Capital market regulation and coronavirus

Speaker: Mark Steward, Executive Director of Enforcement and Market Oversight
Event: ShareSoc Webinar: building market and investor confidence
Delivered: 3 August 2020, 5pm
Note: this is the speech as drafted and may differ from the delivered version

Highlights

• Capital markets work well when investors have confidence that there are effective rules or standards directed to tackling distortions and unfairness. Our secondary market surveillance capability gives us visibility over trading in the market so that we can more readily identify and probe potential suspicious activity and distortions in the market. 
• In cases of market abuse, investor confidence is encouraged when companies take effective internal remedial steps, such as over their governance and oversight structures. Compensation to affected shareholders will play an important part in addressing the consequences of market abuse.
• The FCA has introduced many temporary measures to address the difficulties faced by capital markets during coronavirus (Covid-19). We continue to actively monitor these measures to ensure our markets continue to work well and safely bridge between pre-coronavirus and post-coronavirus worlds.

The direct and individual experience of ShareSoc, both collectively and through its individual members, and the voice and voices it can bring to the table, is an important and valuable contribution to ensuring there is diversity in how we see capital markets. This can only assist in ensuring our markets work well.

I use this phrase ‘ensuring our markets work well’ deliberately. Our core mission, set out in the Financial Services and Markets Act 2000, is to ensure our markets work well. Reasonable experts will approach what this means in different ways but most will accept it involves informed investors making decisions based on timely and accurate information. This means markets operating on the basis of genuine, competitive forces of supply and demand, high standards of stewardship and social responsibility, deep liquidity, strong governance, clear rules and both responsible and responsive regulation.

Quality of market information 

What it doesn’t involve is something like George Akerlof’s market for used cars, or ‘lemons’. This is a market where there is little or no information allowing buyers to tell the difference between a good used car and a ‘lemon’, and where the price for used cars converges around the median.

Incidentally, this month is the 50th anniversary of the publication of this important work. The median price is no good for the seller of a good car ­– it is worth much more – which forces sellers of good used cars to leave the market, leaving only ‘lemons’ on offer, which no-one wants, leading, in turn, to market failure.

All the qualities of a poor market are on display here, most notably asymmetrical information and an absence of standards or rules or a regulator to correct the distortions.

While our capital markets do not resemble this one, all markets can occasionally exhibit examples of Akerlof’s lemon market.

For example, recently, we issued a public censure for market abuse against Redcentric PLC[1] (Redcentric), which is an example of how false or misleading information distorts the market but also how regulation operates to correct it.

Market value of effective regulation

On 7 November 2016, Redcentric announced that its audit committee had undertaken an internal review of Redcentric’s interim results for the 6 months ending September 2016, which discovered misstated accounting balances in the Group’s balance sheet. In particular, the company had misstated materially its net debt and cash position.

As a result, the market price was artificially inflated and this continued until Redcentric issued its corrective statement on 7 November 2016. The artificial price meant purchasers of shares between 13 November 2015 and 7 November 2016 paid a higher price than they would have paid had the false impression not been created. In Akerlof’s terms, these purchasers bought ‘lemons’.

We did not impose a fine on Redcentric. Instead, we issued a public censure. This decision took into account:

• the steps taken by the company to remediate its governance, both in terms of systems, processes and personnel
• the impact a fine would have on the business of the company, which is an essential business providing vitally needed services in the fight against coronavirus
• the impact of the fine on investors, especially the many investors who had not sold their shares following these events and who had demonstrated a commitment to the business and its prospects
• the company’s proposal to remediate, as far as it could, losses to those shareholders who bought shares during the period in which the company’s share price was affected by the false or misleading information net of any shares sold in the period

The remediation scheme involved the distribution of treasury stock to net shareholders and was approved by shareholders in a general meeting.

This outcome would not have been possible without appropriate governance by the board of the company, the remedial steps taken by the board, the nature of the company’s business during the coronavirus crisis and the public interest in ensuring this business continued without interruption or further penalty. The offer of compensation to affected shareholders was also a decisive factor in ensuring the consequences of the market abuse were addressed, at least in part. 

It is also relevant that we have charged three former executives of the company with serious criminal charges. 

When the company issued its corrective statement in November 2016, the share price fell from 150p to below 80p. On the day before we announced our public censure and the compensation scheme, the share price remained well below its pre-correction price at 102p. After the public censure announcement and the company’s regulatory news service (RNS), the share price immediately rose to 128p and it closed today at 146p, very close to its pre-correction price.

I would like to think the market reaction here demonstrates that the market values the combination of regulatory action and responsible governance in restoring investor confidence.

In Akerlof’s view, buyers end up paying the cost of dishonesty in a lemon market. The cost lies not only in the amount the investor is cheated: it includes the losses caused by driving honest business out of the market which, he argues, is a characteristic of undeveloped or immature markets. 

