FSA's Continuing Obligations Regime
Speech by Mike Knight, Manager, Company Monitoring, FSA
City and Financial Conference on the FSA's Continuing Obligations Regime,
21 November 2007.
Good morning and thank you for the opportunity to speak at the City and Financial 'FSA Continuing Obligations Regime' conference. When this event occurred last year the FSA was working intensively on implementing the Transparency Directive, (the TD) – everything from consultation with stakeholders as to how the revisions to the regime might work and what challenges were ahead to the legal transposition work, (actually turning the TD into FSA handbook text).
12 months on, we can now look back on nearly a year of consolidation as this new regime beds down. I propose to set out some reflections as well as remark on the key messages we in the Listing Authority, as well as FSA generally, would want market participants to take from today. I'll structure these comments across four themes: regulatory change; corporate reporting; market conditions and issuer responsibilities; and how the FSA's Company Monitoring team interacts with advisers and issuers.
Regulatory change
You couldn't talk on Continuing Obligations without noting the sheer scale of change that has occurred to the structure of the regime. Those with long memories will remember Chapter 9, (in particular 9.1-9.4), of the old Yellow Book which, upon the UK Listing Authority's transference to the FSA, became the Purple Book. In 2005, through a combination of the FSA's review of the Listing Regime and the necessity to house both the Prospectus Directive and the issuer-facing elements of the Market Abuse Directive within the FSA Handbook, the majority of the Continuing Obligations were hived off to a separate and comparatively slim volume, the 'Disclosure Rules', (DRs).
2007 has seen the expansion of this - to encompass the TD requirements – the result being the 'Disclosure and Transparency Rules. I will leave today's other speakers to outline the detail of these to you, but it's worth bearing in mind that this year, for the first time, has brought about a relatively complete package of periodic and ad hoc disclosure requirements within one volume.
Inevitably there's been a lot for issuers and advisers to get to grips with in the new regime. Some of the changes have been conceptual, some merely the language in which longstanding requirements have been couched. As with other European directives, we have all had to come to terms with adapting UK practices and traditions into something that works within a pan-European framework.
We should also take into account the concurrent revision of the UK Companies Act and complexities behind the phased implementation of this as, noting the recent postponement decisions, and the TD itself. Again, other speakers will take you through the details, but I would like to offer some specific comments from FSA's perspective:
Firstly, we faced a significant logistical challenge in dealing with queries about the new regime. At one stage the UKLA's Company Monitoring team were receiving over 300 calls a week – far more than when the new Disclosure Rules came in. Despite some market participants' perceptions to the contrary, we aren't a vast call centre, so it's been an intense working environment at times.
In addition to dealing with individual queries, we have worked hard to ensure that there is publicly available material setting out our views on how the regime applies. You will probably hear reference today to our List! newsletter distributed to many issuers and representative bodies and placed on our website. After considerable consultation with market user groups, we published the TD- specific List!14 in December 2006. Following the experience we gained in the early stages of TD implementation we updated this in April this year. We've heard from various people that, in absence of CESR Level 3 guidance, (more on this shortly), List! has become a helpful de facto guide to TD obligations, (even though this newsletter is not formal FSA guidance).
One aspect of this exercise has been ensuring that we have adequately engaged with a hitherto relatively unfamiliar constituency for us – major shareholders. Taking on the old Companies Act / DTI regime, in addition to an untested TD framework, has meant that we ourselves have had to come up a substantial learning curve. In addition, we could argue that the UK has been a highly prominent, if not the most prominent, implementer of the TD major shareholdings regime. Let's not forget that the UK markets have very diverse and international issuers, as well as investor communities. The detail of how this shareholdings disclosure regime applies to such a variety of issuers and investors has therefore had as significant an impact in the UK as anywhere.
In line with the FSA's general policy we have been taking a proactive, risk-based approach to policing compliance with the major shareholdings disclosure rules. We also have received a high number of queries relating to the technical realities of 'direct and/or indirect' holdings of voting rights. Whilst we are comfortable in discussing our understanding of these concepts in general terms, in many cases we have considered it more appropriate, at least in the first instance, to require issuers themselves and their advisers to make a judgement call on their own detailed factual circumstances.
We might expect further clarification on some shareholdings technical issues, amongst other issues, as part of the CESR Level 3 process. This is the mechanism by which European regulators meet, with a view to promoting harmonisation of working level arrangements and standards. More information on this can be found on the CESR website.
During 2007 our approach has been one of working to ensure that market participants understand and comply with their obligations. On a few occasions we've needed to take a strong line with issuers and investors and we will be prepared to consider enforcement action where there are grounds for this.
I would emphasise however that, despite these changes, it's important to remember the fundamental requirements and philosophy of the Continuing Obligations regime – to promote adequate information being disclosed to the market such that investors can make informed investment decisions – remains unaltered.
