Current market practice of subsequent prospectus review for bonds and derivatives can be maintained under article 53 FinSA

Article 53(1) FinSA introduces a pre-review of prospectuses by a reviewing body, while article 53(2) FinSA allows the Federal Council to provide for exemptions. The Federal Council should continue to allow subsequent reviews substantially in the same way as the regulatory board allows provisional trading. The confirmation pursuant to article 53(2) FinSA is addressed to the reviewing body and confirms formal completeness against the prospectus content lists. Only administrative consequences imposed by FINMA are attached to an incorrect confirmation.

By Matthias Courvoisier (Reference: CapLaw-2017-16)

According to article 53(2) FinSA (draft Financial Services Act), the Federal Council may designate types of securities for which the review of the prospectus may take place subsequent to publication, provided a bank subject to the Banking Act or a securities firm subject to the FinIA (draft Financial Institutions Act) confirms that at the time of publication the most important information on the issuer and the securities are available.

1) Securities that should profit from an exemption under article 53(2) FinSA

Today, prospectuses are formally reviewed by SIX Exchange Regulation. They check that the prospectus addresses the topics according to the applicable prospectus content list. The review is a condition to listing, not to the public offer. For certain types of securities, exemptions from the review prior to the admission to trading apply. For the admission of bonds, convertibles, and derivatives to provisional trading, the stock exchange only requires an application by a recognized representative. The application describes the securities and contains an assurance that all listing requirements are met, the securities are structured in a way previously approved by the regulatory board and a listing application will follow. The listing prospectus needs to be published at the time of listing. The prospectus may be required earlier for the offering.

These rules allow to issue securities faster than with a pre-review. They enable issuers to react on changing market conditions swiftly, to grab opportunities and to limit risks from negative events. Derivative issuers can implement their ideas faster to react on customer demand. For other securities no exemption is admissible. This differentiation between the different securities is justified: Bonds are generally less risky than equity securities and less dependent on the performance of the issuer. In case of derivatives, the risk depends on the structure of the product and the underlying. The underlying needs to have a publicly accessible market price created on a regular basis. The structure of the bond or the derivative needs to be of a type previously approved by the regulatory board. Thus, also without pre-review the relevant risks are known to the regulatory board. Also, in case of a first time issuer, the stock exchange must first approve the issuer before a provisional admission is possible. This allows to consider whether in the specific case a prospectus pre-review should be requested.

The provisional admission to trading is only a small risk for investors. First, the prospectus review is a mere formal completeness review and has therefore only a small protective effect. Second, the recognized representative needs to confirm that the conditions for listing are met. That means that the prospectus, irrespective of any obligation to offer the securities only with a prospectus, must be available at the time of the application for provisional trading and must formally meet the requirements of the stock exchange. An incorrect confirmation of the recognized representative is a violation of the listing rules and may be sanctioned. Also, if the listing application is not filed within two months or is rejected, the recognized representative may be fined or excluded from filing for provisional trading for up to three years, provided its behavior amounts to the violation of important professional duties. These sanctions ensure protection of the market.

Once in force, article 53(1) FinSA will require the reviewing body to check that the prospectus is complete, coherent and understandable. The legislator justifies the more extended pre-review only with the argument that this is in line with EU law. Experience shows that the practice of the EU supervising authorities varies substantially across countries. Such practice thus gives little guidance for interpreting article 53(1) FinSA. Since the reviewing body does not perform a due diligence on the issuer and the security and the review time shall remain short, the completeness review does not extend to the substance of the prospectus. It remains a formal completeness review. The coherence review focuses on avoiding contradictions within the prospectus as set out in the dispatch to the FinSA. The understandability review will be limited to the question whether the prospectus can be understood by a professional investor familiar with the security and the industry at hand. Ultimately, the review is a formal completeness check as today, enhanced by a review based on the logic within the text (coherence) and based on whether the mere text makes sense to the (professional) investor (understandability).

