Introduction
For corporate finance businesses becoming newly authorised by the FCA, the question as to whether the firm will be “placing financial instruments without a firm commitment basis” has long been a source of confusion. Generally understood to mean activities associated with marketing equities to private investors in advance of an IPO, the scope of “placing” is potentially much wider than this, and could – according to some definitions – incorporate private equity activity as well.
So why is this important? Generally, firms conducting corporate finance or private equity business will opt for a permission profile which puts them in the “CAD Exempt” prudential category, allowing them to advise on and arrange deals in investments but avoiding much of the regulatory burden that firms within the scope of the Capital Requirements Directive (CRD) face.
However, all CAD Exempt firms are required to certify that they will not be “placing” as part of the regulated activities they conduct. If they cannot do this, they automatically become an “IFPRU” firm, subjecting them to the full range of requirements in the CRD and EU Capital Requirements Regulation (CRR). This has wide-ranging consequences from a regulatory point of view, including:
- A requirement to submit quarterly Common Reporting (COREP) reports to the EBA, which require special software to create, upload and validate;
- A requirement to produce and annually review an Individual Capital Adequacy Assessment Process (ICAAP), which analyses the business and control risks a firm faces and has a potential impact on minimum levels of capital to be held;
- A requirement to publish a Pillar 3 report publicly disclosing risk and levels of capital;
- A requirement to have annual audits performed on company accounts;
- More onerous capital requirements, including an absolute minimum of €50,000 capital, which could potentially be much higher if the firm faces significant credit, market or operational risk or has high fixed costs.
- A more onerous compliance burden in general, including the establishment and maintenance of additional documentation such as Liquidity Management and Remuneration policies.
Whether or not a firm will be “placing”, therefore, is a crucial issue when it comes to authorising or varying its permissions.
The definitions of “placing” as an activity tend to be piecemeal and not hugely conclusive by themselves. This Regulatory Bulletin attempts to pull together the somewhat sparse guidance on the topic available from regulatory sources including the FCA and ESMA to help a firm to determine, as far as it can, whether or not it will be “placing”.
Definitions of “placing”
The FCA’s definition
The FCA’s Perimeter Guidance Manual (PERG), at 13.3, sets out the UK regulator’s position on the scope of “placing”.
The definition splits “placing” into two main types:
- Placing or underwriting of financial instruments on a “firm commitment basis”
- Placing of financial instruments without a “firm commitment basis”.
It is generally much easier to determine whether a firm is undertaking the former activity as opposed to the latter, and therefore we do not propose to explore this in any great detail.
Suffice to say, the first activity refers to the activity of placing of financial instruments with investors – generally equities in a pre-IPO context – which involves the firm undertaking the placing making a commitment to purchase those instruments where others do not acquire them. To use a common example, generally when a firm lists on the LSE it will have a syndicate of investment banks acting as placing agents and IPO underwriters; if the flotation does not lead to investors purchasing all of the securities on offer these firms will step in and purchase the equities themselves at an agreed price.
It is relatively simple to determine whether or not a firm is placing or underwriting securities on a firm commitment basis – if it has made a binding undertaking to purchase securities on its own behalf if it fails to place them with investors, it will be conducting the activity. Such firms will generally be “full-scope” IFPRU firms with a minimum capital requirement of €730,000.
As to the definition of the latter activity, the FCA offers the following definition:
“Where the person arranging the placing does not undertake to purchase those MiFID financial instruments he fails to place with third parties.”
To understand this (not particularly enlightening) clarification, we need to put it into the context of the FCA’s general definition of placing:
“We associate underwriting and placing of financial instruments with situations where a company or other business vehicle wishes to raise capital for commercial purposes, and in particular with primary market activity.”
So, according to the FCA, placing involves the following general elements:
- ABC plc wishes to raise capital for commercial purposes;
- ABC engages a regulated firm, XYZ Ltd, in order to assist it to raise this capital;
- XYZ attempts to find and place equity in the firm with potential investors.
The above could refer to traditional “placing” in a pre-IPO context – equally, however, there is nothing to stop this definition potentially encompassing corporate finance activity of other kinds, including “vanilla” corporate finance private equity arranging activity with no element of a listing or public offering. Although the FCA associates placing “in particular” with primary market activity, its definition does not limit the activity to just that.
Clearly, this definition falls short in determining the exact scope of placing, as this could potentially mean that most of the corporate finance firms in the UK are authorised under the wrong permission profile.
Only corporate finance firms which act purely in an advisory capacity, never arranging deals or actively seeking potential investors, can categorically state that they would never be “placing” according to the FCA’s definition. Clearly, it is necessary to seek clarification elsewhere.
