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Author: | Published: 30 Sep 2004
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The new Prospectus Directive (PD), which is due to be fully implemented across the EU from July 1 2005, aims to create common and enhanced standards for the issue of securities and to allow the passporting of approved prospectuses throughout the EU. Its impact will be felt not just in Europe, but also globally, as it will affect all issuers who want to sell or list securities within the EU. It will cause issuers and investment banks to reconsider whether it is necessary to list certain securities at all and, if it is necessary to list them, whether it is necessary for that listing to be within the EU. Switzerland, Hong Kong and Singapore are all actively marketing themselves as attractive listing alternatives to the new EU regime, but what they cannot offer (and time will tell as to whether investors demand it) is securities listed on an EU-regulated market.

Status of the directive

The PD follows the four-stage Lamfalussy process, which comprises the core directive (Level 1), detailed implementing measures (Level 2), non-binding guidance (Level 3) and, eventually, coordinated enforcement procedures (Level 4). The directive itself entered into force on December 31 2003. One of its provisions (fixing of home member state) applies from December 31 2003, but in the main, the directive must be implemented through national law in all 25 EU member states by June 30 2005. The Level 2 implementing measure (the Level 2 Regulation) was published on April 30 2004 and is directly effective, which means that it automatically becomes law in all member states on July 1 2005. The Committee of European Securities Regulators (CESR) published its recommendations for Level 3 guidance on June 24 2004 and, after a consultation period, which closes on October 18 2004, CESR will publish its guidelines before July 1 2005. These do not have to be implemented into national law and are not legally binding, although it is assumed that most member states (and certainly the UK) will adopt them.

When do you need a PD prospectus?

Two situations require the publication of a PD prospectus:

  • When an offer of securities is made to the public in any country in the EU:
    - The definition of offer is extremely broad and covers any "communication to persons in any form and by any means, presenting sufficient information on the terms of the offer and the securities to be offered, so as to enable an investor to decide to purchase or subscribe to these securities".
    - Securities means transferable securities, so non-transferable options, for example, will be exempt from the need to produce a PD prospectus. It is not clear whether employee stock options should be classified as non-transferable securities (and therefore exempt), or whether one should look through the option to the underlying security that is transferable.
    - The obligation to publish a prospectus is subject to a number of exemptions (see below).
  • When securities are admitted to trading on a regulated market in the EU:
    - Admission to trading - this is wider than the current concept of listing, as it includes securities traded on domestic second markets and on trading facilities (for example, virt-x).
    - Regulated market is as defined in the Investment Services Directive, although some EU countries are seeking to remove their second markets from the list of regulated markets (for example AIM in the UK and the Third Market in Austria) or create new markets that are not classified as regulated markets to avoid the need for a PD-compliant prospectus for issues listed on these markets (which do not amount to a public offer).

Diagram 1 illustrates when a PD prospectus might be required.

Diagram 1: When a PD prospectus is required

How do you avoid the PD?

The PD does not apply in a number of circumstances (for example, securities with a maturity of less than 12 months). There is an exemption for corporate issuers that disapplies the PD for offers of securities (debt and equity) where the total size of the offer is less than €2.5 million ($3.06 million) over a 12-month period.

Even where the PD does apply, a number of exemptions are available, if the securities are not admitted to trading on a regulated market in the EU. These are:

  • An offer solely to qualified investors - which is wider than the previously used term in many member states and is wider in reach than the QIB concept in the US.
  • An offer to fewer than 100 people per member state (other than qualified investors) - which is more specific than the existing equivalent exemptions in many member states.
  • An offer where the minimum consideration for each investor, or the minimum denomination for each unit, is equal to or greater than €50,000.
  • An offer where the total consideration is less than €100,000 over a 12-month period.

Given the breadth of these exemptions, non-EU issuers should reconsider whether a listing in the EU (which would require a PD prospectus) is necessary. For many investors (such as fund managers and pension funds) it is, because they are governed by regulations or investment criteria that state that they must invest, wholly or largely, in EU-listed securities. However, if the regulations and/or investment criteria just state that the securities must be listed, it might be worth considering a listing outside the EU (for example, in Zurich, Hong Kong or Singapore, especially if these markets make themselves more attractive to traditional users of Euro markets) combined with the use of the exemptions referred to above.

