Originally published in 2003

This article focuses on the key issues arising out of the Prospectus Directive for SPVs or investment banks issuing listed derivatives under a programme.

How are derivatives treated under the Directive?

The Directive distinguishes between equity and non-equity securities. Derivatives, even if relating to underlying equities, would be non-equity securities for this purpose (unless the securities and underlying equities are both issued by the same entity, or entities in the same group). As in the case of all non-equity securities:

  • as long as the derivatives can only be acquired on issue in amounts of €1,000 or more, the issuer can elect to have the prospectus approved either by the competent authorities in the EU state in which it has its registered office or the state where the securities are to be listed or offered to the public, if different; and

  • if the securities can only be acquired on issue for €50,000 or more ("non-retail securities"), the requirements for a summary to be included in the prospectus, and for annual information on the issuer to be published, are disapplied.

Under the Level 2 measures set out in CESR’s advice to the European Commission, all securities which are not equity securities or debt securities and which do not fall into any other "building block" (such as that for asset backed securities) are, by default, categorised as derivatives. For this purpose, CESR proposes that "debt securities" should be defined as "any security where the issuer has an obligation arising on issue to repay the investor 100% of the nominal value, in addition to which there may also be interest payments". Categorisation of a product as a derivative or a debt security may not always be straightforward. Notes issued on a limited recourse basis by an SPV on a repackaging would seem to be derivatives. On the other hand, many bonds with derivative features will be categorised as debt securities rather than derivatives. CESR proposes to deal with this by requiring disclosures in the prospectus that are similar to the disclosures required in the case of derivatives.

What information is required in the prospectus?

Under CESR’s proposals, the "building blocks" of information that would need to be included in a prospectus relating to derivatives are:

  • Information on the issuer. A somewhat lighter disclosure regime applies to an issuer of non-equity securities where the issuer is a bank or investment firm with experience of issuing such securities. This lighter regime is NOT available for issues by SPVs, which would have to comply with the general disclosure rules applicable to issuers of retail or non-retail securities, as applicable.

In all cases, however, the issuer disclosures seem onerous in the context of derivative issues, where the business activities of the issuer and its group may be of little or no relevance to purchasers of the derivatives. Also, except for issuers of non-retail securities, the proposal to require audited financial information on the issuer in accordance with IAS or equivalent (and including two years’ historical financial information if the issuer has been in existence for this period of time) is controversial. Issuers of non-retail securities whose financial statements are not in IAS form will have to describe the differences between IAS and local GAAP.

More detailed information (equivalent to that required for issuers of equities) is needed in respect of any derivative securities that, while being non-equity securities, give the holder the possibility (on election by the holder or the issuer) of acquiring underlying equities that would be newly issued and are not already admitted to trading on a regulated market.

  • Information on the derivatives. CESR has produced a specific schedule of information to be included in all prospectuses relating to derivatives, whether retail or non-retail.

It is important to note that the "derivatives" schedule applies in respect of all non-equity securities other than "debt securities" and "asset backed securities" as defined by CESR. The only difference between retail and non-retail offerings (so far as the securities note is concerned) is that prospectuses for retail derivatives must include "a clear and comprehensive explanation to help investors understand how the value of their investment is affected by the value of the underlying instrument(s)". This is not required in the case of non-retail derivatives. In view of potential civil liability for misrepresentation, producing both the "explanation" and the "summary" needed in a prospectus for retail derivatives will be fraught with difficulty.

CESR proposes that a prospectus for derivatives (as well as a prospectus for debt securities) should include a description of any interests, including conflicting interests, of persons involved in the issue. This is potentially something of a minefield.

  • Other information. Other "building blocks" of disclosure information may also be relevant, in particular the information required in respect of any guarantee of the securities.

Use of base prospectus?

Currently, it is common to have wide-ranging programmes under which a range of different types of derivative securities (unlisted or listed on one or more exchanges in Europe) can be issued, sometimes by a number of different issuers. The base offering document is approved by the relevant listing authority or authorities, and then securities can be issued through a pricing supplement.

The Prospectus Directive allows an issuer to use a base prospectus (which must be re-issued annually) for issues of "similar" non-equity securities "in a continuous or repeated manner". CESR has interpreted this as permitting a single base prospectus to be used in respect of a programme covering multiple issuers and/or guarantors, and different products. However, a single base prospectus cannot be used to cover issues of (i) asset-backed securities and/or mortgaged backed securities and/or warrants in respect of underlying equities and (ii) other forms of non-equity securities.

A base prospectus needs to include all the detailed information about the issuer and the securities that is set out in the relevant "building blocks" for disclosure produced by CESR, except for the "final terms" of each issue to be effected off the programme. It must also include a general description of the programme, an indication of the type of information to be provided as "final terms" and the way in which the final terms of issues will be published. CESR takes the view that the final terms must be published in all cases (for example on the issuer’s website) even in the case of a purely private placement.

In the case of a multi-product programme, the amount of information to be included in the base prospectus presents a real challenge, particularly as the prospectus must be "easily analysable and comprehensible" and, if the securities may be issued for less than €50,000, must include a non-technical summary. CESR has indicated that if a base prospectus relates to multiple products:

"…the information on different products contained in the base prospectus and likewise in the summary must not be mixed up but has to be clearly segregated."

As regards the "final terms" of each issue off the programme, CESR proposes that issuers should have the choice to issue a document containing simply the "final terms" or a document that also repeats some of the more detailed information in the base prospectus. This document must be filed with the relevant listing authority (and, as noted above, published) but does not require pre-approval by the authority.

Shelf registration document?

An alternative to producing a base prospectus is for an issuer to produce a registration document containing information about the issuer, and then to issue (and obtain approval for) a securities note, and if applicable a summary, each time securities are issued. Effectively, the registration document is a shelf registration document that can be incorporated by reference into the documents produced at the time of each securities offering.

In view of the practical difficulties in producing a base prospectus in accordance with the Directive for a multi-product/multi-issuer programme, it seems likely that issuers of derivative securities will either:

  • have a narrower programme (or even a number of separate programmes) set up for issuing listed securities, with the base prospectus only covering those securities; or

  • simply have a registration document pre-approved, and issue a new securities note and summary (if required) for each listed securities issue. Under the Directive, the competent authority has up to 10 working days (which can be extended if the information supplied is incomplete) to approve the prospectus.

Likely implications?

Since derivatives are unlikely to be admitted to trading on more than one market in Europe or offered to the public, the new Directive would not seem to be of benefit (except insofar as it clarifies and harmonises the circumstances in which unlisted derivatives can be sold without involving a public offer).

In the case of listed derivatives, the detailed contents requirements for prospectuses, the need in many cases for financial information in accordance with IAS and the potential liabilities (for example, where the "explanation" required in the case of retail derivatives is regarded with hindsight as misleading) are likely to increase the costs, the risks and the timescale for issues of listed derivatives. In particular, the use of a single multi-purpose programme is likely to become problematic for issues of listed derivatives.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.