What Does Revision of the Prospectus Directive Mean for Investors?
As announced in its Action Plan on the Capital Markets Union (CMU), the European Commission has decided to revise the Prospectus Directive. The prospectus regime determines the format and content of the legal document that issuers must present to investors before securities (shares and bonds) are offered to the public or admitted to trading on a regulated market. The Commission published its review proposal on 30 November.
The proposal was preceded by a public consultation on the current prospectus regime that the Commission issued in February 2015. Along with 180 other respondents, CFA Institute provided input to the consultation. So what exactly is the Commission wishing to change in the current European prospectus regime, and what could the proposed changes mean for investors?
From Directive to Regulation
The biggest change in the review proposal is that the Commission proposes to change the original Directive into a Regulation. In practice this means that the European Union (EU) Member States would now have to implement the final law into their national legislation word by word. The implementation in all the Member States would also take place at the same time. Directives, on the other hand, give the Member States much more leeway on the practical uptake of the EU law in their respective jurisdictions
As noted in my previous blog post on the Prospectus Directive, the uneven application of the prospectus regime across Member States has posed several challenges not only to issuers, but also to investors and national regulators alike. Accordingly, it is laudable to see that the Commission has taken note and boldly proposed the change to a Regulation.
Cross-border Challenges: Passporting to Become Easier
Partly because the European prospectus regime has been a Directive, national rules on the form and content of prospectuses have varied from Member State to Member State. This has also made cross-border issuances challenging, as for example the prospectus approval times are very different in all the EU countries. The Commission has noted some of these issues in the proposed Regulation.
To lower the cross-border barriers, the Commission proposes to impose uniform disclosure requirements and to improve the “passporting” of prospectuses from one Member State to another. Once a national regulator approves a prospectus, the issuer can ask for a passport to use this prospectus in another EU Member State. No further approvals or administrative procedures relating to the prospectus would be necessary in this “host” Member State. This passport operates on the assumption that minimum content of the prospectus is harmonised at the EU level by the applicable prospectus rules (the basic rules and the delegated and implementing acts).
The Commission also revises the exemption regime for prospectuses. According to the proposal, there would be no requirement to produce a prospectus if the securities offering is between €500,000 and €10 million and made only in the “home” Member State (no passporting allowed). Both the minimum and maximum thresholds have been increased in the legislative revision. In addition, issuers offering nonequity securities solely to qualified investors or requiring a minimum commitment of €100,000 per investor would still benefit from a prospectus exemption.
The Commission also proposes that the European Securities and Markets Authority (ESMA) report annually on the number of prospectuses produced that year. Through the monitoring the Commission would be able to potentially reassess the exemption regime.
Better Readability for Investors
One of the key concerns with the current Prospectus Directive is the usefulness of the prospectus for investors. European prospectuses have often amounted to hundreds of pages, with some exceeding 2,000 pages. It has left many wondering how useful such dense documents are for investors, and how many would actually read them fully before making the decision to invest.
The Commission is now proposing several changes to improve the readability of prospectuses from the investor viewpoint. One of the key proposed changes is the reform of the prospectus summary (Article 7 of the proposal). While the summaries are often dozens of pages long, the Commission is now proposing a maximum page limit of six sides of an A4, written in a font big enough to be readable without a magnifying glass. The proposal also prohibits the use of hyperlinks and incorporation of reference in the prospectus summary in order to enhance the readability of the document.
The proposal is modelled according to the Key Information Document (KID) as defined in the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation. Similarly to the KID, the prospectus summary would have three main sections covering key information on the issuer, the security, and the offer/admission, respectively.
Moreover, the Commission is proposing to refocus the “risk factors” section of the prospectus. The risk section typically runs to dozens of pages as issuers attempt to capture all possible risks that could ever occur and affect the share price. The risk factor section of the prospectus has been considered as the issuer’s “liability shield.” The Commission proposes that in the future, the risks mentioned in the prospectus should only be “material and specific to the issuer and securities” (Article 16).
The Commission also proposes the creation of a pan-European prospectus database. The online databank would be accessible on ESMA’s website free of charge and would contain a search function of all European prospectuses. CFA Institute supports this proposal.
SMEs: Some Reductions in Prospectus Burden
One of the Commission’s main aims with the revision is to simplify the prospectus regime for small and medium-sized enterprises (SMEs). According to the Commission, 99 out of 100 European businesses are SMEs, and thus act as the backbone of the European economy. In the Prospectus Regulation proposal, SMEs are defined as companies with less than €200 million under market capitalization, a threshold that was increased from €100 million to reflect the changes also introduced in the revised Markets in Financial Instruments Directive (MiFID II).
To alleviate the burden that SMEs often face when going public, the Commission proposes several changes to the current regime. For example, SMEs will be encouraged to take advantage of a new “Questions and Answers” (Q&A) format as opposed to producing a full-blown prospectus (Article 15). The Commission notes, however, that this kind of prospectus should not be available to SMEs admitted to trading on regulated markets. CFA Institute agrees that it is important to avoid creating a “two-tier” disclosure standard on regulated markets to make sure that investors in these markets have access to equally high levels of information.
The specific format of the Q&A document would be defined by ESMA after political agreement on the file has been reached among the European Parliament, Commission, and Council (i.e., at Level II). CFA Institute believes that it is crucial to make the proposed Q&A document sufficiently detailed because it would be hard to attract investors to these securities, which are typically more risky than the offerings of larger companies.
The Commission also proposes an “alleviated” regime for secondary issuances. The simplified prospectus will only contain minimum financial information covering the last financial year only, in addition to basic information such as the terms of the offer and risk factors. The new “Universal Registration Document” is also expected to better facilitate frequent issuers through fast-tracked approval processes for secondary offerings (Article 9 of the proposal).
Political Negotiations to Begin
While the Commission has proposed several changes to the current European prospectus regime, the proposal will now be subject to political negotiations and horse trading among the other EU institutions. The European Parliament and the Council (representing EU Member States) will start by analysing the proposal separately in January 2016 at the latest.
Commissioner Jonathan Hill, responsible for financial services at the Commission, said at the press conference announcing the revision that he wishes to have the law implemented in the next two years. Nonetheless, the exact timing depends on how long the political discussions will take. Both the European Parliament and Council are expected to propose several changes to the Commission’s draft law, and it is possible that the final law will be somewhat different from the Commission’s proposal.
Laudable Changes Proposed
CFA Institute broadly supports the changes the Commission proposes in its revision. We support changing the law from a Directive to a Regulation to enhance the harmonisation of prospectus rules in the EU. We also support the creation of a central online database for prospectuses that is free and easy to search.
On the other hand, CFA Institute would like to have further clarity over how the Q&A format for SMEs would work in practice. We also look forward to further discussions on the six-page limit for the prospectus summary. A strict page limit may cause the investor to misinterpret the information provided, both on the potential benefits and risks of the product.
It is clear then that there are many opportunities with the revision to improve investor protection and to make it easier for companies of all sizes to get access to funding in the EU. CFA Institute will continue to closely monitor these developments and to offer input to the discussions on behalf of our members when deemed useful.
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