Newsletter for primary market participants
December 2021 / No. 37
About this edition
Welcome to the 37th edition of the Primary Market Bulletin (PMB).
In this edition we:
- cover the implementation of our postponed rules that require issuers to publish their annual financial reports in a structured format
- explain the importance of adequate business continuity procedures for Primary Information Providers and suggest issuers may want to consider having more than one PIP account, and
- review sponsor requirements to identify and manage conflicts of interest, including some feedback on the range of submissions we have received since we published our Technical Note 701.3.
Are you ready for publishing and filing your structured Annual Financial Report digitally under our new transparency requirements?
Originating as a cross-EU initiative known as the ‘European Single Electronic Format’ (ESEF), the FCA has implemented rules requiring issuers with transferable securities admitted to trading on UK regulated markets to publish their annual financial reports (AFRs) in a structured XHTML web browser format. These AFRs must also be filed with the FCA’s National Storage Mechanism (NSM). Furthermore, in-scope issuers who prepare annual consolidated financial statements in accordance with International Financial Reporting Standards (IFRS) are also required to tag the financial information within their AFRs using a digital classification (taxonomy).
Compared to unstructured files (such as PDF), structured files allow the contents of the financial statements to be readable using specialist software tools and improve the accessibility, analysis and comparability of the information. This also improves transparency and fosters better information for investors, helping markets work well. Market integrity is supported in that the structured data improves the quality and breadth of investor analysis.
To relieve the burden during the Covid-19 pandemic, in November 2020 the FCA delayed the effective date of the requirements, but made changes to its systems to allow issuers to file with the NSM in the new format voluntarily before the rules apply. We want to remind issuers that mandatory filing comes into force for financial years starting on or after 1 January 2021 for filing from 1 January 2022.
The taxonomy currently specified in the FCA rules is the ESEF taxonomy that was in force on 31 December 2020 following the UK’s exit from the EU. This specified taxonomy does not take account of subsequent updates. We have recently consulted on which taxonomies, and the applicable versions of them, we should make available to issuers to use to comply with our rules (see CP21/27: Quarterly Consultation Paper No. 33). As part of this consideration we have noted that issuers may already be considering or even using certain other taxonomies (such as more recent versions of the ESEF taxonomy as applicable in the EU or the UKSEF taxonomy).
To meet the timetable for implementation, issuers will need to devote further and continuing management and operational resource to ensure that they will be able to submit annual financial reports in the required format.
Issuers will need to review the Disclosure Guidance and Transparency Rules (DTR 4.1) to check whether these requirements apply, and to what extent they apply. In general, DTR 4.1 only applies to issuers with securities admitted to trading on a regulated market (so, for example, this excludes issuers of securities on the LSE’s Professional Securities Market or AIM). There are also exemptions for certain issuers of securities on regulated markets, set out in DTR 4.4, which include:
- Public sector issuers (see DTR 4.4.1)
- Issuers that issue exclusively debt securities admitted to trading the denomination per unit of which is at least 100,000 euros (or an equivalent amount) (see DTR 4.4.2).
Our expectations on quality
Any change to the corporate reporting process can create challenges for issuers, especially when introducing new formats and technologies. However, it remains crucial that any output is of sufficient and appropriate quality.
So far, we have had several issuers taking advantage of the option to file structured AFRs with the NSM voluntarily. It is proving to be a very valuable learning experience, particularly where tags have been used and errors and/or warnings have been generated. We recommend that issuers that have already submitted structured AFRs review any feedback provided by the FCA as part of the submission process. Issuers should also be aware that the FCA’s validation system has been enhanced to check for compliance against relevant filing rules so certain submissions that may have been accepted during the voluntary phase would now be rejected.
Information and guidance on XBRL validation issues can be obtained from several sources. For example, the Financial Reporting Council’s Lab has recently undertaken a review of filings under the ESEF rules including those elsewhere in Europe, where some jurisdictions have already mandated the requirements. It has identified some areas where the quality is not of the expected standard. Information on the quality of tagging can also be found on the XBRL International website.
We would remind issuers that they are responsible for all information drawn up and made public under the DTRs. We, therefore, would expect issuers to devote the same level of care and attention to their XHTML AFRs as they do to their AFRs in PDF or printed form.
