UK EQUITY CAPITAL MARKETS IN 2020 AND H1 2021- RIDING THE WAVE

UK EQUITY CAPITAL MARKETS IN
2020 AND H1 2021– RIDING THE
WAVE
23 November 2020 | London
Legal Briefings

In March we wrote a piece (here) on considerations for listed
companies seeking to raise capital in the face of the COVID-19 crisis.
As we expected, the subsequent seven months has seen a raft of
companies coming to market, with more money raised in equity by UK
listed companies in 2020 YTD than in any comparable period for a
decade. This piece, a companion to our earlier piece, looks back at the
key trends over the last seven months and considers the outlook for
UK equity markets.

THEMES OF THE COVID-ERA
UNPRECEDENTED GOVERNMENT ACTION
As noted in our March piece, the COVID crisis precipitated many large fiscal and monetary
stimulus packages from Governments world-wide. In the UK, measures including furlough,
the CCCF, and government backed loans for SMEs rescued many companies that would not
otherwise have survived, and gave others breathing space to ride out the immediate crisis.

Without these measures the volume of equity recapitalisations relative to those we have
seen could have been much higher. However, with recessionary conditions expected to
persist for some time and significant economic challenges ahead, we expect a significant
volume of recapitalisations and full balance sheet repair operations (including debt for equity
swap transactions) still to come, with investors still being prepared to back companies with a
strong investment story.

INNOVATION, INNOVATION EVERYWHERE

The vast majority of clients and advisers have been working from home and complex deals
have been executed over a period of months without any physical meetings. And yet, while
COVID may have dragged some aspects of deal-making into the 21st century, the real
innovation has been elsewhere:

    Regulators and industry bodies responded rapidly, with the FCA publishing guidance that
    allowed companies to raise capital notwithstanding the uncertainties created by COVID
    by publishing the COVID assumptions on which their working capital statements are
    based. In parallel, the UK government introduced legislation temporarily overriding
    companies’ constitutional documents, to allow companies to hold closed meetings. The
    FCA went further still in permitting listed companies to dispense with company meetings
    on class 1 and related party transactions, if they could evidence sufficient support for
    their plans. The Pre-emption Group relaxed their guidelines (initially until 30 September,
    subsequently extended to 30 November) to encourage investors to consider larger non-
    pre-emptive raisings, effectively clearing the path for many companies to raise an
    amount equal to up to 20% of their existing equity by way of a placing and dovetailing
    with the exemption to produce a prospectus under the Prospectus Regulation where
    companies are issuing less than 20% of their issued share capital. The market adapted
    rapidly to the new normal, with companies including WH Smith, SSP, Autotrader, ASOS,
    Hiscox and Unite being amongst those to take advantage of the additional flexibility and
    issuers and their advisers respecting the soft pre-emption and enhanced disclosure
    guidelines set by PEG. This relaxation has been very successful and has certainly
    influenced issuers, with the number of traditional rights issues being less than
    anticipated – and it is likely that there will be pressure to maintain these relaxations
    going forward. However the Pre-emption Group appear to be set to withdraw the
    concession on 30 November as this article goes to press and did indeed make an
    announcement to this effect on 20 November. If this comes to pass, we would anticipate
    a natural pivot towards rights issues and placing and open offer structures for the larger
    capital raises.

    Retail participation increased, as more structures were deployed to allow retail
    shareholders to participate even in non pre-emptive raises. PrimaryBid caught the
    attention of the broadsheet media and then of boards, as they offered companies the
    ability to build a retail tranche seamlessly into existing bookbuild processes, albeit
    capped at €8 million, and so these were more symbolic nods to retail participation on
    larger deals. Broker options were also deployed, alongside clawback to allow a wider
    range of investors to participate alongside institutional places, whilst Shaftesbury
    adopted a bolt-on (non-underwritten) offer for subscription as a feature of their recent
    placing and open offer.

