International Capital Markets Newsletter Issue 1 – Spring 2019: Prospectus Regulation: What Changes on 21 July 2019?

On 20 July 2017, the EU Prospectus Regulation¹ (the “Prospectus Regulation”) entered into force. The Prospectus Regulation was created as part of a group of proposals identified in the European Commission’s Capital Markets Union Action Plan,² which targets strengthening the European capital markets to provide new sources of funding for businesses, increase options for savers and improve economic resilience. The stated overarching objectives of the reform of the current prospectus rules are: (i) facilitating capital market fundraising through the cutting of “red tape” and making prospectuses less burdensome for issuers;
(ii) ensuring investor protection; and (iii) driving supervisory convergence at the EU level.

While certain specific Prospectus Regulation provisions have already come into effect, the bulk of the new regime will enter into force, and replace the Prospectus Directive (2003/71/EC, as amended, the “PD”) on 21 July 2019. Unlike the existing PD regime, the provisions of the Prospectus Regulation will be directly applicable without the need for implementing laws in all EU Member States.

With 21 July 2019 fast approaching, this short guide sets out the headline changes to the prospectus regime for both potential and existing issuers.

Headline changes

1. Introducing a Q&A format for the prospectus summary, replacing the current “elements” based modular format and imposing a seven A4 page limit and a limit on the number of risk factors included.
2. Changing the format and presentation of risk factor disclosure, limiting these to material risks specific to the issuer or the relevant securities.
3. Removing the requirement for audit reports to be prepared and included in respect of profit forecasts and profit estimates.
4. Extending the categories of information, which may be incorporated by reference into a prospectus.
5. Introducing new obligations imposed on financial intermediaries where a supplementary prospectus is required.
6. Changing the methods of publication.
7. Amending the rules regarding advertisements.
8. Simplifying the proportionate disclosure regime for secondary issues.
9. Creating the concept of an “EU growth” prospectus.
10. Introducing the “universal registration document” (“URD”) and “frequent issuer” status.
11. Extending the “wholesale” regime to include debt securities that are traded solely on a regulated market or segment of a regulated market accessible to qualified investors only.

Delegated Act

Under the Prospectus Regulation, the European Commission is empowered to adopt delegated and implementing acts to specify how competent authorities and market participants should comply with the obligations laid down in the Prospectus Regulation.

On 14 March 2019, following a consultation process and the seeking of technical advice from the European Securities and Markets Authority (“ESMA”), the European Commission published the Final Draft Delegated Regulation supplementing the Prospectus Regulation, and accompanying annexes, (the “Delegated Act”),³ which sought to set out further detail regarding the following points of the policy framework laid down in the Prospectus Regulation:

• the format of the prospectus, base prospectus and final terms, together with the specific information to be included therein;
• the reduced contents list and standard format of the EU growth prospectus;
• the reduced information to be included in the simplified prospectus for secondary issuances;
• the minimum information to be included in the URD;
• the criteria for the scrutiny of prospectuses, aimed at creating a single rule book and designed to ensure consistent implementation across the EU; and
• the scrutiny criteria for the URD.

This Delegated Act is the final draft subject to any objections from the European Parliament or the European Council.

Prescriptive Summary requirements (Article 7)

What is changing?

The Prospectus Regulation introduces more prescriptive structure and content requirements for the prospectus summary and widens the exemption from the requirement to include a summary section.

Content Requirements

Prospectus summaries must now be set out in a Q&A style using the following sections: introduction; key information in respect of the issuer; key information in respect of the securities; and key information in respect of the offer of securities to the public and the admission to trading on a regulated market. The risk factors to be included in the summary must be limited to only the 15 most material risk factors (with “materiality” assessed using a qualitative scale of low, medium or high) and the length of the summary must be limited to a maximum of seven A4 pages (rather than the longer of seven percent of the length of the prospectus or 15 pages, as permitted under the PD regime). In order to ensure that the length of the summary is not artificially shortened and to make it easier to read, the Prospectus Regulation continues to require that the summary must not include cross-references or items incorporated by reference and requires that the summary is written in non-technical language.

