New EU legal traps for Asian issuers

Clifford Chance partner Stephen Roith and senior associate Connie Heng discuss how the proposed Transparency Directive could potentially trap Asian issuers tapping the Eurobond market.

For about 40 years, Europe has been host to the Eurobond market largely centred in London. Of major significance to the Eurobond market is the fact that the regulatory regime governing issuers of securities in the European Union (EU) will radically change within the next 18 months or so. Through its Financial Services Action Plan, the European Commission hopes to create an integrated European market for financial services aimed at facilitating capital raising for companies throughout the EU whilst at the same time reinforcing protection for investors. Key measures under the Financial Services Action Plan include:

  • a Prospectus Directive which deals primarily with the initial disclosure requirements for the public offering of securities, admission of securities to trading on an EU regulated market and the use of a single prospectus approved by one competent authority in any EU member state;
  • a Transparency Directive dealing with the periodic disclosure obligations of such issuers;
  • the requirements for listed EU companies to adopt International Financial Reporting Standards (IFRS), the successor to the International Accounting Standards; and
  • a new Market Abuse Directive requiring immediate public disclosure of price-sensitive information by issuers that have securities admitted to an EU regulated market.

The Prospectus Directive, which is the centrepiece of the Financial Services Action Plan, came into force on 31 December 2003 but the Transparency Directive is still in draft form and scheduled to be debated by the European Parliament in the first quarter of 2004. None of the provisions of either Directive is scheduled to have effect as a matter of domestic law in any member state until mid-2005 (in the case of the Prospectus Directive) or early 2006 (in the case of the Transparency Directive).

Nevertheless, Asian issuers of securities (used here to mean any issuer which is not incorporated in the EU) could be taking or planning actions now which, in the light of the provisions of these Directives, could have far-reaching and irreversible effects.

The Prospectus Directive - Competent Authority for Approval of Prospectuses

One of the aims of the Prospectus Directive is to allow issuers to conduct pan-European offerings using a single offer document approved by a regulator in one EU member state. Once a prospectus has been approved by a competent authority in a member state, it can be used in any member state by an issuer for a public offer or to obtain a listing without any additional disclosure being required.

Currently, an issuer is subject to the regulatory regime of each member state in which it chooses to list or offer its securities. Under the Prospectus Directive, approval of the prospectus must be given by a "home member state" of the issuer which removes the flexibility of choice of regulatory regimes which issuers currently have.

The Transparency Directive - On-going Reporting Requirements

The current text of the proposed Transparency Directive seeks to impose on-going reporting requirements on issuers of securities admitted to trading on an EU regulated market. The following requirements are most likely to have an impact on Asian issuers:

  • the requirement to file with the competent authority in the issuer's "home member state" its annual audited and its half-yearly financial statements and a quarterly management statement concerning the financial performance of the issuer, and any material events, during the relevant period;
  • the requirement for an issuer to publish its financial statements in accordance with IFRS or standards "equivalent" to IFRS; and
  • the language in which the issuer's financial information is disclosed.

Why does the choice of "home member state" matter?

Theoretically, it should not matter as the new regime is meant to harmonise the prospectus requirements across the EU. However, in practice, this may be an important factor as a number of discretions under the Prospectus Directive and the Transparency Directive may be exercised differently by different competent authorities and different member states. Further, some competent authorities may prove to be more efficient or flexible in their interpretation and application of certain rules than others.

For example, competent authorities or member states may choose not to accept prospectuses drawn up in certain languages or may require summaries of prospectuses to be prepared both in the language of the prospectus and in another language. (This should not pose a problem where securities are offered or listed in the UK or Luxembourg, as English will be accepted by these member states.)

Where an Asian issuer is not required in its home country to prepare and publish its financial statements in accordance with IFRS, the competent authorities in each member state will have a discretion to determine whether or not to recognise the accounting and auditing standards of an Asian jurisdiction as being "equivalent" to the corresponding standards required of issuers incorporated in a member state. The European Commission has not indicated which countries' accounting standards are "equivalent". For Hong Kong incorporated issuers, this may ultimately prove to be less of an issue as Hong Kong GAAP is in the course of being harmonised with IFRS. However, few issuers in other Asian countries currently prepare financial statements according to IFRS. If the competent authority of an Asian issuer's "home member state" does not recognise such equivalence, the issuer could be obliged either to restate its financial statements according to IFRS or to de-list their securities from all EU stock exchanges when the Transparency Directive comes into effect.

