M&A involving UK-listed companies: impact of forthcoming listing rule reform

July 2024  |  SPECIAL REPORT: MERGERS & ACQUISITIONS

Financier Worldwide Magazine

July 2024 Issue

As part of extensive, ongoing reform to reinvigorate and enhance the competitiveness of the UK’s capital markets, the UK’s Financial Conduct Authority (FCA) has now published a final draft of new listing rules (UKLR) that will govern the listing and ongoing reporting obligations of all Main Market-listed companies in the UK from summer 2024.

The Alternative Investment Market (AIM) rules will continue to apply to those companies traded on AIM.

Among numerous deregulatory changes, the UKLR will fundamentally change the current rules set out in listing rule 10 and 11 that govern significant and related party transactions by premium listed companies, respectively, that will have a material impact the execution, cost, risk profile and, perhaps, frequency of such transactions.

Current regime for significant and related-party transactions

Under current listing rule 10, a premium listed company contemplating a significant transaction outside of the ordinary course of business, such as an acquisition or disposal or entry into and exit from a joint venture or other investment, must assess the significance of the transaction (by reference to certain indicators of size including consideration, profits, assets and capital) with the assistance of an investment bank acting as its sponsor.

For smaller transactions (so-called ‘class 2’ transactions), the listed company may be required to announce prescribed information to the market. For larger transactions (so-called ‘class 1’ transactions where any of the size indicators is 25 percent or more by reference to the listed company), the transaction is subject to approval by the listed company’s shareholders (after publication of a detailed circular that must effectively be signed off by the sponsor and approved by the FCA).

The current rules also require shareholder approval for break fees over 1 percent of the listed company’s market capitalisation and for exceptional indemnities.

Under current listing rule 11, a premium listed company contemplating a transaction with a ‘related party’ (broadly, a director, a shareholder holding 10 percent or more, or a joint venture partner), must assess the significance of the transaction (by reference to certain indicators of size including consideration, profits, assets and capital) with the assistance of an investment bank acting as its sponsor.

For smaller transactions, the listed company may be required to announce prescribed information to the market including a confirmation that an investment bank acting as sponsor believes the transaction is ‘fair and reasonable’. For larger transactions (where any of the size indicators are 5 percent or more by reference to the listed company), the transaction is subject to approval by the listed company’s shareholders (after publication of a detailed circular that must effectively be signed off by the sponsor and approved by the FCA).

Critics of the current regime argue that the requirement for a shareholder vote (and the associated regulatory process that is involved in preparing and publishing a circular ahead of the vote) places undue burden on the corporate activity of listed companies and puts them at a disadvantage in competitive M&A processes, particularly on the buy-side where the sell-side may be looking to transact quickly and will not want to take the timing and execution risk associated with a shareholder vote.

Critics also note that sophisticated capital markets like the US function well without requiring shareholder approval for material transactions and argue that the prescribed disclosure requirements are unnecessary considering the broad continuous disclosure regime that listed companies are subject to in the UK (requiring disclosure of ‘inside information’ without delay).

What the new regime will look like

In general terms, with the new UKLR, the FCA has decided to move away from the well-established requirements for a shareholder vote, extensive role and obligations of a sponsor, and detailed prescribed disclosure, to a lighter touch disclosure-based regime with a much smaller role for a sponsor.

Specifically, the new UKLR introduces changes for significant transactions and related-party transactions, as outlined below.

Significant transactions

First, all listed companies will be required to assess the significance of transactions outside of the ordinary course in accordance with annex 1 of UKLR 7 (but without reference to profits, and the FCA will have greater discretion to grant dispensation from the rules where anomalies arise).

Second, there will be no prescribed disclosure for smaller transactions and no requirement to seek shareholder approval for larger transactions.

Third, larger transactions will still require publication of an announcement at the time of entry into a transaction containing prescribed disclosure on the terms and subject matter of the transaction as set out in annex 2 of UKLR 7 (but the prescribed disclosure will be lighter than that currently required for a shareholder circular and, in particular, there will be no requirement to restate historical financial information or to make a working capital statement).

Fourth, there will be no requirement for a listed company to seek guidance from a sponsor when a significant transaction is contemplated or to appoint a sponsor and obtain a sponsor’s ‘sign-off’ in the context of a larger transaction. However, a listed company will still be required to involve a sponsor to the extent guidance is required from the FCA on its obligations under, or the application of, the rules to the particular transaction (UKLR 7.1.11 and 7.1.12).

Fifth, there will be no requirement for a listed company to obtain shareholder approval to pay a break fee above a certain value or to give a high value ‘exceptional’ indemnity. For high value ‘exceptional’ indemnities (with unlimited liability or liability of 1 percent or more of the listed company’s market capitalisation), there will be an obligation to make an announcement with the prescribed disclosure for larger transactions described above. Exceptional indemnities will exclude customary SPA indemnities or indemnities given in underwriting agreements or to advisers.