We strongly encourage issuers in scope to take advantage of the opportunity to file accounts in the new electronic format voluntarily to help ensure they are familiar with the requirements and the submission process before the mandatory requirements are in place. Issuers that have already filed non-structured versions of their AFRs (e.g. in PDF), are still able to submit a structured version separately (and at a later date). However, these issuers must ensure the underlying information within the reports is identical.
Further information on the UK’s requirements in relation to the ESEF initiative can be found on the FCA’s webpage, including how to file with the FCA. We will be keeping this updated as the FCA’s requirements evolve. We strongly recommend all issuers review these requirements and prepare for change as AFRs in PDF will no longer satisfy the FCA’s transparency rules (DTR 4.1.14R and DTR 6.2.2R).
PIPs – need to disseminate regulated information as soon as possible and have in place effective business continuity arrangements
Issuers must use a Primary Information Provider (PIP) (also referred to as a Regulatory Information Service or RIS) whenever they are required to disclose regulated information. Regulated information is that which is required to be disclosed under Articles 17 – 19 of the Market Abuse Regulation (MAR), the Listing Rules (LRs), and the Disclosure Guidance and Transparency Rules (DTRs) (see DTR 8.4.3R). It includes disclosures of inside information, annual and half-yearly financial reports and notifications of the acquisition or disposal of major shareholdings and voting rights, among other things.
We know that market participants rely on regulated information being made public in a fast and accurate way in order to make informed decisions. In the vast majority of cases issuers can be sure that, when they submit regulated information to their PIP of choice, the PIP will disseminate that information securely and without delay. The FCA’s rules for PIPs (set out in DTR 8) require a PIP to disseminate information received from an issuer ‘as soon as possible’ (DTR 8.4.3R). When assessing whether a PIP has met this requirement, we will have regard to whether at least 95% of all regulated information is disseminated within 5 minutes of receipt (DTR 8.4.4G).
A PIP must also ensure that, if circumstances arise which prevent it from disseminating and continuously receiving regulated information, it has in place adequate business continuity procedures (BCPs)(DTR 8.4.9R). These must be sufficient to ensure the PIP can continue to satisfy its PIP obligations with minimal disruption if there is an outage or other breakdown in business continuity. This is because a failure in a PIP’s systems which prevent it (and thereby any affected issuers) from disseminating regulated information in a timely way could have an impact on the orderliness of the market and wider market confidence.
Effective and robust BCPs are therefore an important part of a PIP’s framework of procedures, systems and controls. Business continuity is one of the matters included in the annual report each PIP is required to submit to us each year, which contains an auditor’s opinion that the PIP has complied with its ongoing obligations in the previous year (DTR 8.5R). We expect PIPs to have in place a clear procedure which details what actions they will take in the event of an outage (to include contacting affected clients) and who is responsible for each action. We are aware that systems failures or outages do occur, albeit most are of a minor nature and are quickly rectified.
Alternative PIP arrangements and the option for issuers to have a second PIP account
As noted above, a PIP must have adequate arrangements in place to ensure that, in the event of a systems outage, it can continue to satisfy its obligations as a PIP with minimal disruption. In considering whether the PIP satisfies this requirement, we will consider whether the PIP has arrangements in place for an alternative PIP to receive and disseminate regulated information on its behalf (DTR 8.4.10G).
We know that these alternative PIP arrangements may not, in practice, be a viable option. It may not always be practical for a PIP undergoing a systems failure or outage to redirect regulated information announcements to an alternative PIP. There may be timing problems if, for instance, the receiving PIP needs to on-board new clients. Given the importance of PIPs being able to disseminate regulated information as soon as possible, we are concerned that there is a potential for delay, and subsequent market disorder, should a PIP seek to invoke its alternative PIP arrangements.
In the event of an outage or breakdown in service which means a PIP cannot disseminate or continuously receive regulated information, a PIP must, under DTR 8.4.36R, notify its clients (and the FCA) as soon as possible. It is important that clients are informed because, otherwise, there is a risk that an issuer (or anyone in possession of the information) may disclose the information itself, on the assumption that it has been disseminated to the market by its PIP. This could lead to inadvertent unlawful disclosure.
