Getting Prospectuses Right

Written by Chris Huhne MEP and published in Borsen Zeitung on Tue 17th Dec 2002

This month's amended proposal from the EU Commission for a prospectus directive represents a big step forward, but there are still substantial problems before the law can be finalised.

The EU directive on prospectuses is designed to enable companies to sell bonds or shares to all investors in the EU with one approved prospectus, rather than fifteen approvals as is the case now. This measure is important because of its potential to reduce issuance costs and boost the securities markets while ensuring that the markets have necessary information.

It has not, though, been easy going. Unfortunately, the initial proposal of the EU Commission in May 2001 was formulated with little market consultation, reflecting both its shortage of resources (with just 100 people covering the whole financial services area) and the tight summit deadline.

There were severe practical flaws that could have seriously damaged both the euromarkets (by pushing eurobonds outside the EU jurisdiction) and the stock markets (by increasing the costs of disclosure and listing for small quoted companies). As a result, the proposal was heavily amended in the European Parliament's first reading in March 2002.

At the same time, the working group of the Council of Ministers - composed of Treasury and national regulatory officials - has also been introducing amendments but it has not completed its work. As an aide to speedy decision-making, the Commission brought forward an amended proposal, taking on board many of the parliament's amendments as well as those initially discussed by the council, on 14 August 2002.

The Commission's amended proposal largely resolves the issue of smaller quoted companies and small and medium sized businesses. SMEs will be have lighter requirements than larger companies, and will be able to update their prospectus annually merely by filing annual financial statements. Other companies will no longer, as at first proposed, have to file a compulsory annual document.

But the Commission's revised proposals for the wholesale or professional markets are still problematic. True, there is a much wider definition of the professional investors to whom issues can be marketed without the full requirements of the directive: the Commission has suggested the inclusion of both high net worth individuals and also those with financial market experience and a regular trading history. In addition, any eurobond with a minimum denomination of €,000 will be deemed to be aimed at the professional market, and any issuer of such bonds will have a single passport (enabling it to go to every investor in the EU) without onerous disclosure requirements.

However, there is one key remaining difficulty, concerning issuer choice over which regulator should be responsible for approving the prospectus. Should it be the country where the company is registered, or the country where the securities are listed? At present, issuers have effective free choice of approval. Thus a Dutch bank issuing derivatives in Germany can get the German regulator to approve the prospectus for use in Germany.

Within the Council of Ministers, there is one group of countries - Germany, Britain, Luxembourg, Austria and Finland - that supports the European Parliament's view of the need for free choice by the issuers. They argue that flexibility is essential to ensure that regulators understand the securities whose prospectuses they approve.

But there is also another group of countries - France, Italy, Greece and Spain - that insists on a national regulatory monopoly on approval of all prospectuses. They argue that it is as mistaken to allow companies to choose their regulator as it is to allow taxpayers to choose their tax inspector. Because these two groups of countries each have enough votes to block agreement, some form of compromise is essential.

One compromise suggested by Finance Minister Hans Eichel is for a single agency to approve prospectuses for the whole EU. In the long run, this will happen. There will probably be one regulator for the whole EU industry, but in the short term national laws and regulations differ so much that we need a period of growing together. A 'big bang' with one agency would risk disrupting the markets and causing serious costs for business as it learned its role.

The Commission, however, has suggested a compromise too close to the Mediterranean view: it suggests that only issuers of bonds in units of €,000 should be able to choose which regulator -home state or listing state - approves their prospectus.

This would be immensely damaging to the markets. In future, the Dutch regulator would have to approve the Dutch bank's prospectus for a German-listed derivative even if it was entirely unfamiliar with the instruments on, say, the Stuttgart exchange. This could put foreign banks at a serious disadvantage in many markets, and would reduce competition and investor protection.

The truth is that the national regulators simply do not have the expertise to handle prospectuses for specialised instruments. Even the London-based Financial Services Authority - the doyen of EU regulators - has no experience of naked warrants or pfandbriefe; Spain has no experience of Medium Term Notes; Greece and Portugal have no experience of securitised bonds. The EU regulators need to act as a team, pooling expertise.

A national regulators' monopoly would also encourage protectionist behaviour, so that companies would be pushed towards listing first on their home market. It would also mean extra costs when a regulator insists on a full prospectus - not just the summary - in the local language as well as an international language. Each 70 pages of legal translation costs €,000.

And it would favour local banks in corporate advisory work since only they would have the regulatory contacts with the national agency. Other banks -except the biggest American investment banks -would not be able to justify the expense of maintaining professional contacts with the national regulator in each EU country. For all these reasons, an important measure of issuer choice is essential if the objectives of the directive - opening up a genuine single market - are to be fully achieved. This will be the central battleground for the autumn.

We need to take a brave step in favour of more competition and freedom. That is what is ultimately best for the investor and the EU economy.