ESMA’s definition
The regulated activity of “placing”, ultimately, comes from MiFID, and so we turn to the European authorities for more guidance.
The European Services and Markets Authority (ESMA) issues periodic Q&As on the scope of regulated activities covered under pan-European regulatory regimes. The issue of placing without a firm commitment basis has, in fact, been addressed by ESMA here in response to the following question:
“I am trying to understand the scope of this activity, and in particular, whether this activity is associated with primary market activity or whether the A(7) activity [placing] may also apply when funds are being raised by private companies (private equity activity).”
ESMA’s response is as follows:
“Placing is the service provided by an investment firm to an issuer whereby the firm undertakes to place financial instruments with investors on behalf of the issuer. Placing can be carried out either on a firm commitment basis or not depending on the type of commitment that firms undertake towards the issuer. It refers to services provided by the investment firm related to primary market activities associated with the issuance of new instruments (including private equity).”
At first glace, the above appears to confirm that private equity activity is considered “placing”; a disquieting conclusion for CAD exempt corporate finance firms.
However, ESMA’s definition includes an important caveat, not included in the FCA’s definition, which sheds some more light on the matter. It clarifies that placing relates to “primary market activity” associated with the issuance of “new instruments”. This is invaluable in helping us understand the scope of the activity, as we can now see which types of private equity fundraising are caught. Consider the following two scenarios:
- ABC Ltd, a private firm, wishes to raise capital to finance expansion into a new country. XYZ Ltd, a regulated firm, is engaged to help find investors willing to inject capital and fund this new expansion. In exchange for capital, investors receive newly-created ordinary shares in the firm, diluting the existing owners’ shareholdings.
- Is this placing? Yes. This is primary market activity associated with the issuance of new instruments, as the shares are being created for the first time in response to investor demand.
- DEF Ltd’s founders and majority shareholders wish to facilitate a partial exit by selling some of their stake in the firm. XYZ Ltd is again engaged to find investors, but this time equity in the firm will come from existing shareholders selling some of their shares to new investors directly.
- Is this placing? No – as the shares in question are already in issue, this is secondary market activity, and would not be considered placing.
Following the guidance above, the crucial question as to whether or not private equity fundraising is considered “placing” is:
Are the equities or financial instruments in question being issued for the first time as part of the fundraising process?
If the answer to the above is yes, it is probably placing; if the answer is no, it is probably not.
I think I might be placing without the appropriate permissions. What can I do to fix this?
Taking into account the above, some readers may still conclude that their firms are conducting placing activity without the appropriate permissions. If this is you, you have a number of options available, as detailed below.
- Option 1: Apply for a Variation of Permission (VoP) to the FCA to remove the limitation on placing. As well as exposing your firm to additional regulatory burden, as detailed above, this application will incur a £250 minimum FCA application fee, and is likely to take around six months. Expect a long wait for a case officer, and additional questions from the regulator when someone finally takes a look at the application.
- Option 2: Engage an appropriately FCA-regulated placement agent to conduct the placing activity. If you are only likely to require placing permissions for certain projects, it may be more timely and cost-effective to engage another FCA- or EEA-regulated firm as a placement agent which has the appropriate permissions. Check the firm’s entry on the FCA Register or equivalent to determine whether the firm has the right permissions. Appropriately permissioned firms will never have a CAD Exempt limitation or BIPRU firm MiFID activity restriction as requirements on their permissions.
- Option 3: Only conduct placing on an “occasional” or “non-regular” basis. CAD Exempt firms have a limitation on their permission in that they cannot perform most types of MiFID investment activity on a “regular” basis, which potentially leaves the door open to performing these activities very occasionally. The scope of this has not been well defined by the FCA, but our previous guidance on the topic opined that this may equate to roughly once a year or less. Bear in mind, though, that if you present or hold yourself out to clients as being able to conduct activity considered as placing, the regulator is likely to conclude that you are in breach – even if the placing only happens every 12 months or less. You should only rely on this exclusion if it is a truly one-off project driven by client demand – if it becomes more regular than this, it is time to explore alternate options.
This article was originally written for CPA Audit who were aquired by Laven in Febrary 2019.
Laven Partners
At Laven, our consultants are on hand to help identify the actions your firm needs to take to ensure you are compliant with new regulations and aware of all the risks outlined in this report. Whether this is through assisting with new policies and procedures that need to be put in place or providing online/in-person training for staff to make them fully aware of the regulatory burden.
Laven has also built Laven Tech, a unique Regulatory Technology (RegTech) solution that leverages advanced technology combined with our vast subject matter expertise. Our RegTech solution is designed to assist fund managers, service providers and investors to meet today’s growing demands.