Issuers are also required to include a selection of historical key financial information in the summary, for which ESMA has developed a number of prescriptive templates (which may or may not match an issuer’s typical presentation of its key financial information).

Exemption

While a summary is not required under the PD in respect of a prospectus for the admission to trading of non-equity transferable securities that have a denomination of at least €100,000 (or an equivalent amount in another currency), the corresponding exemption from this requirement under the Prospectus Regulation applies to all prospectuses that relate to the admission to trading on a regulated market of non-equity securities provided that: (i) such securities are to be traded on a regulated market, or a specific segment, to which only qualified investors have access for the purpose of trading in such securities; or (ii) such securities have denomination per unit of at least €100,000.

What impact could this have?

The existing summary regime under the PD has been accused of encouraging immaterial disclosure. The aim of the changes introduced by the Prospectus Regulation is to push issuers to be more thoughtful and selective in the information included in order to enhance comprehensibility for investors.

For issuers of complex products, it may be that the prescriptive summary content requirements and the reduction in length and flexibility will make it difficult to draft a suitable summary containing all the key information for investors. Issuers should pay careful attention to the risk factors included in the summary section. If a risk factor is mischaracterized or left out due to restrictions on the number of risk factors or length of the summary, this could potentially expose them to increased liability.

Risk Factors (Article 16)

What is changing?

Under the Prospectus Regulation:

• risk factors must be limited to risks, which are specific to the issuer and/or the securities and which are material for taking an informed investment decision, as “corroborated” by the content of the registration document and securities note;
• issuers will be required to assess the materiality of the risk factors based on the probability of their occurrence and the magnitude of their potential negative impact, which, if the issuer chooses, may be disclosed using a qualitative scale of low, medium or high; and
• risk factors must be presented in a limited number of categories depending on their nature, the most material being listed first.

What impact could this have?

Under the current PD regime, risk factors have often become lengthy and generic in nature. The aim of the changes introduced by the Prospectus Regulation is to enhance investor protection by making risks more transparent and ensuring any potentially material risks are highlighted appropriately based on the probability of their occurrence and the expected magnitude of their negative impact when considered in the context of the specific issuer and securities.

The renewed emphasis on materiality, magnitude and probability will likely result in issuers (and other transaction parties) needing to spend more time considering and tailoring the risk factors to be included in a prospectus. It is expected that national competent authorities will focus a considerable amount of their review on the risk factors, may ask issuers to explain their approach to the risk factors included and may raise comments on the risk factors provided. This process may cause delays in the prospectus approval process.

In this respect, on 29 March 2019, ESMA published its final report on guidelines on risk factors under the Prospectus Regulation (the “Guidelines”).⁴ The Guidelines focus on the approach to be taken by national competent authorities in their review of risk factors in accordance with the new Prospectus Regulation, particularly in relation to the requirements concerning specificity, materiality and the presentation of risk factors. In particular, the Guidelines require that:

• the national competent authorities ensure that there is a clear and direct link between the risk factor and the issuer, the guarantor or the securities and that national competent authorities challenge the inclusion of any risk factor disclosure that does not appear to be relevant;
• the national competent authorities challenge: (i) the inclusion of any risk factor that does not demonstrate a material risk; (ii) the omission of a potentially material risk factor that has not been disclosed; and (iii) the inclusion of mitigating language that compromises the materiality of the risk statement; and
• the risk factors be contained in a limited number of categories, subject to their nature, with the most material factors appearing first within each category, and that each risk factor only appear once and only within the most appropriate category.

During the ESMA public consultation process for the Guidelines, concerns were raised that materiality assessments were being assumed by national competent authorities (rather than being the responsibility of the issuer). The Guidelines clarify that the assessment of the materiality of a risk factor remains the responsibility of the persons responsible for a prospectus.