    As we anticipated in our March piece, there has been an increase in structured solutions,
    often with private capital coming in alongside public equity to recapitalise listed
    companies. Aston Martin, Costain and SIG were three early examples of this, with Saga
    being a more recent example and all the more heartwarming for the private investment

coming from the founding family of the business. Structuring private investment into
    public equity can be challenging in practice, given the constraints on what issuers can
    offer private equity investors in exchange for their strategic investment and the need to
    balance the need for investment with existing investors’ concerns about dilution. Deal-
    making bankers have had to work hard in challenging markets to strike deals which can
    be supported by boards and shareholders alike. Whilst these recent PIPE-like
    transactions have all featured conventional equity, we see a possibility that more
    structured solutions, such as warrants and convertibles, could make an appearance in
    the more distressed scenarios.

    In March we wrote: “For most companies, and particularly those most directly impacted
    by Covid-19, an equity raise alone will not suffice and a more comprehensive
    recapitalisation plan may be required. This may necessitate some form of
    accommodation with lenders and noteholders, be it amending and extending existing
    facilities, waiving or removing covenants, payment holidays, rolling notes over or debt-
    for-equity swaps, alongside a large equity raise. Alternatively or in addition, companies
    may combine refinancing with asset disposals.” Many companies have indeed sought
    holistic solutions, pairing equity raises with debt refinancings and/or renegotiation and/or
    asset sales. Often these elements have been interconditional, as was the case for
    Hammerson, whose £552 million rights issue was inter-conditional with its disposal of its
    50% interest in its VIA joint venture. In other cases, including Rolls Royce’s rights issue
    lending syndicates’ relaxation of covenants, extension to repayment dates or provision
    of new facilities have been conditional on equity being raised and/or the proceeds being
    used to repay debt. Deal-makers have had to balance the disparate and occasionally
    competing interests of a range of stakeholders and align multiple negotiation timetables
    to deliver transactions, a considerable challenge against an uncertain market and
    political background.

THE LINE BETWEEN NOT ENOUGH AND TOO MUCH
Investors facing a rush of companies seeking capital on an expedited basis became
increasingly sceptical and challenging of the rationale for some raises. Boards and their
advisers were criticised in some quarters for seeking cash on an opportunistic basis when
there were arguments that it was not really required, and in others for seeking only a partial
solution when investors wanted to see a more comprehensive solution, even if it took longer
to put together. While it seems most listed companies that sought to raise capital were
successful, the process was not always smooth and some companies were challenged by
investors over the necessity or adequacy of their cash raising plans. Investor attitudes to
larger non pre-emptive raises were not uniform, either, and although most were broadly
supportive and backed such raises with cash, those facing significant calls on capital were
vocal in criticising companies forcing them to make the choice between investment and
dilution. This dilemma is expected to become more acute in H1 2021, with companies having
to plan for a more protracted economic hit than was perhaps originally anticipated in the
early stages of the pandemic, notwithstanding the recent positive news on vaccines.

MANAGEMENT’S DILEMMA

Board and management teams occasionally found themselves in the spotlight, with salary
cuts and bonus deferrals on the agenda of investors being tapped for cash and widely
discussed in the media. Perhaps less obviously, there was some media scrutiny of the ethics
of management teams participating in placings, with concerns being raised about
management having preferential access to discounted shares at a low point in the cycle. This
has quietened now, and the orthodox view that it is positive for management to support a
raise alongside investors has reasserted itself.

CAPITAL SEEKING DEPLOYMENT: PIPES AND SPACS
“Private equity is sitting on a lot of dry powder” has been a common refrain for years now
and is still often said. Preqin estimates that globally PE firms have $1.5 trillion ready to be put
to work. With M&A markets having, until recently, been subdued, PE firms have looked at
other means of deploying that capital. PIPEs (private investment in public equity) have risen
up the agenda, although have struggled to gain a foothold in a UK market which is more
conditioned towards straight equity transactions. Nonetheless, the Clayton Dubilier & Rice’s
investment in the SIG recapitalisation was heralded as being an example of a PIPE, albeit
simply structured, and banks have been looking at PIPEs with renewed interest.

There has similarly been increased interest in SPACs (special purpose acquisition companies),
cash shells set up with the goal of acquiring and driving returns from control positions in
companies. A considerable number of SPACs have IPO’d in the US and there is renewed
interest in the UK and Asia, with some deals known to be in the pipeline. SPACs are attractive
in the current market because they give public market investors the opportunity to hold a
liquid security while supporting the M&A strategies of experienced management teams and
founders. For targets and sellers SPACs provide an attractive exit opportunity and a
potentially compelling alternative to a conventional IPO track.

