Australia: ASX Consultation Paper on Capital Raising by Small and Mid Caps - Great Start, but ... ?

Last Updated: 12 May 2012
Article by David Selig

Addisons congratulates the Australian Securities Exchange (ASX) on the issue of its public consultation paper, 'Strengthening Australia's Equity Capital Markets (April 2012)' (Consultation Paper), and thanks ASX for the opportunity to make this submission.

In general, Addisons supports the proposals contained in the Consultation Paper, in particular, those which have been designed to facilitate the capital raising efforts of mid to small capitalised entities (Relevant Entities). We believe that the proposed reforms strike a good balance between, on the one hand, assisting Relevant Entities to access capital more readily, especially in the early development stages of their businesses and, on the other hand, safeguarding the interests of existing shareholders from unwarranted dilution and non-arm's length transactions.

However Addisons has concerns with, and wishes to comment on, the following amendments as proposed in the Consultation Paper.

Existing Listing Rule 7.1.5 and proposed Listing Rule 7.1B.2

15% Rule – Listing Rule 7.1 prohibits a listed entity from issuing or agreeing to issue in any 12 month period, "equity securities" in excess of 15% of the total number of its ordinary securities on issue at the beginning of that 12 month period, unless the issue is approved by shareholders or otherwise falls within one of the exceptions or carve outs to Listing Rule 7.1 (15% Rule).

Specifically, Listing Rule 7.1.5(a) provides that:

"An agreement to issue equity securities that is conditional on the holders of ordinary securities approving the issue before the issue is made is not treated as an agreement [to issue for the purposes Listing Rule 7.1]. If an entity relies on this rule it must not issue the equity securities without approval".

Therefore, in circumstances where a listed entity enters into a contract – for example, an executive employment contract – pursuant to which it agrees to issue ordinary voting shares to a person, but conditional upon first receiving shareholder approval to that issue, the listed entity would, in reliance on Listing Rule 7.1.5(a), not be required to seek shareholder approval to enter into that contract notwithstanding that the magnitude of the issue contemplated in that contract may, either of itself or when aggregated with preceding issues made in the preceding 12 month period, have exceeded, in the absence of Listing Rule 7.1.5(a), the permissible capacity under the 15% Rule.

Addisons considers that the operation of this exception to the 15% Rule, as illustrated in paragraph 1.3, is commercially sensible as it defers the inevitable delay, effort and cost associated with seeking shareholder approval to a proposed issue of equity securities, to a time when the actual making of the contemplated issue becomes a certainty, conditional only upon the receipt of the prior consent of eligible shareholders, whose interests will be diluted as a result of that issue.

However, an anomaly to the application of Listing Rule 7.1.5(a) arises where the 'agreement to issue' is an agreement to issue convertible notes or other securities convertible into "equity securities".

Addisons submits that an agreement which provides for the issue of convertible securities that are convertible into equity securities subject to the satisfaction of certain criteria (such as prior shareholder approval to conversion), is no different, for the purposes of the 15% Rule, to any other agreement to issue equity securities.

However, by reason of the broad definition of "equity securities" in Listing Rule 19.12, which includes relevantly a convertible security (including any debt security convertible into a share or unit), a listed entity is effectively denied the benefit of the carve out from the 15% Rule in Listing Rule 7.1.5(a) where it proposes to enter into a convertible security agreement.

Specifically, ASX takes the view in connection with Listing Rule 7.1.5(a) that, in the context of a listed entity that proposes to issue a convertible security, in order for an exception to the 15% Rule to apply to the conversion of that convertible security into an ordinary share:

  1. the entity must first obtain the approval of its shareholders to and before the issue of the convertible securities, as opposed to prior to the issue of the underlying equity securities upon conversion of the relevant convertible securities. According to the terms of Listing Rule 7.1.5(a), this approval must be obtained even where the terms of conversion of the convertible security are conditional on shareholder approval to the conversion and consequential issue of equity securities; and
  2. when the conversion of the convertible note is forthcoming, the entity may then rely on the exception to the 15% Rule in Exception 4 of Listing Rule 7.2, as opposed to Listing Rule 7.1.5(a),

(collectively, ASX Position)1.

Observations – Whilst we believe that the ASX Position applies a correct interpretation of the current drafting of Listing Rule 7.1.5(a) and related Listing Rules, we submit the ASX Position does not advance the policy objectives underlying the 15% Rule. We submit that there is a substantive difference between an agreement to issue non-voting convertible securities and other agreements to issue ordinary securities (as described in paragraph 1.3 above) that would justify differential treatment of those agreements under the Listing Rules.

The 15% Rule is designed to limit – or at least regulate – the issue of equity securities that could potentially dilute the interests of ordinary securityholders2. That rule is intended to operate in conjunction with the requirements in Chapter 3 and 10 of the Listing Rules that regulate continuous disclosure and the approval of ordinary securityholders to related party transactions, respectively.