Freedom of choice of competent authority can be achieved by the use of simple structuring (such as using a denomination of at least €1,000 (or its near equivalent in other currencies)) so that an issuer can choose the competent authority on an issue by issue basis. See further discussion below.

Asian Issuers may get irreversibly "trapped" in a "home member state"

31 December 2003, the date on which the Prospectus Directive was published in the Official Journal (the Publication Date), could be a critical date for many Asian issuers. On the dates when the member states bring into force domestic legislation to comply with the Prospectus Directive (the Effective Date), many Asian issuers could find that actions taken by them in the period between the Publication Date and the Effective Date have locked them irreversibly into a particular EU member state as their "home member state" for the purposes of the Prospectus Directive and the Transparency Directive.

Issuers of shares, convertible bonds and Low Denomination Securities

For Asian issuers of:

  • shares;
  • convertible bonds of whatever denomination (that is, bonds which are convertible into shares of the bond issuer or another company within the bond issuer's group); or
  • other securities having a denomination of less than €1,000 (or "nearly equivalent") (Low Denomination Securities),

there is essentially a once-only opportunity for them to choose their "home member state" for the purposes of the Prospectus Directive and the Transparency Directive. This arises upon the first occasion after the Publication Date on which an Asian issuer either:

  • makes a public offer in a member state of any such securities; or
  • applies for admission of any such securities to trading on a regulated market in a member state.

The member state in which the public offer is made or in which the regulated market is located will be that issuer's "home member state", once the Prospectus Directive and the Transparency Directive are in force for future issues of shares, convertible bonds or Low Denomination Securities. Although unlikely to be the case, if an Asian issuer chooses to do both these things in different member states, then the issuer may choose which of those actions determines its "home member state" for the purposes of the Prospectus Directive and the Transparency Directive.

To illustrate with an example: An Asian issuer decides to raise funds in the Eurobond market by issuing convertible bonds, shares or Low Denomination Securities. It applies to list such securities on the Luxembourg stock exchange on 15 March 2004 (i.e. after 31 December 2003, the Publication Date), then upon such application (assuming that it has not made a public offering of such types of securities in an EU member state after the Publication Date) the Asian issuer would have irrevocably chosen Luxembourg as its "home member state" with respect to future issuances of such securities for the purposes of the Prospectus Directive and the Transparency Directive. The Asian issuer would be taken to have made the choice now of its "home member state" for such securities even though neither the Prospectus Directive nor the Transparency Directive have been implemented as domestic law in Luxembourg.

Further, if an Asian issuer has any such securities admitted to trading on a regulated market in a member state at 31 December 2005 but, since the Publication Date, it has neither:

  • made a public offer in a member state of any such securities; or
  • applied for admission of any such securities to trading on a regulated market in a member state,

then it has the ability to make an election of its "home member state" for the purposes of the Prospectus Directive and the Transparency Directive with respect to such securities.

Issuers of high denomination securities

An issuer of securities which are not shares, convertible bonds or Low Denomination Securities has the freedom to choose its "home member state" for such securities for the purposes of the Prospectus Directive and the Transparency Directive on an issue by issue basis.

Guarding against possible surprises

Asian issuers should be careful of any communications concerning their securities or any dealings with any regulated market in a member state as such actions could possibly be construed as either an offer to the public in a member state or an application for admission to trading on a regulated market in a member state under the Prospectus Directive.

For example, communications with employees concerning share incentive schemes, while often excluded from any obligation to publish a prospectus, may nevertheless fall within the extremely wide definition in the Prospectus Directive of "offer of securities to the public". Similarly the routine admission of any such shares, even a very small number, to trading on a regulated market in a member state, irrespective of whether any trading of such shares actually takes place on such market, may be sufficient to lock in a home member state for the relevant issuer.

