Legal briefing | Funds | 25 Jul 2019

EU Prospectus Regulation - What fund managers and investment companies' sponsors need to know

Overview

On 21 July 2019, the Prospectus Regulation (EU) 2017/1129 (the “Prospectus Regulation”) came into force. This means new rules now apply when prospectuses are being drafted and approved. The two triggers for a prospectus, however, remain the same, namely admission to trading on a regulated market and an offer of securities to the public. The main aims of the Prospectus Regulation include making prospectuses shorter, more relevant and easier to understand.

Prospectus Regulation provisions which previously came into force

A limited number of provisions came into force in 2017 and 2018:

  • Since July 2017, funds have been able to issue up to 20% of their share capital in any 12 month period without triggering the requirement to produce a prospectus.
  • Since July 2018, funds have been able to raise EUR 8 million by way of a public offer without a prospectus. As before, this is calculated over 12 months and on an EEAwide basis.

Key points

  • All of the provisions of the Prospectus Regulation have come into effect. In the UK, the FCA has incorporated the regulation’s provisions in a new ‘Prospectus Regulation Rules’ chapter of the FCA Handbook.
  • Any issuer seeking approval of a draft prospectus must now do so under the new regime.
  • The summary section of a prospectus must now be in a Q&A format, limited to seven sides of paper. Where a comprehension alert is required under the PRIIPs Regulation in the fund's KID, the same alert must be included in the prospectus summary.
  • Issuers, in conjunction with their sponsors and advisers, will need to conduct an internal assessment to identify the most material risk
    factors. Issuers should be prepared for competent authorities to raise more queries in relation to the risk factors section.
  • The Annexes detailing the specific content requirements of a prospectus have been rewritten, although there are not many substantive differences.
  • Reduced disclosure regimes have been introduced for secondary issues and, for frequent issuers, by way of a Universal Registration
    Document. It is not expected these will be frequently used.

Legislative framework

Primary EU legislation

The Prospectus Regulation repeals and replaces the Prospectus Directive (“PD”) in its entirety. Two further regulations, which also came into force on 21 July, contain additional details (together the “Delegated Regulations”) and replace the PD delegated regulations:

  • Delegated Regulation (2019/980), containing provisions relating to the format, content, scrutiny and approval of prospectuses. The ‘building blocks’ annexes can be found here; and
  • Delegated Regulation (2019/979), containing regulatory technical standards (“RTS”) on key financial information in the summary of a prospectus, the publication and classification of prospectuses, advertisements for securities, supplements to a prospectus, and the notification portal.

UK rules and guidance

The Prospectus Regulation is directly applicable in the UK without the need for implementation, but the FCA has introduced new rules – the Prospectus Regulation Rules (“PRR”), which have replaced the previous prospectus rules – to make sure its Handbook stays up to date. The FCA published the final PRR earlier in the month. The PRR is, broadly, a copy out of the provisions contained in the Prospectus Regulation and Delegated Regulations. The Financial Services and Markets Act 2000 has also been amended to align it with the Prospectus Regulation.

The FCA’s Knowledge Base materials (such as technical notes and procedural notes) are based on the provisions of UK national law implementing the old PD; the FCA has stated that it will publish revised materials to reflect the requirements of the Prospectus Regulation in autumn 2019. In the meantime, the guidance provided by the current materials should be applied to the extent it is compatible with the Prospectus Regulation.

ESMA guidance

It is important to note that certain ESMA guidance will still be relevant. Guidance has been published in respect of the new rules on risk factors (see further information below) alongside technical advice on the simplified disclosure requirements where there is a merger or takeover. New ESMA Q&As have also been introduced and ESMA is continuing to analyse certain of the old Prospective Directive Q&As in terms of whether they should be carried forward.

ESMA proposes to introduce new guidelines in two areas in relation to investment funds:

  • when a fund uses securities financing transactions (“SFT”) and total return swaps other than for the purposes of efficient portfolio management, certain disclosures should be made (so as to align the prospectus disclosure requirements with those in the SFT regulation); and
  • guidance to clarify what the ‘brief description’ of the entity providing investment advice should entail. The rationale for the inclusion of this new draft guideline is that a basic level of transparency should be provided in relation to an entity that can influence the use of a fund’s assets.

ESMA states that the remaining guidance in relation to funds contains only some minor adjustments which is not intended to impact the substance of what is currently contained in the CESR recommendations.

Longer term, the European Commission has requested ESMA to provide technical advice, by 31 August 2020 or sooner, of equivalent criteria for prospectuses drawn up under the laws of third countries.