Related-party transactions

First, under the new UKLR, all listed companies will be required to comply with the related-party transaction rules set out in the UKLR, and a shareholder will only be a related party if it holds 20 percent or more of the votes (up from 10 percent or more).

Second, there will be no prescribed disclosure for smaller transactions and no requirement to seek shareholder approval for larger transactions.

Third, larger transactions (5 percent or more) will require publication of an announcement setting out particulars of the transaction and a sponsor must be appointed as the announcement must include a statement that the board considers the transaction to be ‘fair and reasonable’ having been so advised by a sponsor (UKLR 8.2.1 and 8.2.2).

Timetable for the new regime

The UKLR are expected to come into force in summer 2024 and will have immediate effect. A listed company that is part way through a transaction on such date (referred to by the FCA as a ‘mid-flight transaction’) can cease to treat a transaction as a significant or related-party transaction as such if it no longer qualifies under the UKLR or, if it does qualify, can cease complying with any obligations in the current listing rules that have not been carried over to the UKLR.

For mid-flight transactions that no longer require a shareholder vote, a listed company will generally be required to make the new, UKLR-compliant announcement as soon as reasonably practicable after the transition date and prior to closing of the transaction, even if it has already made a listing rule compliant announcement (although if it has already published a shareholder circular it will be treated as having met the necessary announcement requirements under the UKLR).

Parties that are currently in the process of agreeing the terms of a transaction that could or will become a mid-flight transaction should consider whether, in light of the deal timetable, the listed company counterparty should be obliged to incur the cost of preparing a shareholder circular and holding a shareholder meeting, and when (and by whom) the shareholder vote condition in the transaction agreement may be waived.

Impact of the changes in practice

The commercial rationale for an M&A transaction (and not the process by which it happens) will always be the key driver. However, the FCA’s deregulatory changes should make UK-listed companies more attractive M&A counterparties which, in turn, may increase the amount of M&A they do.

With the removal of the disadvantageous deal contingency risk of having to receive prior shareholder approval for a transaction (and having to offer a higher price to address it), the reforms should make listed companies more competitive buyers in auction processes than before.

The removal of the shareholder vote requirement should also de-risk transactions for buyers of assets from listed companies, which may in turn increase the willingness of listed companies to sell assets and may result in an increase in carve-out transactions in the UK.

For the same reason but in the context of related-party transactions, there may be an increase in transactions between listed companies in which a financial investor holds a stake and the financial investor’s portfolio companies, or between listed companies and unconnected counterparties that happen to have a large common shareholder (because of an institutional investor’s portfolio of holdings in multiple listed companies).

Likewise, the removal of the shareholder vote on a material disposal into a joint venture or the acquisition of a material joint venture interest from a counterparty, as well as on exit options linked to future profitability or an independent valuation or which are otherwise uncapped (such as the put option or drag right customarily requested by a financial investor in a minority investment), will give listed companies more flexibility when negotiating new partnerships, and will de-risk the successful formation of such ventures for all involved.

Although a detailed public announcement will still be required for larger transactions, it should be less costly (both in time and advisory fees) to prepare than a shareholder circular. Financial advisory, accounting and legal costs will be reduced, printing and posting costs will be removed altogether, and all other things being equal, not having to produce a shareholder circular or wait the statutory notice period for a shareholder meeting should allow transactions to close sooner than before (with regulatory consents and approvals becoming the long pole in the tent).

The ability to keep smaller transactions confidential will remove a factor that may have deterred (to varying extents) certain counterparties from transacting with a listed company (although it will remain to be seen whether the need to ensure analysts have the information they require and the provisions of the UK’s continuous disclosure and market abuse regime mean than, in practice, such information continues to be announced notwithstanding the reforms).

While the removal of the shareholder vote may bring about more transactions, so too will it bring about new transaction considerations for listed companies.

There may, for example, be a focus on fiduciary duties and a corresponding rise in shareholder litigation (as there is in the US market) as the protection of a shareholder vote on a deal is removed, as well as increased requests for and reliance by listed companies on opinions from their financial advisers on the fairness and reasonableness of a transaction’s terms.

There is also the risk of activist shareholders increasing their focus on removing directors or voting against their pay packages at annual shareholder meetings following unpopular transactions.

These risks may see an increased focus by listed company boards on shareholder engagement to test the market prior to agreeing the terms of a transaction.

If so, the tension between meaningful investor feedback and the selective disclosure regime under the UK’s market abuse regime (as well as the heightened leak risk) will be a key consideration and may require further practical guidance from the FCA.

 

Will Pearce is a partner and Joseph Scrace is counsel at Davis Polk & Wardwell London LLP. Mr Pearce can be contacted on +44 (0)20 7418 1448 or by email: will.pearce@davispolk.com. Mr Scrace can be contacted on +44 (0)20 7418 1314 or by email: joseph.scrace@davispolk.com.

© Financier Worldwide

BY

Will Pearce and Joseph Scrace

Davis Polk & Wardwell London LLP

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