Overhaul of the UK Listing Regime Continues – A Consideration of the FCA’s Most Recent Proposals Which Are Most Relevant to Growth Companies and How They Compare With the Requirements of AIM and NASDAQ

On 3 May 2023, the UK Financial Conduct Authority (the “FCA”) published significant further proposals in a consultation paper (CP23/10) for reforming the UK listing regime. The consultation paper, which follows the publication of the FCA’s discussion paper in May 2022 and the recent update from the FCA’s chief executive officer (see our client update here), is the latest step in a series of regulatory reviews following Lord Hill’s UK Listing Review conducted in 2021 which looked at ways to make the UK a more attractive listing venue for companies.

The proposed reforms would apply to companies looking to list on the London Stock Exchange’s main market (the “Main Market”) and would, if implemented, narrow the gap with the current premium listing eligibility rules and ongoing obligations which apply to the London Stock’s Exchange’s Alternative Investment Market (“AIM”), whose lighter regulatory framework has historically favoured earlier-stage companies looking to go public. The reforms would also potentially remove some of the regulatory differences between the requirements of the current UK premium listing regime and those of NASDAQ, one of London’s key competitors whose admission rules are generally perceived to be less prescriptive.

Below is our summary and commentary on the proposed reforms most relevant to growth companies and their investors.

Reforms Relating to Eligibility Rules

Single Listing Category
The principal proposal is to merge the current premium and standard listing segments into a single category for equity shares in commercial companies. This single category would have significantly more flexible eligibility requirements than those which currently apply to the premium segment and substantially reduced ongoing obligations. In essence, the FCA’s proposals would move the UK listing regime away from a prescribed rules-based approach designed to protect investors, to a more disclosure-based one in which investors determine for themselves the criteria on which they are prepared to invest and allocate capital. These reforms would align the UK’s regulatory framework more closely with those of other jurisdictions, including the US, which follow a more disclosure-based approach. On balance, the FCA felt a re-balance of investor risk would be outweighed by the wider benefits that could be gained from this reform and the hoped-for increase in companies looking to list in London.

From a growth company perspective, a single listing category for the Main Market would mean that prospective issuers would no longer have to choose between a premium listing with higher regulatory requirements and a standard listing which, whilst providing greater flexibility from a regulatory perspective, has been less well understood and seen as an inferior brand by investors. The FCA noted that it would maintain the minimum 10% free float and £30 million market capitalisation requirements it introduced in December 2021 for the new single category.

Indexation requirements will need to be determined for the single category (currently only premium listed companies are eligible for the FTSE’s Main Market indices) and the FCA acknowledged that index providers are free to implement their own eligibility rules so additional requirements above those required for obtaining a listing could be introduced. How FTSE Russell responds in respect of inclusion criteria it applies for the FTSE UK indices (including the FTSE 100 and FTSE 250) after the proposed reforms take effect will be key.

Financial Eligibility Requirements
The current eligibility rules require a company seeking a premium listing to demonstrate:

• a three-year revenue generating track record;
• three years of audited historical financial information representing at least 75% of its business; and
• a “clean” (i.e. unqualified) working capital position for at least 12 months from the date of publication of its admission prospectus.

By way of comparison, neither AIM nor NASDAQ have a three-year revenue generating track record requirement, but a prospective AIM issuer is required to give a “clean” working capital statement and a prospective NASDAQ issuer must disclose whether its capital resources are sufficient to meet its obligations for the next 12 months from the date of its registration statement.

The premium listing financial track record requirements have often been cited as a barrier to a premium listing for earlier stage businesses looking to IPO in order to fund their growth strategies. These proposed reforms would potentially encourage more growth companies, which are still at a pre- or early revenue stage or whose high growth trajectory is such that their historical financial statements are not fully representative of their current business, to list who would previously not been eligible due to these requirements.

The UK prospectus regime also has historical financial information requirements. The regime is currently being reviewed by the FCA following the conclusion of the UK Prospectus Regime Review and the FCA has stated that if it does explore changes to prospectus requirements in due course, it will consider how they interact with the listing eligibility requirements as they stand at that time.

