Home > Library > Stable Times > Volume 9, Issue 2  

New EU Capital Markets Regime to Significantly Impact Issuers of FA-Backed Notes

The European Union (“EU”) is in the process of implementing major changes to the rules governing the offering and listing of securities in the EU in an effort to create a pan-European securities market. These Rules will impact the entire funding agreement-backed market and the availability of the product as a future funding source to issuers of such securities. This market represented over $34 billion of funding to the insurance industry in 2004.

The EU Prospectus Directive (“PD”) was implemented on July 1, 2005 across all regulated markets in the European Economic Area (“EEA”). The PD governs the content of prospectuses used to offer securities in the EEA, including securities listed on any EU stock exchange. The Transparency Obligations Directive (“TOD”), which is required to be implemented in the EU member states by January 2007, governs the ongoing periodic disclosure obligations of issuers that have offered and/or have listed securities in the EEA. This article briefly describes these new directives as well as the four main alternatives, for non-EU issuers that wish to have continued access to the EU debt markets. The PD and TOD apply to EU-listed EMTN and GMTN programs, as well as any sale of securities (whether off a programme or on a stand alone basis) into an EU member state that is deemed a public offering (under that country's rules).

The PD/TOD rules apply to the Special Purpose Vehicle issuers of the funding agreement-backed notes. Although not specifically referenced in the PD rules, practitioners believe they are likely to apply to the issuers of the underlying funding agreements as well (by analogy to asset-backed and guarantor provisions).

•  Prospective Directive - The level of disclosure required pursuant the PD depends on whether the issuance is “wholesale” or “retail” debt. Unlike U.S. securities law regulation, which focuses on the nature of the investors (e.g. QIBs for Rule 144A offerings), the PD rules focus on the denomination of the security as a proxy for investor sophistication. Issues with denominations of $50,000 (or its equivalent in any other currency) or greater are considered wholesale, with lesser amounts being deemed “retail”.

•  Retail Disclosure - Financial information (annual and interim) must be prepared in accordance with International Financial Reporting Standards (“IFRS”). Also, a more detailed and increased business description is required than current Luxembourg and London Stock Exchange Rules. In addition, an MD&A section as well as Risk Factors and a 2,500-word summary of the programme will need to be included. It is worth noting that the PD will eventually permit the use of certain jurisdictional GAAPs that the EU considers “equivalent” to IFRS, but the issue of equivalence has not been resolved as of yet. It is expected that US GAAP will be deemed equivalent, while the issue of US Statutory Accounting Principles is less clear (primarily because it is a lower priority to the EU regulators). The EU body which advises the EU Commission (“CESR”) has recommended that the EU Commission deem U.S. GAAP equivalent (“the Technical Advice Paper”), but no formal action has been taken. Although recommending equivalence, the Technical Advice Paper highlighted several areas where US GAAP and IFRS differ, and recommended supplementary disclosure on those points. The issue is still open.

•  Wholesale Disclosure - No reconciliation to IFRS is required; merely a summary of differences between IFRS and the issuer's accounting principles. Other disclosure about the issuer is different from, but not significantly more burdensome than, current London or Luxembourg rules, however a Risk Factors section will be required. The non-accounting changes applicable to wholesale debt will not be significant for U.S. issuers, who already have high levels of disclosure in connection with their U.S. securities activities. In addition, issuers of only wholesale debt are exempt from the requirements of the TOD with respect to ongoing reporting.

•  Home Member State - Consistent with the theory of the PD that securities admitted to trade in one regulated market be tradable throughout the EU, non-EU issuers will have to select an EU country (a “home member state”). By such selection, the issuer will submit themselves to the securities regulation of such state, including its prospectus approval process and regulations. Because of how the PD is written, certain types of offerings will have the effect of irrevocably selecting a “home member state”. Therefore, issuers must be cognizant of this issue in executing future transactions (especially retail).

•  Transparency Obligation Directive - The TOD applies to securities issued after January 20, 2005. If applicable, it requires annual and interim financial reports to be prepared in accordance with IFRS (subject to the equivalence issue described above), beginning in 2007. Thus, any U.S. issuer with EU listed securities in denominations below $50,000 that are outstanding in 2007 will be subject to this regime.

Alternatives

•  Issue unlisted securities. An unlisted issuance which is not made to the public does not trigger the PD or TOD requirements. Two issues to consider with this alternative are market acceptability of unlisted securities and avoiding an inadvertent public offering. Unlisted private offerings can have a minimum denomination as low as $1,000 without triggering the PD and TOD rules.

•  Issue wholesale debt only (which may be listed on the LSE or any other EU exchanges). This avoids the most burdensome requirements of the PD and TOD. Other PD requirements will apply, so an issuer choosing this route will still have to file and get approved a new PD compliant MTN offering document with the relevant listing authority after July 1, 2005. (although most changes are non-substantive).

•  List securities on a market outside the EU (e.g. Switzerland, Singapore, Hong Kong). Each of those exchanges has or is putting in place revised listing rules which are similar to existing listing rules in London and Luxembourg. In addition, the Swiss Exchange has approved a relatively simple process to transfer existing listings. These listings will be considered “listed securities” for purposes of European investors. A Brazilian issuer recently opted for a Swiss Exchange listing for a Eurobond.

•  Move to an EU “Exchange Regulated Market”. The PD and TOD apply to issuers with securities listed on an EU-regulated market. The London Stock Exchange and LSE are in the process of establishing separate “segments” that, while not considered EU-regulated, will be subject to regulation by the relevant exchanges. For technical reasons, this alternative regulation system enables securities to be treated as “listed securities” for purposes of the requirements of most of the European investing community. It is expected that the regulations governing these exchange-regulated markets will be largely those in place today. Market acceptability of such platforms has not been tested as of yet.

Read Next: Rethinking Retirement: Americans Must Have New Tools to Prepare for Retirement…and a New Definition of Retirement Itself