I also think it happens in markets where there is an absence of appropriate or effective rules or standards directed to tackling distortions and unfairness. The retail offer of non-traded high-risk investment products to retail consumers may be a lemon market for that reason.

This is not the case in the capital markets we are talking about here where:

• we have visibility of what is happening
• there are clear rules and regulations in place that permit effective monitoring
• there are disciplines around disclosure of inside information and in respect of key transactions 
• we are able to supervise and enforce standards to stifle harm, impose sanctions and redress the costs of dishonesty 

In respect to secondary market surveillance, last year we ingested close to 10 billion transaction reports and over 150 million order reports every day into our market data processor which gives us visibility over trading in the market, to identify suspicious activity and to make better decisions about what we need to probe further.

Surveillance, in this sense, is regulatory sunshine and ensures distortions caused by undisclosed information, misleading information, misuse of information and other ‘lemon’ problems are more readily identified and tackled.

That’s not to say we always get it right, but it is important that we are aiming to be as well informed as we can, sensitive to the right dynamics. 

Market regulation during coronavirus 

Let me now turn to how we have monitored the market in recent times since the lockdown.

You will have seen our focus on mortgage relief and retail credit and lending relief. These are temporary measures intended to temper what may be a very difficult period for many households and to help bridge the gap between the pre-coronavirus and post-coronavirus worlds. 

We have also been busy in respect to our capital markets.

Very early in the lockdown we provided temporary relief to listed companies with an additional two months to file audited financial statements. This measure recognised the impact of the virus on businesses and operations was sudden, difficult to evaluate and quantify and would inevitably mean financial statements would take additional time to prepare. 

Later, we addressed interim accounts deadlines, giving hard-pressed companies additional time to publish their half-yearly financial statements too – an extra month in this case.

And we also implemented a series of measures for companies raising new capital. These measures included clarity around due diligence for working capital statements in prospectuses, which again recognised the current circumstances are raising risks of material uncertainties. 

We also announced that we would be prepared to give waivers, on a case-by-case basis, for general meetings to be convened for some Class 1 and related party transactions where relevant approvals, in writing, from up to the required majority had been obtained. This move recognised the practical difficulties in convening meetings during lockdown with social distancing in place as well as the potential need for some companies to move more quickly than notice periods for meetings might have otherwise permitted.

As part of that package we welcomed the work of the Pre-emption Group (PEG), an industry group of issuers, investors and intermediaries, changing its guidelines to temporarily support non-pre-emptive issues of up to 20% of issued capital (up from the so-called “5+5” limit set out in the existing Statement of Principles). 

The PEG recommendation recognises the current coronavirus crisis may require some quoted companies the need to raise cash on a very urgent basis.

Importantly, there are also recommended safeguards: shareholders should be fully informed of the circumstances of the fund raising; a representative sample of major shareholders should be consulted; there should be ‘soft’ pre-emption, which means, to the extent possible, allocations should replicate the existing shareholder base and company management should be involved in the allocation process. The FCA endorsed these recommendations.

These measures are temporary ones and, like the relief for mortgages and certain credit products, they are also intended to help the market safely bridge the pre-coronavirus and post-coronavirus worlds.

Some might argue some of these measures reduce the level of investor protection, especially the pre-emption recommendations.

This is where balance is important. Ensuring all investors are adequately protected must be the first consideration because a market that permits informational asymmetries, or reduces the function and power of shareholders in the general meeting, is not a market that works well. Equally, companies that are unable to raise capital quickly in a crisis affects the wellbeing of the whole market, including investors. The balance here is not a constant one. Events, like coronavirus, can create imbalances which need to be corrected, sometimes with temporary measures like these ones, to ensure markets continue to work well. 

Overall, the reaction to these measures has been very positive from both buy and sell sides and UK’s capital markets have been extremely liquid and busier than other European market centres. 

Importantly, UK-listed companies and AIM[2] companies have been able to raise needed funds in size and at speed.

Since the start of the year, UK markets have raised £23.7 billion in new capital with 327 transactions, more than 3 times the next busiest European markets in both volume and number making the first half of this year the most active since 2009. 

Not all of these transactions have taken advantage of, or required, the temporary relief. But many have. Of the 15 largest transactions of any type, 7 have been large placings using the pre-emption dispensation.

And while the dispensation will have had a dilutive effect, the dilution applies to all pre-existing shareholders equally and, in these cases, ranges from 0.26% to 1.22%. 

The FCA also resisted calls to alter Listing Rules applicable to premium listed companies that caps the maximum discount in a placing to 10%. 

We strongly believe these measures have been beneficial to all investors as well as issuers and that the balance between urgency, need, efficiency, avoidance of uncertainty and investor protection has been struck in the right place. This allows uncertainties arising from the coronavirus crisis to be addressed and issuers to be able to undertake key transactions and raise capital quickly despite the lockdown. 

The aim of bridging the pre-coronavirus and post-coronavirus worlds remains an important one and we continue to monitor, very actively, all these measures to ensure our markets continue to work well, which is the essence of our mandate.