Live transactions

Prospectuses which were approved prior to 21 July 2019 will remain valid for up to 12 months (or the end date of the existing placing programme, if earlier). Supplementary prospectus issued on or after 21 July 2019 in relation to a prospectus approved before that date will need to address only old regime’s requirements rather than the provisions of the Prospectus Regulation.

Going forward, (as confirmed by the FCA in an Update published on 5 July), any issuer seeking approval of a draft prospectus must do so under the new regime. Applications submitted to the FCA containing draft prospectuses that have been prepared in accordance with the pre-21 July regime will not be valid and will not be approved: in practice, the approval process for any prospectus dated under the old rules will now start again.

The Update also confirms that issuers and their advisors should update references to the new Prospectus Regulation Rules where required – for example, referencing the right exemptions when applying for admission to the Official List.

There are new FCA checklists for documents being submitted for approval under the new regime. The approval process remains unchanged. There will, however, be a new requirement for issuers to send to the FCA a “data checklist” (including the issuer’s LEI and information about the securities), so that the FCA can submit this information to ESMA. However, as ESMA has advised that it does not require the full data set to be submitted at present, the FCA has confirmed that it is currently making only limited changes to its electronic submission portal for the submission of documents, and issuers and their advisers should continue to use existing processes for the time being.

Content requirements

General disclosure standard

New wording has been introduced into the disclosure test; a prospectus must now contain necessary information which is ‘material’ to an investor in relation to it making an informed assessment. The scope of information specifically stated in the disclosure standard has been also widened to include “the reasons for the issuance and its impact on the issuer”. Although the principle of disclosure remains the same, the changes should encourage more focussed disclosure.

Summary – form and content

A key change is to the rules relating to the preparation of the summary of the prospectus. The content requirements under the new regime are far more prescriptive than they were before.

The summary must:

  • be written and presented in a concise manner, and read as an introduction to the prospectus;
  • follow a new question-style format (i.e. it is no longer a requirement to present the summary in tabular form);
  • include the most material risk factors (specific to issuer and securities), with a total maximum limit of 15 risk factors; and
  • be accurate, fair, clear and not misleading. Recital 31 of the Prospectus Regulation states that issuers have discretion in selecting the information that they deem to be material and meaningful for inclusion in the summary.

The summary must now be split into four sections. The Prospectus Regulation stipulates the content requirements for each:

  • Introduction;
  • Issuer key information;
  • Securities key information; and
  • Offer key information.

There is new page limit, seven sides of A4 (previously, the limit was 7% of a prospectus, or 15 pages, whichever was longer).

The introduction section must include a warning to investors about the potential loss of their investment.

There are new restrictions on how key financial information is presented in the summary. The information must be presented in accordance with tables set out in the RTS contained in Delegated Regulation (2019/979), which vary depending on the type of issuer and the securities being issued. Closed ended funds are required to provide the information contained in the table at Annex VI. For listed funds, it is now required to have separate line items in the summary financial disclosures showing accrued and paid management and performance fees.
Where an issuer does not have an item appearing in a table in its financials (which is likely to be the case in respect of accrued fees) it may substitute the corresponding item from its accounts. Issuers are also permitted to include additional line items or alternative performance measures.

Risk factors

The disclosure regime in respect of risk factors has changed, with the aim of making the risk factor section of a prospectus shorter and more relevant. Under the new regime, risk factors should be limited to those risks specific to the issuer or the securities in question which are material to making an informed investment decision.

In addition, risk factors must be:

  • adequately described;
  • corroborated by information elsewhere in the prospectus; this is in contrast to current practice where risk factors are sometimes on topics not covered elsewhere in the prospectus; and
  • presented in no more than ten categories, with the most material risk included first in each category. “Material” for this purpose will need to take into account the probability of occurrence and expected magnitude of a negative impact.

The approach taken in the new regime is akin to the UK’s current approach i.e. an increased focus on specific, material and tailored risk factors. In its current technical note on risk factors, the FCA states that risk factors should be presented and grouped in a coherent manner, and those considered to be of the greatest significance should be prominently placed at the beginning of each section or group within the ‘risk factors’ section.

ESMA has published new guidelines on risk factors. ESMA’s guidelines are designed to assist competent authorities; however in practice they should also be considered by those responsible for drafting risk factors. The guidelines propose that competent authorities should challenge the inclusion of risk factors that have not been drafted specifically for the issuer or securities or are generic and only serve a disclaimers or where there is no direct link between the issuer or the securities and the risk factor.

The guidelines contain some useful practical drafting points:

  • a risk factor should only appear once, in the most appropriate category;
  • whilst the most material risk factors have to be presented first, it is not mandatory for all remaining risk factors within each category to be ranked in order of materiality;
  • category headings should be easily identifiable, i.e. appropriate spacing and in bold;
  • sub-categories should only be used where inclusion can be justified – the example given in ESMA’s
    guidance is where there are multiple types of securities. This would be relevant for C share issues; and
  • ESMA states that risk factors should be amended where mitigating language is included which obscures the
    remaining risk.