The final report states that the Guidelines will become effective two months following their publication on the ESMA website in all official languages.

Profit Forecasts and Profit Estimates

What is changing?

The Delegated Act removes the requirement for audit reports to be prepared and included in respect of profit forecasts and profit estimates.

What impact could this have?

While the removal of this requirement potentially eases the burden and costs on issuers and encourages issuers to include profit forecasts and profit estimates in their prospectuses, it may also raise concerns for investors and other transaction participants over the level of comfort provided in respect of profit forecasts and profit estimates, which will need to be otherwise addressed as part of the due diligence process.

Incorporation by reference (Article 19)

What is changing?

The categories of information which may be incorporated by reference into a prospectus has been significantly widened by the Prospectus Regulation. In addition to annual and interim financial information (and audit reports thereon) and annual reports, the following information may be also incorporated by reference provided that it has been previously or is simultaneously published electronically:

• management reports;
• regulated information (including all information required to be disclosed by an issuer under the Transparency Directive⁵ and Market Abuse Regulation);⁶
• corporate governance statements;
• valuation reports;
• remuneration reports;
• memorandum and articles of association;
• memoranda in connection with a takeover, merger or division; and
• documents containing information on the number and nature of securities allotted to directors or employees or issued to shareholders by way of dividend.

Documents incorporated by reference must be accessible in the relevant electronic location for ten years from the initial publication date. The prospectus must also include a cross-reference list to enable investors to identify specific items of information incorporated by reference and hyperlinks to all such documents.

What impact could this have?

This change is expected to reduce the time and cost of producing certain disclosure. In particular, it may reduce the time and cost of producing a supplement when material documents arise after a prospectus is published.

Supplements to the prospectus (Article 23)

What is changing?

The Prospectus Regulation imposes specific disclosure obligations on financial intermediaries in connection with the publication of a supplementary prospectus. Where securities have been purchased or subscribed through a financial intermediary, that financial intermediary will have an obligation to inform investors of the possibility of a supplement being published, where and when it will be published and to assist investors to exercise their withdrawal rights. The financial intermediary is required to contact investors on the day that the supplement is published.

What impact could this have?

The additional specific disclosure obligations will impose an increased administrative burden on financial intermediaries after the publication of a supplement, who will be required to contact and assist investors. There could also be a practical issue of determining at which point the financial intermediary must inform investors about a “possibility” of a supplement and how that obligation is to be balanced with their duties to the Issuer.

Electronic publication (Article 21)

What is changing?

Pursuant to the Prospectus Regulation, an approved prospectus must be made available to the public prior to securities being offered to the public or admitted to trading. The Prospectus Regulation specifies that in order to make a prospectus available to the public, it must be published on: (i) the website of the issuer; (ii) the website of the financial intermediary placing or selling the securities; or (iii) the website of the regulated market where the admission to trading is sought or where no admission to trading on a regulated market is sought, the website of the operator of the multilateral trading facility. The approved prospectus must then remain publicly available electronically for at least ten years after its publication. If the prospectus contains a summary, the summary must also be separately accessible from the prospectus. Additionally, ESMA will maintain a free and searchable online database of all the prospectuses approved in the European Economic Area (the “EEA”) and other related documents.

What impact could this have?

The electronic publication requirements under the Prospectus Regulation are likely to have little impact on issuers (as prospectuses are already published electronically under the PD). However, the centralized ESMA database will help consumers to have greater access to information, and issuers may have the opportunity for cost savings, as paper prospectuses will only be required if a potential investor expressly asks for one.

Advertisements (Article 22)

What is changing?

The general requirements for advertisements under the Prospectus Regulation is consistent with the regime under the PD (i.e., that advertisements are clearly recognisable as advertisements, do not contain information which is inaccurate or misleading and are consistent with the information included (or to be included) in a prospectus).

