Speech by Marc Teasdale, Head of the UK Listing Authority, FCA, at the Institute on Securities Regulation in Europe (Thirteenth Annual), Practising Law Institute, London. This is the text of the speech as drafted, which may differ from the delivered version.
I intend to speak this morning about the changes to the Listing Rules we have proposed in response to recent concerns about minority investor protection, and to outline some of the internal and external debates that we had along the way. Ensuring an effective yet proportionate regime for the protection of minority investors is of course a key concern for a primary markets regulator, but it also requires the balancing of a number of competing considerations.
Shortly after I agreed with Nilufer that this would be an interesting topic for my address, she sent me a copy of the client briefing her firm had just published, setting out some early views on our proposals. The first sentence of the introduction read ‘The FCA’s latest proposals to enhance the listing regime... have resulted, finally, in a more proportionate and focussed set of reforms’.
As a regulator you quickly learn to take praise wherever you can find it, so at the time I naturally focused more on some words in that sentence than others. But in fact what I thought you would find interesting today is some of the journey we went through whilst producing our proposals and some of the issues we encountered, and so why the process was perhaps more iterative than we had at first intended.
We first started our thinking and discussions in this area almost two years ago. As you are probably aware, the debate was prompted by concerns from the investment community about governance failings at a small number of high-profile issuers. Obviously I can’t talk publicly about individual cases, but you probably all know who I’m talking about. Some of those issuers might even be valued clients for people in the room today.
In the time between then and now we have been engaging with market participants, and the issues they have raised, on an almost full-time basis. The time this has taken reflects both the strength of the views held, and the complexity of some of the issues raised.
A common theme of recent discussions of equity markets issues has been the need for greater engagement by investors. However, we found both institutional investors and pension funds to be extremely engaged with the issues we were discussing, and crucial to ensuring we produced an appropriately balanced set of proposals. Pension funds in particular emerged as a really vocal and engaged market participant, and we welcome them as a valuable contributor to our policy making on a continuing basis.
This constituency in particular raised a number of questions which caused us to think about parts of the listing regime, and our role within it, more or less from first principles. This also made us realise that we had to do more than we had to date to articulate clearly our regulatory philosophy and our view of the boundaries of our role. These questions included:
- How broadly or narrowly should we interpret ‘consumer’ when thinking about the FCA’s consumer protection objective in a primary markets context?
- Does our established view of the UKLA as a regulator concerned primarily (although not exclusively) with disclosure remain fit for purpose?
- Should the listing authority play any role in ensuring that those adopting an index-tracking investment model are not exposed to inappropriate investment decisions?
In reality, these questions were just different ways into the same fundamental question – how does the FCA describe its consumer protection objective when operating as a primary markets regulator?
Equally of course these questions, interesting as they were, represented only one side of the debate.
Issuers, controlling shareholders and those often lumped together as the sell side were equally vocal and had strong points of their own to make. There was a strong view amongst this community, which incidentally the FCA would not seek to challenge, that there is nothing inherently wrong with the presence of a controlling shareholder in the governance structure of a listed company.
We recognised that a significant number of listed companies have large shareholders on their registers, and that the overwhelming majority of them are governed very effectively. We were therefore rightly cautioned against placing burdens on the many simply to address the problems of the few.
We were also reminded that there is an important distinction between minority protection and minority control, and that we should aim for the former and be vigilant against inadvertently introducing the latter. Finally, we were also reminded of the need to be careful not to upset the balance between investor protection and the accessibility of the UK primary market.
There is a risk when seeking to balance or navigate strongly held polarised views that you judge success by the extent to which you have managed to make everyone equally unhappy. But it was important for us that our final proposals attracted genuine and broadly based support.
In seeking to address these questions, it was also important that we set them squarely within the framework of our new objectives which came into force last year.
The FCA’s statutory objectives, which explicitly include listing activity for the first time, contain a very broad definition of consumer. This definition clearly includes investors in securities, but one question we were being asked was who do we really have in mind when determining the appropriate level of consumer protection for premium listed markets, given the wide range of different types of investor?
Our objectives recognise that different levels of protection are appropriate for different markets, securities or consumers, but this doesn’t take the question much further in situations where differing types of investor are equally important participants in essentially the same market.
Our regulatory model (a handful of albeit significant eligibility conditions aside) has long been one based on disclosure – in order to operate effectively, the system envisages investors making informed decisions based on the information available to them. Under this model the listing authority largely (although not exclusively) sees its role to be to ensure that risks are sufficiently and clearly brought to the attention of the investor, who makes a decision, based on his or her individual expertise, experience and risk appetite as to whether the investment is one worth making.
The index-tracking strategy employed by a large number of investors potentially challenges this model. In a system where investors track stocks in indices, the disclosure that we, and you, ensure appears in prospectuses does not really help. Those investors will buy those stocks in any event, and so pages of risk factors detailing the risks of investing in certain industries or geographies, or under certain governance models, may in fact serve to antagonise rather than inform.
It was in this context that the linkage between listing and the indices also became most relevant. If when we admitted an issuer to listing, it also became eligible for an index, weren’t we in fact making a decision that certain investors should hold that stock whether they wanted to or not? If, as some seemed to be arguing, we should read the investor envisaged by our consumer protection objectives to mean primarily those with an index-tracking strategy, then wasn’t our basic regulatory model flawed, and producing inappropriate outcomes? Those outcomes in recent years had seemed to include forcing certain investors to buy into companies whose governance arrangements they found to be undesirable.