In circumstances where a PIP notifies its clients of a breakdown in service, our practice is to encourage the PIP to be clear whether it is invoking its alternate PIP arrangements and is transferring announcements to that PIP. This is important, as an issuer will need to take this into account when deciding whether or not to make its own arrangements for disseminating the relevant information. Where the issuer needs to disclose inside information, for instance, this must be done ‘as soon as possible’ under MAR Article 17 (and DTR 6.3.3R), and the issuer will wish to ensure the information is disseminated without delay.
To minimise the risk that an issuer’s usual PIP may not be able to transfer regulated information to an alternative PIP in a timely fashion, and the consequences of this, issuers may want to consider whether to set up and maintain a second PIP account themselves. This would mean that, when its usual PIP notifies of a breakdown in service, an issuer would be able to use this second PIP to ensure its regulated information is disseminated in a timely way, as required by MAR, the LRs and the DTRs. Although we recognise there may be a cost for issuers in maintaining a second PIP account, there would be a corresponding benefit. Issuers would be able to use the second PIP in the event of an outage at their usual PIP and so meet their disclosure obligations.
Sponsors: identifying and managing conflicts – review of sponsors’ requests for guidance
Sponsors are required to take all reasonable steps to identify and manage conflicts of interest that could adversely affect their ability to perform their functions under LR 8 properly. In certain situations, as set out in our guidance, or where a sponsor is in any doubt about whether a conflict can be effectively managed, it should contact the Primary Market Specialist Supervision Team at the FCA before it decides if it can provide any sponsor services. Sponsors must at all times deal with the FCA in an open and co-operative way.
In August 2017, we issued Technical Note 701.3 (TN 701.3) which provided updated guidance to sponsors on their conflict obligations. This included guidance on when sponsors should contact the FCA’s Primary Market Specialist Supervision (PMSS) team if they are in any doubt about whether they can effectively manage a conflict. We have recently reviewed the conflict queries we have received from sponsors since the publication of TN 701.3.
From our review, we observed the following:
- The majority of sponsors have not submitted a conflict guidance request since the introduction of Technical Note 701.3.
- The overall number of conflict queries received per quarter since the introduction of Technical Note 701.3 has fallen compared to the 10-year average. However, we observed an uptick in submissions during 2020 driven by Covid-19 related capital raising transactions.
- Over 75% of guidance requests related to potential conflicts involving the sponsor’s group acting as a lender to the issuer or other party connected with the transaction.
- In the vast majority of cases we agreed with the sponsor’s own analysis of whether a conflict existed and, if so, their proposals to effectively manage such conflict. In a small number of cases we disagreed with the analysis, resulting in changes to the sponsor’s role or its arrangements to manage the conflict.
- Sponsors’ submissions generally met the requirements in our guidance.
We will use the results of our work to inform our reviews of future conflict queries we receive from sponsors. We encourage sponsors to review the remarks set out in this note and to take them into account when deciding whether or not to make a conflict submission to PMSS.
We have completed a review of the conflict queries we have received from sponsors since the publication of Technical Note 701.3 in August 2017. Given the passage of time since we published our updated guidance, we wanted to reflect on the type of conflicts we have been contacted about and the outcome of these discussions. Over the course of the period of the review we observed a large variance in the number of times that each sponsor has contacted us with a query. This suggests to us that some sponsors may not understand our guidance or may be interpreting it differently to others. The results of our review help us in seeking to understand where this might be the case. We have also taken the opportunity to remind sponsors of specific aspects of our rules and guidance.
Sponsors are required to take all reasonable steps to identify conflicts of interest that could adversely affect their ability to perform their functions under LR 8 properly (LR 8.3.7BR). In identifying conflicts of interest, LR 8.3.8G requires sponsors to take into account circumstances that could:
(1) create a perception in the market that a sponsor may not be able to perform its functions properly, or
(2) compromise the ability of a sponsor to fulfil its obligations to the FCA in relation to the provision of a sponsor service.
Where a sponsor is not reasonably satisfied that its organisational and administrative arrangements will ensure that a conflict will not adversely affect its ability to perform its functions properly under LR 8, it must decline or cease to provide the sponsor service (LR 8.3.11R).