The key difference between the Prospectus Regulation and the PD is that the Prospectus Regulation widens the rules applicable to advertisements to cover any “communications” (as compared to “announcements” under the PD), with consistency requirements also for both written and oral communications relating to the offering (whether or not they are being used for advertising purposes).

What impact could this have?

The expansion of the regime to cover all written and oral communications relating to the offering will require issuers and transaction participants to exercise increased care to ensure consistency across all statements and offering documents and to ensure that the content requirements of the Prospectus Regulation (and delegated acts) are complied with.

Oversight of the advertising rules will be conducted by the national competent authority in the jurisdiction where the advertisement is distributed, which could give rise to divergent views in the context of cross border offerings.

Simplified disclosure regime for secondary issuances (Article 14)

What is changing?

Since 20 July 2017, a prospectus has not been required to list fungible securities (including shares) of the same class as securities already admitted to trading on the same regulated market if those securities represent less than 20 percent of that class (an increase from the previous 10 percent cap under the PD).

With effect from 21 July 2019, a simplified prospectus will be available for issuers whose securities have been admitted to trading on a regulated market or an SME growth market (which includes AIM) continuously for the preceding 18 months.

A simplified prospectus for secondary issuances, which are either offered to the public or admitted to trading on a regulated market, may be used by:

• issuers whose securities have been admitted to trading on a regulated market or SME growth market continuously for the preceding 18 months and who issue fungible securities;
• issuers whose equity securities have been admitted to trading on a regulated market or SME growth market continuously for the preceding 18 months and who issue non-equity securities; and
• offerors of securities, which are admitted to trading on a regulated market or SME growth market continuously for the preceding 18 months.

What is simplified disclosure?

A simplified prospectus shall consist of:

1. a summary in accordance with Article 7;
2. a specific registration document; and
3. a specific securities note (not applicable to issuers under paragraph (b) above).

The reduced information requirements for secondary issuances include details regarding: the prospects of the issuer, significant changes in the business and financial position since the end of the last financial year, the rights attaching to the securities, the reasons for the issuance, its impact on the issuer (including capital structure) and the use of proceeds.

What impact could this have?

Around 70 percent of all prospectuses approved annually are drawn up by companies whose securities are already listed on a regulated market and which are, therefore, already subject to ongoing disclosure requirements under the Market Abuse Regulation and Transparency Directive. The changes outlined above are, accordingly, expected to have a significant impact by reducing the cost of secondary offerings (or tap issuances), helping issuers return to market as and when additional capital is needed.

The ability or appetite to use the simplified disclosure regime may depend upon where the securities are being offered or other jurisdictions in which the securities are listed. For example, non-EU regulators (such as the U.S. Securities and Exchange Commission) or market practice may require the production of an offering document for a secondary issuance (unless the automatic shelf registration regime can be used) or there may be other disclosure or liability concerns with respect to the use of the simplified regime, such as potential liability under U.S. federal securities laws in respect of offers of securities made into the United States or to U.S. investors. Investor expectations and other marketing considerations may also continue to drive a preference for a full offering document to be prepared.

Issuers should note in respect of the increase to the prospectus exemption threshold for secondary offerings (from 10 percent to 20 percent), that the ability to access such relief will also depend on their “home” EU Member State. In certain Member States, national law does not allow for the disapplication of pre-emption rights, requiring companies to go to their existing shareholders for approval prior to making an offering. While the Prospectus Regulation removes this obligation (at least from a prospectus requirement perspective), this may be irrelevant if such an approach results in the issuer being in breach of local companies law that grants pre-emptive rights. In addition, certain Member States (such as Germany and Austria) impose a 10 percent full documentation threshold for capital increases without the disapplication of pre-emption rights.

Forms of registration documents and securities notes for secondary issuances of equity and non-equity securities are set out in the annexes to the Delegated Act.

Creation of the “EU growth prospectus” (Article 15)

What is changing?