Buttressing these fundamentals are protections such as the Model Code, which seeks to ensure that key individuals within primary listed equity issuers are not perceived to be at an informational advantage to other market players. I would remind you that such individuals, given the sensitivity of information they may have access to –company financial performance for instance - should not forget any Code of Market Conduct obligations that might be relevant to them.
Evolving corporate reporting
We recognise that the specific changes to the Continuing obligations regime sit within a wider context of developments in corporate reporting. There has of course been significant progress in developing globally recognised accounting standards and, in addition to quantitative disclosure, there is greater focus on the role of narrative reporting. Many issuers now communicate with their shareholders on a wholly electronic basis, further promoting the ease of production and dissemination of relevant information.
One of the key changes seen this year is the revised financial reporting timetables, gradually biting as we transition into the new rules. Ever more issuers are required to meet these accelerated deadlines. We have heard concerns that these revisions would be difficult for issuers to meet. However, whilst we are aware that the greatest impact will probably not be seen until 2008, we are pleased to observe that to date, TD-obligated half yearly reports have been reported on a timely basis. I would add that we have been proactive in contacting issuers to ensure awareness of the revised measures. In due course we plan to revert to our approach of using our powers to impose listing suspensions should deadlines not be met.
The new ‘Interim Management Statements’ have attracted some press comment. I can confirm that the FSA continues to monitor how issuers are using these to explain material events and transactions between more formal period end reports. We have maintained an approach that, in the UK, we would look to the market – issuers, investors and analysts; to identify how IMSs could best deliver their objectives. Could, for instance, evidence that analysts are able to garner adequate information to update their clients on their recommendations show this process as working ? We will also need to keep an eye on developments at CESR level where IMS are a subject which is on the agenda for work in the Level 3 process.
There has been some speculation that some issuers are adopting a minimalist approach and/or are not complying with their obligations. We continue to monitor the situation and will take action where appropriate. We have also flagged the possibility of undertaking a wider review in 2008-9. Such a review might be at our initiative or form part of CESR-related work.
FSA also remains active in EU financial reporting policy negotiation and implementation. We are working closely with the Financial Reporting Review Panel, one of the FRC bodies, to ensure that the necessary review and enforcement procedures are in place for financial reporting for all TD issuers – equity, debt and depositary receipt issuers. One of the key aspects of this is that the TD covers so-called ‘third country’ issuers. Slightly disappointingly, this has meant us having to be in contact with to issuers across a number of jurisdictions to ensure that the requisite administrative arrangements are in place. We would remind international issuers looking to take advantage of the EU capital markets and the UK markets in particular, not to forget their reporting obligations.
Further, the UK continues to be a leading contributor the EU wide ‘equivalence’ debates on accounting standards for third country issuers. You should keep an eye out here for upcoming European Commission publications on this. CESR has also just published a report on implementation and enforcement of IFRS within the EU.
As ever, the philosophical debates continue about optimal levels of reporting. Some commentators will argue for continuous - effectively real time - financial reporting. What is certainly true is the need for issuers to remain cognisant with the real time context for the reporting of inside information. Interestingly, we have informally met with a range of market participants to debate how inside information originates within issuers across different sectors and as a consequence when possible disclosure obligations may arise. Take for instance, a general retailer in the lead up to Christmas – could one week’s like for like trading performance, should it be significantly behind the previous year, require disclosure? What would happen if the following week’s performance then was particularly good?
We would say that issuers and their advisers need to take account of the information needs and expectations of the ‘reasonable investor’, the test that underpins several key aspects of the Directives that are implemented in the DTRs.
In June this year we sent, (and published on our website) a ‘Dear CFO’ letter to the majority of the non-FTSE 350 equity issuers to remind them of the necessity to ensure they have adequate systems and controls to allow them to meet their ongoing obligations. The importance of this will only increase if credit and economic conditions tighten.
The Listing Principles set out the high level requirements here, but in essence, we would expect that the key decision making organs of an issuer, (the most obvious being the board itself), on a timely basis, are able to identify concerns where inside information may arise and to assess disclosure obligations against this. Undoubtedly, they will need to be supported by appropriate internal reporting procedures as well as through their dealings with bodies such as auditors and accountants. Many issuers will seek advice from a broker when determining price sensitivity of a potential announcement.
Market conditions and dynamics
The third theme warranting comment is that of market conditions seen during the year. You could say there’s been two distinct periods:
Firstly, the ‘frothiness’ of bid speculation that was present earlier in the year. My team’s working days, which entail monitoring price movements in a range of stocks, seemed to be dominated for quite some time by news that yet another private equity bidder was running the rule over a listed company and speculation about the next takeover target was rife.
In this context it is worth saying something about our relationship with the Takeover Panel. The Panel is, of course, the lead authority for takeovers where UK companies are the target and we endeavour not to duplicate the work they do. The Panel will normally lead on real time contact with advisers to the parties involved in these situations. We liaise closely with the Panel – we are in contact most days – and we have a good working relationship with them.
