All change: A new single segment model for UK listings?

Introduction

On May 26, 2022 the Financial Conduct Authority (FCA) published DP22/2 (the DP) setting out for discussion a potential new single segment approach to UK listings of equity shares in commercial companies. This is the latest step in the ongoing listing review process initiated by the publication of the Hill Review in spring 2021 and builds on elements of the FCA’s previous paper on this topic (CP21/21) published in summer 2021.

Whilst we are still at a relatively early stage in the review process (with the FCA noting that, depending on feedback, another discussion paper may needed before any consultation on more concrete proposed amendments is initiated), the introduction of a new single segment would represent the most significant change to the current rules for many years.

In this briefing, we discuss the key features of the single segment regime outlined in the DP and some of the drivers behind discussions in this area.

Why is moving to a single segment regime for commercial companies under discussion?

The DP reflects a number of underlying concerns that have been raised by market participants previously, including that some premium segment requirements lack the flexibility needed by high growth and innovative companies, that the purpose of the standard segment (as an alternative to premium listing for commercial companies) is not clearly defined or understood. Further, a multi-segment model inevitably suggests a hierarchy where one segment is perceived to be superior.

The DP outlines the difficulties inherent in dealing with these concerns through making changes to the standard segment and explains that the FCA has therefore developed a single segment based model for discussion which it believes addresses the key conclusions from feedback it has received.

Another topic raised by respondents in feedback to CP 21/21 regarding the standard segment was the linkage in the current regime between premium listing and eligibility for index inclusion. The FCA acknowledges this issue but makes the point that it does not control index inclusion criteria. However, it notes that in developing the single segment model outlined in the DP it has taken into account how index providers might react to such changes and has been in open dialogue with them about these issues.

What would the eligibility requirements for the new single segment look like?

The main differences in the proposed eligibility requirements for the single segment when compared to the current premium listing rules relate to financial eligibility criteria. When contrasted with the current requirements for standard listing, the main changes (in addition to the more extensive continuing obligations discussed below) are the proposed application of the sponsor regime and the premium listing principles.

In the context of financial eligibility criteria, the DP notes that some issuers (often in the technology and bioscience sectors) are unable to meet the current requirements for premium listing which may mean they choose to list on alternative markets, making it more difficult for UK investors to access these types of companies. In this context, the single segment model discussed in the DP suggests removing the current premium listing requirements for a three year revenue earning and representative track record, for the three year track record to cover at least 75% of the business and for a “clean” working capital statement. Instead, the FCA envisages the regime would be based on disclosure, allowing investors to decide whether or not to invest based on information contained in the issuer’s prospectus¹. The FCA also notes that a review of the financial disclosure requirements under the prospectus regime is likely to be required in the context of separate ongoing developments in that area². We expect these proposals to be welcomed by issuers, with the track record requirements being widely recognised as one of the key areas that causes difficulties for certain types of issuer seeking a premium listing under the current rules.

In relation to sponsors, the FCA sees the regime as playing a key role in helping to ensure that robust minimum standards would be supported, so it is seeking views on maintaining the substance and purpose of the existing rules in this area but applying them to all issuers within any new single segment. The FCA’s proposed retention of the sponsor regime is unsurprising, although we expect changes to the regime may follow in due course, with responses in this area likely to focus on some of the specific questions raised in section four of the DP about certain aspects of the current regime, including those relating to record keeping and conflicts which were identified by respondents to CP21/21 as possible areas for review.

In order to reduce complexity and duplication, the FCA is also considering removing those premium listing eligibility requirements that duplicate continuing obligations and instead including a requirement for companies to confirm, as part of the eligibility process in connection with listing, that they will be able to comply with the relevant continuing obligations (discussed in further detail below).

The free float requirements and minimum market capitalisation requirements (which currently apply to both premium and standard listed commercial companies) would continue to be a feature of the proposed single segment regime.

Would dual class structures be eligible for the new single segment?

This is an area where the FCA is seeking views. It notes that one option would be to restrict the new single segment to dual class structures that satisfy the recently introduced requirements for premium listing³ - these include, amongst other things, restrictions on when the weighted voting rights are exercisable and a requirement for the weighted voting rights shares to be held by directors. The FCA acknowledges that this approach would be less flexible than the current regime, which allows dual class structures that do not meet these requirements to list on the standard segment, but notes that when consulting on the recent premium segment changes the FCA received considerable negative feedback in relation to permitting less extensive safeguards than those that were ultimately implemented.

