The UK is opening up the listing process

The UK is opening up the listing process. It may encounter difficulties along the way

The race to attract new business has begun. Competition between exchanges to host the listings of a new generation of companies – fast-growing technology businesses, so-called new economy companies and sovereign-controlled entities – has increased dramatically in recent months.

News in 2016 that Saudi oil giant Aramco was in the process of choosing a venue to sell five percent of its shares set the wheels in motion. While the London Stock Exchange (LSE) has been the main contender to be awarded the highly lucrative listing, its counterparts in New York and Hong Kong have also been vying for pole position – as have those in Toronto and Singapore reportedly. Ever since the announcement, exchanges have been ramping up regime improvements in a bid to entice companies that wouldn't traditionally have had the profile to list.

The UK, in particular, has been making headlines with a series of moves and announcements with Hong Kong and Shanghai hot on its heels. Former LSE chief executive Xavier Rolet was joined by prime minister Theresa May in April 2017 as they travelled to Saudi Arabia to discuss Aramco's listing options. In July, the Financial Conduct Authority (FCA) announced a new category in its premium listing segment for sovereign-controlled businesses.

Though Aramco is not the only company that could use this type of framework – a number of state-backed natural resource companies in some emerging markets could go down the premium listing route – it's certainly the most high-profile, and the one which has made the most headlines. According to Shearman & Sterling partner Pawel Szaja, there are a number other companies in Russia, Kazakhstan or southern Europe that could prove suitable candidates as well.

Another change that's attracted attention is the new rule requiring businesses wanting to list in London to publish a registration document and hold a presentation to publish research. This is intended to level the playing field between both so-called connected and unconnected analysts, and bring the UK closer to the US and French disclosure regimes, where transparency is paramount. These new rules, which help ensure more transparency and fairness in the research process, have been applicable since July 1 2018.

Most recently, Canadian cryptocurrency Argo announced it had chosen to list on the LSE – and has been given the green light by the UK Listing Authority (UKLA) – despite reportedly having no revenue and operating in a sector which is under intense global regulatory scrutiny. The company's founder told the Financial Times it had chosen London 'because of the city's role as a global hub for financial technology and the cachet it would add to its brand'.

Symbolic value

By Sharon Kits Kimathi, senior reporter, IFLR Practice Insight Syndicate bankers believe that the FCA's steps to relax the IPO premium listing was more symbolic than transformative in an attempt to woo the state-owned Saudi Arabian Oil Company (Aramco). "The stock exchange has put pressure on the FCA as Aramco is big, but just because it's big does it then make it okay to change the rules?" queried a head of advisory at an investment management firm. "It leaves a bad taste." The head of advisory wondered what the end outcome would be, noting: "Once you start there, what else are you going to change? And who decides to waive it, and why?" He feels that overall the change will dilute the quality of listing in London. He was concerned that this rule relaxation would lead to further changes for Aramco to be included in the FTSE UK Index Series. Premium listings are necessary to make a company eligible for inclusion in the FTSE UK index series, but it does not mean that a premium listed company is guaranteed a right to list on an index. "The key point is the quality of listing in the FTSE, and by reducing and relaxing those rules you are messing or potentially messing with that level of quality which I don't think favourable," said the senior analyst. "Listing on an index is important as the UK market is more passive than active," said the partner. Listing such a sizeable company as Aramco would expose passive investors of the relevant indices to a different type of risk from that which they had assumed. "I can understand the temptation to relax it to attract the listing of Aramco in light of Brexit, and in order for London to remain attractive and competitive," said one senior financial markets analyst at a research firm. "However, I think the fear is that it lowers, or will potentially lower, the quality of companies listed here which is causing serious concern." Her main worry was that loosening these regulations would leave shareholders exposed to any future issues with the company like bankruptcy or legal action. But the private practice partner feels differently. "There's symbolic value as London is open to sovereign-owned companies looking for business to sit in London, and it's the value of the message which is important for people overseas to ensure that it's welcoming," he stated. He feels that the changes are not all about Aramco. "Although the proposal has often been linked with the possible Aramco IPO, the reality is this is much wider than that," he said. The partner noted that there are a lot of other companies that have been looking at this segment. "This is primarily being backed by commodity-driven countries looking to diversify their economies, but there is also a potential second wave of nations looking to find funding, pay back debt and invest in infrastructure," he noted. Saudi Arabia's exchange the Tadawul was officially included on the MSCI emerging markets index on June 21. The step was seen as an important validation of the stock exchange amid market speculation of where Aramco will be listed. Advances in the Saudi state's stock exchange could lead to further concessions in the UK ahead of Aramco's anticipated listing. (Extracted from 'Buy and sellside reveal FCA premium listings concerns' available at www.iflrinsight.com.

London gets its strength from multiple sources: the sheer volume of investors that gravitates around it, the corporate governance standards it upholds and its status as most liquid market in Europe. But with the threat of a no-deal Brexit on the horizon, the UK capital markets have to remain an attractive option, even on a pan-European scale, and drawing listings from a wider variety of companies is one solution. After all, nearly one-third of all EU listings are carried out in London.

