Services: Corporate & Commercial
Industry Focus: Life Sciences & Healthcare

What you need to know

  • Both ASIC and ASX are scrutinising the activity of companies seeking to undertake initial public offerings.
  • The regulators are focussed on tightening up financial disclosure obligations, advocating for robust due diligence practices in IPOs, and bringing about critical changes to the Listing Rules which will come into effect before the end of this year.
  • ASX proposes to raise the bar for listing, impose greater restrictions on backdoor listings and clarify its discretion to refuse a listing even if the relevant requirements under the Listing Rules are met.

The regulatory spotlight has recently become sharply fixed on the conduct of companies seeking to undertake initial public offerings (IPOs) and list on the Australian Securities Exchange (ASX). Both the Australian Securities and Investments Commission (ASIC) and ASX are scrutinising activity in this sphere, and the bar for listing will soon be raised with changes to the Listing Rules expected to take effect before the end of this year.

For companies operating in the healthcare and biotechnology sectors seeking to raise capital through listing, the regulators' concerns should be squarely on their radars. Now is time to get across the issues that have piqued ASIC and ASX interest, prepare for the impending changes to the Listing Rules, and carefully consider the timing and approach to future IPO activity.

ASIC scrutiny of financial disclosure obligations and due diligence practices

On 12 May 2016, ASIC issued a consultation paper entitled Improving disclosure of historical financial information in prospectuses: Update to RG228 (ASIC Consultation Paper).1 RG228 refers to ASIC Regulatory Guide 228, which deals with effective disclosure for retail investors. The ASIC Consultation Paper recommends changes to RG228 to address ASIC's concerns that some companies lodge prospectuses with incomplete historical financial disclosure. ASIC suggests that anything less than 2.5 – 3 years' audited accounts will not be satisfactory. ASIC is expected to release the updated RG228 in the second half of 2016.

Following the ASIC Consultation Paper's release, on 14 July ASIC published Report 484 Due diligence practices in initial public offerings (ASIC Report).2 The ASIC Report followed an empirical study of the performance of numerous IPOs during 2012-2014, through which ASIC identified several concerns about the way companies are conducting their due diligence. Those concerns include:

  • varying quality in due diligence processes, with poor due diligence often leading to defective disclosure in prospectuses
  • the tendency of some companies to take a 'form over substance' approach to due diligence, focusing on box-ticking rather than on disclosure in the prospectus
  • in some instances, directors having only 'superficial' involvement in due diligence activities.

ASIC reported that it found a link between poor financial disclosure and subsequent poor performance of the issuers. It also reported that low-cost due diligence processes can often lead to delays, further work and ultimately higher costs for the entity seeking to IPO. For a more detailed update about the ASIC Report, as well as recommendations on the steps that should be taken to ensure your due diligence process meets ASIC's expectations, read our previous article here.

Finally, in its 2016-2017 Corporate Plan released on 31 August,3 ASIC notes that one of its focus areas is promoting gatekeeper conduct in markets. In the context of IPOs, this includes a project focussed on identifying and assessing potential areas of regulatory concern to ensure effective intervention mechanisms are in place in future. It also includes a project to improve the quality of financial information in prospectuses, which we expect will result in revised guidance.

ASX tightening the reins on listings

On 12 May 2016, coinciding with ASIC's announcement of its focus on financial disclosure in prospectuses, ASX issued a consultation paper entitled Updating ASX's admission requirements for listed entities (ASX Consultation Paper).4

The ASX Consultation Paper sets out proposed changes to the current Listing Rules, with ASX stating that the objective of those measures is to appropriately balance:

  • the interests of companies and investors in promoting efficient capital raising
  • maintaining market integrity
  • providing a market that is internationally competitive.

New admission requirements

A company that is seeking an ASX listing must satisfy one of two financial tests – the profits test or the assets test. The key changes to the financial thresholds proposed by the ASX Consultation Paper are summarised in the table below.

Current position ASX proposal
Profits test
(for the 12 months prior to admission)		 Consolidated profit of $400,000 Consolidated profit of $500,000
Asets test

Net tangible assets of $3 million;

or

Market capitalisation of $10 million

Net tangible assets of $5 million;

or

Market capitalisation of $20 million
Spread requirements & free float rules

400 security holders;

350 security holders if an entity has a free float of at least 25%;

or

300 security holders if an entity has a free float of at least 50%.

Each security holder must hold a parcel of securities with a value of at least $2,000.

Although not specifically required by the Listing Rules, Guidance Note 1 provides that ASX has a general expectation a company will have at least 10% free float. ASX is currently exercising its discretion to require applicants to have a minimum free float at the time of listing of 20%.

200 security holders if an entity has a free float <$50 million;

or

100 security holders if an entity has a free float of =$50 million.

Each security holder must hold a parcel of securities with a value of at least $5,000.

