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Focus: ASX consultation paper on mid to small caps equity raisings

4 April 2012

In brief: The Australian Securities Exchange has proposed to increase the capital raising limit for mid to small caps. Partner Julian Donnan (view CV) and Senior Associate Robert Speed look at the proposal which should mean greater flexibility for a large number of ASX-listed companies.

How does it affect you?

  • The proposal to facilitate capital raisings involves lifting the placement capacity limit for mid to small caps from 15 per cent to 25 per cent of capital within a 12 month period.
  • The new ASX proposals are set to deliver greater flexibility to conduct placements for companies with a market capitalisation of $300 million or less.
  • The quid pro quo for entities relying on this new rule is the requirement for additional disclosure at a shareholders' meeting to approve the utilisation of this additional 10 per cent placement capacity and post-issue reporting to the market.
  • Submissions on the proposals close on 14 May 2012.

Background to the proposal

On 2 April 2012, ASX released a paper setting out proposals designed to facilitate capital raisings for mid to small caps and updating ASX's admission requirements. This package is the first of the listing initiatives that ASX proposes to release in 2012.

To facilitate capital raisings by mid to small caps, eligible entities will be able to seek approval from shareholders on an annual basis to issue an additional 10 per cent of their issued equity over and above the existing 15 per cent limit prescribed by Listing Rule 7.1. The 10 per cent of new equity must not be issued at a discount to market price of greater than 25 per cent. The current regime for placements set out in Listing Rules 7.1 and 7.3 would continue to apply to mid to small cap companies as well.

ASX's proposal sets the threshold for mid to small caps as being $300 million market capitalisation, which it says is a good proxy for companies outside the S&P/ASX 300. Such entities account for approximately 76 per cent of all entities listed on ASX, but only 6 per cent of total market capitalisation on ASX. Just over half of these mid to small caps are resource companies. ASX states that equity funding is typically the only source of funding available to these smaller companies, and that investors in these companies can be expected to be aware of this need.

The proposal in detail

The proposal has the following elements.

  • Under the proposed new Listing Rule 7.1A, an 'eligible entity' (the defined term for mid to small caps) can seek shareholder approval to issue equity securities, which include shares, under the new rule. The new rule sets out a formula for the maximum number of equity securities that can be issued under the rule, which (generally speaking) equals 10 per cent of issued capital during the 12-month period.
  • The shareholder approval, once obtained, can be relied on for 12 months or until shareholders approve a transaction under Listing Rule 11.1.2 or 11.2 (substantial change in nature or scale of the entity or disposal of its main undertaking).
  • The equity securities issued under this rule must be issued at a price that is at least 75 per cent of their market price. The market price is to be determined by calculating the average of the closing price on ASX for the securities during the 15 trading days immediately preceding the issue.
  • If the consideration for the equity securities that are the subject of the placement is non-cash, a report prepared by either an independent expert or the directors (assuming they are suitably qualified) must be released to the market indicating how the consideration is valued.
  • In order to obtain shareholder approval under Listing Rule 7.1A, the notice to shareholders will need to contain the information required under Listing Rule 7.3A. That information is:
    • the minimum price at which the equity securities may be issued;
    • a statement of the risk of economic and voting dilution of existing shareholders, including the risk that the share price may drop following the issue and that the issue price may be lower than the trading price on the issue date;1 
    • the date by which the new equity securities may be issued;
    • the purpose of the issue;
    • if the entity has previously obtained approval under Listing Rule 7.1A, the total number of equity securities issued in the preceding 12 months as a percentage of capital, and the details of each issue; and
    • a voting exclusion statement under which any person who may participate in the proposed issue or otherwise obtain a benefit if the resolution is passed is excluded from voting on the resolution.2
  • Following completion of any share issue under Listing Rule 7.1A, Listing Rule 3.10.5A will require the company to make an announcement containing the following information:
    • details of the dilution to existing shareholders as a result of the issue;
    • where the shares are issued for cash, a statement of the reasons why the entity undertook a placement and not a pro rata or other similar issue;
    • details of the allocation policy for the issue;
    • details of the underwriting arrangements including fees; and
    • any other fees or costs incurred under the issue.

Commentary

The approach adopted by the ASX has the capacity to benefit small and mid caps by providing additional flexibility for their funding options and dispensing with the costs of calling additional shareholder meetings. We think the proposal will be well received by the market as a step in the right direction but some refinement may be required. Our initial observations are as follows.