Our guidance in LR 8.3.12G sets out that, if a sponsor is in doubt about whether a conflict can be effectively managed, it should discuss the issue with us before deciding if it can provide a sponsor service. Queries of this nature are dealt with in accordance with SUP 9, usually in the form of a written submission to us setting out sufficient information and allowing us time to respond to a request for guidance. When deciding whether to contact us and when providing information in a submission, sponsors should have regard to the requirement in LR 8.3.5R to deal with the FCA in an open and co-operative way.
When we receive a written request for guidance, we may require sponsors to provide further information to help us to assess whether a conflict exists and whether the systems and controls the firm has in place to manage the conflict are effective. Following this intervention, and where we are not reasonably satisfied that a conflict can be effectively managed, we will want to have a discussion with the sponsor to decide on appropriate next steps. This could include asking the sponsor to resign from providing the sponsor service. Alternatively, the sponsor may decide to cease providing other services or products to the issuer.
In March 2017, following a Call for Views in CP14/21, we consulted on a new guidance note – Technical Note 701.3. At the time, we concluded that the current rules and guidance around sponsor conflicts were, broadly speaking, operating effectively but recognised that sponsors wanted more clarity and guidance on specific aspects.
The updated Technical Note contains some practical guidance on how we expect sponsors to assess conflicts and our expectations of sponsors in this area. We retained our position that, where a sponsor is reasonably satisfied that either no conflict exists or it can manage the conflict, we do not ordinarily expect it to contact us. However, we set out a number of exceptional circumstances where we would ask that a sponsor contacts us at the earliest opportunity and before it decides if it can provide any sponsor services. These circumstances include where the size of a proposed loan (prior to syndication) is greater than 0.5% of the sponsor group’s total assets. They also include where, in the context of a related party transaction, a sponsor proposes to provide a fair and reasonable opinion and is also acting in another capacity, such as providing acquisition finance, for the related party or other party to the transaction. In this latter case, we consider that there may be a perception in the market that the sponsor cannot perform its functions properly and so, were the sponsor to act, market confidence in sponsors may be adversely affected.
Expectations ahead of our review
Before carrying out our review, we considered what changes in the number and nature of conflict queries we reasonably expected to see as a result of our revised guidance in TN 701.3. This produced the following expectations:
(1) Fewer queries from sponsors, but queries focused on the specific areas of actual or perceived conflicts as highlighted in our updated guidance.
(2) A broadly similar number of queries from sponsors, particularly from those with business models that are alike.
(3) Queries from sponsors at an early stage of the sponsor service and with sufficient detail and analysis to allow us to properly assess the situation without making further information requests.
(4) Only a limited number of queries where we come to a different view and outcome compared to the sponsor’s original conflict analysis.
Results of our review
Our review focused on areas involving the volume and nature of conflict queries we received from sponsors following the publication of our revised guidance in TN 701.3. For each area, we have set out the change in behaviour we expected to see as a result of our updated guidance and the results of our review.
Overall volume of queries
Given the updated Technical Note sought to clarify existing guidance and provide further guidance on specific aspects of LR8, we expected to see an overall reduction in the number of queries from sponsors since its publication.
As the chart shows, on average the number of sponsor guidance requests to us each quarter over the last 10 years has gradually reduced. Since we introduced the updated guidance in August 2017, we have seen a further decrease in the average number of queries. We recognise that these numbers will, to some extent, be driven by the number of transactions sponsors will be working on, and the number of submissions made by sponsors to our Listing Transactions department during this period also decreased. We received an increase in conflict queries during 2020 where the number of sponsor services increased as issuers sought to raise new capital as a result of the Covid-19 pandemic.
Number of queries from sponsors
The chart above shows the total number of conflict queries we received since August 2017 from sponsors currently on the FCA list of sponsors. The majority of sponsors have not submitted a conflict query to us since August 2017 and around a quarter of sponsors have submitted between 1 and 5 queries.