A number of exemptions (for both offerings and admissions to trading) apply to certain types of securities. These largely track existing exemptions and cover situations such as conversion offers, mergers and takeovers and employee offers. The current exemption on admission to trading for shares representing less than 10% of a class already listed also remains, although it now applies over a 12-month period.

Rights issues

Traditionally in the UK, rights issues have been subject to a relaxed disclosure regime - comprising a circular or abbreviated prospectus rather than a full prospectus. However, under the PD, no preferential treatment is afforded to rights issues (other than the exemption for shares representing an increase of less than 10%, which only applies on admissions to trading, not on a public offer). So any rights issue to the public will require a full PD prospectus.

Secondary market trading

The 1989 prospectus directive only required a prospectus to be produced when securities were offered to the public for the first time - clearly excluding offers in the secondary market. The PD does not carry over this concept. The Commission believes that retail investors in the secondary market should obtain the same protection as on a primary offer in terms of disclosure, despite the fact that there should be adequate information available to retail investors of listed securities through the operation of the Transparency Obligations Directive (see below). Unfortunately, the PD makes no allowance for this and creates a situation where all offers of securities (whether listed or not) require the publication of a PD prospectus, unless an exemption applies. This could mean at an extreme that any investor selling through a market where they cannot control how many purchasers buy their shares could be triggering a prospectus requirement. This is clearly an unintended result, and it is hoped that member states will seek to clarify the position as they implement the directive into national law.

Contents of a PD prospectus

Although the framework for drawing up a prospectus is contained in the PD, all the detailed content requirements are set out in annexes to the Level 2 Regulation. Despite looking complicated, not much has actually changed with regard to disclosure. As before, the prospectus must contain all information that is necessary to enable investors to make an informed assessment of the assets and liabilities, financial position, profit and losses, and prospects of the issuer and of any guarantor, and of the rights attaching to the securities.

International accounting standards

The biggest issue relating to disclosure is that of accounts, as the PD is being introduced in conjunction with the move across Europe to international accounting standards (IAS). Subject to some limited transitional provisions, the International Financial Reporting Standards Regulation (IFRS Regulation) requires that EU companies, whose (debt or equity) securities are admitted to trading on a regulated market in the EU, prepare their consolidated accounts in accordance with IAS for any financial year starting on or after January 1 2005. As a result, the PD starts from the premise that all issuers, EU and non-EU, must include in any prospectus IAS accounts or accounts reconciled, restated, or equivalent to IAS. The question of what should be deemed equivalent to IAS is being considered by CESR. As a first step, CESR will publish a concept paper that will establish the principles upon which equivalence could be assessed and the methods and criteria to be used for the technical assessment of equivalence. Once this is finalized (expected to be December 2004), the second step for CESR is to determine whether US, Canadian and Japanese Gaap should be considered equivalent by applying the principles set out in the concept paper. CESR hopes to submit its final advice to the Commission by June 30 2005.

For countries with a national Gaap not regarded as equivalent to IAS, issuers and guarantors who do not prepare their accounts in accordance with IAS or an equivalent will (subject to the €50,000 exemption discussed below) be required to reconcile or restate their accounts to IAS before they are included in any prospectus or furnished as part of the issuer's continuing obligations under the Transparency Obligations Directive (see below). This is an onerous requirement and may drive the development of unlisted debt or derivative products (especially those equivalent to convertibles) that fall outside the scope of the PD.

This is the most important change that the PD will bring about - and principally impacts non-EU issuers of equity and debt. There is an exemption from the requirement to use IAS for non-equity securities with a denomination of at least €50,000 (wholesale debt) and some transitional measures that will provide temporary relief, especially to non-EU issuers. Some non-EU issuers are reserving the contractual right to delist to avoid having to re-state their (or their guarantor's) accounts to IAS.

Guarantors

A guarantor must provide the same level of disclosure as if it were the issuer. The concept of guarantor includes keepwell providers and other providers of credit support (including, for example, monoline insurers).