"Are EU investors reticent to dip their toe in London now?" asks a member of the equity capital markets (ECM) legal team at an investment bank. "There is definitely more dialogue about which exchange to list on, and more conversations are happening about Frankfurt and New York."

Other exchanges are fuelling the competition fire.

The Hong Kong Stock Exchange is expanding its own regime to facilitate listings of companies from emerging and innovative sectors, and those from companies with much-discussed weighted voting right structures. While this may be a peculiarity that it is in large part limited to Asian companies, its use is spreading beyond the region. In the US, meal delivery kit service Blue Apron followed the lead of camera and social media company Snap last year by offering so-called no-vote shares, with both deals attracting criticism from investment management companies and shareholder lobbyists alike.

In a sense, regulatory changes are to some extent driven by commercial imperatives.

"It's interesting: exchanges are becoming more accommodating of businesses' needs on the back of the competition between exchanges," says a senior ECM execution market participant at one investment bank in London. "But the regulators still need to uphold standards – the UK has always been a gold plating jurisdiction after all."

The recent relaxation of the rules carried out by UK regulators signals that the country is more open for business than ever before, but at what cost?

"It's a fair question to ask if regulators are driving these changes or if investors and banks worldwide are playing a role too," says the senior ECM market participant. "That being said, is relaxing market conditions going to boost the number of initial public offerings? I am not sure."

With competitiveness in mind, the FCA is pushing forward with the introduction of a new category of premium listing, which is targeted at companies controlled by a state. More generally, a premium listing is only available for any issuer that meets the 'UK's super-equivalent rules which are higher than the EU minimum requirements'.

The move has been criticised for reportedly being a direct response to Saudi Aramco's planned $2 trillion IPO though other companies could potentially qualify including UK lender RBS.

Under the new rules, those types of companies could apply to list using the more relaxed regime if they wished to. In its response to the FCA's consultation, Afme notes that the proposed listing category is 'likely in reality to be an alternative to a standard listing rather than a full premium listing'.

"The word premium is quite important here," says James Jarvis, corporate governance analyst at the Institute of Directors. "If we create a new category, why not address challenges specific to sovereign controlled companies? Down the line, this new framework opens the door to all kinds of sovereign-controlled entities being able to list."

The issue of the quality of potential issuing companies under the premium listing category is key. It's one factor that has played an important role in the FCA watering down some of its changes between the consultation, which kicked off in the summer of 2017, and the final changes announced in July 2018. It has stated that any changes are implemented should enhance not diminish corporate governance, saying these are a competitive advantage for London markets. This argument has been criticised extensively.

One such change that's been made concerns the appointment of independent directors, which is to be subject to separate approval by independent shareholders. But the board of directors will be able to overrule votes by independent shareholders after a 90-day cooling-off period.

Chris Cummins, chief executive of the Investment Association, said the changes were at odds with 'valuable and hard-won investor protections'.

"One solution would have been to give independent shareholders a binding vote on the appointment of non-executive directors," says Jarvis. "That or introduce a requirement for the company to also explain in its annual report how its own governance policies compare to those put forward by the OECD, for instance."

Two other changes have made their way to the final version of the regime.

Under the new framework, the requirement for a relationship agreement – under which the issuer with a controlling state-owned shareholder must abide by certain disclosure and transparency requirements – is scrapped. The FCA has said that 'past experience has shown that these agreements can be impracticable for sovereigns,' a point of view it has maintained since the consultation on the new listing regime was announced.

Another exemption which has attracted its own share of scrutiny is the so-called related party change. Sovereign-controlled entities are not compelled to obtain an advance fairness opinion from a sponsor or the approval of independent shareholders' before transacting with the government though have to disclosure dealings in a timely manner. This also applies in the event of an IPO. While it's true that the scope of this exemption is smaller than what the FCA initially proposed in the consultation last year, it still appears in the final version.

Some commentators have pointed out this doesn't make a massive difference from an investor's perspective as the relevant information is disclosed to investors at some point down the line. In fact, government-controlled entities, primarily those operating in emerging markets, have used global depositary receipts to list in London anyway.

"The regulator may be removing the related party approval requirement but any dealings will be scrutinised at great length by the investor community through disclosure," says Szaja.

There is nevertheless a lot of apprehension in the market when it comes to minority investor protection and equality of treatment, especially as the FCA has gone to some length to explain why a company whose majority owner is the government is in a different position to other companies.

There is more dialogue about which exchange to list on, and more conversations are happening about Frankfurt and NYC

According to one member of the investor community, this could stem from any of these factors: the political agenda behind the government ownership structure, the undue 'hands on' ownership, the lack of accountability and efficiency, or the difficulty for minority shareholders to gage the company's actions.