These interconnecting issues were the ones that generated the greatest strength of feeling, but ultimately our answers to these questions were informed by a relatively clear-headed view of our role and responsibilities.
We think the correct approach is to read the definition of consumer and therefore investor widely rather than narrowly. Because this definition is so wide, and because the premium listed market serves the interests of such a broad range of investors, we felt a policy solution that focussed purely on one investment model, or on one risk appetite, was unlikely to be fit for purpose.
It therefore also follows that in our view disclosure is the principal (albeit not the only) regulatory tool that we should seek to use in ensuring appropriate investor protection. It is investors themselves, with access to appropriate levels of disclosure, that are best suited to determine whether or not an investment is suitable for their particular circumstances.
Finally therefore, we were and remain very wary of a model that requires the listing authority to make judgements to exclude from premium listing (and incidentally therefore the indices) those companies which are eligible for listing but which might not constitute suitable investments for certain types of investor. We see our role to be to enable investors to make properly informed investment decisions, but not to make those decisions for them. The tracking investment model has at its heart a hole where such judgements and decisions might otherwise be made, but it was clear to us that we should not seek to fill that hole through wholesale changes to the listing criteria, or by reserving to ourselves discretion over the suitability of individual investments.
As a consequence, the changes we have proposed are targeted to the particular problem underlying the concerns investors had raised. In our view, this problem was that in certain circumstances minority investors felt they lacked sufficient tools or levers when their interests conflicted with those of a controlling shareholder. Although the number of cases where specific concerns had been identified was small, we recognised that those cases could disproportionately impact the perception of the premium listing segment, to the potential detriment of a far broader range of market participants.
When deciding upon an appropriate solution to this problem, we were guided by another important principle. We think it is key to the effectiveness of the listing regime that all shareholders are appropriately engaged in the governance of the companies they own, and are supported in this engagement by appropriate tools and disclosure.
We therefore identified three circumstances where a targeted re-balancing of the relationship seemed appropriate:
- when the controlling shareholder is not observing accepted market norms
- in the election of independent directors
- on the cancellation of listing
So firstly, we thought it was important that the listing regime should describe the basic standard of behaviour to which all controlling shareholders could be held. We therefore proposed to require all issuers with a controlling shareholder to enter into a relationship agreement. This agreement requires them to be able to operate independently of their controlling shareholders, and requires any transactions with them to be conducted on an arm’s length basis.
Because we thought this requirement really just embodies norms of behaviour which well-run companies are already meeting in practice, we thought it appropriate to put real power in the hands of minority shareholders where these standards are not being met. In that event the exemptions from the related party regime are removed in relation to transactions between the issuer and the controlling shareholder. This gives minority shareholders the right to vote on all transactions between a controlling shareholder and the company, and veto them if they wish. We think this constitutes a significant re-balancing of the relationship, and puts real power in the hands of minority shareholders, but only does so in those limited circumstances where it is appropriate.
Secondly, as independent directors act as an important source of challenge and control within the governance structure of a listed company, we thought it was appropriate that independent shareholders should have a fuller say in their election. We therefore proposed additional voting power for minority shareholders in the election of independent directors where a controlling shareholder is present.
Finally, we sought to enhance the voting power for minority shareholders where a company with a controlling shareholder wishes to cancel the issuer’s premium listing. Cancellation of listing removes from shareholders significant rights of participation in the governance of a company, and so we thought it important that minority shareholders are given a proper say in this decision. In such circumstances we have proposed that cancellation should also require the approval of a majority of votes of the independent shareholders.
We also recognised that active engagement should be supported by appropriate disclosure, so we also proposed enhanced disclosures in two contexts - when independent directors are proposed for election, and in relation to related party transactions. Incidentally, many of our stakeholders were very clear on the importance of our related party regime in signalling, and if necessary regulating, the quality of the governance arrangements in place where a controlling shareholder is present.
The consultation period has now closed, and broadly the proposals have been well received. We have received some useful technical feedback on some of the detail of the proposals that we are really grateful for. A number of stakeholders have argued that the most effective solution to the problem would have been to introduce new rules biting directly on controlling shareholders themselves. Whilst this is an entirely reasonable view, we didn’t think such rules were necessary in order to produce an effective set of proposals, and such a move would also take the regime in a new direction, and potentially raise new practical challenges. Ultimately of course the Act does not currently give us the legal power to make listing rules in relation to controlling shareholders, so this is really a matter for Government rather than for us.
To conclude, when producing the final set of proposed changes to the listing rules, we sought to produce targeted enhancements to minority investor protection whilst remaining sympathetic to the interests of the broader community that listed markets serve. In doing so we effectively answered the 3 questions I outlined at the start of my address in the following way -
- firstly, we think we have to recognise the breadth of the definition of consumer, and so operate a regime that accommodates a broad range of participants and investment approaches;
- secondly, we think the most effective way of doing this is to operate a regime which relies significantly upon disclosure to enable suitably engaged investors to make important decisions on a properly informed basis. Our interventions to enhance minority protection were therefore targeted rather than general.
- and so finally, we see our role to be to enable investors to make properly informed investment decisions, but not of course to make those decisions for them.
If this morning I haven’t managed to convince you of our success in this regard, I hope at least to have given you a better sense of the journey. Thank you.