We recognise there are a number of reasons why a sponsor may have decided it did not need to contact us to discuss sponsor conflicts during this time period. For example, many of the sponsors in this group do not generally provide lending services to clients. However, sponsors should not automatically assume that, given the nature of their group’s business model, conflicts do not exist. We often discuss conflict cases where the sponsor’s group has a directorship at or an equity interest in the issuer or other party to the transaction or where the sponsor may be providing certain advisory services to both sides of the transaction. TN 701.3 contains some common examples of potential conflict scenarios as well as factors to take into account generally when identifying potential conflicts.
We would also generally expect to receive a similar number of conflict queries from sponsors whose group operates a similar business model and undertakes a similar number of sponsor transactions. For example, sponsors whose groups provide loan finance to clients are likely to encounter conflict scenarios that are specific to transactions where the sponsor group is providing finance to an issuer or other party in addition to its sponsor role. We sometimes observe a sponsor making a conflict submission to us whilst not receiving a corresponding submission from the joint sponsor acting on the same transaction and in a similar conflict position. This suggests to us that there may be different risk appetites amongst similar sponsor firms when deciding whether to contact us.
Submissions by type of transaction and nature of conflict
The most common types of sponsor conflict queries involved class 1 disposals and acquisitions and IPOs. By far the most common type of conflict we received queries about involved the sponsor’s group having an existing lending exposure or where new lending was being proposed.
Outcome of discussions
In the majority of all queries we received we agreed with the sponsor’s own conflict analysis, resulting in no change to the sponsor group’s role for the transaction.
These queries reflected the circumstances set out in our guidance where we request the sponsor to contact us where there was an unusual element in the sponsor’s role or transaction. We consider it was appropriate for the sponsor to contact us to allow us to gain an understanding of the conflict position and ensure the sponsor has given proper consideration to whether or not it is conflicted. There were only a small number of queries where we did not consider there was a need for the sponsor to contact us. The results of our review, as demonstrated by the data above, suggest that sponsors are largely assessing conflicts in line with our guidance.
Cases of interest
Below, we have highlighted some cases where, following discussion with us, sponsors took action to reduce the risk that there may be an actual or perceived conflict of interest.
Operational and administrative arrangements
During our review of a conflict query from an integrated investment bank, we gave the sponsor feedback that their proposed management of the conflict through the separation of deal teams did not appear to be fully aligned with the guidance in TN 701.3. The sponsor’s group was proposing to provide a new loan to the issuer at the same time as acting as sponsor. We were concerned that, as a senior employee of the firm was a member of the lending team and the sponsor team, the firm’s decisions about the sponsor service could be influenced by the lending interests of the sponsor firm. As a result of our enquiries, the firm removed the individual from the sponsor team. This ensured that each team could carry out their roles independently of one another, with separate committee processes and controls, including arrangements to manage information flows between the lending team and sponsor team.
Provision of margin loans
A small number of queries involved the sponsor firm having provided or proposing to provide loan finance through a margin loan. As this type of financing typically involves collateral in the form of the issuer’s equity securities, there is a possibility of the collateral being enforced. Depending on the size and terms of the margin loan, this could result in the sponsor having a material equity interest in its client. The likelihood of this happening is increased where the issuer is experiencing financial difficulty. In this circumstance we would be concerned that the sponsor group’s interests may be in conflict with its role as sponsor because it may have a material equity interest in its client. For the queries we received, we sought to understand from each sponsor whether the issuer was or was likely to become financially distressed as well as the maximum equity interest that the sponsor’s group could have in the client were the loan to be enforced. Where, based on the information provided, the risk of the sponsor having a material equity interest its client was low, we were generally comfortable that the guidance set out in TN 701.3 could be applied without the margin element of the loan being an issue. In line with the guidance in TN 701.3, sponsors should contact us where there are any unusual, novel or complex features to the transaction or the sponsor’s involvement in it.
Provision of a fair and reasonable opinion and acquisition financing
A sponsor informed us that it had confirmed to an issuer that the terms of a transaction with a related party were fair and reasonable in accordance with LR 13.6.1R(6) at a point in time when the sponsor had been invited by the related party to provide acquisition financing for the transaction. We were concerned that any knowledge the sponsor had of its potential participation in the financing could have influenced the giving of its fairness opinion. Following our concerns that a conflict of interest, or a perception of a conflict of interest, existed at the point the sponsor gave its fair and reasonable opinion, the issuer instructed another sponsor that was not in the same position to provide a new confirmation under LR 13.6.1R(6). In line with the guidance in TN 701.3, where a sponsor is providing confirmations of this type and is acting in another capacity for the related party or other party to the transaction, we would ask that the sponsor contacts us before deciding if it can provide the sponsor services.
