Could FCA reforms weaken governance standards for UK-listed companies?

The UK financial regulator has proposed relaxing eligibility criteria for companies listing in London, in a bid to kick-start the market

Experts are divided over planned reforms designed to encourage companies to list on the London Stock Exchange, with some warning that they could expose investors and advisers to greater risk.

In December 2023, the Financial Conduct Authority published draft rules that will merge its existing “standard” and “premium” listing categories into a single equity bracket, known as the “commercial companies” category. Earlier in the year, the regulator acknowledged that the UK’s listing rules are viewed as overly complicated. 

Companies have lately shunned the London market in favour of other jurisdictions such as the US — or abandoned plans to list altogether — despite efforts to court high-profile listings of companies such as Saudi Aramco. The state-backed oil giant’s flirtation with listing in the UK capital prompted the creation of the premium category in 2018. 

“The market for companies listing is very competitive,” law firm Travers Smith partner Andrew Gillen tells Sustainable Views. According to EY, the number of London listings fell by 62 per cent in 2022 to just 45 companies arriving on the market from a record 119 the previous year. Meanwhile, the US remains an attractive market for blockbuster initial public offerings, and 63 per cent of IPOs took place in the Asia-Pacific region in 2022, EY says.

Besides creating a new equity category, the FCA has also proposed measures aimed at removing costs, including watering down rules for banks that advise companies listing in London. Known as “sponsors”, banks including Berenberg and Liberum also counsel businesses beyond their IPO, including in areas such as takeovers. 

The reforms will “open up the market to a broader range of companies” and make listing in London more attractive, particularly for higher-growth companies that want to expand through acquisitions, predicts Gillen. Larger mergers and acquisitions currently suffer from delays and costs associated with regulation, he says, so “removing that obstacle to significant transactions is a significant step forward”.

But some commentators are concerned about the impact the FCA’s proposals could have on governance standards in the London market. “It’s certainly a backwards step for the UK,” law firm Pomerantz director of ESG and UK client services Daniel Summerfield tells Sustainable Views. “We’re viewed very highly by other markets in that regard.”

Rebalancing risk

The watchdog wants to shift its listing regime away from regulation and towards more company disclosure and engagement, with a greater emphasis on the use of stewardship and shareholder rights to direct companies. Companies in the new category will still have to comply with the UK Corporate Governance Code.

“We recognise these proposals would result in a rebalancing of risk. We have to recognise that this may mean more failures as part of ensuring the market overall supports the risk appetite the economy needs,” the FCA admits in its consultation.

The FCA proposals also include reducing requirements for historical financial information, and companies that intend to list will no longer need to provide a statement setting out their working capital. 

According to Pomerantz’s Summerfield, the merging of premium and standard categories is “a major problem” and could cause issues for passive investors such as pension schemes, many of which exclude certain companies for governance reasons.

“The premium listing is a prerequisite for a lot of index providers to include companies in their indices,” he says. “There’s a real risk that pension schemes that invest in index funds will be exposed to companies which otherwise would be on the standard listing and not in their portfolios.”

The reforms are “going to increase the due diligence on the part of investors prior to making that investment, and it’s going to make investment in UK equities riskier”, he adds.

Speaking to The Telegraph in January, short seller Carson Block, the founder of Muddy Waters Capital, cautioned the UK against following the US on listing rules.

“The US provides the highest valuations for listed companies, but in many ways the US leads the race to the bottom in terms of the corporate governance practices,” Block says. “The moral choice for the UK is to say, ‘fine, we will remain somewhat of a niche market and non-tech oriented market, but we will have among the cleanest major liquid markets in the world’.”

Reputational risk

The FCA envisages a reduced role for sponsors and a lower threshold for companies that wish to provide sponsor services.

Under the current regime, sponsors have to demonstrate competence over a three-year period — the regulator wants to extend this to five years. “Given the dearth in IPOs over the past two years or so, the FCA needed to be more flexible in assessing competency for sponsor applicants,” law firm Bird & Bird partner Clive Hopwell tells Sustainable Views in a statement.

The watchdog has also removed the need for sponsors or shareholders to give the green light to “significant transactions”, limiting the sponsor’s role to significant equity fundraisings where a prospectus is required, related party transactions — those between a listed company and a related party of that company, which will need a sponsor’s opinion — and reverse takeovers.

The moral choice for the UK is to say, ‘fine, we will remain somewhat of a niche market and non-tech oriented market, but we will have among the cleanest major liquid markets in the world’

“This is another example of the FCA passing greater risk to investors, and I suspect that many will feel uncomfortable with the fact that companies will now be able to undertake significant transactions which fall short of a reverse takeover without the involvement of a sponsor or the need for shareholder approval,” says Delphine Currie, partner at law firm Reed Smith, in a statement. 

Weaker eligibility criteria could also create reputational issues for the sponsors themselves. “I doubt that sponsors will take much comfort from these words,” says Currie. “The reputational risk for a sponsor in bringing an unsuitable company to the market cannot be underestimated, and this risk is likely to increase as the reduced eligibility criteria will inevitably lead to more companies seeking a listing.

“While there is a theoretical risk that the proposed changes could result in unsuitable companies coming to market, I think that, in practice, sponsors won’t want to risk their reputation,” Currie adds, predicting that they “will go above and beyond the basic requirements to ensure that only those companies that they think are ready for listing and will succeed on the market are admitted”.

Compelling destination

The watchdog is operating a consultation on sponsors until February 16, with a separate consultation on its wider draft listing rules running until March 22. It intends to bring new rules governing sponsors’ competence in the spring, and will publish its finalised listing rules at the start of the second half of 2024.

Liberum head of investment banking Dru Danford says the reforms will make London a more compelling destination for raising capital.

“I don’t believe the proposed reforms to the listing rules alone will negatively impact standards or shareholder protections,” he says. “Any investor deploying capital to make a return should accept that there is a certain level of risk involved — no amount of regulatory oversight can ever entirely eliminate that.”

Berenberg co-head of UK investment banking Ben Wright also thinks governance standards will be unaffected by the new rules. Without shareholder approval or guidance from sponsors, he predicts that companies looking to carry out transactions will “probably become a bit more conservative initially and probably increase your spend on lawyers and accountants, to make sure that you’re really hitting the mark”.

Rebalancing rules away from investor protection could also help them make more money on the London market.

“Often, the companies which are perceived to have weaker governance are the companies that offer investors the greatest gains and the most interesting investment opportunities,” says Marc Proudfoot, head of investment trusts at law firm Howard Kennedy. “At the moment, the rules are so focused on protecting investors from risk that they make it very difficult for these types of companies to make it to the market.”

A spokesperson for the FCA said: “We want the UK to be a magnet for the brightest and best companies to list here, compete and grow. That’s why we are taking forward reforms to attract a greater range of companies by simplifying the regime and moving to a disclosure-based system.

“UK investors continue to buy across global markets where additional premium protections don’t exist and it is not clear whether they really play a part in decision-making. We welcome feedback on our detailed proposals to make sure that we have the balance of risk right.”

This article has been updated to include the FCA’s comments.