In this context, we also draw ASX's attention to Listing Rule 19.2 which provides that an entity must comply with the Listing Rules as interpreted "in accordance with their spirit, intention and purpose; by looking beyond form to substance; and in a way that best promotes the principles on which the listing rules are based".

The effect of the ASX Position is to, inter alia, require a Relevant Entity to wait at least 35 to 40 days after deciding to issue convertible securities, before it will be able to obtain the prescribed shareholder approval to the issue of those convertible securities and subsequently obtain access to those subscription funds3. That delay is often a very serious commercial impediment to the efficient operation of Relevant Entities when presented with opportunities that require speed and certainty of funding. Further, no substantive benefit to the issuer's shareholders appears to be derived from that delay.

In our opinion, the ASX Position is contrary to the policy objectives of the 15% Rule and ASX's purposive approach to interpreting the Listing Rules4. In the Consultation Paper, ASX states that "ASX proposes to enhance its single board by putting in place capital raising rules that directly address the needs of these companies to raise capital by placements and to reduce the compliance cost of using the placement mechanism.".5

The ASX Position appears to unnecessarily burden Relevant Entities by requiring them to incur significant delay as well as expense in convening a general meeting to approve the issue of convertible securities prior to a time when there exists any reasonable likelihood or certainty that those convertible securities will in fact convert into equity securities that would have a dilutive effect on the current ordinary security holders of those Relevant Entities. In fact, it is not uncommon that convertible securities issued by an entity may never convert into ordinary voting shares. For example:

  1. convertible securities may be issued on terms that the issuer will have the option to redeem those convertible securities prior to or upon the final maturity date;
  2. the terms of conversion of the convertible securities – e.g. where an entity is performing poorly and the terms of conversion are contingent on the price of the underlying securities being a certain percentage about the conversion price – may never be fully satisfied; and
  3. the entity may undertake further capital raisings after the issue of the relevant convertible notes such that, at the time of conversion of those convertible securities, the issue of the aggregate number of resulting ordinary securities in the preceding 12 month period would no longer cause a breach of the 15% Rule.

When one considers the common uncertainty surrounding the potential conversion and dilutionary effect of convertible securities at the time of their issue, it seems more appropriate, as a practical matter and in light of ASX's declared policy objectives underlying the 15% Rule, to require Relevant Entities to obtain the requisite shareholder approval under Listing Rule 7.1 prior to and as a condition of conversion of the relevant convertible securities into ordinary voting securities, where it is anticipated that such conversion will otherwise result in a breach the 15% Rule.

In other words, we suggest that the application of Listing Rule 7.1 and associated Listing Rules should be restricted to the issue or agreement to issue of ordinary voting securities, and not "equity securities" in general, to address the 'anomaly' situation described at paragraphs 1.5 to 1.8 above (both inclusive).

When one considers ASX's market analyses in the Consultation Paper, which indicates that the practical likelihood of Relevant Entities receiving the required approval of their ordinary security holders is extremely high6, there is no apparent benefit in requiring them to procure shareholder approval to the issue of non-voting convertible securities in anticipation of their possible conversion into ordinary voting shares.

Addisons' suggested amendment – We note that:

  1. the drafting of Listing Rule 7.1B.2 - as presented in Annexure 5 of the Consultation Paper7 – suggests that there is no intention to make any substantive change to the current terms of Listing Rule 7.1.5(a); and
  2. there does not appear in the Consultation Paper any proposed amendment to the definition of either "equity security" or "convertible security", as set out in LR 19.12.

Therefore, for the reasons set out in paragraphs 1.9 to 1.17 above (both inclusive), Addisons submits and recommends that the proposed drafting of Listing Rule 7.1B.1 be amended to read as follows:

"7.1B.1 In working out the number of +equity securities that any entity may issue or agree to issue under rule 7.1 (including the amount "C" referred to in that rule), or that an eligible entity may issue or agree to issue under rule 7.1A.2 (including the amount "E" referred to in that rule):

  1. [as provided for in the Consultation Paper];
  2. [as provided for in the Consultation Paper];
  3. if the +equity securities are +convertible securities that are issued or agreed to be issued upon terms that provide:
    1. the issue of +ordinary securities upon conversion of those convertible securities is conditional on the holders of +ordinary securities approving the issue before the issue is made; and
    2. the holders of those +convertible securities will not be entitled to vote on any matter other than those referred to in rule 6.3, as adapted in accordance with rule 6.4,
      each such +equity security is excluded from the amount "C" referred to in rule 7.1 and excluded from the amount "E" referred to in rule 7.1A.2; and
  1. [as provided for in the Consultation Paper]."