What would the continuing obligations for the single segment look like?

The FCA envisages that these would comprise mandatory continuing obligations that would be applicable to all issuers in the segment and additional “opt in” supplementary continuing obligations.

On IPO, companies would decide whether to opt in to these additional obligations or not and, once listed, moving in and out of the supplementary obligations regime would be akin to the current process for moving listing categories and would require shareholder approval where appropriate.

Whilst the DP sets out a possible split between mandatory and supplementary continuing obligations for discussion, the FCA is seeking views on the principles it has outlined as underlying this split as well as the resulting division. The FCA notes that the intention is for the division between mandatory and supplementary obligations to be narrower than the current gap between the standard and premium regimes.

We expect this is likely to be a key area of discussion in responses to the DP, with a focus in particular on the obligations that would fall within the mandatory regime and whether these strike the right balance between investor protection and issuer flexibility.

Mandatory continuing obligations

The mandatory obligations are intended to be set at a level that ensures an appropriate baseline of transparency, investor protection and corporate governance but which means listing is still accessible to different types of issuers. In the DP, the FCA identifies these as being requirements focused on transparency and on protecting shareholders where their interests may be different to those of management or a significant shareholder.

The proposed split set out in the DP envisages that (in addition to obligations that already apply to both premium and standard listed issuers – for example, under the DTRs) the mandatory obligations would also include a number of requirements that apply on a “comply or explain” basis and/or which currently only apply to premium listed issuers. These include (amongst other things):⁴ “comply or explain” obligations relating to the corporate governance code, climate reporting and diversity and inclusion; control of business requirements (including the current adjusted regime for mineral companies); the premium segment related party transaction rules; the requirement to comply with pre-emption rights; and the need to obtain shareholder approval for cancellation of listing.

Supplementary continuing obligations

These would provide an enhanced role for shareholders in holding companies to account on an ongoing basis, with issuers able to “opt in” to the additional obligations if they feel this would add value for them and their shareholders.

The key areas the DP envisages would be covered by supplementary continuing obligations are the existing controlling shareholder regime, the independent business requirements and the rules on significant transactions under LR10 (all of which currently apply only to premium listed issuers).

The FCA notes that where companies decide not to opt in to the supplementary obligations, they should be able to explain this choice to investors in the context of their overall business strategy. To avoid complexity, the FCA proposes that issuers should not be able to opt into individual supplementary continuing obligations (i.e. they would need to opt into all or none) although it is interested in further views on this aspect of the regime.

In relation to the rules on significant transactions, the FCA is seeking views on whether the current threshold for Class 1 transactions (which triggers the requirement for shareholder approval and production of a detailed, FCA approved circular) is set at the right level. This reflects concerns that have been raised that the existing regime, including the time required to prepare a Class 1 circular and convene a shareholder meeting, may be putting premium listed companies at a competitive disadvantage when making acquisitions/disposals compared to unlisted companies or companies listed in other jurisdictions. We expect further debate in this area will be welcomed by issuers.

Would the new single segment apply to entities other than commercial companies?

The new single segment would essentially apply in relation to listings of equity shares in commercial companies, with the existing regime being preserved for other types of securities and issuers.

As such, it is not envisaged the single segment regime would apply to closed-ended investment funds which the FCA intends would remain subject to the same regime as currently applies under LR15 (albeit without use of the “premium listing” label). The FCA notes that it has not identified any substantive concerns in relation to the rules which apply to closed-ended investment funds, although it would be interested in views on any changes that could be desirable, including any aspects of the potential reforms to the commercial companies regime that are worth consideration in the context of funds.

The FCA also discusses specific issues around the application of a new single segment regime to shares of special purpose acquisition companies (SPACs) and overseas companies as well as to depository receipts.

SPACs would be unlikely to meet the eligibility requirements of the single segment outlined in the DP. Instead, the FCA would consider allowing them to list under the provisions currently applicable to the standard segment. This is subject to the proviso that, following an acquisition, the combined business would likely need to meet the new eligibility criteria for the single segment to be able to maintain an Official List listing. We think this approach is sensible, recognising that the specific characteristics of SPACs mean that they are unlikely to fit within the single segment requirements for commercial company issuers whilst ensuring that a suitable listing venue remains available for them. Existing SPACs, as with other standard listed issuers, would be subject to the transitional provisions discussed below.

