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PD3: Key Considerations for debt issuers
The EU Prospectus Directive (2003/71/EC) (the “Prospectus Directive”) is in the process of revision. The proposed changes will have an impact in the future on issuers of both debt and equity who wish to offer their securities to the public in Europe or to have them admitted to trading on a European Regulated Market.
The latest developments are the publication on 15 March 2016 of a revised proposal by the Council of the European Union (the “Revised Proposal”) and the issuing on 17 March 2016 of an Opinion of the European Central Bank, each in respect of the new draft regulation designed to replace the current Prospectus Directive. This Revised Proposal and the opinion of the ECB are in response to the original European Commission draft of 30 November 2015 (the “Original Proposal” and, as modified by the Revised Proposal, the “Proposal”), which in turn came after a period of general consultation with market participants. The proposed changes are part of a wider effort to put in place a pan-European “Capital Markets Union” designed to render markets more efficient.
The date of entry into force of the new regulation is as yet uncertain. It is expected that there will be a grandfathering period during which programme base prospectuses approved before the new rules apply will continue to be valid. Under the Revised Proposal, this period has been extended from 12 months to 24 months. So this should give issuers ample time to prepare for the changes.
The new regime will take the form of a European “regulation”. It will thus be fully applicable by member states directly after its adoption by the Commission. This is in contrast with previous prospectus rules which have been adopted by way of “directive”, an act which requires member states to take the necessary measures internally to implement the content of such directive, and which has led in the past to some inconsistency in approach and timing for adoption.
This newsletter provides: (i) an overview of the main proposed amendments to the Prospectus Directive relevant for debt issuances and (ii) a commentary on some of the key proposals and the differences between the Original Proposal and the Revised Proposal.
The main tenets of the existing Prospectus Directive will remain, in particular that a prospectus is to be prepared in two circumstances: (i) a non-exempt public offer in Europe or (ii) admission to trading on a European regulated market.
The new regulation will, however, bring about revisions to both of the concepts in (i) and (ii) above as well as a number of other parts of the current Prospectus Directive where regulators and practitioners feel that the current provisions have either not met their objectives or have failed to take account of other legislative and market developments.
Exemptions from the “public offer” prospectus trigger
The exemption from the public offer regime for issuers of debt securities with a minimum denomination of EUR 100,000 will be withdrawn entirely. Issuers not wishing to trigger a full public offer will therefore have to rely on the remaining exemptions (offers addressed to qualified investors only; offers addressed to fewer than 150 natural or legal persons per member state; and offers addressed to investors who acquire securities for a total consideration of at least EUR 100,000 per investor).
Exemptions from the “admission to trading” prospectus trigger
There will be a new limited exemption for secondary issuances of debt securities fungible with securities already listed that represent an increase in size of issued securities of 20 per cent. or less, over a period of 12 months. Previously this exemption existed for equity securities only and was limited to 10 per cent.
Prospectus summary
The prospectus summary is to be shortened to a maximum length of six pages of A4 (currently 15 pages or 7 per cent. of the length of the prospectus). The Revised Proposal further requires that the summary be “easily understood”. A set format will be required, based on the key information document (KID) for packaged retail and insurance-based investment products, with four main sections specifying the following:
i. introductory warning language;
ii. key information about the issuer;
iii. key information about the securities; and
iv. key information about the offer of securities to the public/admission to trading.
Within these four main sections, there will be sub-sections for including, inter alia, key financial information, summary risk factors (limited to the five most important) and summary information on any guarantor or guarantee.
The summary currently required in base prospectuses for retail programmes will be removed and replaced by a summary of each issue to be included in the final terms on each drawdown.
Wholesale/retail distinction to fall away
The distinction between disclosure required for “retail” securities (i.e. securities of a nominal value lower than EUR 100,000 or its equivalent in other currencies) and that required for “wholesale” securities (i.e. securities of a nominal value of EUR 100,000 or higher) will fall away. A unique format based on the current wholesale regime is now expected to apply in all circumstances.
Risk factors to be shortened
The risk factors section of the prospectus is to be reduced and limited to material and specific risks relevant to the particular issuer (and not generic risks). The risks will also need to be classified over a maximum of three categories on the basis of their level of materiality as well as the probability of their occurring throughout the life of the securities issued. The European Securities and Markets Authority (“ESMA”) is expected to develop further guidelines regarding risk factors.
Tax disclosure
There will no longer be a requirement to include withholding tax disclosure covering the jurisdictions of the issuer and guarantor and all jurisdictions where application for admission to trading or public offers are made. It will be replaced by warnings that the tax legislation of the investors’ and issuer’s member states may have an effect on income received. Information on taxes will only be required where the proposed investment entails a specific tax regime such as investments in securities granting investors favourable tax treatment.
Disclosure by SMEs to be reduced
The definition of SMEs will be extended to include those with an average market capitalisation of less than EUR 200,000,000.
SMEs may use a reduced form of prospectus disclosure and may draft a prospectus which will take the form of answers to a pre-established questionnaire.
Incorporation by reference to be extended
The “incorporation by reference” mechanism will be extended to include all published regulated information and historical annual and interim financial information and audit reports. This is designed to reduce duplication between the prospectus and information disclosed, for instance, under the transparency and market abuse regimes.