More time is likely to be spent in preparing this section of the prospectus, which will be under increased scrutiny. The real impact will be seen once the FCA’s new approach to risk factors becomes clear. In practice, balancing the Prospectus Regulation requirements and 10 b 5 disclosure standards and practices where there is an offer to institutions in the United States may prove to be difficult.

Building Blocks

The Annexes which formed part of the old regime, and which governed the content of the main body prospectuses, have also been repealed and replaced. Although the Annexes have been rewritten, there are not many substantive differences.

Minimum Disclosure Requirements: Relevant Annexes for closed-ended collective investment undertakings

                                                                      Old Regime                         New Regime

Registration Document for                           Annex I                                  Annex 1
Equity Securities                                                                               

Share Securities Note                                   Annex III                                 Annex 11

Additional disclosure for                              Annex XV                               Annex 4
registration Documents for
collective investment
undertakings

In its consultation published in July 2017, ESMA stated that it considered that the existing regime for closed-end funds largely worked well and therefore it did not propose to make significant changes to the existing disclosure regime. The majority of changes made are to align the wording of the disclosure requirements with the disclosure required under Article 23 of the AIFMD, thereby reducing duplication and administrative burden. The changes that have been made are not expected to result in substantive difference to corresponding disclosures made in prospectuses prior to the rule changes.

Also introduced is an ability for reduced disclosure on significant underlying investments (i.e. those representing 10 or 20 per cent of gross assets of the fund) in limited circumstances where an issuer can reasonably demonstrate that it cannot access the relevant information (for example, in hostile situations).

Unfortunately, a comparison of the old and new disclosure requirements has not been published and so issuers should work closely with advisers to ensure the disclosure requirements required under the new regime are met.

Incorporation by reference

The Prospectus Regulation extends the categories of documents which can be incorporated by reference and now includes all regulated information (as that term is defined in the Transparency Directive). Under the old regime, regulated information could only be incorporated by reference if it has been filed or notified with the home member state. Also included is a list of documents which may be incorporated, for example, management reports and corporate governance statements.

Profit forecasts

A prospectus containing a profit forecast no longer has to include an auditor’s report. However, given that a prospectus has to include a statement that the forecast has been prepared on a basis that is comparable with the historical financial information and consistent with the issuer’s accounting policies, we expect that sponsors will continue to seek comfort from auditors, albeit on a private basis.

Significant change statement

The statement which must be included in the prospectus has been altered slightly; previously the statement was “no significant change in the financial or trading position of the Group”. It must read “no significant change in the financial position or financial performance of the Group”. The change should be reflected in the requisite comfort letters that are provided by the reporting accountants.

Articles of Association

As an issuer's articles of association are included among the documents that an issuer needs to “make available” (previously the list of hard copy documents in display) and can now be incorporated by reference, the disclosure requirements in relation to the articles of association have been reduced.

Interaction between the Prospectus Regulation's summary provisions and the PRIIPs Regulation 

Comprehension alert

The Prospectus Regulation states that the comprehension alert required under the Regulation on key information documents for packaged retail and insurance-based investment products (the “PRIIPs Regulation”) must be included in the summary where applicable. This doesn’t mean an alert must be included where an issuer is simply subject to the PRIIPs Regulations (and must, therefore, produce a key information document (“KID”)) - a comprehension alert is not required to be included in all KIDs. The criteria for inclusion is, essentially, where a fund invests in underlying assets in which retail investors do not commonly invest (‘assets’ are not defined). If, however, a product is determined to be complex under the relevant provisions contained in MIFID II, the comprehension alert must be included.

Where a comprehension alert must be included, the PRIIPs Regulation doesn’t provide for any deviation from the stipulated wording and so the exact wording contained in the PRIIPs Regulation should be used, i.e. “You are about purchase a product that is not simple and may be difficult to understand”.

A comprehension alert may also need to be included in advertisements (see ‘Advertisements’ below).

KID substitution

The Prospectus Regulation gives issuers who are subject to the requirement to produce a KID under the PRIIPs Regulations the option to use the KID in substitution for part of the prospectus summary. The issuer will be deemed to have produced the KID and fulfilled such obligations under the PRIIPs Regulations, so long as it provides investors with a copy of the summary.

The issues with the KID content are already well publicised and there is no obvious reason for a fund to want to include the KID in its key marketing document. As a result, we do not expect this option to be used by any well advised fund.