Other events to scrutinise closely include the following:

  • routine updates of medium term note (MTN) and similar debt issuance programmes (even if no securities are being offered or issued at the time) - for example, where a programme provides for securities issued under the programme to be admitted to trading on the Luxembourg stock exchange, the update process would arguably involve an application for admission to trading on a regulated market of securities to be issued under the programme. This would not be a concern if the programme documentation at the time of the establishment or updates state that no notes issued by such issuers having a denomination of less than €1000 (or its equivalent in any other currency) may be issued under the programme; and
  • the establishment of any new MTN or similar debt issuance programme.

Commercial paper programmes should not be a concern as commercial paper with a maturity of less than 12 months is outside the scope of the Prospectus Directive and the Transparency Directive.

Some important exemptions from on-going obligations

€50,000 appears to be the magic number as a number of exemptions from on-going obligations are available to issuers with debt securities in a minimum denomination of €50,000 (or its equivalent in another currency). These exemptions include:

Prospectus Directive:

Under the Prospectus Directive, issuers of such securities are exempt from the requirement to file annually with the competent authority of their "home member state" a document listing all of the information they have published over the preceding 12 months in compliance with their obligations under laws and regulations applicable to them in any country. This exemption does not apply to convertible bonds.

Transparency Directive:

  • Exemption from financial reporting: Issuers will not be required to comply with requirements to file with the competent authority in its "home member state" its annual audited financial statements and its half-yearly financial statements, in each case prepared according to IFRS, together with a management report including a review of the performance of the issuer's business during the relevant period and a description of the principal risks and uncertainties it faces; and
  • Easier language regime: Regulated information can be disclosed to the public either in a language accepted by the competent authorities of the home and host member states or in a language customary in the sphere of international finance (which is generally accepted to be English), at the choice of the issuer.

The Transparency Directive only applies to issuers with securities admitted to trading on a regulated market in an EU member state. For Asian issuers which have shares, convertible bonds or securities which have a minimum denomination of less than €50,000 (or equivalent in another currency) listed in the EU when the Transparency Directive comes into effect as domestic law in the relevant member state(s), their only options are either to comply with the requirements of the Transparency Directive or to remove their relevant securities from admission to trading on the relevant regulated market(s).

"Grandfathering" provisions

For issuers of debt securities which have a minimum denomination of less than €50,000 (or equivalent in another currency), which are already in issue and which will not mature until after the Transparency Directive comes into effect as a matter of domestic law in the relevant member state(s), currently the only "grandfathering" provision is a discretion for the competent authority in the relevant home member state to exempt the issuer for a period of seven years from the obligation to disclose half-yearly reports. These very limited "grandfathering" provisions are only available to issuers whose last application for admission of any debt securities to trading on a regulated market in the EU is made before the Publication Date of the Prospectus Directive.

Asian issuers considering a new issue may want to include provisions in their new issue documentation giving them the option to switch the listing of their securities to non-EU stock exchanges if the Transparency Directive is brought into force in a form which they find onerous.

To list or not to list…

Since the Sarbanes-Oxley Act came into force in the wake of the Enron debacle, Asian issuers have been less willing to embark on registered offerings in the United States. With the impending radical changes to the regulatory regime governing issuers of securities in the EU, Asian issuers considering a fund raising exercise in the international capital markets will now not only have to consider the impact of the Sarbanes-Oxley Act but also the possible impact of the Prospectus Directive and the Transparency Directive.

None of the provisions of either Directive is scheduled to have effect as a matter of domestic law in any member state until mid-2005 (in the case of the Prospectus Directive) or early 2006 (in the case of the Transparency Directive). Even after they become effective as a matter of domestic law, it remains to be seen how each member state will implement and enforce the laws in practice. Until the dust settles, Asian issuers are faced with uncertainties, in particular, their disclosure and on-going obligations. The Singapore stock exchange, which streamlined its prospectus approval process two years ago, has become increasingly popular with Asian issuers as a venue for listing. With the changes looming in the EU, we are already seeing more Asian issuers gravitating towards the Singapore stock exchange in order to take advantage of its professional yet less burdensome regime. The Singapore stock exchange may well emerge as the "winner", at least in the Asian context, of the competition to attract listing business in the new US and EU regulatory environment!

Stephen Roith can be contacted at: [email protected] and Connie Heng at [email protected]

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