Format

Under the PD, the issuer will have a choice of format for the prospectus. It can either be a single document, or a tripartite document made up of a registration document, a securities note and a summary note. Non-equity securities issued under a programme (for example, a medium-term note programme) or in a repeated manner by credit institutions can use a base prospectus supplemented by a term sheet.

Summary

A summary of the prospectus (with a suggested limit of 2,500 words) will become mandatory for all issues other than wholesale debt issues (although a competent authority may still request one for a wholesale debt issue). The summary must be in non-technical language and contain a warning that it should be read in conjunction with the rest of the prospectus.

Risk factors

The inclusion of risk factors, although common in practice, will become mandatory in those member states where it is not already.

Incorporation by reference

Information can be incorporated into a prospectus by reference (although not into the summary), as long as it has previously or simultaneously been approved by, or filed with, the competent authority of the issuer's home member state (see below).

Other disclosure issues

  • There are provisions that allow a competent authority to accept a prospectus drawn up in accordance with non-EU rules, for example, an SEC-approved prospectus, if it follows IOSCO standards and the information is equivalent to that required under the PD. However, it is not yet clear what the policy of national regulators on this will be. In practice there will probably be no change in the short term, so the prospectus will still need a wrap.
  • Although the Level 3 guidance produced by CESR is technically non-binding, it is expected that most home member states will incorporate it into their disclosure requirements. There is a concern that, as this guidance process is continuous, it will add an ever-increasing number of layers to the basic disclosure requirements set out in the PD and the Level 2 Regulation.
  • Similarly, although member states are not allowed to require additional disclosure in a prospectus (to that contained in the PD, the Leval 2 Regulation and Level 3 guidance) it is feared that individual stock exchanges may find other ways to strengthen disclosure (for example, by using eligibility criteria or listing requirements).

Liability for the prospectus

The PD contains a list of those responsible for the contents of the prospectus. They are the issuer (or its administrative, management or supervisory bodies), the offeror, the person asking for the admission to trading on a regulated market and any guarantor. The inclusion of offeror may catch investment banks in certain circumstances, giving them clear liability where previously it was only arguable.

Despite the harmonization of content and, to some extent, distribution requirements, the PD provides no harmonization of civil liability in respect of that content. Each member state will still be allowed to maintain its own national liability rules for prospectuses. One exception where the PD does attempt to harmonize liability is for the summary of the prospectus (designed to meet the concern that a person responsible could be liable for incomplete information contained in the summary, especially with a suggested limit of 2,500 words). The PD provides that civil liability attaches to the summary only if it is misleading, inaccurate or inconsistent when read together with the rest of the prospectus. To implement this harmonized liability for the summary, some member states will need to update their national laws to avoid there being a conflict. There is still a fear, though, that a domestic court might seek to conclude that the summary is by its nature misleading if an investor is unable to read and understand the full prospectus because it is in another language.

Annual statement

By way of a continuing obligation, issuers whose securities are admitted to trading on a regulated market (other than issuers of wholesale debt), will be required to file an annual disclosure list with their home member state (see below). This should contain or refer to all information that the issuer has disclosed to the public during the last 12 months pursuant to obligations imposed upon it by securities regulators in the EU or elsewhere in the world, including the US. However, there is no obligation to keep the list updated throughout the year (although this was the original idea behind this requirement). It could be important to include disclaimers in the list to ensure that investors in a particular home member state do not rely on information in the annual information document to the extent that the information was not directed at them, prepared for them or specifically disclosed in the home member state. The information may also be out of date and this needs to be warned about.

Approval of a PD prospectus

Home member state

Under the PD, each issuer has a home member state, the competent authority of which is the entity responsible for approval of prospectuses. An issuer's choice of home member state will therefore be important. This is especially so for non-EU issuers of equity (including convertibles) and low denomination debt (non-equity securities with a denomination under €1,000, or near equivalent in another currency) because the member state in which they make their first application for admission to trading on a regulated market or public offer in the EU after December 31 2003 will be fixed as their home member state - this fixing is permanent. For EU issuers of equity and low-denomination debt, the home member state has to be the country in which they have their registered office so there is no need for any election.