Dual Class Share Structures
The FCA recognised that it needed to further amend the new dual class share rules it implemented in December 2021 in order to address the risk that a single listing category is too narrow in its eligibility requirements and hence unappealing in the absence of an alternative listing segment, especially to companies that are founder-backed (which is often typical for growth companies in the Tech sector, in particular). It therefore proposes to introduce a more flexible approach to dual share class structures with the following features:

• Enhanced voting rights exercisable on all matters and at all times – enhanced voting rights can be exercised on any shareholder vote (with the single exception of any issuance of new shares at a discount greater than 10%), not just removal of the holder as a director or after a change of control (which are the current triggers)
• Enhanced voting rights only exercisable for 10 years – the FCA proposes extending the sunset period from five years to 10 years to allow founders more time to implement their vision
• Restrictions on transfer – it is proposed that shares with enhanced voting rights automatically convert to ordinary shares upon the holder ceasing to be a director. Currently enhanced voting rights may only be transferred to the beneficiaries of the director’s estate upon such director’s passing
• No specific voting ratio or weighting limits – the FCA is proposing to remove limits on the maximum enhanced voting ratio (currently 20:1) that can be attached to enhanced voting rights shares, preferring to leave it to the market to negotiate a suitable level and acknowledging that ratios or thresholds add complexity, are difficult to monitor and may limit forms of dual share class structures, which tend to be fairly bespoke in design
• Enhanced voting right shares can only be held by a director of the company – the FCA is proposing to maintain this requirement of the current rules whereby enhanced voting rights can only exist as long as an individual remains involved in setting the strategic direction of the issuer

The above features would bring the UK regime closer in line with the US, where such structures are more frequently used and subject only to specific requirements at a State level based on where the relevant company is incorporated, albeit still more limited in certain respects than in the US. For example, in the US, it would be typical for all pre-IPO shareholders (i.e. not just directors) to receive enhanced voting rights and, while sunset provisions are common, there currently is no mandatory time limitations for sunset provisions in the US. Dual share class structures are not generally permitted on AIM and so would make a Main Market listing potentially more attractive to a founder-backed growth company in this respect.

Reforms Relating to Continuing Obligations

Significant Transactions
Under the current regime, premium listed companies are subject to a host of disclosure and approval requirements relating to significant transactions (as set out by reference to “class tests” under the Listing Rules). The FCA proposes to overhaul this regime and raise the thresholds which trigger such disclosure and reduce the instances where prior shareholder approval is required, to introduce more flexibility and proportionality that many stakeholders say are necessary but currently lacking in our current regime.

Specifically, the FCA is proposing to:

• Remove the need to obtain prior shareholder approval (and therefore the preparation of an FCA-approved shareholder circular) for any significant transaction other than a reverse takeover
• Only require an announcement of a transaction at or above the current “Class 1” threshold of 25%
• Retain a reduced role for a sponsor, which focuses on its provision of guidance as to whether the issuer is in compliance with its relevant obligations, but which does not require a “sponsor declaration” nor a requirement for the sponsor to “sign off” on the relevant announcement

The proposed changes will move Main Market requirements closer to the more disclosure focused NASDAQ obligation to publicly disclose material events and by requiring shareholder approval for only the largest of M&A transactions aligns the UK significant transaction regime more closely with London’s main peers across Europe. If adopted, the rules applicable to AIM quoted companies would be more restrictive than those on the new listing segment in that AIM quoted companies are currently required to seek prior shareholder approval in respect of any disposal which, when aggregated with any other disposals over the previous 12 month period, would exceed 75% of the class tests.

The FCA’s proposals on significant transactions should meaningfully reduce the administrative burden and costs associated with conducting transformative transactions for companies with a Main Market listing and provide growth companies who choose the Main Market with an opportunity to pursue a more agile inorganic growth strategy post IPO and an ability to execute M&A transactions with greater speed. In particular, it will mean that Main Market listed companies are no longer at a competitive disadvantage when participating in an M&A auction process against private company or overseas listed bidders.

