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Lexis®PSL Corporate and Market Tracker have conducted research to examine current market trends in respect of equity capital markets (ECM) transactions in 2019.
Background and approach
For this review of risk factor disclosure, we looked at 38 prospectuses in relation to 2019 Main Market IPOs or new admissions and ten AIM admission documents published in 2019. It forms part of our annual trend report which aims to provide insight into the current dynamics of ECM activity in the UK. The other parts of our 2019 trend report comprise:
• IPOs in 2019—Main Market and AIM
• Secondary Offers in 2019—Main Market and AIM
• Standard listings in 2019
• Legal and regulatory developments in Equity Capital Markets 2019
Prospectus Regulation risk factor disclosure requirements
The Prospectus Regulation (EU) 2017/1129 introduced more prescriptive requirements relating to risk factor disclosure in prospectuses from 21 July 2019. The primary purpose of the new requirements is to ensure that investors can assess all relevant risks and make an informed decision about investing in the issuer’s securities.
Article 7 of the Prospectus Regulation provides that for an equity prospectus, the summary should contain no more than 15 risk factors grouped into two sections:
• a brief description of the most material risk factors specific to the issuer under a heading ‘What are the key risks that are specific to the issuer?’ (Article 7(6)(c))
• a brief description of the most material risk factors specific to the securities under a heading ‘What are the key risks that are specific to the securities?’ (Article 7(7)(d))
Article 16 of the Prospectus Regulation provides that risk factors should be:
• specific to the issuer and/or the securities
• material for making an informed investment decision
• corroborated by the content of the prospectus, and
• categorised in a limited number of categories depending on their nature
Article 16(1) further provides that materiality should be assessed based on the probability of the occurrence of the risk and the expected magnitude of its negative impact. The assessment of materiality may be disclosed using a qualitative scale of low, medium or high.
In October 2019, the European Securities and Markets Authority (ESMA) issued final guidelines (under its mandate in Article 16(4) of the Prospectus Regulation) to help national competent authorities in their review of risk factor disclosure in prospectuses (ESMA Guidelines). Although the guidelines are addressed to national competent authorities, they will (as ESMA acknowledges) also be useful for issuers and advisers when drafting risk factor disclosures to expedite the approval process of the prospectus.
Main Market IPO risk factor review
We reviewed a total of 38 prospectuses published in 2019 in relation to IPOs or new admissions to the Main Market (2019 IPO prospectuses). Of these, nine were published after the risk factor disclosure provisions in the Prospectus Regulation came into effect on 21 July 2019 and 29 were published before that date.
Number of risk factors
Although it is too early to draw any firm conclusions as to the effect of the new provisions on risk factor disclosure, the average number of risk factors in 2019 IPO prospectuses published after 21 July 2019 (the date the new provisions on risk factors came into force) decreased compared to the average number of risk factors in 2019 IPO prospectuses published before that date.
Before 21 July 2019, the average number of risk factors in the risk factor section of 2019 IPO prospectuses was 44 and after that date the average fell to 37.
A higher proportion of 2019 IPO prospectuses published before 21 July 2019 had over 30 risk factors in their risk factor section than prospectuses published after that date. A third of 2019 IPO prospectuses published before 21 July 2019 had over 50 risk factors in their risk factor section. The proportion fell to 22% after 21 July 2019.
Likewise the number of risk factors in the summary section fell. Before 21 July 2019, 18 of the 2019 IPO prospectuses (63%) had over 15 risk factors in the summary section and after this date only one 2019 IPO prospectus had over 15 risk factors in the summary section. The Prospectus Regulation provides that the summary in an equity prospectus should contain no more than 15 risk factors.
Brexit risk factors
Brexit seemed to trouble Main Market issuers less in 2019 than in 2018. In 2019, 42% of prospectuses published in relation to Main Market IPOs or new admissions (16 out of 38) contained a reference to Brexit in their risk factor section. In 2018, 82% of the Main Market IPO prospectuses we reviewed in our 2018 ECM trend report mentioned Brexit.
In 2018 some issuers included very lengthy Brexit risk factors. Aston Martin (which was admitted to listing in October 2018) had one of the most detailed Brexit risk factors seen in our review including details of the percentage of cars sold in EU Member States and the effect of Brexit on these sales, the problems associated with increasing costs of non-sterling denominated raw materials, the threat to its supply chain in EU Member States and the impact on its ability to recruit and retain skilled workers from European countries. Five prospectuses we reviewed in 2018 (19%) had Brexit in one of their top three risk factors.
In 2019, only one issuer (an investment fund seeking to invest in life science companies in various geographies with a particular focus on the US, Europe and China) included Brexit in one of its top three risk factors. This was under a heading dealing with the global range of the company’s investment policy and the company’s investment being subject to domestic and global political and economic risks. In general, Brexit risk factor disclosures were shorter in 2019 than in 2018.
Brexit risk factors in 2019 IPO prospectuses tended to focus on the general effect of Brexit on the UK and global economies, legislative and regulatory regimes and the equity, financial and foreign exchange markets.