Concerns surrounding foreign controlled companies are not new. In 2013, the Serious Fraud Office launched a criminal investigation into the dealings of FTSE 100 company Eurasian Natural Resources Corporation (more commonly referred to as ENRC) after allegations of fraud and corruption. Indonesian coal mining company Bumi saw its shares suspended from trading after auditing issues were made public. Investor group PIRC said that both cases highlighted a 'problem resulting from over-liberalisation of the listing regime when the UK Listing Authority was under the control of the ineffective Financial Services Authority, and the newly listed London Stock Exchange was pulling in lower quality companies on a volume and fee driven basis'.

"Sovereigns are the marmite in the market," says one head of investment banking legal. "The UKLA sees it as keeping the UK as competitive as possible: the rationale is, if you take quality out of the equation, more companies on emerging markets will diversify their sources of funding, including in the London markets."

But it remains to be seen whether similar companies – in structure at least – to Aramco will indeed go down the premium listing route, or whether the fear of some market participants that the regime has been tailor-made for Aramco is unfounded.

"There are some economies that are looking to end their dependence on funding from the natural resources sector that could make good candidates too," says Nick O'Donnell, partner at Baker McKenzie. "Financial institutions could also be an easy sector to list as they're highly regulated anyway."

Another set of rules which has attracted interest is the introduction of more transparency pre-IPO. Under the new framework, unconnected analysts – those that don't belong to the syndicate of banks underwriting the IPO – must be given access to the same information as their connected counterparts in order to produce pre-IPO research. Connected analysts can't publish their research until the IPO prospectus is released.

The FCA said it's focused on restoring the centrality of the approved disclosure document and make it central to the listing process.

"With this front loading of disclosure, it's no coincidence that the UK is moving to a more continental mode, like the French document de base," says the head of investment banking legal. "That being said, I don't think the market is tying itself in knots with unconnected analysts writing research: the buy-side has a good understanding of who the trusted operators are anyway."

The FCA notes that there is a 'risk of bias being imparted to connected research,' and uses the US case surrounding the Toys 'R' Us IPO in 2010, where 10 US broker dealers were found to have used their equity research analysts to win investment banking business by offering favourable research coverage.

The regulator may be removing the related party approval requirement but any dealings will be scrutinised by the investor community through disclosure

In the UK, the privatisation of Royal Mail in 2013 brought to light concerns emerging from allegations that share prices had not been valued correctly. Following the IPO, HM Treasury's Myners report suggested the system should be altered so that share prices could be changed later in the process and proposed more transparency in the bookbuilding process. As pricing has traditionally being driven by connected research – with the associated risk that the pricing process is not as fair and transparent as it should be – any reform to the IPO research process would in theory be welcomed.

The changes have come at an interesting moment in the equity markets. Since January,

Mifid II requires that investment firms pay for research independently to show they have not been induced to trade – the so-called unbundling of payments for execution and advisory services.

It's been widely reported that investment firms have cut resources allocated to research, and, as such, it remains to be seen whether there will be demand for unconnected research on smaller deals, or those deals involving smaller companies. This could produce extra costs for companies and potentially deter some companies from listing altogether.

In particular, smaller brokers may find it challenging to recalibrate their business models, but they will have a lot information at their disposal to write on companies in which they don't have an underwriting mandate.

"The fact of the matter is: unconnected analyst presentations are not well attended," says the senior ECM execution market participant. "And there also may need to be some fact checking because of divergent messaging."

"This may be solved by having a base prospectus," he added.

Ashurst partner Nicholas Holmes told IFLR that the latest changes are a very watered-down version of the Myners report. "Potential investors will have the document for longer, and this may make life a little easier for them, but the benefit is somewhat marginal," he said.

The FCA has also weighed in on the timing of issuer and analyst interactions, undoubtedly with Mifid II requirements in mind but also in line with the US approach. The FCA has reminded the market of the new requirement under Mifid II that explicitly obliges firms to 'introduce a physical separation between analysts and others in the business whose interests may conflict with those of the recipients of the analyst's research'. In essence, analysts are prohibited from interacting with the company that is the subject of their research for a certain timeframe. The new system in place intends to police both how the information is disseminated and who has access to it.

"The net effect of this is forcing the legal, research, compliance and control functions of the bank to talk to each other," says the head of investment banking legal. "It's making us more active in the process."

It would seem the UK regulators are moving towards a principles-based approach to the IPO process – in favour of more investor transparency and equality – as opposed to its current rules driven framework.

The UK is on a mission to prove it's open for international business, with the prospect of a hard Brexit looking like a distinct possibility. But it remains to be seen how effective the newly-introduced rules will be. The UK has entered the race for competitiveness on all fronts.

In the case of Aramco, most of the criticism has been directed at the rationale behind the creation of a new segment: is it only the Aramco segment, as it's sometimes referred to, or is it for any company that can fit the profile?

When it comes to investment research, it's widely expected that banks will evaluate the applicability of the new rules on a case-by-case basis. It's also likely that some pockets of the market will not be affected by the changes, especially when it comes to pre-IPO research with one market participant describing the effect of the rules as 'a quiet murmur'.