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UK 'Controlled' Companies: New Listing Rules!

Published on Sat, Jun 07,2014 | 13:20, Updated at Mon, Jun 09 at 19:31Source : CNBC-TV18 |   Watch Video :

Last month, UK’s Financial Conduct Authority brought into force new listing rules for controlled companies i.e. companies where a single shareholder has more than 30 percent. What we would in India refer to as promoter led companies. The new rules require

- The controlling shareholder to sign a relationship agreement with the company that says amongst other things that related party transactions will be conducted at arms length. Failing which, they will be subject to approval of majority of the minority. That’s similar to what India has just legislated in Companies Act, 2013

Financial Conduct Authority
Introduces New Listing Rules
For premium listed  companies with a ‘controlling’ shareholder

Controlling Shareholder: >30% shareholding

New Listing Rules: Controlled Companies

Controlling shareholder must enter Relationship Agreement with company
Agreement must contain mandatory ‘independence provisions’

- Related Party Transactions should be at arm’s-length
Or approved by Independent Shareholders

- De-listing of a controlled company will also require majority of minority approval. This too is similar to SEBI’s prevailing delisting regulations

New Listing Rules: Controlled Companies

De-listing resolution requires approval of 75% of those who vote
De-listing resolution to be passed by majority of independent shareholders who vote

- But the UK goes one step ahead of India to also require majority of minority approval for the appointment of Independent Directors

New Listing Rules: Controlled Companies

Independent Directors
- Must be approved by shareholders
- Must be approved by Independent Shareholders

What prompted the UK to make these changes and to better understand the impact of them, CNBC-TV18’s Menaka Doshi speak to Peter King, Partner at Weil, Gotshal & Manges

Doshi: I would like to start with one step in which the UK has gone ahead of India and that is the step in which they require independent shareholders to approve the appointment of independent directors. Can you take us through this change and the impact it will have?

King: The Financial Conduct Authority (FCA) is very keen to ensure that independent shareholders in a controlled company- a company which has a controlling shareholder- are represented by directors, who they feel are independent, who really do represent them. They do not want those independent directors just to be people who the controlling shareholder has approved and has appointed himself. So they have brought in this rule to ensure that those independent directors are voted on by the independent shareholders and not by the controlling shareholder and it is important to understand one or two cultural differences which make a difference here- first of all in this country, its usual for shareholders in companies of any decent size to vote on the entire board every year. So, every annual general meeting, there will be votes on every appointment of all the directors including the independent directors.

Second, our corporate governance code requires the board to contain a strong independent element and normally that’s interpreted as meaning that the Chairman must be an independent chairman and there must a majority of independent directors on the board. So that means that the independent directors have very considerable power and by making sure that those independent directors are elected only by the public shareholders, only by the independent shareholders, the FCA has strengthened the position of the independent shareholders.

Doshi: This majority of minority vote requirement in the case of related party transactions in the Companies Act here in India has set off quite the debate about how it compromises the ability of the majority shareholder to exercise his legitimate majority. I do not want to get into much detail on that but I do want to point out that maybe you won’t have that same debate in the UK because there seems to be a rather convenient out to this independent director requirement and that is that if this approval from independent shareholders is not obtained, the company may propose a further resolution within 120 days on which all shareholders will be entitled to vote and hence the independent shareholders approving the independent directors requirement may in fact get diluted.


New Listing Rules: Controlled Companies
Independent Directors
- Must be approved by Independent shareholders
- If this approval not obtained company may propose 2nd resolution within 90-120 days in which all shareholders can vote

King: Yes. What the FCA was anxious to avoid was a standoff, a fight if you like, between the independent shareholders and the controlling shareholder. They didn’t want to get into a position where the company effectively has no functioning board because the board keeps proposing candidates for the independent director role and the independent shareholders keep on rejecting them. They wanted to make sure that there was, if you like, a tiebreaker.

My own view and I think this is shared by quite a lot of lawyers in London, is that they don’t what to use this tiebreaker except in very extreme circumstances because it is a disaster if the independent shareholders and the controlling shareholders are disagreeing over the choice of independent directors. And just to deal with one other point you made- I think it is important to realize that the controlling shareholders still has very considerable power. The shareholders can only vote on the candidates that are actually put forward by the board because the controlling shareholder will certainly be represented on the board. It means that only the candidates which the controlling shareholder is happy with will be put forward to shareholders for approval. So, in practice, the controlling shareholders still have quite a bit of power over who is appointed as an independent director.

Doshi: What was interesting in the second point that seems to be on this new listing rules is the return of relationship agreements. Now the UK has experimented with relationship agreements before. They fell off few years ago, they are now back and within them, there is that requirements that all related party transactions have to be at arm’s length. If they are not, then again you require a majority of the minority to approve them.

