From later this year, ASX will refuse to list companies that fall short of several more demanding tests that it intends to introduce. ASX has seen an increase in unsatisfactory listing applications during the past 18 months and recently announced significant rule changes to refresh expectations for quality.
With a mooted more onerous net tangible assets test, market capitalisation test, profit test and spread test, as well as new qualitative criteria to be appropriate for listing and a minimum free float requirement, ASX intends to pull all its regulatory levers to lift quality. For back door listings, ASX is additionally contemplating bringing forward the date of suspension from trading, introducing a review fee, formalising an extended review period and in all but exceptional circumstances requiring a prospectus rather than an information memorandum. In this update Jeremy Wickens and Cameron Bill explain the proposed changes and their significance.
ASX is in the process of finalising its proposed rules changes and will shortly release consultation papers, with an earliest conceivable implementation date in July 2016.
Increased financial admission tests
Most significantly, ASX intends to raise each of the 3 financial admission tests (at least one of which most applicants must meet):
- net tangible assets test: increasing from $3 million to $5 million;
- market capitalisation test: increasing from $10 million to $20 million; and
- profit test: increasing from $400,000 to $500,000 consolidated profit from continuing operations for the 12 months before the listing application (with no change to required aggregated profit from the last 3 financial years of $1 million).
The marked increase in company scale required by the increased tests raises real questions about ASX's role. One of ASX's traditional features has been its lower thresholds for early-stage companies to list, relative to other exchanges internationally. While there is a public expectation for regulators to vet the integrity of listing aspirants, precluding smaller companies is a blunt instrument to achieve this. The approach sits uncomfortably with the Turnbull government's recent focus on innovation and, since it will drive some start-up enterprises to pursue more private funding, limits retail investors' access to those opportunities at lower valuations.
Higher value shareholder spread test
Another significant change ASX proposes is to increase the minimum parcel from $2,000 to $5,000 worth of shares per shareholder counted toward the spread test. This may be coupled with a decrease in the number of shareholders required (currently 300, 350 or 400 shareholders, depending on the proportion connected with the company). ASX is concerned that the current parcel size may not be valuable enough to demonstrate genuine market support for a company, having had experiences of spread being achieved by artificial means.
We see an ongoing market perception is that spread is a major hurdle. Powerful evidence of this is the recent popularity of back door listings, which are more expensive and take longer than IPOs, but are chosen principally because of the assistance with spread that the listed company offers. We see increasing the spread parcel size will fall most heavily on back door listings, since the listed company participant typically has a low valuation, meaning a low parcel value for most of its shareholders and, with a larger parcel size, will have far fewer qualifying shareholders to contribute towards spread.
ASX is also reviewing its unpublished practice of requiring 'emerging markets' listing applicants to have Australian residents comprise at least 75% of their shareholders that are counted toward the spread test. This reflects the perceived challenges that predominant foreign ownership creates for liquidity and enforcement of ASX's rules against achieving spread by artificial means (slipping shares to promoters' family members and other associates). We would prefer to see ASX addressing these challenges in other ways and instead consistently projecting an 'open for business' message that encourages ASX listing wherever a company's assets, head office and shareholders are located.
New minimum 'free float'
ASX intends to require in the order of 10% of listing applicants' securities to be held by non-insider investors, with the exact percentage to be determined in consultation with ASIC. ASX has seen listing applicants with large anticipated market capitalisations but relatively small capital raisings, meaning insiders may continue to hold the overwhelming majority of securities. It is concerned to ensure adequate liquidity and that such companies may have ulterior motives in seeking listing, given they are not motivated by capital raising or liquidity.
How would a free float test likely affect behaviours? Would a large company raise more and list on ASX or retain its preferred ownership structure and list elsewhere? It's often undesirable to be a minority shareholder in an illiquid tightly held enterprise, but potential investors can assess this. It is not necessary to protect them against even considering it.
New qualitative criteria
ASX intends to add to the existing criteria for appropriateness for listing, including by requiring at least some board experience of managing listed companies and of managing the type of business being floated (particularly in a back door listing) and a satisfactory and explicit minimum subscription condition.
We support ASX providing further guidance about the measures it uses to assess quality. By ASX being transparent on this, listing applicants can implement appropriate structures before applying. We see case by case assessment as a far preferable way to promote quality listings than the blunter instrument of increasing financial admissions tests.
ASX closing the back door?
For back door listings, ASX is additionally contemplating bringing forward the listed company's trading suspension to immediately after the transaction announcement. Currently, listed companies are suspended on the date shareholders approve the transaction. ASX is seeking to stop securities that are issued in a pre-prospectus capital raise in anticipation of the transaction being quickly on-sold for a handy profit in the post-announcement trading window. However, we see this is already controlled by ASX's existing escrow regime.
Bringing forward suspension will eliminate the other key advantage of back door listing transactions. That is, the opportunity to gauge market reaction after a transaction is announced, via the trading performance of the listed company. This can underpin confidence in investor support for the capital raising and assist in its pricing. It can also assist in justifying the company's valuation for the purpose of the market capitalisation test and its consolidation ratio for the purpose of ASX's 2 cent minimum securities issue price. Together with the increase in spread parcel size, if implemented, the changes may well end the appeal of the back door process.
Regarding back door listings, ASX also proposes:
- in all but exceptional cases requiring a prospectus to be used, rather than an information memorandum – we see this having little impact, since back door listings typically require a capital raise (and so cannot use an IM), ASX already requires IMs to meet the key higher content standard applying to prospectuses and although IMs are not required to be lodged with ASIC, ASX's current practice is to provide IMs to ASIC for review;
- to make use of its power to charge a review fee for the notice of shareholder meeting to approve the transaction – we know budgets are usually very tight for back door listing candidates and they will feel the pinch from extra fees; and
- formalising a three week (at least) review period for the notice of shareholder meeting – we see that this is not a major change from current practice, rather it will raise awareness of the need to build that period into timetables and that the first crunch point for ASX scrutiny is on lodging the notice of meeting.