How the EU Prospectus Directive Will Impact Issuers
The Prospectus Directive (the “Directive”) will be applied throughout the EEA and is due to be implemented by EU Member States, on 1 July 2005. As many regulatory uncertainties have now been clarified, this article highlights issues and suggests solutions for EU issuers to consider, such as whether to issue to the wholesale or retail market, how to avoid investors’ rights to cancel a purchase of securities and about the form a prospectus may take.
The Directive sets out the new requirements for content and approval of a prospectus applicable to offers of securities and the admission of securities to trading on regulated markets, such as the London Stock Exchange, throughout the EEA.
The principal achievement of the Directive is that a prospectus approved by the regulatory authority of one EEA state can be passported to make retail offers throughout the EEA without requiring further approvals from local regulatory authorities.
Issuers who wish to continue to issue securities on a regulated market after 1 July 2005 will be required to submit updated documents which are Directive-compliant to their relevant regulatory authority for approval. Issuers will want to comply with the new requirements to ensure that they are not out of the market because of these changes. Whilst some issuers are likely to find the additional disclosure requirements of the Directive relatively easy to satisfy as they will already be preparing their accounts in accordance with International Financial Reporting Standards (“IFRS”) and their annual reports will contain much of the additional information required under the Directive regime, they will have various strategic decisions to make and implement before 1 July.
Directive-compliant prospectuses can be drawn up as a single prospectus consisting of a “registration document” (containing corporate details and information about the issuer), a “securities note” (containing information about the securities offered to the public or to be admitted to trading on a regulated market) and a “summary note” (giving an overview of the essential characteristics and risks associated with the issuer and the securities).
For MTN programmes covering plain vanilla issues, a “base prospectus” is required (which contains the same elements described above about the issuer and the securities in one document), and a pricing supplement termed “final terms” is used for each issue. The advantage of this arrangement is that only the base prospectus, and not the final terms, needs to be approved by the regulator, allowing immediate sales issues the programme using final terms without additional approval.
If a prospectus supplement is required, investors have a right to cancel their purchases for two working days from the date of publication of the prospectus supplement. Issuers will wish to avoid this occurring.
For MTN programmes, one solution, which the UK Listing Authority (the “UKLA”) has indicated it will accept, is for the issuer to produce a separate “registration document”, to be read alongside the base prospectus. Using this approach, the registration document would be approved by the UKLA and a proforma securities note would be approved in principle. The registration document would incorporate by reference that part of the base prospectus which contains the information required by the Regulations (see below). Instead of issuing notes under a base prospectus, which could trigger the requirement to produce a prospectus supplement, the securities could be issued under the registration document. On drawdown, the issuer could issue a securities note which, together with the registration document (both of which would be formally approved by the UKLA), could constitute the prospectus. The securities note would incorporate by reference information contained in the base prospectus and set out, in similar form to a pricing supplement, the information for the specific issue. As a securities note is not a prospectus supplement, the cancellation right would not be triggered.
To permit the wholesale Eurobond market to operate and activities such as underwriting to take place, a Directive-compliant prospectus is not required when offers are made only to “qualified investors”, such as credit institutions, investment firms, governments and certain “small or medium size enterprises” (“SMEs”), or the securities are “non-equity securities” with a denomination of at least €50,000 (“wholesale debt”), unless the securities are to be admitted to trading on a regulated market. Where wholesale debt is to be admitted to trading on a regulated market, the requirements are less onerous than for the retail market.
However, it will not be possible to access retail investors generally if sales are made relying on the qualified investor exemption because it only extends to SMEs (and certain individuals) in an EEA state if that state has elected to establish a register of such investors. Even if an EEA state does so (e.g. the UK will), the class of individuals is very limited and there are not likely to be many applicants who would wish to apply for individual “qualified investor” status because their inclusion on the register would be an indication of their relative wealth.
Denominations of less than €50,000 may be attractive to institutional investors as it enables them to finely tune the investment spread in their portfolios to get the appropriate weighting. It is also easier for them to trade securities of smaller denominations on the secondary market. The issue of securities with low denominations may be attractive to some issuers based on their investor market, despite the more onerous Directive requirements and the greater risk that an issuer could face litigation under the Directive.
The new passporting regime under the Directive allows sales by an issuer to retail investors throughout the EEA (after initial approval of the prospectus by the regulatory authority of one EEA state) by the approving regulatory authority simply notifying the competent authority of each of the relevant EEA states of such proposed sales. The only constraint is that issuers may be required to translate the summary section of its prospectus into the national language of the relevant EEA state, or the whole prospectus if it is not in a language used in international finance, such as English. This translation requirement is likely to lead to issuers limiting retail sales to those jurisdictions that do not require a translation from English or where the cost of translation is likely to be justified by additional sales.
The most significant issue that issuers need to consider is the increased risk of litigation where a prospectus is used for retail sales. Civil and criminal liability for breaches of the provisions implementing the Directive’s requirements are decided by each EEA state and an issuer could potentially be sued in each state where its securities are offered or sold for an alleged breach of the Directive. This means that issuing to retail investors could greatly heighten the risk to issuers. Critically, where the denomination of the securities is €50,000 or more, no prospectus is required under the Directive for sales in an EEA state unless there is admission of the securities to trading on a regulated market in that state. Therefore, in such case, the issuer should only be capable of being sued for failure to comply with the Directive in the EEA state where the prospectus is originally approved for any such admission. As a result, issuers should want to be convinced by their investment bankers that the pricing advantages for a retail issue outweigh the increased risks of litigation.