Three issuers in 2019 went into more detail as to how Brexit would affect their business. The prospectus published by the payments and foreign exchange company Finablr included statements about the effect of Brexit on downgrading of the outlook of the UK government’s bond rating and credit rating and the effect on the group’s cross-border payments franchise business which operates from the UK into the EEA in reliance on passporting rights under the Payments Services Directive.
The Brexit risk factor in the prospectus published by Aquila European Renewables Income Fund referred to possible changes to the national private placement regimes which could restrict the company’s ability to market its shares in the EEA.
The law firm DWF Group in its Brexit risk factor discussed the possible negative impact on the group’s financial position to the extent that Brexit results in a decreased demand for the group’s services or increased costs which have a greater impact than any increased demand as a result of advising on Brexit-related matters. DWF highlighted that in the months following the referendum to leave the EU, the company experienced short-term decrease in the demand for its real estate practice area.
None of the prospectuses relating to IPOs or new admissions in 2019 (before or after 21 July 2019) described risks factors using a qualitative scale of low, medium or high as suggested in Article 16(1) of the Prospectus Regulation.
Number of categories
After 21 July 2019, issuers organised their risk factors into three to six categories. The maximum number of categories envisaged by the ESMA Guidelines for a standard, single issuer, single security prospectus is ten.
The majority of 2019 IPO prospectuses published prior to 21 July 2019 organised their risk factors into two to six categories, with two issuers using seven categories and one (a mining company with operations in Kazakhstan) using eight categories.
Commercial companies listing in 2019 generally categorised their risks factors into the following categories:
• risks related to the company’s business
• risks related to the company’s industry and/or sector
• risks related to the offer and the shares, and
• risks related to taxation
Companies operating in emerging markets often included a separate risk factor category on risks related to the particular jurisdiction where the company operates.
The ESMA Guidelines (paragraph 35) suggest that risk factors relating to the issuer could be organised into categories containing
• risks related to the issuer’s financial situation
• risks related to the issuer’s business activities and industry
• legal and regulatory risk
• internal control risk, and
• environmental, social and governance risk
and risk factors relating to the securities could be categorised into:
• risks related to the nature of the securities
• risks related to the underlying securities
• risks related to the guarantor and the guarantee, and
• risks related to the offer to the public and/or admission to trading on a regulated market
Only one company in 2019 (Thalassa Holdings) used sub-categories in its organisation of risk factors.
The ESMA Guidelines state that sub-categories should only be used ‘where their inclusion can be justified based on the particular circumstances of the case’.
It is difficult to draw any conclusions as to whether risk factors have become more concise after 21 July 2019.
Only one company listing in 2019 had over 30 pages of risk factors (Airtel Africa) and this was before 21 July 2019. In this period, nine prospectuses (31%) had between 20 and 30 pages of risk factors. After 21 July 2019, two prospectuses (22%) had between 20 and 30 pages of risk factors.
The average number of pages of risk factors before 21 July 2019 was 17 and this fell to 16 pages after that date.
Standard listing risk factor
Most prospectuses published by companies seeking a standard listing in 2019 (15 out of 19) contained a risk factor about a standard listing affording less regulatory protection that a premium listing. All but one company seeking a standard listing had a separate section in their prospectus about the consequences of a standard listing.
AIM admission documents
The Prospectus Regulation and the ESMA Guidelines on Risk Factors do not apply to AIM admission documents published by issuers being admitted to trading on AIM (although the contents requirements of an admission document are drafted by reference to the prospectus contents requirements). However, market practice may develop so that the AIM risk factor disclosures follow those in Main Market prospectuses.
Out of the ten admission documents published in 2019 (relating to new issues), two contained over 40 risk factors, seven contained 30 but less than 40 and one contained less than 30 risk factors.
Brexit seemed to be of more concern to AIM companies than to Main Market companies as all but one company which was admitted to trading on AIM in 2019 included Brexit as a risk factor. However, Brexit did not feature in the top three risk factors in any 2019 AIM admission document.
An example of a more detailed Brexit risk factor disclosure can be found in the admission document published by the café-bar operator, Loungers plc. This outlined the effect of Brexit on the group’s ability and its suppliers’ ability to source supplies necessary for the group’s operations, such as, meat, produce and other fresh or non-perishable items in particular as the group is dependent on certain suppliers sourced from outside the UK. The increased competition for personnel that the group may face given a potential shortage of suitable workers across labour markets after Brexit was also noted.
Risk factor disclosure in 2020
When the 2019 prospectuses and AIM admission documents were drafted no one could imagine how the world would change in 2020. While risk factors relating to Brexit may still be important as we head towards the end of the implementation period, the effects of the coronavirus (COVID-19) pandemic and the associated prevention measures imposed by governments around the world are taking centre stage. It is likely the disclosures around risk factors will need even more careful drafting as the impact of the coronavirus crisis is assessed.
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Market Tracker is a unique service for corporate lawyers housed within Lexis®PSL Corporate. It features a powerful transaction data analysis tool for accessing, analysing and comparing the specific features of corporate transactions, with a comprehensive and searchable library of deal documentation across 14 different deal types. The Market Tracker product also includes news and analysis of key corporate deals and activity and in-depth analysis of recent trends in corporate transactions.
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