Whilst the single segment would be open to overseas incorporated commercial companies, including those with one or more listings elsewhere, the DP recognises that it may be challenging for them to meet all of the relevant requirements. The FCA would therefore seek to retain flexibility by maintaining separate listing requirements for such companies based on the existing standard segment rules (and, in that context, would consider whether additional criteria should be developed to ensure overseas companies seeking admission under those requirements have a primary listing elsewhere). Again, this approach recognises the specific issues that overseas companies may have in complying with the new single segment requirements – in particular, in circumstances where they have a primary listing elsewhere and are already subject to extensive continuing obligations.

In the context of depository receipts (or GDRs) representing shares, which are currently only eligible for premium listing in the case of sovereign controlled commercial companies, the FCA has indicated this is an area where it welcomes further feedback as comments were only made by a small number of respondents to CP21/21. As depository receipts are similar to equity shares in commercial companies, the FCA is interested in views on whether they should be eligible for listing on the single segment and, if so, whether any of the requirements described in the DP may cause issues in this context. Given GDRs are already eligible for premium listing in the context of sovereign controlled commercial companies, it would seem unlikely that they would not technically be capable of being admitted to the new single segment provided they were structured in a way that provides holders with substantially the same rights as holders of equity shares.

If a new single segment is introduced, are transitional provisions envisaged for existing listed issuers?

The FCA notes that this is something that would need to be consulted on if it were to proceed with a single segment regime. The DP indicates that the FCA would be likely to grandfather existing standard listed commercial companies, effectively allowing them to retain their standard listing (although they could choose to move to the new single segment if eligible). In relation to existing premium listed issuers, the FCA envisages they would engage with their shareholders about whether to adopt the supplementary continuing obligations and the DP notes that one way of achieving this would be to require a shareholder vote in each premium listed company within a specified period – again, the FCA is interested in any views on this approach.

As the DP notes, it would not be in the interests of investors for standard listed companies that cannot meet the new single segment requirements to be delisted. As such, the suggested inclusion of grandfathering provisions is welcome. Clearly the introduction of a single segment regime would have a lesser impact on existing premium listed companies, given both the mandatory and supplementary obligations discussed in the DP are based on requirements that already apply to such issuers. However, as the FCA notes, following the introduction of any single segment regime, there would need to be some form of mechanism for existing premium listed companies to determine whether to opt in to the supplementary continuing obligations. The suggested requirement for a shareholder vote would seem a sensible way to address this.

Conclusion

The potential new single segment model discussed in the DP would represent a significant departure from the current regime. Although the two tier approach to continuing obligations means there would still be the potential for a perceived hierarchy, the fact that the gap would be narrower than between the current premium and standard regimes (and that issuers would structurally be part of the same listing segment) is likely to go some way to addressing this point.

A key area where we can expect to see discussion amongst market participants in response to the DP is the split between mandatory and supplementary continuing obligations, particularly whether the position outlined in relation to mandatory requirements strikes the right balance between investor protection and issuer flexibility. There are also likely to be views on aspects of the current rules that could be streamlined and/or simplified as part of this process (for example, the LR11 related party rules).

In a wider context, the interaction with index inclusion remains a key issue if a decision is taken to move towards a single segment regime along the lines set out in the DP. The FCA acknowledges that index providers may set their own criteria requiring issuers to comply with the supplementary continuing obligations (and potentially their own additional requirements) and that this is not something the FCA has direct control over. However, given the importance of index inclusion for many issuers, we expect the approach ultimately taken by index providers is likely to be a key factor for them when determining whether to “opt in” to any supplementary continuing obligations.

In terms of next steps, whilst responses to the DP are requested by July 28, the FCA recognises that (depending on feedback received) a further discussion paper may be appropriate before moving to any consultation on detailed underlying rule changes. So although the DP represents an important step in the UK listing reform process, it is clear that the introduction of any new regime is still some way off and the finer details are still very much up for discussion and debate.

More generally, the proposed reforms should also be viewed in the context of the wider package of initiatives currently underway, including the review of the UK prospectus regime by HM Treasury (the outcome of which was published in March 2022) and the UK Secondary Capital Raising Review (the recommendations of which have yet to be published at the date of this briefing) which, together with the DP, represent the most significant overhaul of UK rules in this area for many years.