Voting exclusion statement

Pursuant to proposed Listing Rule 7.3A.5(c), a voting exclusion statement is required to be included in any Notice of Meeting pursuant to which a Relevant Entity seeks approval under proposed Listing Rule 7.1A.

Listing Rule 14.11.1 sets out, inter alia, the persons who are proposed to be excluded from voting on a resolution for the purposes of proposed Listing Rule 7.1A, they being:

"A[ny] person who may participate in the proposed issue and a[ny] person who might obtain a benefit, except a benefit solely in the capacity of a holder of ordinary securities, if the resolution is passed" (Voting Exclusion).

The Voting Exclusion operates to safeguard the interests of existing shareholders of a listed entity by ensuring that a resolution to issue equity securities under proposed Listing Rule 7.1A is not passed by the votes of those existing shareholders – in particular, substantial shareholders – whose interests in the relevant listed entity will increase as a result of the approval of that resolution or who are otherwise likely to personally benefit from the passage of that resolution.

However, as ASX appreciates, at the time of consideration and voting upon such a resolution, in particular, there is often a high level of uncertainty as to the likely level of participation in the proposed issue8.

Further, as is recognised in the Consultation Paper, Relevant Entities are typically seen as "speculative" and therefore significant institutions are often not permitted under their investment charters to subscribe for securities in such Relevant Entities. As a result, Relevant Entities are forced to rely more heavily on existing shareholders, executive management or private underwriters for capital9.

In light of the foregoing, we submit that the Voting Exclusion, as currently drafted, can operate to unduly impede the capital raising efforts of a Relevant Entity by precluding its existing shareholders – in particular, 'cornerstone' investors and executive securityholders – from:

  1. underwriting an issue by that Relevant Entity where those shareholders have voted on the resolution to approve that issue pursuant to Listing Rule 7.1A; or
  2. voting to approve that resolution if they intend to underwrite the relevant issue.

This is especially problematic where there is no other source of capital funding readily available to the Relevant Entity.

In circumstances where there is likely to be a genuine shortfall in the level of subscription under a proposed issue, the Voting Exclusion effectively:

  1. forces the Relevant Entity to either look to external underwriters to underwrite the issue or alternatively, abandon its capital raising efforts if the underwriting fees are prohibitive or the external underwriters refuse to underwrite the issue; and
  2. denies the Relevant Entity the opportunity to raise capital on the endorsement of 'internal' underwriters who may be more familiar with (and therefore have greater confidence in) the business and prospects of the Relevant Entity and whose interests are aligned with the interests of that Relevant Entity and its shareholders.

We submit that the Voting Exclusion should be amended, subject to appropriate limitations and disclosure requirements (as detailed in paragraph 2.12 below), to provide an express carve-out for those existing shareholders who propose to underwrite a proposed issue under Listing Rule 7.1A on arm's length terms and to enable their vote(s) on the resolution to approve that underwritten issue to be counted.

In further support of this submission, we note that the proposed amendment is consistent with the approach that has been taken with respect to the "20% rule" in section 606 of the Corporations Act 2001 (Cth) (Corporations Act). Specifically, Item 13 of section 611 of the Corporations Act provides an exemption from the blanket prohibition in section 606 against the acquisition by a person (and its associates) of an aggregate voting power in excess of 20% in a particular company where:

  1. the issue is to a person as underwriter to the issue or sub-underwriter;
  2. the disclosure document discloses the effect that the acquisition would have on that person's voting power in the company; and
  3. the issue "is made genuinely accessible to shareholders in general".10

In essence, we submit that the amendments suggested in paragraph 2.12 below are simply an attempt to harmonise the intent of the above legislation with the corresponding Listing Rules.

In addition, as is stressed in the Consultation Paper, the introduction of proposed Listing Rule 7.1A does not affect the operation of, or the protection provided to shareholders under, the related party provisions of the Listing Rules11 or the general operation of the Corporations Act or the Takeover Panel's Guidance Notes12.

Addisons' suggested amendments – For the abovestated reasons, Addisons submits that, for the purposes of proposed Listing Rule 7.3A.5(c), Listing Rule 14.11.1 be amended to read as follows. In drafting these suggested amendments, we have adopted similar limitations and conditions to those imposed by ASX in past ASX waivers, for the purpose of ensuring that the practical operation of the Listing Rules in protecting smaller shareholders against dilution is not undermined:

"7.1 and 7.1A [as provided for in the Consultation Paper]

7.1A A person who may participate in the proposed issue and a person who might obtain a benefit, except a benefit obtained, if the resolution is passed, solely in the capacity of:

