companies to list on the London stock exchange (LSE). The European Securities and Markets Authority (Esma) is also expected to publish a consultation paper this week as part of efforts to boost capital access for smaller companies and head off any preference for raising money in the US.

But Latham & Watkins Olof Clausson said changing the listing rules would do little to attract listcos to the region’s markets. “EU and UK markets have some serious problems that a simple change to the listing rules will not address,” he said.

What needs to change

Pre-deal research had taken on increasing significance in the marketing of a deal, he explained. This had created a tremendous amount of additional work for investment bankers and lawyers to ensure consistency of information across the IPO prospectus, marketing data as well as analyst presentations and equity research. This had thereby affected the speed and cost at which a company was able to list.

Others believed the growing focus on equity research had also placed increasing pressure on equity analysts to squeeze as much positive news as possible out of a company, unduly influencing IPO pricing.

A London-based ECM lawyer said changes needed to be made to allow the publication of equity research later in the IPO process. “It’s much healthier to allow IPO pricing to develop organically,” he said. “We’ve forgotten that an IPO should be priced at the lowest price a company ever trades at.”

It would be better, he argued, to follow the US system in which a draft prospectus was filed with the Securities and Exchange Commission (SEC) six or eight weeks before an IPO road show. This allowed institutional investors to properly research a company before the road show started. More and deeper institutional knowledge allowed for more effective capital formation, he said.

“The US model is much more efficient, when it comes to due diligence, drafting the prospectus and marketing a deal without the involvement of equity research, than the EU model,” he said.

“It’s obviously not perfect but US dealmakers are able to go to market more quickly and at less cost than their EU and UK counterparts and that ultimately makes their market more attractive,” he said.

Misguided regulation

Another UK-based ECM in-house counsel said regulators had lost touch with market realities. “The listing rules have very little to do with how we execute IPOs today,” he said.

He questioned if the EU prospectus directive had been applied properly.

“The IPO prospectus is no longer the key document it was meant to be,” he explained. “Regulators don’t realise that it’s actually the analysts’ research report not the prospectus that drives the IPO process. If they knew the extent to which information is made available in research reports, they’d be horrified.”

Regulators needed to focus much more on how IPOs are marketed in the EU and UK today, and the documentation used for that process, he said. “I struggle to see the point of filing a prospectus with the regulator, for the regulator to review if the regulator then doesn’t even look at any of the other marketing documents being used,” he said.

An EU Jobs Act?

Under UK proposals fast-growing technology companies will be able to float as little as 10 % of their business on the LSE. The current requirement is that at least 25 % of the shares of a listed company be freely-tradeable.

Both the UK rule changes and Esma’s paper aim to address the difficulties faced by small to medium enterprises (SMEs) in accessing financing. They mirror the US Jumpstart Our Business Startups Act (Jobs Act), as signed into law by President Obama on April 5 2012, which intended to improve capital formation for US growth companies.

Clausson said the Jobs Act had been a Silicon Valley driven initiative. However, he believed it remained to be seen what market impact it would have.

Jones Day’s Daniel Busher said the battle cry on both sides of the Atlantic had been that the IPO model was broken, but for very different reasons. “The Jobs Act is an attempt to address the issue in the US,” he explained. “The European market needs to also address reducing the burdens, shortening the timetable but still providing meaningful information to investors.”

Replacing written research with analysts speaking directly with investors, like in the US, was being actively considered, he said. “The Jobs Act allows confidential submissions but then the prospectus must be public 21 days before the road show, allowing investors to focus on the principal disclosure document,” he said. “That seems like a good idea, and could be done with pathfinders, another idea being actively considered.”

Allen & Overy’s Mark Dighero believed the UK move to ease listing rules for SMEs was a good idea in principle. But he remained sceptical it would have much impact in reality.

“Lowering the free float requirement is a good idea, but it doesn’t address the liquidity issues investors will face if they are only offered small pools of shares,” he said. “Changing rules to make SME IPOs cheaper and faster is again a nice idea but if that was really the main issue why aren’t such companies looking to list on London’s AIM market, which was created in part for that purpose.”

“The poor performance of EU and UK ECM has eroded investor confidence in the market,” he said.

“Changing the listing rules won’t change that,” Dighero added. “Nor will it dissuade technology companies from listing in the US, where the market is more knowledgeable about technology and more willing to invest in techcos.”

Another UK-based ECM lawyer said the wall of money available in the US made it a very attractive market for buyers. “There’s a huge willingness to back companies in the US,” he said. “It’s hard for the smaller EU and UK markets to compete with that.”

He argued that shifting to a US regulatory regime, and lessening the focus on pre-deal research was not the right way to go, however. “It would create a whole minefield of legal issues,” he said.

“I don’t think the EU model is completely broken,” he said. “It would be great if we came up with a better one but the IPO model we’re currently following works in the rules.”

Indeed, Akin Gump’s Strauss Hauer & Feld partner Anthony J Renzi in Washington DC last month argued European and UK markets, such as the Oslo Stock Exchange and London’s AIM, presented an attractive alternative to a US IPO for many SMEs.

But the UK-based ECM lawyer believed the US draft prospectus model was a good idea in theory. “The obvious benefit of this is that lots of investors get to look at the preliminary numbers and make an educated decision on the stock,” he said.

But he warned companies would be uncomfortable with the public airing of information. “It’s a bit like opening up your kimono and letting everyone take a look,” he said.