The EU growth prospectus is a new concept introduced in the Prospectus Regulation, which will be available to SMEs (i.e., companies with a market capitalisation of up to €43 million, turnover of up to €5 million or fewer than 250 employees), mid-sized companies admitted to an SME growth market (provided their market capitalisation for the previous three years is less than €500 million) and other non-listed issuers (such as larger companies with market capitalisations over these thresholds but that have 499 employees or fewer) where the offer of securities to the public is for a total consideration of less than €20 million per year.

The EU growth prospectus allows issuers to draw up a simplified document when offering securities to the public, provided that their securities are not traded on a regulated market. SMEs will also be able to passport an approved EU growth prospectus into all EEA Member States.

The prescribed format for the EU growth prospectus (including the summary, registration document and securities note) is set out in Chapter IV of the Delegated Act.

What impact could this have?

The simplified disclosure requirements included in the EU growth prospectus should make it quicker, cheaper and easier for SMEs to raise funds of up to €20 million. This could potentially promote access for SMEs to the equity capital markets at an earlier stage than has generally been the case under the PD, which also has the potential benefit of increasing the issuer’s public profile and brand recognition.

Issuers should note that where they already have securities admitted to trading on a regulated market, they will not be eligible to use the lighter disclosure rules, in order to avoid a “two-tier” disclosure standard.

In addition, whether disclosure is in fact lighter under an EU growth prospectus remains to be seen. When similar reforms to the PD were introduced in 2010, the alternative disclosure rules were rarely used. Many companies did not want to be perceived as producing a lower level of disclosure and, therefore, opted to adhere to the standard disclosure regime instead. Investment banks were also keen to follow the established market practice in respect of disclosure. At this stage, it is unclear if the same attitudes will prevail with respect to the EU growth prospectus.

Creation of the Universal Registration Document (Article 9)

What is changing?

Under the Prospectus Regulation, an issuer whose securities are admitted to trading on a regulated market (whether or not that issuer is incorporated in the EEA) has the option to draw up a URD each financial year (which describes certain key features of the issuer’s business and organisation). The URD is a shelf registration document that allows frequent issuers to benefit from a fast track prospectus approval process and more streamlined financial reporting requirements.

If a URD is filed with a competent authority and approved for two consecutive years, the company will achieve “frequent issuer status” and all subsequent URDs may be filed without prior approval and reviewed on an ex post basis (i.e., after the document has been filed). Once in place, a URD can be used to form a prospectus, with the addition of a securities note and summary, and issuers will benefit from a truncated approval process of five working days, provided certain conditions are met.

What impact could this have?

URDs will enable issuers to quickly access the capital markets when needed or when market conditions are favourable, as URDs will be subject to a faster approval process than a standard prospectus, since the main part of the prospectus will have already been reviewed or be available for review. This will be useful to issuers that are looking to take advantage of market windows. A further significant benefit of URDs is that URDs can be used in lieu of annual financial reports (if published within four months after the end of the financial year) or half-yearly financial reports (if published within three months after the end of the first six months of the financial year) required under the Transparency Directive, saving the cost and time of having to make duplicative public disclosures to the market.

Issuers should note, however, that, as the URD is a multi-purpose document which can be used for offers or admissions to trading of equity and non-equity securities, the URD must be prepared in accordance with the disclosure requirements for equity issuances (i.e., applying the most stringent regime) notwithstanding the issuer’s intended use for the URD. In addition, there is a degree of uncertainty for issuers that obtain “frequent issuer status.” If the relevant competent authority concludes that the URD contains “a material omission, a material mistake or material inaccuracy,” it can require the issuer to make changes to the URD even after it has been published. This could lead to concerns of potential liability to investors that made investments based on the published URD, which subsequently had to be changed following receipt of a request from the relevant competent authority.

The specific information that must be included in the URD is set out in Chapter II of the Delegated Act.

Wholesale regime (Article 1.4(c))

What is changing?