The information which is eligible for incorporation by reference will, however, be strictly determined in advance. Under the existing regulation, the list is more restrictive but non-exhaustive, though certain regulators have imposed their own requirements.
A “universal registration document”
A “shelf” registration document detailing the issuer’s business and financial position may be filed with a competent authority every year. This document may then be incorporated by reference into the prospectus. This mechanism (which has existed in France for many years) would enable issuers to get their prospectuses approved more quickly by a competent authority.
Storage and publication of prospectuses
The ESMA will make available to the public without charge a central electronic database of prospectuses. This is intended to facilitate practitioners’ access to data (prospectuses, supplements, final terms etc.) across the EEA and will enable the ESMA to draw up a yearly report on European issuers and market statistics and trends.
The available methods of publication for the prospectus have also been modernised, so that from now on electronic publication will be the only acceptable means. There has also been a useful change to the publication method which allows issuers to publish on their websites: there is no longer the requirement that the prospectus be simultaneously placed on the website of the financial intermediaries placing or selling the securities, including the paying agent. Access to electronic prospectuses may be filtered and require interested parties to disclose their country of residence. However, disclaimers limiting legal liability or requirements to pay a fee will not be allowed.
Issuers established in countries outside the EU will need to appoint a representative in the European country where the securities are admitted to trading or publicly offered.
If a base prospectus expires during a public offer period, the offer to the public may continue after the expiration date provided that a new base prospectus is approved before such date and the form of final terms for the public offer appears in the new base prospectus.[1]
Under the current rules, the denomination of the securities issued is important for two reasons:
With the new rules the automatic public offer exemption for high denominations will no longer be available. Issuers will therefore need to look for other exemptions to avoid triggering a full public offer. In the context of debt issuances, these will most likely be the exemptions for:
The wholesale/retail distinction that exists for disclosure purposes will also be removed. Whereas currently wholesale debt issuers benefit from a rather lighter disclosure regime than their retail counterparts, from now on a single format will now apply in all circumstances. The new unified format is yet to be established, but it is expected to track the existing requirements for wholesale debt. This should result in some lightening of the disclosure burden for issuers of low denomination/retail notes without any concomitant ramping up of requirements for notes with high denominations (although see the new rules for the summary below).
The advantages of issuing wholesale-denominated notes in both these circumstances will thus disappear.
The stated aim of these changes is to achieve greater trading liquidity by removing barriers for established investment grade issuers to issuing “plain vanilla” securities in smaller denominations, thus making the debt more appealing for retail investors on the secondary market[2]. The ECB is also in favour of the changes from an operational perspective.[3]
Will it then be more attractive for issuers henceforth to issue lower denomination notes because of the less stringent disclosure regime and the loss of the automatic public offer safe-harbour? Not necessarily. A number of other considerations will still be relevant:
The objective of the summary is to provide investors with key information about the issuer and the securities in a concise, non-technical way. The last set of amendments brought into the Prospectus Directive in 2012 were designed in part to address perceived failings in the consistency of retail prospectus summaries, though many market participants feel that they failed to achieve that result. Summaries, especially those produced for base prospectuses, where all possible terms need to be summarised, remain unwieldy and difficult to construe. Moreover, regulators have been taking an inconsistent approach to the review of summaries.
We do not at this stage know the detailed disclosure requirements for particular types of securities – these will be published later through delegated acts. However, if, as seems to be the case, the current distinction between retail and wholesale regimes is to disappear, then this would mean that a summary in the specified statutory form would henceforth be required for issues which previously fell into the “wholesale” regime and were thus exempt. This will result in costs for issuers of high-denomination securities in the preparation of the summary itself and any required translation[5]. In addition, as with the question of denominations discussed above, practice for prospectuses prepared for European-listed securities where a placement is made in the United States pursuant to Rule 144A would need to be reconsidered. For Rule 144A issuances, it would be usual to include a summary section at the beginning of the offering document. The form of the summary required under the new proposal is unlikely to align with general US practice for summaries. For example, the requirement that only five of the most important risk factors be summarised and that the summary be limited in length might in some circumstances prove too much of a constraint from a US disclosure perspective. The consequence might be a bifurcated approach for European-listed 144A offering documents, with a summary compliant with European regulation followed by a US-style “overview” section.
It is recognised that the existing programme summary serves little purpose and, since it needs to contain résumés and square-bracketed options for all possible terms contained in the programme as a whole, is difficult to read and unhelpful for investors. Under the new rules, the requirement to include a “programme summary” in the base prospectus is withdrawn. A summary will instead be attached to each final terms upon issue. The wording of the Proposal[6] suggests that a “form” of this final terms summary no longer needs to be included in the base prospectus and reviewed by the competent authority at the time of the programme establishment/update. If this is the case, this will create an unusual situation where summaries in stand-alone prospectuses are reviewed by the regulator, whereas forms of summaries for programme drawdowns are not, even though the forms of final terms themselves are[7].