The UK has long been considered an attractive listing destination for founders and
management teams of SPACs because, unlike in the US, it does not require shareholder
approval of a de-SPAC transaction or give investors redemption rights. However, with the
overwhelming investor demand for SPACs being based in the US there has been pressure for
UK SPACs voluntarily to adopt some of the US investor protections, which in turn may negate
the advantage of the UK as a listing venue, There is also concern in the market about the
impact of the UK requirement for SPACs’ listings to be suspended when they announce a de-
SPAC transaction until such time as there is sufficient information about the target in the
market. As a result of this perception there are now substantial discussions on how to
improve the UK SPAC offering (which we are actively engaged in).

LOOKING AHEAD
THE FRUITS OF DISRUPTION

In hindsight, our piece in March was perhaps overly focused on recapitalisations and
insufficiently open to the possibility of other capital markets activity. That suited the
prevailing mood but perhaps failed to anticipate the speed with which investors would seize
the opportunity to invest in businesses positioned to capitalise from opportunities in the
COVID era. The COVID crisis has provided an opportunity for disruptors as well as breathing
life into the SPAC market as investors seek opportunities to allocate capital. As conventional
retail has faced unprecedented turbulence and a host of household names including
Debenhams, Maplin and ToysRUs have entered insolvency processes, online retailers such as
Amazon have experienced significant sales growth. E-commerce company The Hut Group has
announced plans to launch a £4.5 billion IPO and other e-commerce companies are known to
be in the IPO pipeline. Online food service companies are expected to follow, at the same
time as many restaurant chains struggle. Notwithstanding the challenges in the real
economy, global stock markets have recovered most of their losses from earlier in the year,
and in the case of the NASDAQ have hit new highs. Hong Kong deal makers report a heavy
IPO pipeline, notwithstanding Ant Financial withdrawing what would have been the World’s
largest ever IPO last month. European new issuances are also fairly robust, especially in
those sectors which are resilient in the current environment, such as technology, healthcare
and biotech.

Away from IPOs, whilst government measures to support the economy have postponed
distress in some sectors it is still widely expected that distressed M&A will be more of a
feature in 2021 than in 2020 to date. At least some of that distressed M&A will be equity
funded or involve equity market solutions alongside business combinations. We may also see
more equity-funded conventional M&A too; for example see the recent announcement of a
proposed break-up bid of RSA plc, in connection with which Tryg, the Danish insurer has
entered into a standby underwriting facility to fund its share of the purchase price.

The future is, as ever, impossible to predict. Much will depend on the course that COVID
takes and the speed with which global economies recover. Deal windows can close and
optimism can fade. But as it stands, Q4 2020 and the first half of 2021 look to be busy and
varied in UK equity capital markets, with all forms of ECM activity being present.

THE REGULATORS’ QUANDARY
Earlier we discussed the key role regulatory innovation played in facilitating deals. Many of
the key reforms were introduced on a temporary basis and will be reconsidered in due
course. Some, such as the change to allow companies to hold virtual company meetings, are
unlikely to be adopted permanently although parliament would do well to allow ministers the
power to reintroduce that flexibility (including for meetings already called) without primary
legislation in the event of a further lockdown.

We noted above the FCA’s welcome relaxation of working capital disclosure rules to permit
companies to state the COVID-related assumptions underpinning their reasonable worst case
scenario. In practice, however, it is often challenging to identify what is, and what is not, a
COVID-assumption and there is a considerable grey area between those assumptions which
are clearly COVID-related (eg assumptions about the duration of lockdown) and those
assumptions which relate to behavioural and wider market changes that might flow as a
consequence of COVID. The FCA has a difficult task in ensuring that issuers are not precluded
from sharing valuable context with investors whilst at the same time not undermining the
import of the working capital statement itself. Similarly there is sometimes tension between
the desire of issuers to share information with investors about the pro forma impact of
recapitalisation on, for example, leverage metrics, and the FCA’s strict application of pro
forma disclosure rules. In both these areas there is a good case for flexibility and facilitating
more high quality disclosure, rather than less.