Under the PD, issuers of non-equity securities with a minimum denomination of at least €100,000 (or the equivalent in other currencies) benefit from “alleviated” disclosure requirements, the so-called “wholesale regime.”

Pursuant to the Prospectus Regulation, this wholesale regime will also be extended to include non-equity securities that are traded solely on a regulated market or segment of a regulated market accessible to qualified investors only (such as the Professional Segment of the Luxembourg Stock Exchange launched in November 2018).

What impact could this have?

The ability to offer debt securities in lower denominations to qualified investors may enable issuers carrying out smaller offerings to further expand their investor base and increase liquidity in their securities. The level of this impact will, however, depend on the growth of qualified-investor only regulated markets. At present, these are limited in number and so it remains to be seen whether issuers and transaction participants will seek to take advantage of the expansion to the wholesale regime.

Conclusion

With 21 July 2019 fast approaching, competent authorities have started accepting Prospectus Regulation-compliant prospectuses for review. Since the end of April 2019, the UK’s financial conduct authority (the “FCA”) has been accepting prospectuses and other Prospectus Regulation documents intended for approval on or after 21 July 2019 for review, with such reviews being conducted under the new regime. The FCA will continue to review documents under the existing regime where approval is scheduled for before 21 July 2019.

While the Prospectus Regulation will not apply retroactively (and securities with PD-compliant prospectuses or base prospectuses approved prior to 21 July 2019 will be grandfathered until the later of the validity period of the offering document or 21 July 2020), existing and potential new issuers should start familiarising themselves now with the new requirements.

What about Brexit?

For so long as the United Kingdom remains a member of the EU, the above changes implemented by the Prospectus Regulation will be directly applicable in the United Kingdom with effect from 21 July 2019.

In the event that the United Kingdom leaves the EU prior to 21 July 2019, as the Prospectus Regulation will not be operative, it will not be caught by the European Union (Withdrawal) Act 2018. In such scenario:

• If the United Kingdom ratifies the draft Withdrawal Agreement between the United Kingdom and the European Union prior to 21 July 2019, there will be a 21-month implementation period during which the United Kingdom will continue to implement new EU laws, including the Prospectus Regulation.
• In a no-deal Brexit scenario, the Financial Services (Implementation of Legislation) Bill proposes that the Prospectus Regulation will apply in full in the United Kingdom from 21 July 2019.

If the United Kingdom leaves the EU following 21 July 2019, the Prospectus Regulation will already be operative and. accordingly, is expected to automatically become law in the United Kingdom under the European Union (Withdrawal) Act 2018.

What next?

Further delegated acts and regulations from the European Commission on key areas of the Prospectus Regulation and setting out further detail on the new disclosure requirements are expected to continue to shape the regulatory framework in the coming months. As the new regime becomes tried and tested, the approach of national competent authorities to the review of new disclosure requirements (in particular, regarding risk factors and summaries) and the application of the relevant guidelines will also inform market practice going forward.

In November 2018, ESMA published an amended proposal for ESMA to assume the role of competent authority in respect of: prospectuses for non-equity securities to be traded on a market on which only qualified investors have access; prospectuses related to asset-backed securities; prospectuses drawn up by property companies, mineral companies, scientific research-based companies or shipping companies; and prospectuses drawn up by third country issuers (i.e., an issuer which does not have its registered office in the EEA).

If approved, a new chapter will be required to be added to the Prospectus Regulation relating to ESMA’s powers to scrutinise and approve such prospectuses.

Footnotes

1) Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC

2) Action Plan on Building a Capital Markets Union

3) COMMISSION DELEGATED REGULATION (EU) of 14.3.2019 supplementing Regulation (EU) 2017/1129 of the European Parliament and of the Council as regards the format, content, scrutiny and approval of the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Commission Regulation (EC) No 809/2004

4) ESMA Guidelines on risk factors under the Prospectus Regulation

5) Directive 2004/109/EC

6) Regulation (EU) No 596/2014