One last roll of the dice to kick-start UK listings and dampen the allure of the US stock markets?

Authors: Ian Lopez, John Satory and Nick Skill

The FCA unveils proposals for a potential overhaul of London listing regime in an attempt to boost growth and competitiveness

Since the 2008 financial crisis, the number of listed companies in the UK has fallen by 40%, whilst in the past decade the market cap of UK-listed equity as a proportion of global equity markets has declined by nearly half from 5.8% to 3.1%. This decline has been accompanied by various growth/founder-led companies publicly expressing their reasons for not considering the UK as a viable listing option, preferring to look elsewhere, most notably the US. Factors such as a growing “valuation gap” between UK and US listed markets, Brexit-related uncertainty, currency volatility, and flourishing private markets have contributed to this trend, with many tying the fortunes of the London Stock Exchange to the flagging self-confidence of the City.

As part of its efforts to counteract this decline and enhance the UK’s competitiveness, in May 2023 the Financial Conduct Authority (“FCA”) published its highly anticipated consultation paper outlining its proposed reforms to the London listing regime. The proposed changes are more extensive and potentially more radical than previously floated, reflecting a notable shift towards a disclosure-based framework.

Single listing segment: The key reform proposed is that the existing premium and standard listing segments would be replaced with a single listing segment that would apply for all equity shares in commercial companies (the “ESCC”). The governance framework for companies within the ESCC would be set out in a single set of Listing Principles that would combine the existing rules for premium and standard listed companies with some amendments to promote sound corporate governance and accountability.

Eligibility criteria: The existing requirement to provide a three-year financial and revenue-earning track record and a “clean” or “unqualified” working capital statement would be removed. In addition, the rules regarding independent business and operational control over main activities would be adjusted to allow for greater flexibility in accommodating different business models and corporate structures.

Dual class share structures: A more flexible approach would apply to try and cater for US-style founders’ rights. This includes incorporating provisions for dual class share structures and applying enhanced voting rights to all matters (other than approving share issues at a discount of more than 10%). Additionally, extending the sunset provision from five years to ten years would be applied, after which the enhanced voting rights would cease, and there would be no maximum ratio for enhanced voting (currently set at 20:1). The requirement that shares with enhanced voting rights can only be held by directors will remain and it is proposed that all such shares would automatically convert to ordinary shares upon the holder ceasing to be a director. This compares with the US where dual class share structures are generally permitted—albeit made available to all shareholders and not just directors—and have been adopted, in particular, by many listed technology companies, though not without controversy.

Shareholder controls: No FCA-approved circular or shareholder vote would be required for related party transactions (“RPTs”) or Class 1 transactions (bar reverse takeovers). Instead, transactions meeting the current Class 1 threshold of 25% would need to be announced (with the announcement containing the information currently required for a Class 2 transaction). No announcement would be required for any transaction under this threshold. For RPTs, transactions of 5%+ under the class tests would only require announcement and the board making a “fair and reasonable” statement. Shareholder votes would continue to be required in relation to discounted share issues and share buybacks in line with current requirements. In addition, the FCA proposes to remove the ‘profits test’ currently used to classify significant transactions. As a comparison, in the US shareholder approval is generally not required for significant acquisitions (absent shares being used as merger consideration exceeding 20% of outstanding common stock or voting power).

Controlling shareholders: Replace existing rules requiring a relationship agreement between a listed company and its controlling shareholder with a “comply-or-explain” approach in which the absence of a relationship agreement would require specific disclosures in the prospectus and annual financial reports. The rules regarding the election of independent board members would remain unchanged.

Continuing obligations: The ESCC will retain the “comply or explain” approach to the UK corporate governance code and the annual reporting obligations in LR 9. In earlier discussion papers, ESCC participants could opt in to supplementary disclosure obligations, but on a set-menu rather than buffet basis. The FCA has dropped the set-menu approach and is allowing companies to determine their own additional corporate governance measures, alongside a set of mandatory continuing obligations. This significantly departs from the status quo and gives companies and shareholders greater latitude in deciding where shareholder approvals are required.

Sponsor regime: A sponsor’s role on an IPO will continue largely unchanged, though due diligence exercises will have to encompass the new eligibility requirements and sponsors will have to advise on transfers to the ESCC. However, post-IPO the reforms would significantly scale back a sponsor’s involvement, with their services being limited to fulfilling advisory roles on significant transactions and RPTs. Further changes to the role of the sponsor are expected, particularly on sponsor competence requirements and recordkeeping obligations.

Delisting: To try and mitigate the risk to shareholders of take-private transactions, the ESCC will retain the requirement for a 75% shareholder vote in favour of delisting and the 20-business-day cooling off period, and the requirement for an FCA-approved circular. This would be a new requirement for companies currently in the standard segment.

Scope: Separate listing categories would be maintained for investment funds and for other types of securities but (i) a new listing category would be introduced for SPACs; (ii) a new “other shares” listing category would include non-equity shares such as preference shares; and (iii) the FCA is considering whether there is a need to retain the sovereign-controlled commercial companies listing category.

FTSE inclusion: Traditionally, one of the benefits of a premium listing was the ability to be eligible for inclusion in FTSE’s UK indices. This led to increased demand for their shares because certain institutional investors were required to hold equity in companies included in the index. The FCA has acknowledged that it will remain open to index providers to set higher or different standards than the listing rules should they wish to supplement the minimum standards required under the proposed reforms. FTSE has yet to comment on whether it would introduce its own additional eligibility criteria.

Next steps: The FCA has not given an exact implementation date but has signalled that the reforms may take effect in early 2024. The FCA acknowledges that further consultation is needed on the proposals in order to move towards draft revised Listing Rules. To that end, a draft rule handbook and further details of the transitional arrangements will be published in Q3. The consultation will close on 28 June 2023.

Fried Frank view: Enhancing the UK’s appeal as a listing destination is crucial for ensuring the long-term competitiveness of its financial services sector. The proposed amendments to the Listing Rules represent just one of several reforms being considered by the FCA to reboot, and revitalise, UK plc. On their face, these changes, in particular, those that ease the governance and regulatory burden on IPO applicants and existing listed companies, are a step in the right direction to boost IPO activity and stem the exodus to foreign exchanges.

However, a word of caution. The transition towards a disclosure-based regime will place a greater onus on investors to carry out due diligence before making an investment and on institutional shareholders to secure sufficient engagement with companies on key transactions. The danger exists that reducing the regulatory hurdles to listing and eroding shareholder controls could potentially create hazards for unsophisticated investors and damage the reputation of the UK listing regime. Having said that, easing the governance burden in a responsible and sensible manner is a prudent course of action. In particular, eliminating the requirement for shareholder approval and FCA-approved circulars for Class 1/RPT transactions is a welcome change and would address a longstanding concern that the current rules stymie company innovation and disadvantage UK premium listed issuers in competitive M&A processes. This change could potentially have a positive effect on M&A activity and will also align the UK listing regime with many of its competitors in the US where prior shareholder approval of the acquiring company’s shareholders is generally not required for significant acquisitions.

London’s cultural, legal, and time zone advantages remain strong, and the fresh impetus displayed by policymakers to revitalise the UK’s equity markets should be applauded. However, the deep-seated issue remains that depressed UK share prices, coupled with the prevailing perception that certain types of business (e.g., tech) will be undervalued if they choose to go public in London, present significant obstacles to the UK’s listing regime regaining its former pomp and competing on a global scale, particularly with the US markets.