Related Party Transactions
Balancing the FCA’s desire to promote a more open and flexible listing regime with the potential for conflicts of interest inherent in related party transactions (“RPTs”), the FCA has proposed a radical overhaul of the existing RPT regime. Under the new proposals, shareholder approval would no longer be mandatory for an RPT (including those with a controlling shareholder). Instead, for transactions over a 5% class test threshold, companies would need to make an announcement with specified disclosures, including a statement by the issuer’s board of directors that the transaction was fair and reasonable as far as shareholders of the company were concerned and that the company had been advised to such effect by a sponsor. No rules would apply to RPTs below the 5% threshold.

As above for significant transactions, here the proposed changes will move Main Market requirements away from shareholder pre-approval and closer to the current AIM requirements and the equivalent NASDAQ obligation to publicly disclose material events. These proposals further reduce the ongoing administrative burden and costs related to a Main Market listing and will likely be welcomed by growth companies (particularly founder-led companies) which may retain legacy arrangements with related parties at the time of listing.

Controlling Shareholders
Premium listed companies with a shareholder holding 30% or more voting rights in the issuer (taking into account any parties with whom it is acting in concert) are currently required to enter into a binding relationship agreement with the shareholder which must contain certain prescribed undertakings from the shareholder that are designed to support the company’s ability to comply with the Listing Rules on an on-going basis.

Whilst not providing detailed plans at this stage, the FCA is proposing to reframe the requirement for such a relationship agreement under a “comply or explain” approach whereby an absence of a relationship agreement would require specific disclosures and inclusion as a risk factor in a company’s prospectus and annual financial report, potentially accompanied by prescribed wording flagging the non-compliance. It is envisaged that there will be no enhanced oversight of RTPs for failure to comply with the controlling shareholder regime.

The FCA is also proposing to retain the current rules which require the election of independent directors, cancellation of listing and transfer between listing categories to be separately approved by independent shareholders (i.e. excluding a controlling shareholder) as well as the full register of members. The FCA’s approach to this proposal recognises the greater importance of these controls as safeguards for investors where more flexible dual class share structures are permitted.

Whilst having a relationship agreement in place with a controlling shareholder is not a formal requirement for being admitted to AIM, it is not uncommon for agreements to still be entered into in order comfort investors who come in at IPO. NASDAQ does not have an equivalent requirement for a relationship agreement to be put in place at the time of IPO.

Independent Business and Control of Business
The current eligibility rules for a premium listing require a company to satisfy the FCA that it carries on an independent business as its main activity and has operational control over such business. Neither AIM nor NASDAQ have similar requirements.

Whilst the rules are supported by guidance on when it will likely be determined that the rules have not been satisfied, the FCA noted feedback that these requirements can create perceived uncertainty and at times require nuanced judgements to be made for certain business models, including franchise structures and companies making minority investments in other entities which results in longer listing application processes for certain companies.

The FCA is therefore proposing to explore a modified form of these obligations and will consider amending existing provisions to be clearer that the FCA is open to diverse business models and potentially more complex corporate structures. Whilst not of primary relevance to “classic” operating companies, greater flexibility in relation to these requirements would nonetheless be welcomed given their past application has sometimes led to unexpected outcomes in eligibility applications.

Next Steps
The FCA’s consultation on the proposed changes will run until 28 June 2023, following which the FCA expects to issue a further consultation paper and draft new rules by the autumn, with the aim of achieving substantial progress by the end of 2023.

While some details remain to be provided, the overall significance of the reforms being proposed by the FCA cannot be underplayed – they represent material changes to the current regime which, when taken together with the changes advocated in the Secondary Capital Raising Review and the expected changes to be implemented under the UK Prospectus Regime Review, mean that the UK capital markets regulatory landscape is in the process of being radically reshaped.

If you would like to discuss any of the topics raised in this alert or have any queries about the UK listing process and the status of its ongoing reform, please reach out to the Goodwin team members listed below.