  • Some of the post-issue announcement requirements (per the proposed Listing Rule 3.10.5A) appear either unnecessary or may possibly confuse investors. As shareholders are approving the potential dilution scenarios in advance, there would not seem a need to reiterate the point after the event. Furthermore, the requirements that the entity disclose why it chose a placement as opposed to a pro rata issue and to set out the allocation policy are more likely, in our view, to encourage formulaic disclosure that will not enlighten shareholders or the market. Finally, it may not always be immediately apparent if a placement, or a particular part of a placement, has been conducted under the 15 per cent available under Listing Rule 7.1 or the further 10 per cent available (if approval is obtained) under the new Listing Rule 7.1A. It may be preferable to harmonise the post-issue announcement requirements for all placements, whether conducted under Listing Rule 7.1 or 7.1A. To that end, we think the current Listing Rule 3.10.5 is both appropriate and sufficient for either rule.
  • The requirement to disclose to shareholders at the approval stage a variety of dilution scenarios appears reasonable. However, mandating disclosure of a hypothetical dilution scenario that assumes that the price of ordinary securities has fallen by at least 50 per cent may send a signal to investors that is unduly negative and/or may have little bearing on future events.
  • The resolution for approval under Listing Rule 7.1A will need to contain a voting exclusion statement under which anyone who 'may' participate in the placement or may otherwise benefit from the passage of the resolution will be excluded from voting. Given the likelihood that the identity of the placees for a Listing Rule 7.1A placement will not have been determined at the time of the shareholders' meeting (due to the 12-month timeframe available), and cornerstone investors and founding shareholders will be a likely source of future capital, it is not clear if any shareholders ought to be excluded from voting on this basis.3
  • Listing Rule reform to enhance placements seems at odds with much of the current commentary (particularly from fund managers and the Australian Shareholders Association (ASA)) criticising the practice of placements in preference to pro rata or other entitlement offer structures that prioritise existing shareholders. Overall, however, we suspect that much of that criticism is levelled at capital raisings undertaken by ASX100 companies, and not the mid to small caps.
  • Under its publication of August 2011, the ASA notes that it may vote against directors seeking election or re-election if that person was a member of the board at the time of a capital raising that offends its policy on pro rata issues, Equitable Treatment of Shareholders in Capital Raising. It is interesting that the ASX's post-issue disclosure requirements clearly place the spotlight on directors by requiring details of their involvement in allocations and consideration given to making the issue to existing security holders.
  • ASX has had, for a number of years, a policy in place under which companies may obtain a waiver from Listing Rule 7.3.2 in relation to structured capital raisings (see ASX Companies Update 11/07). Under Listing Rule 7.3.2, any issue of shares approved by shareholders under Listing Rule 7.1 must be issued within three months of the resolution being passed in order to have the benefit of the approval. Under the Companies Update, ASX states that it may grant a waiver of that rule, such that the period is extended to up to 12 months, for a detailed and structured capital raising program that is 'clearly linked to a well articulated program of work or project that is supported by detailed research or analysis'. ASX has only granted waivers in accordance with the Companies Update in very limited circumstances. The Companies Update is obviously targeted at resources companies that require equity capital to fund the development of a project. In light of its minimal use, it may be that the various requirements imposed by ASX under the Companies Update (including the rather detailed requirements about the project or program of work that to be included in the notice of meeting to approve the issue and the fact that an application to ASX for a waiver will be required) are too onerous for it to be attractive to companies. If the current proposal is adopted, ASX may overcome the limitations with the current policy and reduce the need to grant waivers.

ASX's proposal goes some way to balancing the competing tension between, on one hand, enhancing the ability of small and mid caps to conduct placements in a way that achieves greater flexibility and is more cost effective with, on the other hand, the interests of existing shareholders in not having their shareholdings diluted at prices that are substantially less than the prevailing market price. It may also assist the ASX in retaining its status as an attractive exchange for mid to small caps, particularly in the resources area, as it competes with exchanges, such as Toronto, that already facilitate placements of up to 25 per cent in certain circumstances without shareholder approval.

Footnotes
  1. This statement must be accompanied by a table describing the potential dilution of shareholders on the basis of at least three different assumed issued prices and three different assumed capital bases.
  2. The ASX paper suggests that the requirement for a voting exclusion statement only applies if the company obtained a Listing Rule 7.1A approval previously. We see no reason why a voting exclusion statement would not be required in all cases and assume this is an error.
  3. The same issue can theoretically arise under Listing Rule 7.1 placements, however, it is more often the case that approval under 7.1 is sought after conditional placements have already been agreed with investors, in which case it is clear who ought to be excluded from voting.

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