The Listing Rule changes announced on Friday will lower the compliance costs around capital raising and are to be welcomed for that reason, especially in the present economic environment. But in the process the relaxation of some protections could undermine investor confidence in the market.
This Brief Counsel looks at the rule changes and canvasses some of the potential implications.
Announcing the changes, the NZX said they were designed to "maximise flexibility and reduce the cost and time delay for listed issuers raising capital". They are a response to the current financial crisis, although not all directly concern capital raising. But there is a cost in that some of the protections against related party dealings have been loosened.
The NZX has sought to address concerns that investor confidence will be undermined by requiring additional disclosure of related party transactions. Whether it has managed to strike the right balance between efficiency and integrity in capital raising remains to be seen.
Capital raising options for existing listed issuers
Issuers generally raise additional capital in one or more of the following ways:
- Placements to targeted investors – usually financial institutions, high net worth investors, or selected existing shareholders, with limited documentation. Under current rules shareholder approval is generally needed to place more than 15% of a class of equity securities in a 12-month period.
- Rights issues to existing investors in proportion to their shareholding using a "short form" prospectus. Rights are sometimes tradable through the stock exchange. Under current rules, rights issues can take 6 to 8 weeks to complete.
- Share/unit purchase plans – offers of up to $5,000 per existing security holder using simple documentation under a Securities Act exemption notice.
Under current rules
- Generally, directors and their associated persons cannot participate in security issues without shareholder approval unless an NZX waiver is granted, and
- NZX approval is required if a placement or share/unit purchase plan issue is at a greater than 10% discount to the pre issue volume weighted average market price (VWAP) over the last 20 business days.
Under company law directors must resolve that the terms of the offer and consideration required is fair and reasonable to the company and existing shareholders.
In selecting the method of capital raising, and price of additional securities offered, directors need to balance the speed and flexibility of placements against the potential dilution of existing security holdings, particularly for public investors. While a pro rata rights issue may lead to a more equitable outcome, the additional cost of preparing a prospectus and the additional length of the offering period lead to greater issue cost, especially if the issue is underwritten. Some issuers have sought to reduce this tension by combining placements with share/unit purchase plans to existing shareholders.
Changes directly affecting capital raising
The rule changes:
- raise the current limit on placements (without shareholder approval) from 15% to 20% of the class of equity securities (and from 20% to 25% for NZAX issuers)
- allow directors and their associated persons to participate in placements, subject to the board certifying their participation is in the best interests of the issuer and fair to equity security holders not participating
- reduce the minimum timeframe for completing a rights issue from 6-8 weeks down to slightly more than three weeks, by reduction of the prior notice period for a rights issue from 10 business days to five, and reduction of the minimum period to accept the offer, or for any rights trading, from 18 business days to 12, and
- remove the requirement for NZX approval to a placement or share/unit purchase plan at a greater than 10% discount to VWAP. Instead, the issuer can make a placement at any price, but if at a greater than 15% discount to VWAP over the last five business days the board must certify that the consideration (price) for the issue is fair and reasonable to the issuer and shareholders who are not receiving securities.
The greater ability to place capital without shareholder approval could lead to greater dilution of existing shareholders. A similar change promoted by ASX before the financial crisis was strongly resisted by Australian shareholder groups, and did not proceed.
The reduced minimum period for rights issues could make this option more attractive, and at reduced underwriting risk and therefore cost, if capital needs to be raised on a more urgent basis.
Changes not directly affecting capital raising
In addition, other rule changes:
- increase thresholds for entering into related party transactions without shareholder approval from 5% of average market capitalisation to 10% for transactions, and 0.5% to 1% for provision of services
- allow directors to be paid director remuneration in shares, without specific shareholder approvals, at a VWAP price (with no discount) if shareholders pass a general resolution once permitting such a practice. It will be interesting to see how many listed issuers pick up on this option, heading into their next annual shareholder meetings
- allow executive directors to be issued securities as long as their participation is determined by criteria applying to employees generally
- remove current restrictions on the buy back of equity securities from employees (although rules restricting non pro rata buy backs from directors without shareholder approval remain), and
- increase the permitted level of financial assistance to employees each year from 2% to 5%, and over a five year period from 5% to 10%, of average market capitalisation.
These changes are more controversial, as the link to the current financial crisis is more tenuous. For larger issuers, the increases in thresholds for related party transactions is particularly significant – for example, an issuer with a $2 billion market capitalisation would be entitled to undertake a $200 million related party transaction without shareholder approval (previously $100 million). Some submitters argued the relaxation of self dealing rules could undermine investor confidence in the market. Under the Securities Markets Act, Commerce Minister Simon Power may disallow rule changes if he considers they are not in the public interest. The Minister has chosen not to exercise this power (no pun intended), because the Minister has been satisfied by additional protections put in place following discussions between NZX and the Securities Commission.
- A new rule 10.1.3 will require disclosure to the market of related party transactions involving more than 5% of the average market capitalisation of an issuer, and
- NZX has committed to review the rule changes in 12 months.
Proposals that will not proceed
NZX has abandoned earlier proposals to restrict majority shareholders from voting on the re-election and remuneration of independent directors and the removal of requirements for appraisal reports, following significant adverse feedback.
The rule changes designed to facilitate capital raising by issuers will be welcomed by issuers. The increased flexibility to undertake placements, and for related parties to participate in them, will intensify the tension between speed of execution, and maintaining equity amongst existing shareholders. It will be interesting to see how issuers respond.
It will also be interesting to observe the extent to which the greater flexibility around self dealing rules undermines investor confidence.