Such review gives little additional protection to investors. There is thus no reason why bonds, convertibles, and derivatives should not be captured by the exemptions of article 53(2) FinSA in the same way as they may be admitted to provisional trading without previous prospectus review. As today, it is justified to require that the structure of the security be one previously approved. Thereby one must be allowed to rely on the experience of the stock exchange before the entering into force of the FinSA, and let the reviewing body set up a list of accepted structures. It must however not matter whether the issuer is a first time issuer or not because the review of the issuer is not a subject of the review performed by the reviewing body. The stock exchange remains free to require a general first time issuer review for its own purposes. For a derivative one should request that the underlying of the derivative be traded with regularly resulting publicly accessible market prices. The reason is that a derivative on a non-traded underlying can only be described by explaining the underlying and the influencing factors in detail. Also, only in this way an indirect public offer of a non-traded underlying through a derivative may be prevented. This justifies a pre-review to make sure that such product is at least coherent and understandable. Regular trading and publicly known prices of the underlying should also be a requirement where the value of a bond is dependent on the value of another security as in case of convertible bonds. Since the value of high yield bonds, i.e. bonds below investment grade, are also dependent on the issuer’s business and may at least in riskier cases be modelled as derivatives of the issuer’s equity, it is justified to require for high yield bonds that the issuer’s equity be traded in the same way.

A mere subsequent review for equity securities or exchange traded products has never been market practice and so there is not sufficient justification to allow a mere subsequent review for these other securities.

2) Confirmation under article 53(2) FinSA

Article 53(2) FinSA requires that a bank or a securities firm confirms that at the time of the prospectus publication the most important information on the issuer and the securities is available. That provision leaves open a number of questions:

The first question is what the content of such confirmation is. Article 53(2) FinSA does not exempt from the prospectus requirement. According to article 42(1) (a) and (b) FinSA, the prospectus must contain certain information on the issuer and the securities. The detailed content will be defined in an ordinance of the Federal Council based on article 48(c) FinSA. Thus, FinSA and the corresponding ordinance define the information that must be available at the time of the prospectus publication. The reference of article 53(2) FinSA to the most important information must therefore be a subset of that information, without there being any hint what kind of subset that could be. Article 53(2) FinSA could however have a broader meaning by capturing information not explicitly mentioned as minimum content of the prospectus, but being required under the general rule of article 42(1) FinSA that the prospectus needs to contain all information essential for an investor’s decision. However, the confirmation in article 53(2) FinSA is a mere (temporary) substitute to the review under article 53(1) FinSA. It can therefore not have a further scope than such review, which is, with respect to completeness, a mere formal review against the content lists. Therefore, the confirmation pursuant to article 53(2) FinSA is only a confirmation that the prospectus contains the (most important) information on the issuer and the securities as required by the prospectus lists to be promulgated under article 48(c) FinSA. The reference to the ’most important’ information may be practically relevant whenever an exception under article 43(b) FinSA needs to be applied for. The mere formal test is appropriate in view of article 53(1) FinSA and the confirmations provided today by recognized representatives to the regulatory board to obtain approval for provisional trading.

The second question is who the addressee of the confirmation is. The preliminary draft required the bank or securities firm to guarantee the availability of the respective information. This was not introduced into the draft legislation which requires a confirmation only. A guarantee would have been in favor of investors, but not a confirmation. Therefore, the reviewing body is the addressee. That is in line with current practice of the recognized representative providing its confirmation to the regulatory board and with article 42(5) FinSA, which only requires the prospectus to mention that it has not been reviewed yet, but not to refer to the confirmation. Also investors’ protection does not require a confirmation addressed to investors, because any wrong confirmation may have supervisory consequences. A bank or a securities firm has a high incentive to issue truthful confirmations. This makes apparent the true purpose of article 53(2) FinSA, which is not to ensure that there is someone liable for a wrong confirmation, but rather that public offerings of securities with mere subsequent reviews are accompanied by banks or securities firms.

The third question is what the consequences of an incorrect confirmation are. The confirmation is not part of the prospectus, so that no prospectus liability is attached to the confirmation. The penal provisions of FinSA do not sanction incorrect confirmations. Only article 90 FinSA gives the supervisory authority of the bank or the securities firm the power to take measures to prevent breaches or to remove their effect. FINMA could e.g. order a bank coordinating the issuance of a bond to stop the offering in case of a wrong confirmation.

The fourth question is on what basis a bank or securities firm should give the confirmation. The confirmation is more limited than what a recognized representative has to confirm today to the regulatory board. Therefore, there is no need to enhance compliance procedures. If the bank is drafting the prospectus as in many straight bond issues, it will be the task of those involved to establish a rule check based on which the confirmation can be issued. If the bank does not have the lead in the drafting, as is the case for convertibles and high yield bonds, the bank should ask the legal counsels involved to provide a rule check and to give the very same confirmation in their technical opinion, which is already marked practice. There is no requirement that the banks or securities firms establish the rule check by themselves. Without violating any duty, this may be delegated to outside counsels. One may expect that a counsel qualified to draft a prospectus is also qualified to issue an opinion on the completeness against a content list.

Matthias Courvoisier (