We do remain concerned at the high level of ‘informed’ price movements, and the leaks that may precipitate these, occurring before announcements of UK M&A transactions. We published a study this year that suggested, on the latest available data, (2005), that such movements occurred in 25% of cases. This is, importantly, not of course the same as saying that there was insider dealing in the same number of cases and it is not therefore a statistic that we review in isolation.
In addition to our work on detecting and pursuing insider dealing, we want to improve controls over inside information, particularly relating to M&A deals, to reduce the potential for leaks. FSA's Marketwatch publication, (Marketwatch21, published in July 2007, http://www.fsa.gov.uk/pubs/newsletters/mw_newsletter21.pdf), contains outlines of good practice for the handling and control of inside information, for all those who handle this type of information including issuers and regulated firms.
We stated in the publication that we will take action in circumstances where we feel a leak of inside information has occurred, particularly where this may be deliberate. We forwarded a copy of the article to issuers subscribing to UKLA's LIST! publication and hope that you have seen it and are undertaking reviews of your own controls against the good practice. We are working with issuers and representative bodies to further promote standards and with a view to market participants themselves developing a voluntary statement of good practice.
Also coming to the fore this year is the role of activist shareholders. Some will argue that listed issuers are having to develop new strategies for dealing with what some commentators portray as the widening disparity in objectives between boards of listed companies and particular activists or funds. The robustness of the major shareholdings disclosure regime can be important in such contested situations.
You will have seen the recent coverage of FSA’s proposals regarding disclosure of major voting rights stakes held via derivatives, in particular CfDs. The FSA recognises the importance of developing a disclosure regime that best fits the needs of the UK. This is not a clampdown on CfDs but a means, following extensive research, of addressing the concerns about their use on an undisclosed basis. While the behaviour that concerns us is not widespread, it is important enough to require a tightening of the existing regime to ensure fair and orderly markets. Our goal is to provide an effective and proportionate disclosure regime that works for all involved, and sustains market confidence and efficiency. We remain in the consultation period, so I would encourage delegates and their firms to respond with their thoughts.
Conditions in the latter part of the year have obviously been more choppy and overshadowed by the credit crunch. So it may be worthwhile to say a few words about the responsibilities of issuers when faced with bad news. The Continuing Obligations framework under which we operate is based on the requirement to disclose information which meets the tests for inside information. The disclosure regime does recognise that some information can be kept confidential until developments are at a stage when an announcement can be made without prejudicing the legitimate interests of the issuer. However, the ability to delay disclosure of inside information is conditional not absolute. In particular it is subject to there being no leaks and the delay not being likely to mislead the public. These are conditions specified on the face of the Market Abuse Directive itself and we do not have the ability to waive them.
We do recognise that the Continuing Obligations regime applies across a wide range of circumstances which companies can encounter. The UKLA will continue to treat individual cases on their merits and expects issuers and their advisers to do likewise.
We also recognise that, unlike periodic reports where companies will have tried and tested processes and an obvious announcement date, ad hoc events which can affect a company's share price and trigger disclosure obligations can arise very quickly and unexpectedly. These events can also often be unpleasant and stressful. Bad news is obviously unwelcome to those who have to cope with it and we appreciate that making an announcement to the market may not be the company's top priority in these circumstances. But when bad news has crystallised it is necessary to inform the market and unless the conditions for delaying disclosure are met, announcements should be made as soon as possible.
Closing remarks
I would like to close by saying something about how the Company Monitoring team operates and what you might expect when dealing with us.
Our working day starts at 7am, when we look through the press and media services for suspicions of leakage of inside information. Where this seems likely or possible, we follow through by contacting the issuer or its agents or advisers. We may ring you if our records show that you're involved in a transaction or story. We may need to delve into or push hard on a particular issue in order to comfort ourselves that no announcement would be required, should this be the case. Occasionally these investigations will result in an announcement being made, perhaps with a little encouragement from us. In rare circumstances we may need to require that an announcement be made. Suspension of the listing of a security is also an option – either requested by the issuer or imposed by us.
We take a risk based approach to dealing with helpdesk queries. We need to focus our energies on dealing with issues arising for both companies and investors that pose a genuine threat to the clean and efficient operation of the markets. We are less keen to deal with queries where it is obvious that the enquirer has not undertaken their own research and wants to use us as a free compliance or legal service. Similarly we do not take kindly to companies' and directors' advisers pushing us to approve or legitimise individual transactions or proposals.
Nonetheless, difficult circumstances can be resolved with good communication. We will always endeavour to respect market participants' viewpoints, knowledge and experience but to do our work properly, we may need to push hard when investigating leaks, rumours and uncertainties. So advisers and issuers should on occasion expect to be challenged by us; it is part and parcel of our job of trying to ensure that the market receives the information it is entitled to.