  1. a holder of ordinary securities; or
  2. an underwriter or sub-underwriter to the proposed issue provided that:
    1. the underwriting arrangements are on arms' length terms;
    2. all material terms of the underwriting or sub-underwriting arrangements are disclosed in accordance with Listing Rule 3.10.5A(d), including:
      1. the fees payable to the underwriter and sub-underwriter (as applicable);
      2. the existing interests of the underwriter and sub-underwriter (as applicable) in the issuer entity over the immediately preceding 12 month period;
      3. the potential effect of the proposed issue on the interests of the underwriter and sub-underwriter (as applicable) in the issuer entity;
      4. whether the participation by the underwriter or sub-underwriter (as applicable) in the proposed issue is on behalf of any other person, and if so:
        1. the identity of that person;
        2. the nature of the relationship between that person and the
          underwriter or sub-underwriter (as applicable);
        3. the relevant interest that that person may acquire in the equity securities of the issuer entity as a result of the participation by the underwriter or sub-underwriter (as applicable) in the proposed issue; and
        4. any other information that, in ASX's opinion, is material;
    1. the benefit to be obtained by the underwriter or sub-underwriter (as applicable) from participating in the proposed issue is limited to:
      1. the fees payable to the underwriter and sub-underwriter (as applicable); and
      2. any issue of equity securities in the issuer entity in accordance with the terms of the underwriting arrangement; and
    1. where the benefit to be obtained by the underwriter or sub-underwriter (as applicable) from participating in the proposed issue includes an issue of equity securities in the issuer entity:
      1. all eligible participants in the proposed issue have had a reasonable opportunity to participate in that issue prior to the issue of equity securities in the issuer entity to the underwriter or sub-underwriter (as applicable);
      2. the issue of equity securities in the issuer entity to the underwriter or sub-underwriter (as applicable) is made on the same terms as the proposed issue; and
      3. the issue of equity securities in the issuer entity to the underwriter or sub-underwriter (as applicable) is completed within 10 business days of the closing of the proposed issue.

7.2 Exception 9 [as provided for in the Consultation Paper]..."

We thank you in advance for your consideration of the matters referred to above. If required, we would be happy to meet with ASX to discuss these submissions more fully.

The writer acknowledges the assistance of Belle Jing and Leah Hecht of Addisons for their significant contribution to the drafting of this submission.


1 Per email from Andrew Kabega of ASX to Addisons dated 17 April, 2012 at 3:50 pm. In that email, Mr Kabega advised, in relation to the proper interpretation of Listing Rule 7.1.5, that "to the extent the maximum number of ordinary securities into which the note can be converted exceeds that company's available capacity under Listing Rule 7.1, any agreement to issue the convertible note must be conditional on shareholders approving the issue of the note before the issue is made."
2 First paragraph of Note to Listing Rule 7.1.4(c): "ASX will take into account the policy objective of the rule being control over the dilution of security holders and the economic and voting characteristics of the security."
3 We assume that it will take between 7 to 14 days to prepare a Notice of Meeting. After the dispatch of the Notice of Meeting, a listed entity must give its shareholders at least 28 days' notice before convening the relevant general meeting (Corporations Act, s 249HA).
4 See paragraphs 1.10 and 1.11 of this submission as well as Annexure 3 of the Consultation Paper.
5 Consultation Paper, Executive Summary, paragraph 8; see also Consultation Paper, Section 3: "ASX consultation".
6 Consultation Paper, page 12:"ASX conducted a survey of 244 general meetings (including AGMs) held in 2011 by 200 mid to small caps seeking capital raising approval. Of these 244 meetings, based on information provided to the market, only one resolution was rejected. Where security holder approval of placements is routinely obtained by mid to small caps, ASX listing rules may be imposing an unnecessary regulatory burden, reducing flexibility and adding to the costs of capital raising."
7 The proposed LR 7.1B.2 provides that "an agreement to issue equity securities that is conditional on holders of ordinary securities approving the issue before the issue is made is not treated as an agreement. If an entity relies on this rule it must not issue the equity securities without approval."
8 This uncertainty has clearly been contemplated by ASX in drafting proposed Listing Rules 7.3A and 3.10.5A, which do not include a requirement equivalent to Listing Rule 7.3.4, namely, the disclosure of the names of the allottees of the proposed issue or the basis upon which they will be identified or selected.
9 Consultation Paper, Executive Summary, paragraph 7.
10 In Re InvestorInfo Ltd [2004] ATP 6 at 37, the Takeovers Panel provided guidance in relation to the proper reliance on the exemption to section 606 contained in Item 13 of section 611 of the Corporations Act, by considering the "extent to which participation in the rights issue (and in alternative benefits) is made genuinely accessible to shareholders in general" and the "likely effects of the issue on shareholders and the issuer".
11 Exception 14 to Listing Rule 7.2 exempts an entity from obtaining approval under Listing Rule 7.1 where approval has been obtained under Listing Rule 10.11. There is no equivalent exemption from obtaining approval under Listing Rule 10.11.
12 Takeovers Panel, Guidance Note 17, paragraphs 19-21 (inclusive).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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