Scope of the guidelines
The guidelines are addressed to national competent authorities (NCAs, such as the FCA in the UK) but will be of interest to issuers to avoid incurring any unnecessary delays in the prospectus approval. The aim of the guidelines, which apply from 4 December 2019, is "to encourage appropriate, focused and more streamlined disclosure of risk factors, in an easily analysable, concise and comprehensible form, by assisting competent authorities in their review". In so doing, ESMA hopes that issuers will move away from including risk factors which are generic and only serve as disclaimers, as they could obscure more specific risk factors that investors should be made aware of.
According to recital 54 of the Prospectus Regulation, the primary purpose of risk factors is to ensure that investors "make an informed assessment of [the] risks and thus take investment decisions in full knowledge of the facts" and, consequently, generally include information concerning:
- the issuer's financial situation;
- the nature of the security;
- the issuer's business activities and industry;
- legal and regulatory risk;
- internal control risk; and
- environmental, social and governance risks.
What do the guidelines say?
There are 12 guidelines, spread across six categories (specificity, materiality, corroboration, presentation of risk factors, focussed/concise risk factors and those risk factors in the summary). Each guideline is accompanied by explanatory paragraphs which give further guidance as to how the guidelines should be interpreted. Below is a summary of the main considerations in each category of guideline.
Each risk factor should identify and disclose a risk that is relevant to the issuer or the securities concerned, rather than simply comprising generic disclosure.
Risk factors should take into consideration the actual affect an industry/sector risk has on that specific issuer. For example, a particular risk might represent a lesser potential adverse effect to a market leader than it might to a new entrant to the same market. Accordingly, merely replicating risk factors seen in prospectuses produced by similar businesses will likely no longer be appropriate.
While NCAs are not required to assess the specificity of each risk factor, they should ensure that a disclosure establishes "a clear and direct link" between the risk factor and the issuer or securities.
The level of materiality of a risk factor should be clear from the disclosure provided.
ESMA believes that providing quantitative information within the disclosure of risk factors helps to demonstrate the materiality of specific risk factors. Such information may be readily available from previously published documents (for example, management reports, financial statements or announcements to the market under Article 17 of the Market Abuse Regulation). However, it may not always be appropriate for quantitative information to be included. Where this is the case, the disclosure should be described in qualitative terms. Whichever approach is taken, the impact of the risk factors must be adequately explained and be consistent in presentation, with the most material risk factors appearing first in each category.
Issuers should ensure that any mitigating language used should not compromise the clarity of the messaging regarding the materiality of the risk factor. While mitigating language itself is not prohibited, issuers should reassess the materiality of the risk in light of the mitigating language (for example, with reference to risk management policies). If the issuer determines that the mitigation in place reduces the risk to such an extent that the risk is no longer material, it should either remove the risk factor or remove the mitigating language.
The specificity and materiality of a risk factor should be corroborated by the overall picture presented by the prospectus. It will not always be necessary (although it is likely to be the case the majority of the time), that direct/clear corroboration is demonstrated via the inclusion of specific corresponding information elsewhere in the prospectus.
Within the risk factors section of the prospectus, the risk factors should continue to be divided up into certain categories (and, if appropriate, sub-categories). The categorisation of risk factors (and ordering of risk factors within each category) will be dependent on the issuer and should aid comprehension of the risks. A risk factor should only appear once, in the most appropriate category.
In accordance with Article 16 of the Prospectus Regulation, the most material risk factors have to be presented first in each category, but it is not mandatory for all the remaining risk factors within each category to be ranked in order of their materiality. Issuers should use as few categories as possible in order to present the risks factors in a comprehensible manner. NCAs will question the use of more than 10 categories for most standard prospectuses.
Risk factors should be of sufficient length or ensure that their specificity and materiality is clear and their presentation is appropriate and focussed. However, NCAs should challenge lengthy risk factors where such verbiage obscures comprehension.
Risk factors in summary
Presentation of risk factors in the summary of a prospectus should be consistent with the presentation based on materiality in the risk factor section.
Competent authority to challenge issuers
The guidelines make it clear that NCAs should, as part of their usual review processes of draft prospectuses, challenge issuers where the standards required by the guidelines have not been met. Any such challenge should be by way of a discussion between the NCA and the issuer.
Should the issuer be unable or unwilling to comply with the NCA's required changes, then the NCA is empowered, under Article 20 of the Prospectus Regulation, to refuse the approval of the prospectus and terminate the review process.
Impact on AIM admission documents
Although these guidelines are not directly applicable to AIM applicants and issuers, drafters of admission documents would do well to follow the guidance provided by ESMA to ensure a clarity of messaging concerning the inherent risks concerned with AIM applicants and issuers and their securities. Albeit, with no formal approval process of admission documents on AIM, there won't be the same scope for AIM to review and challenge draft disclosures.
Osborne Clarke comment
These guidelines form part of the wider updates and refinements being made to the prospectus regime and will be welcomed by drafters and readers of prospectuses alike. 'Size inflation' of prospectuses in recent years has, as the guidelines note, adversely affected their comprehensibility. A set of targeted and streamlined risk factors will contribute to improving the overall look and feel of documents being produced in future.
In practice, the guidelines should merely serve as a reminder to practitioners and issuers of best practice and ensure that only the most specific and material risks to a business or its securities are disclosed, rather than necessitate wholesale changes to the drafting process.
An opportunity missed?
It is unfortunate that the guidelines did not go further and provide guidance as to appropriate levels of risk factor disclosure depending on the target audience of the specific prospectus (beyond highlighting factors such as the unit denomination being at least €100,000, or the securities to which the prospectus relates concerns securities which will be only on a regulated market, or a specific segment thereof, to which only qualified investors have access). No distinction has been made, for example, between a retail offering and those issues targeted at qualified investors. Accordingly, the same levels of disclosure about the risks of investing in listed securities will still be appropriate. However, it is likely that ESMA would point to the fact that the prospectus is live for a year after publication and a retail investor could acquire the securities in the aftermarket, as a reason for not recommending fuller disclosure in such prospectuses.
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