There will be some changes to the format of prospectuses because of the new requirement that the prospectus for a straight debt issue to investors contain two years of I FRS or equivalent accounts. However, the Directive expressly permits the incorporation by reference of documents previously filed with the same regulator, so it will be possible to satisfy this, and many of the other new requirements (examples include details about interim accounts in the case of retail issues) by incorporating information from the issuer’s annual report and accounts (but information may not be incorporated by reference in the summary section of a prospectus).
A potentially serious threshold issue for issuers who do not benefit from transitional relief – in the case of EEA issuers, by virtue of having securities admitted to trading on a regulated market on 1 July 2005; or in the case of non-EEA issuers, by virtue of having their securities admitted to trading on a regulated market on 1 January 2007 and who have prepared their accounts to local standards (subject to them giving a true and fair view – is the requirement in the annexes to the Regulation that “the most recent year’s historical financial information must be presented and prepared in a form consistent with that which will be adopted in the issuer’s next published annual financial statements having regard to accounting standards and policies and legislation applicable to such annual financial statements.”
For example, if the accounting treatment for an issuer’s accounts in respect of 2005 will be different from that with respect to 2004 because of changes to IFRS or a change from national accounting standards to IFRS and the 2004 accounts are included in the prospectus, the 2004 accounts will have to be adjusted to conform to the new basis. This has the effect of bringing forward the need for this adjustment as the 2004 accounts included with the 2005 accounts would in any event have to be on a basis consistent with the 2005 accounts. However, making this adjustment in time for the prospectus may be problematic if this requirement has not been anticipated.
The listing approvals for an MTN programme normally run for 12 months. MTN issuers should have been contacted by their dealers already regarding the need to have their prospectuses re-issued under the new Directive requirements and further approved on or after 1 July 2005 in order for them to continue to access the regulated markets. Issuers needing to update their programmes prior to 1 July 2005 because their current approval has expired may, from now, submit their prospectuses to the UKLA for approval as “listing particulars” which are prepared only in accordance with the Directive requirements. This allows an issuer to use a Directive-compliant prospectus before and after 1 July 2005 and avoids the need for an issuer to update its programme in accordance both with the current UKLA listing rules and the Directive.
Other regulators, including Luxembourg, are also accepting prospectuses and MTN documents from issuers for review in anticipation of the 1 July 2005 effective date. In contrast to the UKLA’s approach, Luxembourg is allowing issuers to extend the life of their MTN programmes to permit drawdowns off programmes which would otherwise have expired before 1 July 2005 without the need for updating until they are able to submit a Directive-compliant prospectus with the new requirements.
Although the UKLA will be able to give an informal indication whether a document will meet the new requirements under the Directive, the prospectus must still be formally re-approved on or after 1 July 2005. An issuer must then either confirm that, as at the date of re-submission, there have been no material changes or litigation, or include additional information to make sure the prospectus is completely up-to-date and accurate.
The UK is currently in the process of establishing a listed, but unregulated market in EU regulatory terms, which is likely to be known as the “Professional Securities Market” (the “PSM”). A similar approach is being taken in Luxembourg and Ireland. Its establishment is designed to continue to allow issuers who do not wish, or are not able, to comply with the Directive’s requirement for IFRS or equivalent accounts (or the Transparency Directive’s similar requirement in the future) to continue to issue and list their securities in the UK. This is because the Directive will not be applicable to the listing and admission of securities to trading on such market. However, the securities can only be marketed and sold under an exemption from the Directive, such as that for sales to qualified investors. Therefore, a general marketing to individuals of the securities will not be possible. Furthermore, it remains unclear whether institutional investors will be subject to any internal restrictions which prevent them from investing in securities only admitted to such a market or which limit such investments, despite various surveys of investors by the International Primary Market Association.
The UK and Ireland currently intend that the content requirements of a prospectus for the PSM will be broadly the same as for a wholesale prospectus under the Directive. A corporate responsibility statement will be required. Luxembourg, by contrast, will not be applying the Directive to its PSM but will instead apply its current listing regime.
The PSM’s most important value for issuers preparing IFRS accounts appears to be in providing a safety net if they are unable to have a Directive-compliant prospectus in place on 1 July 2005. Issuers which do not update their prospectuses to be Directive-compliant once the Directive comes into force will automatically be able to use their programmes on the PSM. However, as discussed above it remains to be seen whether institutional investors will be able to, or would want to, invest in securities listed on the PSM.
It is clear that issuers and their treasurers will need to make a few key decisions between now and 1 July 2005. The regulators have been very helpful during this transition period and many of the previous uncertainties have now been clarified. There is no reason to believe that issuers will be out of the market after 1 July 2005 because of these changes, provided action is taken quickly to address them. May, June and July in 2005 promise to be very busy months for issuers, their advisers and the regulators.