Perceived conflict from complex financing arrangements
A sponsor requested guidance on its role as sponsor on a reverse takeover. The sponsor had existing financing arrangements with the issuer with the possibility that these might be refinanced as a result of the transaction. The sponsor’s group had also provided an equity collar and margin loan to a large shareholder of both the issuer and target. Following our application of the reasonable market user test (which is explained in TN 701.3), we were concerned that the extent and complexity of the financing arrangements could, irrespective of any arrangements the sponsor had in place to manage the conflict, create a perception of a conflict. In response to our concerns, the sponsor decided to cease providing its sponsor role on the transaction and another sponsor was appointed.
Our observations from cases
Below, we have set out some observations following our review of sponsors’ submissions to us about conflict queries.
Content of conflict submission
We often see no or limited details of the firm’s own analysis of whether the firm can appropriately manage the conflict or where it has concerns that a perception of a conflict exists. In some submissions, a sponsor will not precisely identify the actual or perceived conflict, so making it difficult for us to understand its analysis of how the conflict can be managed. As we state in TN 701.3, it is important that we receive the sponsor’s own analysis to allow us to properly evaluate the situation. Where this is not included, we will typically request this information, which inevitably delays our ability to provide a response to the guidance request.
Use of the reasonable market user test
We introduced the concept of the reasonable market user in TN 701.3 which sponsors could use to help assess circumstances where a perceived conflict of interest exists. We have seen only limited references to this in submissions to us and would encourage all sponsors to consider this analysis where relevant. Where a sponsor does include a reasonable market user analysis, this helps us to analyse and come to a view on whether, irrespective of the systems and controls a sponsor may have to manage conflicts, a reasonable market user would consider the sponsor to be conflicted.
Timing of engagement with us
A sponsor should always contact us at the earliest opportunity and before deciding if it can provide sponsor services. Although we will require sufficient information to properly respond to guidance requests, sponsors have found it useful to engage with us at the initial stage of a transaction where the sponsor has identified the possibility of a role or interest. Where a sponsor does not contact us at the earliest opportunity, it proceeds with the transaction at its own risk, including the risk that we may seek information and/or assurances or otherwise intervene at a later stage of a live transaction. Sponsors must at all times deal with the FCA in an open and co-operative way.
Complex or unusual situations
Our guidance asks that a sponsor always contacts us where there are any unusual, novel or complex features to the transaction or the sponsor’s involvement in it that may be relevant to considering actual or perceived conflicts of interest. This includes unusual aspects to a service or product being provided by the sponsor’s group, the sponsor’s fee or its relationship or arrangement with other parties connected to the transaction.
Provision of fair and reasonable opinion
Due to the importance of the sponsor’s confirmation under LR 11.1.10R(2)(b) or LR 13.6.1R(6), we will be particularly concerned that an actual or perceived conflict of interest may exist where the sponsor firm is also providing services to the related or other party to the transaction. This will typically include where the provision of financing is being made but could also include other services such as FX hedging. In such cases, any actual or perceived lack of objectivity on behalf of the sponsor may call into question the validity of its opinion. Our involvement in these situations has resulted in changes to the sponsor’s role and we therefore urge sponsors to contact us to discuss such situations before providing advice to the issuer.
We would encourage all sponsors to review the feedback in this review and refresh their understanding of the rules and guidance including Technical Note 701.3. The nature of conflicts will depend on a firm’s business model but nevertheless we urge sponsors to keep their conflict obligations at the front of their mind.
For sponsor firms that have not previously contacted us to request guidance on a conflict case, we anticipate it will be a useful exercise for your firm to reflect on why this has been the case and identify if there are specific areas not previously considered that may be relevant in the future.
We remind sponsors to contact us at the earliest opportunity and ensure their submission precisely identifies the actual or potential conflict and, where applicable, includes an assessment under the reasonable market user test.