How should HAs respond to changes in capital markets prospectus regulation?

How have risk factors changed?

Any RP issuing a bond after 21 July must reflect the changes made by the PRRs, in the drafting and presentation of the ‘risk factors’ section of a prospectus. It is fair to say that there are currently strong similarities across most RP bond issues – understandable for a sector facing many of the same challenges.

But the new PRRs explicitly confront this homogeny. Since 21 July, issuers have been required to:

1. Include only those risks that are specific to the issuer or the bonds being issued, and that are material for taking an informed investment decision
2. Assess the materiality of the risk factors, each of which is to be measured by reference to the probability of their occurrence and the magnitude of their negative impact. This assessment may be disclosed by using a qualitative scale of low, medium or high (but there is no absolute requirement for disclosure of this assessment)
3. Present such risk factors within a limited number of categories and, in each category, identify the most material risk factor first

In tandem with these changes, guidelines were produced by the European Securities and Markets Authority (ESMA) earlier this year to assist competent authorities (so, for any UK based issuers, the FCA) in their review of risk factors in accordance with the PRRs, notably in respect of the assessment of ‘specificity and materiality’ of risk factors.

Specific and material

The ESMA guidelines have made it explicit that there must be a clear and direct link between the risk factor and the issuer or the securities. While the responsibility for assessing lies with the issuer, the ESMA guidelines state that risk factors should be those which can be “corroborated by the content of the prospectus” and it should be “apparent from the disclosure of the risk factor”.

ESMA’s emphasis on demonstrating the materiality of a risk (for example, by reference to the probability of such risk occurring and expected magnitude of its impact) suggests that issuing RPs should include information quantifying the risk, or, if not available, they should be willing to categorise a risk factor by reference to a scale of high, low or medium risk.

A proactive approach

These new rules reiterate that risk factors are there to protect investors, not to mitigate issuer liability. In fact, the ESMA guidelines actively encourage competent authorities to challenge issuers on the inclusion of any risk factors not evidently relevant to that specific bond issue, and that appear to have been included solely as a disclaimer.

Increased scrutiny from such authorities will require issuers to focus wholeheartedly on considering and fine-tuning risk factors to include only those realistically applicable to them – thwarting an understandable temptation to include a broad range of risk factors, regardless of relevance. RPs’ officers should take a proactive approach to drafting the risk factors in collaboration with their solicitors when preparing for a bond issue, and be prepared to justify their approach to the presentation of such risk factors with corresponding evidence.

While the ESMA guidelines recognise that, within a sector, certain risk factors will be repeated across different issues, they are clear in requiring differentiation as to the precise impact on each issuer.

Ultimately, from both the PRRs and the ESMA guidelines, it is clear that the steer is towards presenting risk factors as a key source of information and protection for investors and RPs looking to the capital markets should be aware of this shift in emphasis.

Rosanagh Herries, finance and housing solicitor, Winckworth Sherwood