The responsibility regime for summaries will not change, despite the views of some investors’ associations[8]. So responsibility will not attach solely on the basis of the summary in isolation without regard to the rest of the prospectus. The Revised Proposal does however include an insertion (qualification?) about the length and content of the summary[9], the sense of which is unclear.
Many issuers are already categorising risk factors in order of importance, but they tend to do this within other categories such as risks related to the issuer, risks relating the jurisdiction in which the issuer operates, risks relating the securities, etc. Moreover risk factors are often grouped along with other risk factors with which they have a logical connection for ease of reading rather than mixing two otherwise completely unrelated risks whose probability of happening is considered to be comparable. Lastly, importance and probability are not necessarily one and the same, and any order which purports to deal with both concepts is potentially flawed. It is thus difficult to see how any further categorisation will work in practice.
We await the ESMA-developed guidelines on the specificity and materiality of risk factors and their allocation across the categories before we can comment more meaningfully on the new risk factor regime. Anything that takes us too far away from current practice is again likely to be a hindrance from the point of view of compatibility with International/US offering documents.
There are, however, a couple of potentially beneficial side-effects from the point of view of improving disclosure:
The changes to the tax disclosure requirements are mentioned in a recital only and not in the body of the Proposal itself. They will presumably be fleshed out in the delegated legislation. Under the current Prospectus Directive and associated regulations, withholding tax disclosure is required for retail denominated issuances only, so in fact the proposed changes can simply be seen as an effort to align the requirements for tax disclosure with the current wholesale regime in conformity with the other changes. Nonetheless it is the practice of many issuers (and has been since development of the Eurobond) to include tax disclosure even where not required by law. This is particularly the case when one is dealing with a complicated jurisdiction or where a change in tax treatment might have a fundamental effect on the structure of the notes or the operation of the call options. We may expect this practice to continue.
Article 16 of the current Prospectus Directive has in the past given rise to some confusion as to whether withdrawal rights should apply to wholesale issues as well as retail issues. In an apparently ill-thought-through amendment as part of the 2012 revisions to the Prospectus Directive a phrase was added to the effect that walk-away rights would only apply: “Where the prospectus relates to an offer of securities to the public”. Confusion subsisted because the wide definition of “offer of securities to the public” includes any communication to investors, and was not limited by reference to “non-exempt” offers only. Some regulators and many practitioners have subsequently taken the view that only non-exempt public offers should give rise to walk-away rights. Neither the Original Proposal nor the Revised Proposal has addressed this point head-on. [11]
This is a completely new provision, so it remains to be seen how it will work in practice. It may be that the representative will act simply like an agent for receipt of process in Europe and will receive any official correspondence from the regulator, including enforcement notices.
Two important deletions to the Original Proposal have been brought in by the Revised Proposal:
Both of these deletions are to be welcomed.
[1] See also the European Securities and Markets Authority Questions and Answers – Prospectuses – 24th updated version from 6 April 2016, which clarifies the same point.
[2] See Recital 47 of the Revised Proposal and Consultation on the Review of the Prospectus Directive – Feedback statement on the public online consultation, response number 5.
[3] See the Opinion of the European Central Bank of 17 March 2016 on a proposal for a regulation of the European Parliament and of the Council on the prospectus to be published when securities are offered to the public or admitted to trading.
[4] 2004/109/EC
[5] To the extent that an issuer wishes to passport its prospectus for listing purposes elsewhere in Europe and the local regulator requires a translation of the summary. The regulator would in principle have the right to require a translation into the local language under Article 25 to the Proposal.
[6] See Recital 30 and Article 8(7) of the Revised Proposal. Compare, however, Article 8(8) which says that the summary shall be subject to the same requirements as the final terms – one of those requirements is that a form of it must appear in the Base Prospectus.
[7] A related point is the requirement to follow the A, B, C form of categorisation when determining what type of disclosure goes where, another result of the 2012 Prospectus Directive amendments. This categorisation has not yet been touched on by the new rules. If it does remain as it is, it is not clear how the “A, B, C” regime will be applied in the context of final terms summaries. If, as discussed above, the final terms summary is only prepared at the time of issuance and the form is not reviewed by the regulator, will this mean that the summary may only contain C-type information? If so, and bearing in mind the requirement that the summary may contain no cross-referencing to other sections of the prospectus, this constraint is unlikely to improve the legibility or comprehensiveness of any such summary.
[8] See Consultation on the Review of the Prospectus Directive – Feedback statement on the public online consultation, response number 9.
[9] See the insertion in Article 11 of the Revised Proposal: “…despite having regard to the restriction on the length and content of the summary…”
[10] See Article 16 and Recital 48 of the Revised Proposal.
[11] On the other hand, it is now specified in Recital 58 of the Revised Proposal that “the right to withdraw should apply only when the prospectus relates to an “offer of securities to the public” in an apparent attempt to distinguish it from something which is not an offer to the public. Article 72 also makes it clear that ESMA may draft regulatory technical standards for situations where supplements need to be published as a result of a material mistake or inaccuracy, so perhaps they will deal with this question too.
[12] Though NB that there is currently an inconsistency between the body of the Revised Proposal itself which removes this stricture (Article 26), and the text of Recital 61 which retains it.VVV