The Pre-Emption Group has also confirmed that it is not extending the flexibility to allow
larger non pre-emptive raises now the impact of the crisis has abated somewhat and
companies have had significant time to take up the relaxation. However, there is a sense now
that companies have had ample opportunity to take advantage of the flexibility, but others
will argue that in times of uncertainty the flexibility remains welcome. In the medium term,
the PEG will also need to consider whether the genie can ever truly be put back in the bottle;
there is a strong intellectual argument that if companies ought to be able to raise 20% non
pre-emptively during one crisis, subject to certain consultation and soft pre-emption
protocols and with adequate disclosure, they ought to be allowed to do the same in another
crisis, even if that crisis is more sector or even company-specific. More widespread adoption
of PrimaryBid or other retail options would further weaken the argument for strict limits on
placings, particularly if structured to prioritise existing holders. In the future there will be a
need to resolve the disconnect between the guidance as to the pre-emption authority which
should be sought by listed companies at their AGMs (which is limited to authority to issue up
to 5% of the company’s shares, or 10% to fund an acquisition or specified capital investment)
and the reality of what investors are prepared to support. At present the cashbox structure
bridges the gap, but a more substantive solution would be welcome.

Looking further into the future - the effective cap of €8 million on any retail tranche (to avoid
the need for a prospectus under the EU Prospectus Regulation) has meant the benefits of
retail participation on some larger raises were more optical than substantial, but one wonders
whether politicians keen to show a Brexit dividend might alight on the idea of increasing that
threshold to encourage another era of direct share ownership. Tell Sid! A review of retail
participation in UK equity markets would be welcome and may help to address the reluctance
on the part of banks and other intermediaries to engage in retail offers on most transactions.

More generally, we are of the view that law makers should continue to explore ways for listed
companies to be able to access capital markets quickly and efficiently, and there has been a
growing consensus in the market that a further review of the UK listing regime may be
necessary to ensure that the UK is well positioned to attract highly mobile international
capital in the future. This culminated in the announcement on 19 November 2020 that the
Treasury (as opposed to the FCA) has initiated a broad review of the UK listing regime, with
Lord Hill appointed as chair (see here). This review seeks to balance the thorny question of
how to balance making the UK an attractive market for international companies to list, while
retaining appropriate standards of corporate governance, with a focus on free float
requirements, dual class share structures, track record requirements, prospectuses and dual
and secondary listings. This will be a potentially significant review, coinciding with the
degree of regulatory freedom that Brexit presents. Responses to the call for evidence are due
on 5 January 2021 and we expect that this will be a significant area of focus for market
participants during 2021.

INCREASED FOCUS ON ESG
ESG (Environment, Social and Governance) has been the acronym on everyone’s lips over the
last 12 months and it is impossible to ignore the broader social and environmental context in
which the COVID crisis has emerged. A considerable body of guidance has been published on
the disclosures issuers should be making in their prospectuses about ESG matters, and these
are of relevance to all issuers, not just those in heavily polluting industries or substantial
operations in countries with low-paid workers. As the COVID crisis evolves we can expect to
see companies raising capital subject to greater scrutiny from investors and the press on a
range of maters including the sustainability of their business models, their ethics and
business practices, impact on the environment and broader society, their record on diversity
and inclusivity and pay practices. Whilst Europe has led the way in ESG regulation and
guidance to date, increasing global awareness will drive the development of new practices
and standards, which will be relevant to practitioners across the market.

KEY CONTACTS
If you have any questions, or would like to know how this might affect your business, phone,
or email these key contacts.

MIKE FLOCKHART         TOM O'NEILL             MICHAEL JACOBS         DINESH BANANI
PARTNER, LONDON        PARTNER, HEAD OF        PARTNER, LONDON        PARTNER, LONDON
                       US SECURITIES,

+44 20 7466 2507         LONDON               +44 20 7466 2463         +44 20 7466 2042
Mike.Flockhart@hsf.com                        michael.jacobs@hsf.com   Dinesh.Banani@hsf.com
                         +44 20 7466 2466
                         Tom.ONeill@hsf.com

GREG MULLEY
PARTNER, LONDON

+44 20 7466 2771
greg.mulley@hsf.com

LEGAL NOTICE
The contents of this publication are for reference purposes only and may not be current as at
the date of accessing this publication. They do not constitute legal advice and should not be
relied upon as such. Specific legal advice about your specific circumstances should always be
sought separately before taking any action based on this publication.

© Herbert Smith Freehills 2021

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