ASX proposes to introduce a new Listing Rule requiring 20% minimum free float requirement for ASX listings at the time of admission. This proposed rule change will formalise ASX's current position.

Clarity around ASX discretion

ASX also proposes to update two other documents – the Introduction to the Listing Rules and Guidance Note 1 – to reinforce its discretion in admission and quotation decisions, and to provide guidance on:

  • when ASX may exercise its discretion not to admit an entity to the official list; and
  • where an applicant may be considered lacking the structure and operations appropriate for a listed entity.

The issue of ASX's discretion to deny a listing is particularly topical, given its recent decision in Guvera Limited (Guvera):

Earlier this year, ASX exercised its available discretion in assessing listing applications by denying Guvera Limited admission to the ASX.
Guvera is a music streaming business that primarily earns its income from ads. It targets emerging markets such as the Philippines and India. Guvera sought to undertake an IPO and raise between $50 million to $100 million. In the 2015 financial year, Guvera made only $1.2 million in revenue, resulting in a loss of more than $81 million.
Despite Guvera meeting the Listing Rule requirements for listing, ASX took the step of blocking the IPO; a decision which is not open to review. ASX has not publicly stated its reasons for the decision, but its action confirms the position stated in the ASX Consultation Paper that "the discretion to not admit and quote may be exercised even where an entity technically meets all of the specific conditions set out in the listing rules for listing and quotation."
Further, in ASIC's most recent quarterly corporate finance report issued in August 2106,5 ASIC discusses the Guvera case and refers to ASX's discretion as an "absolute discretion in deciding whether or not to admit an entity to the official list and to quote its securities".
Guvera has recently withdrawn from its Australian operations.
Changes to backdoor listings

Currently, an entity that announces a backdoor listing is able to trade up to the day on which security holders are asked to approve the transaction. If approval is obtained, ASX then suspends trading in the entity's securities until the entity has re-complied with ASX's admission and quotation requirements.

ASX proposes to amend this policy to place greater restrictions on backdoor listings. To do so, ASX proposes to suspend trading in an entity's securities from the moment it announces a backdoor listing until it has recomplied with ASX's admission and quotation requirements.

This move illustrates the concern of both ASX and ASIC about the increase in the number of early stage tech companies using backdoor listings.

When will the proposed changes to the Listing Rules take effect?

ASX has received a considerable number of submissions in response to the ASX Consultation Paper. We anticipate that the final version of the Listing Rule changes and associated guidance will be released in September or October (subject to regulatory approval) with commencement of the changes currently scheduled for 19 December 2016.

In our experience, ASX is already using its discretion to apply some of the changes, for example, in relation to backdoor listings.

What will be the impact of ASX's proposed changes?

The changes proposed under the ASX Consultation Paper have triggered divergent views. Some have argued that innovation will be stifled while others have suggested that the proposed changes will reduce risk and increase the integrity of the market.

Whichever way we look at the proposed changes, the reality is that once they take effect, they will see start-ups and early stage companies putting off listing until they reach a market value of $20 million or $5 million in net tangible assets. Both benchmarks are significantly higher than those currently in place.

As a result, we may see more companies seeking hurried backdoor listings before the changes kick in. However, companies seeking to take this approach must bear in mind that they still need to meet all current admission requirements.

What next?

ASIC has already made plain that it expects a robust due diligence procedure to form part of any IPO. Further, we expect both ASIC and ASX to issue updates very shortly about the respective changes they have proposed to RG228 and the Listing Rules.

For companies in the healthcare and biotechnology sectors, the task of valuing intangible and IP-based assets can sometimes be difficult, which could understandably trigger concerns or questions about how the new Listing Rules will impact their IPO aspirations. We think the ultimate effect of the proposed regulatory changes will not necessarily be the prevention of good businesses from obtaining listings at all; rather, there will simply be a longer lead time to obtain a listing. In light of the new requirements that will soon need to be met (particularly the asset or profits tests, and the provision of audited financials), the value of advanced planning and preparation cannot be underestimated.

Footnotes

1 The ASIC Consultation Paper is accessible at http://asic.gov.au/regulatory-resources/find-a-document/consultation-papers/cp-257-improving-disclosure-of-historical-financial-information-in-prospectuses/

2 The ASIC Report is accessible at http://asic.gov.au/regulatory-resources/find-a-document/reports/rep-484-due-diligence-practices-in-initial-public-offerings/

3 ASIC's 2016-2017 Corporate Plan is accessible at http://www.asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-283mr-asic-s-corporate-plan-2016-17-to-2019-20-and-focus-for-2016-17/">

4 The ASX Consultation Paper is accessible at http://www.asx.com.au/regulation/public-consultations.htm

5 ASIC's latest quarterly report "ASIC regulation of corporate finance: January to June 2016" is accessible at http://asic.gov.au/regulatory-resources/find-a-document/reports/rep-489-asic-regulation-of-corporate-finance-january-to-june-2016/

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories