16 October 2002

 

Ms. Merope Sylvester
Listing Review Project Manager
Financial Services Authority
25 The North Colannade
Canary Wharf
London E14 5HS
United Kingdom

 

Re: FSA's Discussion Paper 14: "Review of the Listing Regime" (Ref. FSA DP14)

 

Dear Ms. Sylvester:

 

The European Advocacy Committee ("EAC" or the "Committee") of the Association for Investment Management and Research ("AIMR")¹ is pleased to comment on the Financial Services Authority's ("FSA" or the "Authority") discussion paper 14, Review of the Listing Regime (the "Review"). The EAC is a standing committee of AIMR charged with reviewing and responding to major new regulatory, legislative, and other developments that may affect investors, the investment profession, and the efficiency and integrity of European financial markets.

 

General Comments

 

The Committee supports the FSA's efforts to maintain the integrity of the U.K. capital markets by reviewing its existing regulatory framework. Such a review is important because over time, regulations may become outdated as new types of financial instruments and activities are created to give issuers new financing and risk management options.

 

In this context the Committee recognizes the changing landscape of regulation within the EU and the effect proposed directives may have on the FSA's role in regulating capital markets within the United Kingdom. As such, we support the FSA's efforts to poll the views of its constituents to determine how it can most effectively fulfill this changing role. Furthermore, the Committee recognizes the importance and relevance of U.K. markets both within Europe and globally. Its reputation as a global regulatory trend setter is well deserved.

 

Our purpose for commenting on this Review is twofold. First, we wish to express our views on the important changes contemplated by the FSA. Second, by stating our views in this context, the EAC will have set precedents for AIMR committees in other jurisdictions to follow.
Finally, as a matter of courtesy, we are sending copies of this letter to representatives of the CESR and the EC, in addition to those of the FSA.

 

Specific Comments

 

Corporate Governance
The FSA has a number of tools through which it regulates the way issuers seeking to list their securities in the United Kingdom govern their enterprises. Among these tools are the:

 

• Model Code, which discourages abuse in the disclosure and dissemination of financial results and significant announcements;
  
• Code of Market Conduct (the "COMC"), which discourages the misuse of information; and
  
• Combined Code, which comprises the Principles of Good Governance and the Code of Best Practice and governs the purpose, function and structure of the board of directors and the functions institutional investors play in corporate governance.
  

 

New legislation coming from the European Commission's Market Abuse Directive (the "Directive") will supersede many of the issues covered by the COMC.

 

Q1: Do you feel the disclosure requirement imposed on issuers in the listing rules to state whether they have abided by the Combined Code is valuable?
In general, the Committee sees such disclosures as useful. If a company states that it is abiding by the local rules in one market within the European Union, the new rules creating a "European Passport" for issuers imply that the issuer also is abiding by laws elsewhere.

 

We particularly support the FSA's requirement that issuers fulfill all the obligations of the Combined Code to claim they have upheld its provisions. If, as in other jurisdictions, issuers could state they abided by the requirements without having to meet all of them it would dilute the value of such disclosures.

 

Q2: Do the provisions of the Model Code still add value in the modern regulatory framework?
Based upon the description provided by the FSA, it appears that the regulations provided by the COMC and the Directive will adequately cover the objectives previously performed by the Model Code. If, after a review of the final form of the Directive, the FSA determines that the Model Code provides redundant protection, then the Committee believes the Authority should no longer require issuers to abide by it, using instead the COMC and the Directive to accomplish the objectives the Model Code has covered. To do otherwise would reduce the efficiency of issuers and potentially make the United Kingdom a less-attractive market for both issuers and investors.

 

Corporate Communication
Corporate communication rules established by the FSA and the U.K. Parliament cover the timeliness and content of disclosures of inside information and forward-looking statements. Many of these issues also are covered by the proposals contained in the Directive, although the FSA points to subtle differences in the manner in which they are regulated.

 

Q3: Have we identified the key issues we should review in the area of corporate communication or are there other areas that you feel merit our attention?
The Committee is concerned that the Review does not mention either the manner in which such communications are disseminated or the time frame in which issuers must make such disclosures. If issuers are not required to disseminate relevant financial and operational information in a manner accessible to all investors and in a time frame which would make the knowledge useful, then investor confidence will erode as "insiders," those with access to the intelligence, are seen as having an unfair advantage arising from their access to nonpublic information.

 

To that end, the Committee reiterates the position we expressed in our letter to CESR on September 30th regarding the Directive, wherein we discussed our desire for a dissemination system that ensures access to the general public. We described our desire for a central repository within the European Union that could disseminate information, including non-public information, through competent authorities in each Member State. To supplement that disclosure, we suggested that CESR propose "permitting issuers to simultaneously disseminate information broadly … on the company's Web site, a broadcast press release or an advertisement in a newspaper."²

 

Regarding the timeliness of such information, the Committee reiterates the view AIMR has consistently taken, specifically that competent authorities should require issuers to disclose critical price-sensitive information to investors as soon as possible. For matters under negotiation, that would mean as soon as agreement in reached. For all other matters, however, that would mean immediately. Rules that expressly or inadvertently permit issuers to delay dissemination of critical information provide insiders with opportunities to act on information ahead of other shareholders, undermining market integrity and fairness.

 

Q4: Do the current corporate communication rules deliver all the necessary disclosures to maintain market confidence and protect investors?
The Committee had no comment regarding this question.

 

Shareholders' Rights and Obligations
The FSA's corporate governance rules contain safeguards to protect shareholders in potentially dilutive transactions by, among other things, requiring shareholder votes on major transactions, and disclosures of related-party and director transactions. Such rules serve U.K. investors well. However, some U.K.-listed companies have expressed concerns that some of those safeguards may put them at a competitive disadvantage with companies from other jurisdictions. In this as in all other similar matters, the needs of investors must supersede those of issuers.

 

Q5: What are your views on the contribution that shareholder rights' provisions make to market confidence and investor protection?
The Committee applauds and supports the FSA's objective of maintaining market confidence and investor protection through the transparency of information, particularly as it relates to major transactions, insider dealings, material changes in ownership and related-party transactions. Such information is essential in maintaining market confidence and gives shareholders the tools they need to make informed investment decisions.

 

Equally important, however, is the timeliness of the information provided. As stated above, AIMR has maintained that immediate dissemination of information to shareholders is an effective means of ensuring market confidence and of preventing abuse. This position includes immediate or prompt dissemination of financial reports, as well. Indeed, while the Review did not specifically request comment on requiring quarterly financial reports by issuers, the Committee urges the FSA to incorporate such requirements prior to the final adoption of the EC's Transparency Obligations Directive (the "TOD"), planned for later this year.

 

The Committee also urges the FSA to incorporate timing considerations into its review of Listing Rules. Delaying disclosure of information about director transactions, for example, until months after they've occurred does little to help investors make informed investment decisions. Furthermore, it provides insiders with a window of opportunity to trade on non-public information. However, by requiring insiders to disclose their activities prior to execution of planned trades, investors receive an indication of how people with presumably superior knowledge view the company's operations and financial prospects. Such information is essential to investors and enhances their ability to make informed investment decisions.

 

Financial Information
Rules requiring newly listed companies to prove that they have at least a year's worth of working capital and an audited financial history are an essential feature of the disclosures U.K.-listed companies are required to make. The problem is that many start-ups do not have a sufficiently long history to provide such information, forcing the FSA to consider how to ensure access to capital for "a wide range of companies" while also providing investors the information they need to make informed investment decisions. At the same time, the U.K. market is facing changes regarding the frequency and timing of financial reports issued by companies of all sizes as a result of proposals included in the TOD.

 

Q6: What role should the FSA, as competent authority, play in ensuring that financial information is of sufficiently high quality for investors?
In general, information quality is a function of the accounting methods used to develop the numbers, the reliability and transparency of the reported information, and the timeliness with which the information is presented to shareholders. To that end, AIMR has consistently maintained that all providers of financial information, regardless of size, industry, locale and maturity, should adhere to the highest standards of transparency, accuracy, relevance and timeliness in financial reporting. As such, the Committee urges the FSA to ensure the quality of information by requiring that all issuers under its Listing Regime meet such standards.

 

However, it is unrealistic to expect the FSA to review the books of every issuer under its purview given limitations on its financial and human resources. Nonetheless, the Committee believes the Authority should hold corporate managers to the highest financial reporting standards. In particular, when a breach of the standards does occur, the FSA should alert the marketplace about the issuer's use of questionable, inaccurate, untimely or omitted disclosures. The potential for having their corporate reputations dishonored by such disclosures will persuade most issuers to strive to meet the objectives set by the FSA.

 

Q7: How significant is the contribution that the current requirement for a working capital statement makes to maintaining market confidence and protecting investors?
The Committee did not have a comment on this issue.

 

Q8: Should the rules recognize the particular needs of SMEs and provide a framework for a wider range of size and type of company?
AIMR and the EAC have consistently maintained that the needs of investors for full, complete and transparent financial information should supersede the desires of issuers to minimize such disclosures. For example, all issuers, regardless of size, who engage in complex financial transactions should be required to provide the same high-quality disclosures regarding those transactions. The Committee reiterates that view here.

 

The FSA should establish a minimum standard for financial disclosure that every listed company must meet. Furthermore, the Authority should set that threshold at a significantly high level to ensure that investors have enough information about the operations and financial prospects of those issuers to make informed decisions.

 

Such requirements are particularly important for SMEs. Given the lower levels of diversification in their business activities, together with fewer capital resources, limited operating histories and, frequently, untested management, such companies have the potential to present significant risks of major loss to investors. Furthermore, permitting SMEs to withhold certain information may reduce their costs in the short run, but it also might discourage investors from investing in these companies without significant discounts in pricing, thereby raising their long-term costs of capital.

 

Sponsors
Q9: Do you consider the sponsor regime provides a cost-effective method of ensuring appropriate due diligence is undertaken before an issuer is admitted to the official list?
The Committee is hesitant about the use of sponsors to ensure adequate and accurate information is available prior to listing. In particular, we have reservations about entrusting such activities to investment bankers or auditors, both of which have inherent potential conflicts of interest when it comes to ensuring information about an issuer is complete, accurate and without material omissions or misstatements. On many occasions in the past both groups have chosen to disregard their obligations to shareholders in favor of serving their own interests or those of management or other special interests opposed to those of securities owners. Besides, the long-term costs in lost market credibility and confidence from a system depending on these entities may outweigh the short-term savings achieved by letting the sponsors perform this highly sensitive function.

 

Ultimately, it is the Committee's preference to have an independent third party perform the due diligence duties related to an initial listing. However, because the role of the sponsor is essentially to ensure the issuer provides information that shows it has certain financial resources and capabilities, our concerns about the use of sponsors are reduced somewhat. Nonetheless, the Committee still urges the FSA to place a heavy burden of proof on the sponsors to ensure the information is fair, complete and accurate. To secure that goal, we urge the Authority to be ready and willing to exercise its enforcement powers to publicly punish and admonish sponsors that publish faulty, inaccurate or incomplete financial and operating reports about issuers. It is hoped that the threat of a loss of reputation, together with the prospect of a loss of business franchise, will encourage sponsors to attend to the best interests of shareholders.

 

Organizational Issues
Q10: Do you have any suggestions as to how the competent authority could improve the transparency of its decision-making process?
The Committee strongly favors the use of a newsletter to help the FSA keep the public informed about its regulatory activities and views. In fact, the Committee suggests that such a newsletter incorporate guidance, frequently asked questions and updates on disciplinary actions against issuers and sponsors. Competent authorities in other jurisdictions have used similar publications in the past with success. We feel the FSA would help build investor confidence in the U.K. market and, in turn, help lower the cost of capital for issuers by doing so, as well.

 

Closing Remarks

 

The EAC appreciates the opportunity to comment on the FSA discussion paper 14, Review of the Listing Regime. If you or your staff have questions or seek amplification of our views, please feel free to contact James C. Allen, CFA, by phone at +1.434.951.5558 or by e-mail at james.allen@cfainstitute.org.

 

Sincerely,

 

Dr. Luigi Gubitosi, CFA Chair European Advocacy Committee

James C. Allen, CFA Associate, AIMR Professional Standards & Advocacy

 

¹ With headquarters in Charlottesville, VA, and regional offices in Hong Kong and London, the Association for Investment Management and Research is a non-profit professional organization of 61,000 financial analysts, portfolio managers, and other investment professionals in 124 countries of which 48,800 are holders of the Chartered Financial Analyst (CFA ) designation. AIMR's membership also includes 123 affiliated societies and chapters in 40 countries. AIMR is internationally renowned for its rigorous CFA curriculum and examination program, which had more than 100,000 candidates from 143 nations enrolled for the June 2002 exam.

2 AIMR European Advocacy Committee letter to the Committee of European Securities Regulators, dated 30 September 2000, regarding CESR's Advice on Possible Level 2 Implementing Measures for the Proposed Market Abuse Directive, pages 7-9.