Rather worryingly though, the Prospectus Regulation includes a provision that a member state acting as a home member state may require an issuer to use the KID in part substitution of its summary. No further guidance is provided as to the circumstances under which member states should impose this.

New simplified disclosure regimes

Secondary issues

The Prospectus Regulation sets out a reduced disclosure regime for funds making a secondary offer where the issuer has had its securities admitted to trading on a regulated market for at least 18 months. One of the most significant reduced disclosure requirements is to include only one year (as opposed to three years) of accounts. This is unlikely to be used though where there is any significant fundraising activity outside the EEA, particularly in the US.

The reduced disclosure regime is not expected to have a significant impact for funds. One of the key changes for trading companies is that the operating and financial review can be incorporated by reference from the accounts. This has already been the accepted practice for listed funds for a number of years.

Universal registration document

A universal registration document (“URD”) is a shelf document maintained by an issuer on an ongoing basis. It enables issuers to conduct an offering on an accelerated basis by using the URD together with a securities note and summary. Once a URD has been approved for two consecutive financial years, subsequent URDs may be filed with competent authority without prior approval (provided one is filed each financial year). A further benefit is that prospectuses prepared using a URD benefit from a fast track approval; five, rather than ten, working days.

A URD may prove attractive to any investment funds which anticipate having a rolling 12 month placing programme that is renewed on an annual basis (i.e. where it expects to be issuing new shares each year).

Operative differences

Supplementary prospectuses

There is a new obligation on financial intermediaries to contact investors on the day of publication of a supplementary prospectus to inform them of their withdrawal rights.

Publication of prospectuses

The previously available option of publishing in printed form at offices of issuer, regulated market or financial intermediary will no longer be available. Instead, the prospectus will be will be deemed to be available to the public when published on the website of the issuer, relevant financial intermediary or the regulated market where admission is sought.

Website references

If the issuer has a website, it will be required to disclose its address in the prospectus, with a disclaimer noting that the information on the site does not form part of the prospectus, unless that information is incorporated by reference.

Hyperlinks can be included in a prospectus provided that the prospectus includes a statement that information on the website does not form part of the prospectus and has not been approved by the competent authority.

Advertisements

An advertisement is now more broadly defined to be a “communication” which:

  • relates to a specific offer of securities to the public or admission to trading on a regulated market; and
  • aims to specifically promote the potential subscription or acquisition of securities.

The new definition could potentially include purely bilateral conversations (for example, emails and phone calls) which satisfy the test.

There are no transitional provisions: any advertisements for offerings going beyond 21 July 2019 will need to comply with new regime.

A PRIIPs comprehension alert must be included in advertisements where (i) the advert relates to ‘complex’ securities; and (ii) where it will be included in the prospectus summary.

Brexit

Of course, the continuing spectre of Brexit adds a layer of uncertainty to the introduction of the new regime.

In the event of a deal, under the terms of the Withdrawal Act, the Prospectus Regulation will be onshored and will continue to apply during the transition period. In the event of a No-deal Brexit, the regime will stay in place due to the provisions having been copied out to form the PRR chapter of the FCA Handbook. In time, there may well be a divergence between the EU prospectus rules as amended in the future, and the position as adopted by the UK upon exit.

Passporting

The Government has confirmed that it intends to treat prospectuses that are valid in the UK before exit (including EU prospectuses passported into the UK) as valid for the remainder of the 12 months from their date of approval, even where that includes a period after the UK exits the EU. However, prospectuses that are approved before exit day by the FCA will not be able to be passported in the EU in the event of a no-deal Brexit. Looking ahead, any new prospectuses which are intended to be used to market to UK investors will need to be
approved by the FCA, regardless of whether the prospectus has already been approved by another member state.

ESMA Guidance and Q&A

Non-Legislative material – known as ‘Level 3 materials’, such as ESMA Q&As and guidance, will not be incorporated into UK law under the Withdrawal Act, or in the event of a No Deal Brexit.

The FCA has stated that it will issue non-Handbook guidance on its approach after exit day to existing EU Level 3 material. The FCA has also said it would not carry out a detailed line-by-line review of all existing EU Level 3 materials and that it expects issuers to continue to apply Level 3 materials to the extent that they remain relevant, as they did before exit-day. Indeed, rule 1.1.17 of the PRR includes a provision that, in determining whether the rules have been complied with, the FCA will consider the relevant ESMA prospectus recommendations, Q&As and opinions (to the extent relevant).

In relation to the recently published consultation paper on replacing the CESR guidelines with new ESMA guidelines, the FCA has stated that it does not consider consultation documents to be Level 3 materials. It will continue to have regard to material such as consultation papers where and if relevant.

 

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