The consultation period is scheduled to close on 2 January 2013, with the FSA expected to publish its feedback in spring 2013. The proposed changes are motivated principally by the FSA’s desire to provide better protection to minority investors. This follows from criticism that the credibility of the premium listing segment has been affected due to a failure by listed companies to properly regulate relationships with their controlling shareholders.
Whilst the proposal for relationship agreements is in many respects a codification of existing best practice, this will mark a return to the pre-2005 position, where the Listing Rules contained an express requirement that an issuer with a controlling shareholder should conduct its business independently of that controlling shareholder, with all transactions and relationships between them being at arm’s length and on a normal commercial basis. This was principally documented in a “relationship agreement” between the company and the shareholder.
Under the old regime, a “controlling shareholder” in this context was a person (or persons acting jointly by agreement, whether formal or otherwise) who was either: (i) entitled to exercise, or control the exercise of, 30% or more of the rights to vote at general meetings of the issuer (voting rights attaching to treasury shares being excluded from the calculation of this percentage); or (ii) able to control the appointment of directors who were able to exercise a majority of votes at board meetings of the issuer.
The obligation to enter into a relationship agreement will be set out in new LR 6.1.4ER(1). The meaning of a “controlling shareholder” will be the same as its previous definition under the pre-2005 Listing Rules. In addition, under a new LR 9.2.2AR(1), there will be an obligation for an issuer to have a relationship agreement in place with any controlling shareholder(s) throughout the duration of its listing (and not just at the time of admission).
Under the proposals, the minimum contents of a relationship agreement will be prescribed by the Listing Rules. These will be set out in a new LR 6.1.4FR, and (consistent with current market practice) will include the following:
- That transactions and relationships between an issuer and its controlling shareholder must be at arm’s length and on normal commercial terms.
- A controlling shareholder must abstain from any acts that would have the effect of preventing the issuer from complying with its obligations under the Listing Rules.
- A controlling shareholder must not influence the day-to-day running of the issuer at an operational level or hold a material shareholding in any significant subsidiaries of the issuer.
- The relationship agreement should remain in place whilst the issuer is listed on the premium segment of the Official List or until it no longer has a controlling shareholder.
- Material amendments to the relationship agreement may only be made with the approval of the independent shareholders of the issuer (i.e. as if they were related party transactions under the Listing Rules).
Although not set out in the minimum content requirements, in some circumstances an issuer may seek to include additional provisions, such as non-solicitation and non-compete clauses, or requirements as to a minimum number of independent directors being on the issuer’s board.
Directors of an issuer with a controlling shareholder will have to include a statement in the company’s annual report setting out that it has complied with the relationship agreement throughout the entire financial year (new LR 9.8.4R(14)); or where the issuer has not so complied, the directors will be required to inform the FSA and to make disclosures in the company’s annual report so as to enable shareholders to evaluate the impact of non-compliance.
It is likely that the proposals to introduce minimum content requirements for relationship agreements in the Listing Rules will go some way to promoting better corporate governance by putting a framework in place to ensure that the issuer’s transactions and relationship with its controlling shareholder are at arm’s length. However, it is possible that the new requirements to have a relationship agreement in place throughout the duration of the listing will create difficulties in circumstances where a shareholder becomes a controlling shareholder after admission and, for example, refuses to enter into the agreement. In addition, the requirement limiting the ‘influence’ of a controlling shareholder on the operational business of the issuer may prove problematic in practice where (as is often the case) the controlling shareholder is represented on the board of the issuer or associates of the shareholder perform executive roles within the issuer.
Under the Listing Rules, the FSA cannot currently impose obligations or sanctions on controlling shareholders. Although it has said that the imposition of a continuing obligation for a relationship agreement will give it greater scope for enforcement, the FSA will nevertheless be left with the dilemma that the use of available sanctions against the issuer, such as a fine, demotion to standard listing or even de-listing, could operate to the detriment of the independent shareholders that the proposed changes are designed to protect.
A full copy of the FSA Consultation Paper 12/25 can be found here.