An overview of the proposed material related party transaction regime (in CP 19/7) which implements part of the EU Shareholder Rights Directive II.
The FCA has published a consultation paper (CP19/7) with its proposals for implementation of parts of the EU Shareholder Rights Directive II (SRD II). This includes a new related party transaction regime which will run alongside the existing related party regime in chapter 11 of the Listing Rules (Chapter 11 regime). The new regime will require UK companies with shares admitted on a regulated market to disclose and obtain board approval for material related party transactions. Some premium and standard listed companies and all sovereign controlled companies will also have to comply.
SRD II amends the Shareholder Rights Directive to strengthen shareholder engagement and increase transparency. SRD II must mainly be implemented into national law by EU Member States by 10 June 2019. As the implementation date is after the UK is expected to exit the EU, the FCA state that these proposals will only be implemented if the UK exits the EU with a transition period. Otherwise the FCA will wait to see how the government proceeds, as various measures in SRD II need to be implemented through UK legislation. See here for more information on SRD II.
Proposed material related party transaction regime
Who will be in scope?
The current Chapter 11 regime only applies to premium listed companies and will remain in place. The FCA has not proposed any changes to the Chapter 11 regime as it applies to premium listed companies.
The FCA is proposing that there will be an additional regime which will apply to all companies with their registered office in the UK and whose shares are admitted to trading on a regulated market, whether in the UK or elsewhere in the EU, as required by SRD II.
This will include UK incorporated issuers of non-listed shares admitted to trading on a regulated market (such as the Specialist Fund Segment or High Growth Segment in the UK, or a regulated market elsewhere in the EU).
To reconcile the SRD II scope with the principle that all issuers in a given listing category should meet the same requirements, the FCA is also extending the scope to include:
- all issuers with a premium listing (other than open-ended investment companies subject to LR16) not already caught in the new definition, and
- all issuers with a standard listing of equity shares (LR14) not already caught in the new definition
in each case as though they were a company within scope. Companies will, however, be exempt if they are already subject to equivalent provisions in their country of incorporation to avoid duplication of obligations.
The rules will not apply to standard- listed GDR issuers as GDR issuers are not within the scope of SRD II.
The FCA is also extending the scope to include all sovereign controlled companies and, in the case of these companies, is extending it to include shares and GDRs.
Where are the new rules?
The new rules will form part of the corporate governance rules in the Disclosure Guidance and Transparency Rules (DTRs).
Amendments will also be made to the Listing Rules to bring these additional companies in scope.
Who is a related party?
Related party has the meaning given in the International Financial Reporting Standards (IAS 24) which is wider than the definition in the Chapter 11 regime. (This definition will change if the definition in the IAS changes.)
A related party in IAS 24 is currently a person or an entity that is related to the reporting entity:
- A person or a close member of that person’s family is related to a reporting entity if that person has control, joint control, or significant influence over the entity or is a member of its key management personnel.
- An entity is related to a reporting entity if, among other circumstances, it is a parent, subsidiary, fellow subsidiary, associate, or joint venture of the reporting entity, or it is controlled, jointly controlled, or significantly influenced or managed by a person who is a related party.
What is a related party transaction?
The transactions are the same as for the Chapter 11 regime, namely:
- a transaction between an issuer and a related party
- an arrangement pursuant to which an issuer and related party each invests in, or provides finance to, another undertaking or asset, or
- any other similar transaction or arrangement between an issuer and any other person where the purpose and effect is to benefit a related party.
What transactions are excluded?
Transactions/arrangements in the ordinary course of business and concluded on normal market terms are excluded.
The FCA is also proposing that the following transactions are excluded:
- certain transactions between the issuer and its subsidiary undertakings
- transactions offered to all shareholders on the same terms, and
- transactions in relation to remuneration that is awarded in line with provisions which the government will propose in due course to implement the remuneration aspects of SRD II.
The FCA is not proposing exemptions for transactions entered into by credit institutions nor for transactions for which UK law requires approval in a general meeting (with protections for the fair treatment of all shareholders and the interests of the company and non-related party shareholders).
Companies have to maintain adequate procedures, systems and controls so that they can assess whether a transaction or arrangement with a related party is in the ordinary course and on normal markets terms.
The FCA is also proposing to include certain “anti-avoidance” provisions from the existing Chapter 11 regime so that transactions cannot be structured to avoid the disclosure requirements.
When is a related party transaction material?
Member States can set their own materiality thresholds and the FCA is proposing to use the same class tests as those in Chapter 10 of the Listing Rules so far as possible to determine whether a transaction is material. A transaction will be material where any of the percentage ratios is 25% or more.
What approval is required?
Under the Chapter 11 regime, any related party transaction must be approved by the company’s shareholders (and the related party cannot vote) and announced.
Under the new regime, material related party transactions will have to be approved by the board (rather than the shareholders) and any director who is a related party cannot vote. The transaction will also have to be announced but the FCA have decided not to require a report assessing whether the transaction is fair and reasonable (which is an option under SRD II). The transaction will have to be announced no later than when the terms of the transaction are agreed.
Do transactions have to be aggregated?
Yes, transactions will have to be aggregated in a similar way to the Chapter 11 regime.
What are the key differences to the current Chapter 11 regime?
The key differences are:
- the scope is much wider and catches many more companies
- the related party definition is wider and there are, therefore, a small number of instances in which the existing premium listing requirements will not cover SRD II requirements and premium listed companies will have to consider both regimes.
- ordinary course transactions are only exempt if they are also concluded on normal market terms
- not as many transactions are excluded
- materiality threshold is much higher
- only board approval is needed, no need to go to shareholders.
When will the new rules apply?
Companies within scope will have to comply with the new requirements from the start of the first financial year following 10 June 2019.