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Relaxed UK IPO rules could see activist shareholders ‘resorting to the courts’ over ESG

London Stock Exchange
The number of listings in London fell by 62 per cent in 2022 compared with 2021 (Photo: Chris Ratcliffe/Bloomberg)

Experts fear the UK regulator’s attempts to rejuvenate the London listings regime could attract companies with weaker governance, prompting an increase in litigation from investors

The Financial Conduct Authority has proposed simplifying the UK’s listing rules as part of a push to kick-start the ailing London market, sparking fears about a watering down of investor protections.

The number of London listings fell by 62 per cent in 2022 compared with the prior year, according to EY, dropping from a record 119 companies arriving on the market to just 45. Companies are choosing to list in other jurisdictions, with 63 per cent of initial public offerings taking place in the Asia-Pacific region last year.

The FCA acknowledged in May that the UK’s listing regime is seen as overly complicated. It set out a series of proposals including replacing its existing “standard” and “premium” listing categories with a single equity category. 

The watchdog said that this would eliminate eligibility requirements that deter early-stage businesses from listing and be more accepting of dual-class share structures, which give certain shareholders — usually company insiders — greater voting rights than other shareholders.

The FCA proposed removing compulsory shareholder votes on areas such as acquisitions, in order “to reduce frictions to companies pursuing their business strategies”. 

Hayden Morgan, head of sustainability advisory at law firm Pinsent Masons, told Sustainable Views that the FCA’s mooted dual-class share structure “could be considered as eroding shareholders’ rights and influence over a firm’s climate strategy”.

Speaking on a UK Sustainable Investment and Finance Association panel in September, Daniel Summerfield, director of ESG and client services at law firm Pomerantz, warned that relaxed listing rules could spark the arrival of companies with lower governance standards.

“We as investors might have fewer protections to hold companies to account,” he said. “So that may be where litigation starts to become used more frequently to hold companies to account and to address issues which haven’t been looked at properly by the company.”

Summerfield pointed to actions taken by US investors, noting that settlements between companies and investors in the country can include changes to corporate governance and ESG.

Under UK listing rules, companies are required to make climate-related disclosures on a ‘comply or explain’ basis. While the UK’s listing requirements appear onerous, the process itself of joining the London market does not carry explicit ESG demands. The UK does not have “a robust framework” to compel ESG disclosures during IPOs, according to a note by law firm Clifford Chance. 

However, the FCA published a note in 2020 explaining how existing UK rules may compel ESG disclosures during an IPO. Part of the UK’s Prospectus Regulation requires IPO prospectuses to provide the “necessary information which is material to an investor for making an informed assessment … of the issuer”.

Clifford Chance argued that this could include information on companies’ responses to the objectives such as the UK government’s target of reaching net zero by 2050.

We as investors might have fewer protections to hold companies to account. So that may be where litigation starts to become used more frequently

Daniel Summerfield, Pomerantz

 

Though the FCA may see cutting red tape as a way to encourage listings, one lawyer claimed that investors will step up and use legal action to hold companies to account.

“With growing concern that London’s capital markets may be losing their allure, it is unsurprising to see calls to ease regulatory rigour, not least because ESG compliance is quickly becoming a highly politicised area,” said Vernon Dennis, a partner at law firm Howard Kennedy.

Warning that investors will punish companies with weak environmental credentials, Dennis added: “Activist shareholders and a wider constituency of stakeholders will also seek to police conduct, readily resorting to the courts.”

Montanaro Asset Management head of sustainable investment Ed Heaven told Sustainable Views that companies coming to market under the FCA’s new regime will still be expected to demonstrate credible climate plans and report on these transparently.

“If they fail to do this, it will become more difficult for certain investors to buy the company’s stock, particularly given the increase in sustainable regulation and funds having net zero targets of their own to meet,” he said. 

“Any failure to address climate change adequately by directors will most likely lead to a rise in engagement, albeit given the general increase we have seen in climate litigation over the last few years, in some cases we could see it resulting in legal action.”

Caroline Escott, senior investment manager for active ownership at Railpen, which manages around £34bn in assets for the UK’s railways pension funds, said it was reasonable to think that the rolling back of investor protections “might well attract companies who would prefer a reduced shareholder voice on what are fundamental business decisions”.

“Meanwhile, companies that opt for dual-class share structures, without a reasonable sunset clause, are signalling an unwillingness to work in true partnership with their shareholder base,” she continued. “This is potentially an indicator of their wider attitude to good governance and shareholder engagement.”

An FCA spokesperson said: “We considered these issues prior to launching our consultation.

“With many investors choosing to back companies listed overseas where these protections don’t exist, we haven’t seen much evidence that investors do in fact value them. Our reforms, if implemented, would bring our listing standards in line with comparable markets.

“These are proposals at this stage and we are in the process of considering responses to the consultation.”

 

A service from the Financial Times