King: That is right and in practice although the rule requiring relationship agreements was abolished for a while, it had now been brought back. A lot of companies with controlling shareholders still had relation agreements because institutional and other investors here in the UK expect it to see them in place and the relationship agreement would contain, as you say, a number of broad principles including a principle that the controlling shareholder will not use his power as shareholder to prevent the company from carrying on an independent business and will ensure that all transactions between it and its associates and the company are done on arm’s length basis.

Doshi: I am curious Peter- besides this related party transactions, what has prompted the return of relationship agreements given that they were abolished a few years ago as you pointed out as well. Why did the authorities think that it was necessary to bring back this relationship agreement? The reason that I am asking is because I would also like to point out that when Securities and Exchange Board of India (SEBI) put out a thought paper on new corporate governance norms here in India, it did in fact include the idea of this relationship agreement as something that controlled companies should follows. Of course it hasn't become regulation or guidance as yet in India but I would like to know more about why UK is reintroducing this?

King: It is worth saying a little bit about why we have companies in the UK that are controlled by a single shareholder. We have actually very few companies that have a group of promoters, perhaps a family or something like that, on the lines that you have in India. Most of our controlling shareholders fall into two categories,- the first category is the private equity houses who have floated companies within their portfolio but maintained a shareholding of 40 to 50 percent and those private equity houses have absolutely no interest in exercising undue rights of control. They wish to preserve the value of their investments. So they wish to behave in a way that the outside investors are very happy with particularly because they may wish to sell further shares in the future. So that is one category. The second category however is the one that has caused the problem for the Financial Conduct Authority (FCA) and that category largely relates to companies which are controlled by stakes in the form of Soviet block and in other parts of the emerging markets world and in those cases most of these companies are natural resources companies. The State or State owned entity has retained considerable control over the company even after it has been floated on the London Stock Exchange and there are circumstances which are well documented where some of those companies have been subjected to what is considered to be undue rights of control by the controlling shareholder and the London Stock Exchange and the FCA has considered whether those companies are suitable for listing at all and rather than simply saying we don't want the business from those companies and let them go to their own stock exchanges in Kazakhstan or in Nigeria or wherever it may be, they said we would rather have that business but we want to be sure that investors are properly protected. And that is why they felt it necessary to introduce these requirements.

Doshi: I want to come to the final point then and that is to do with the delisting of a controlled company which now also requires a majority of minority approval - again something that has prevailed in India for several years now under SEBI's delisting regulations. This is being introduced in the UK fresh up the back of an interesting case that involved an Indian group which is Essar which ran into opposition from some of its shareholders in the process of taking itself private again- that is Essar Energy that I am referring to.

King: Yes, again there are some cultural differences which are important. Normally in the UK when a company is looking at delisting, the majority shareholder would look to make an offer to acquire all the shares held by the minority and would expect to get to a point where under our squeeze out rules, the majority shareholder can in fact acquire 100 percent of the shares in the company. That is what the majority shareholders in Essar Energy has sought to do and the other notorious case from a couple years ago where this has happened is the ENRC case. The previous threshold was 75 percent and of course a lot of majority shareholders are sitting very close to that 75 percent level and could achieve a delisting very easily and the FCA was concerned that by doing that, minority shareholders might be deprived of the value in their shares unfairly. The delisting rule is designed to prevent that or at least to make it more difficult, which it does.

Doshi: You mentioned in your alert to clients that all of these combined changes in the listing rules will have at best a limited effect on the way shareholders conduct their relationship with the listed company?

King: Yes, as I mentioned earlier on, a lot of our companies don't have a controlling shareholder and in fact companies with controlling shareholders are quite rare. One question which we do still have is whether these rules will act as a deterrent to companies listing in London, perhaps companies from emerging markets where the culture is a bit different where perhaps a family or a controlling shareholder wants to retain a big interest and wants to retain more control than London will allow him or them to do.

Doshi: I am sure you won’t have any trouble with companies from India Peter, because they are all getting used to many of these provisions that either already exist in SEBI regulations or are being introduced through the new company law. So in that sense you might say that India's corporate governance requirements are a little bit ahead of the curve than the UKs and normally, it is the other way around - we draw inspirations from your regulations.

King: You are absolutely right and if an Indian company is complying with the new requirements in your Companies Act and the various new norms that SEBI is introducing at the moment, that company will be in a very good position to get a listing in London because a lot of the requirements will already be dealt with. So maybe we will see more Indian companies thinking about a secondary or perhaps even a primary listing on the London market.


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