Debt programme and standalone prospectuses: modernization of the Prospectus Directive
On 30 November 2015, the Commission published its Proposal on the prospectus to be published when securities are offered to the public or admitted to trading (so-called PDIII). This follows the Commission's Action Plan on Building a Capital Markets Union, published on 30 September 2015 following its earlier consultation, in which the Commission states its belief that the Prospectus Directive (PD) should be modernised to (i) make it less costly for businesses to raise funds publicly, (ii) update when a prospectus is needed and (iii) streamline the information required and the approval process. To minimise variation in the interpretation and application of the legislation across the EU in order to ensure the proper functioning of the internal market and guarantee investor protection, the Commission proposes that the Level 1 framework for the prospectus regime, which is currently set out in a Directive, should now take the form of a Regulation. As a Regulation, it will be directly applicable in Member States and no implementing legislation will be required for the provisions to take effect in each jurisdiction. It is envisaged that the new Regulation will also incorporate certain provisions which are currently set out in the existing Level 2 Prospectus Regulation (PD Regulation).
Some specific areas of concern from a mainstream debt securities perspective include:
- Removal of the distinction between wholesale and retail issues – Article 1.3 of the draft Regulation omits the exemption from the requirement to prepare a prospectus for offers of securities to the public in the EEA for issues of debt securities with a denomination of EUR 100,000 or above (wholesale issues), which is currently set out in Article 3.2(d) of the PD. Article 1.3 does, however, retain the exemption from the prospectus requirement for offers addressed to Qualified Investors (defined by reference to the definition in the Markets in Financial Instruments Directive (MiFID)) only and for offers where investors acquire securities for a total consideration of at least EUR100,000. Article 7 of the draft Regulation, which sets out the requirements relating to summaries, similarly omits the exemption from the requirement to include a summary in a prospectus for a wholesale issue which is currently set out in Article 5.2 of the PD. In addition, Article 13 of the draft Regulation, which sets out the minimum information and format requirements, omits the reference to differentiated disclosure requirements for a prospectus relating to a wholesale issue which is currently set out in Article 7.2(b) of the PD. The Commission indicates in the explanatory memorandum accompanying the draft Regulation that a unified prospectus template for debt securities will be developed. This will take the existing PD Regulation wholesale disclosure annexes as a starting point and add in only those information items necessary for retail investor protection.
The main reason cited for the removal of this distinction is that, in order to improve secondary liquidity in the European bond markets, it is necessary to remove the incentives to issue in high denominations. The Commission's view is that while the need for additional disclosure and a summary in prospectuses for wholesale issues, will involve an increase in costs for relevant issuers this will result in the issue of more debt securities with lower denominations.
This will in turn lead to more buying and selling interest in the markets and diversification of portfolios for investors, which will be beneficial to all. It is not clear that all market participants will agree with the Commission's view and instead this amendment may drive issuers of debt securities in today's fully functioning and effective wholesale markets away from admission to trading on EEA regulated markets altogether. It is also worth noting that this amendment is out of line with other legislative initiatives relating to more complicated debt securities which are not seen as appropriate for retail investors in general, such as securitisation instruments.
Consequently this could result in these instruments being subject to a more onerous prospectus disclosure regime without any clear corresponding benefit. A more appropriate course of action than complete removal of the distinction would be the inclusion of an alternative mechanism to distinguish between those debt securities which will be sold to institutional investors only and those which will also be sold to retail investors. The most workable alternative would be to provide that, where the initial distribution of the debt securities is to Qualified Investors (as defined), only a prospectus prepared in connection with the admission to trading on a regulated market of those securities will not need to include a summary and will need to meet the existing lesser disclosure requirements for wholesale issues.
- New requirements relating to risk factor categorisation and restriction on the number of risk factors included in a summary – Article 16 of the draft Regulation introduces a new requirement for risks to be presented in distinct categories according to their materiality based on the issuer's assessment of the probability of their occurrence and the expected magnitude of their negative impact. In addition, Article 7.6(c) of the draft Regulation provides that a summary must contain a brief description of no more than five of the most material risk factors. The draft Regulation envisages that ESMA will develop further guidelines in this area. These new requirements are overly simplistic. They will introduce increased liability for issuers given the potential for mischaracterisation of risks and are unnecessary given the existing scope for a competent authority to refuse approval of a prospectus if any of the disclosure set out in it is not easily analysable and comprehensible. It should also be noted that these proposals would be likely to raise heightened considerations in relation to relatively complicated instruments, such as asset backed securities. These new requirements should be dropped.
- Other changes relating to requirements for summaries and supplements – Summaries – Article 7.3 of the draft Regulation requires a summary to be a maximum of six sides of A4 paper using characters of readable size. This is obviously significantly shorter than what is envisaged in Article 24.1 of the current PD Regulation, which is a maximum of 7% of the length of the prospectus or 15 pages, whichever is longer. Articles 7.6 to 7.8 of the draft Regulation set out requirements to include titles in the form of questions for each sub-section of the summary. This represents the Commission's attempt to model the prospectus summary as much as possible on the Key Information Document required under the PRIIPs regime. These changes would require issuers to adjust their approach to drafting summaries significantly and consequently involve additional time and expense. The proposals are particularly problematic when considered in combination with the proposed removal of the distinction between wholesale and retail issues discussed above, given that a wider range of issuers would potentially need to comply with the summary requirements. Once again, heightened concerns arise for portions of the market which are less conducive in general to simplified disclosures of this nature, such as asset backed securities. Supplements – Article 22.5 of the draft Regulation provides that a competent authority may request a consolidated version of the supplemented prospectus to be annexed to the relevant supplement to ensure comprehensibility – this would again involve additional time and expense for issuers.
- Limited "grandfathering" provisions in draft Regulation – the draft Regulation contains limited "grandfathering" provisions. Article 44.4 of the draft Regulation provides that a prospectus approved under the existing PD regime, as implemented in the relevant Member State, before the date of application of the new Regulation will be continue to be governed by that regime until the end of its validity period or until 12 months after the new Regulation applies, whichever occurs first.
Significant challenges arose in relation to the implementation of the last set of amendments to the PD in 2012/2013. Given this experience and the significant nature of the changes which would be introduced were the draft Regulation adopted in its current form, it would be advisable to specify a longer period during which market participants and regulators alike will be able to adjust to the new regime. This is particularly so because it is envisaged that a large amount of detail relating to these changes will follow in delegated acts from the Commission (these may take the form of Regulatory Technical Standards and Implementing Technical Standards) and guidelines from ESMA, which could take some time to finalise. An extended grandfathering period would enable the continued efficient functioning of the markets and, in particular, would help to reduce the costs associated with updating debt programme base prospectuses to reflect the new requirements.
The Commission's legislative proposals will now be considered by the European Council and the European Parliament. There is no formal industry wide consultation process associated with the proposals, but Allen & Overy will be actively participating in any opportunities to make views known via various channels, such as through industry association advocacy efforts and by raising points with contacts at national competent authorities.