The question of what constitutes a public offer for the purposes of triggering a home member state election for non-EU issuers is far from clear. Therefore, non-EU issuers need to be extremely cautious if they are seeking to use the public offer limb of this test. It is also not clear what happens when an issuer makes simultaneous public offerings in more than one member state. In view of the considerable differences in the regulatory approach and language requirements across the EU many non-EU companies are engineering an offering/admission in their country of choice.

Inadvertently choosing the wrong home member state (for example through the operation of a share-option scheme) is something the issuer cannot subsequently change. Making an error and thinking you have chosen one member state, but in fact having triggered an election in another member state, will lead to even bigger problems. The issuer might then be distributing a prospectus that has not been approved correctly, which might raise questions as to the validity of the prospectus.

Both EU and non-EU issuers of debt with a denomination equal to, or greater than, €1,000, (or near equivalent in another currency) and most derivatives (unless the underlying securities belong to the issuer's group) still have a free choice of competent authority on an issue-by-issue basis. This means that an issuer may have several home member states: one for all issues of equity and low-denomination debt, and other ones for individual debt issues.

Host member state

The rules determining the competent authority that must approve a prospectus do not restrict the choice of stock exchange for any listing or the country in which any public offer can take place. Although an issuer's home member state approves the prospectus and any supplements, it is valid for use (as an offer document or a listing document) in any other EU member state (known as a host member state) provided such host member state is notified (passporting). Although the host member state can impose listing requirements under Article 8 of the Directive on Admission of Securities to Listing (2001/34/EC), it is not allowed to undertake any approval or administrative procedures relating to the prospectus (other than require that the summary be translated into its official language).

Relationship with the Transparency Directive

The PD is being introduced in conjunction with the Transparency Obligations Directive (TOD), which relates to the continuing obligations of issuers whose securities are admitted to trading on a regulated market in the EU. In particular, it covers the publication of annual and half-yearly financial reports - also starting from the premise that all such issuers, wherever incorporated, should be using IAS accounts or accounts reconciled, restated, or equivalent to IAS. Issuers of shares, who do not otherwise publish quarterly financial reports, must also publish an interim management statement between the annual and half-yearly reports. TOD also contains disclosure requirements for major shareholdings in all companies (whether incorporated in the EU or not) that are admitted to trading on a regulated market in the EU. Notification will start at 5% of the voting rights, but many jurisdictions already meet or exceed the proposed standards.

Generally speaking, an issuer's TOD home member state will be the same as that elected (or deemed to have been elected) for equity and low-denomination debt issues under the PD. Under TOD an issuer can only have one home member state, and an election remains valid for at least three years unless the issuer ceases to have securities admitted to trading on a regulated market in the EU.

Implementation of TOD is expected in late 2006, a full year after the PD has come into effect, and this timing mismatch, together with the fact that some of the definitions are different in the two directives, may cause issuers some problems.

Conclusion

Although the PD, the Level 2 Regulation and guidance are not expected to cause large upheaval in the capital markets, a lot will depend on how each member state implements the PD into national law. Only when this is known will it be clear whether the PD has achieved its aim of harmonizing the public offer and listing regimes across the EU.

Author biographies

Mark Kalderon

Freshfields Bruckhaus Deringer

Mark is a partner in the financial institutions group. He specializes in banking, insurance and securities regulation. He advises on regulatory issues in relation to debt and equity securities offerings as well as on conduct of business and prudential issues affecting financial institutions. He is a member of the Securities Institute Regulation and Compliance Diploma Panel. Born in 1957, Mark was educated at Balliol College, Oxford and the University of Chicago Law School and has been a partner since 1990.


Alexandra Hope

Freshfields Bruckhaus Deringer

Alexandra is a knowledge management lawyer in the securities group. She specializes in equity offerings and the impact of forthcoming EU securities legislation. Born in 1968, Alexandra was educated at St Andrews University and the College of Law, and has been at Freshfields since 1995.



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