A UK review has proposed relaxing the rules around dual-class shares, but some investors are not on board, reports Tim Human
The principle of ‘one share, one vote’ is long cherished by the UK investment community. Under current Financial Conduct Authority (FCA) rules, companies cannot be included on the premium segment of the London Stock Exchange (LSE) – the gold standard for corporate governance – if they have dual-class shares. Such companies also miss out on inclusion in key indexes such as the FTSE 100.
But London’s struggle to attract IPOs has forced a rethink. A government-commissioned review has proposed relaxing the rules around dual-class shares, as long as certain safeguards are met. The hope is to lure fast-growing, entrepreneur-led companies that want to tap the public markets without giving up control.
Investor expectations, however, might not shift with the regulatory landscape. Some asset managers have already indicated they will push back against the proposals. Whatever the final outcome of the review, London listings with dual-class shares are set to remain closely scrutinized.
IPO woes The government review – chaired by Lord Hill – released its findings in March. It reported that the UK accounted for just 5 percent of IPOs globally between 2015 and 2020. The country has also witnessed a 40 percent decline in the number of public companies since 2008. ‘Looking at our relative performance and the range of feedback we have had, it is clear the current listing regime is in need of reform,’ notes the report.
To boost the number of IPOs, the Hill Review recommends a raft of changes for UK equity markets, including a relaxation of the rules around dual-class shares. It says companies with differentiated voting rights should be permitted on the premium segment – but with added protection for investors.
The report suggests dual-class shares should be allowed for up to five years only and the maximum voting ratio limited to 20:1. In addition, it suggests that shares with higher voting power should be held only by directors, convert to ordinary shares on transfer (with some exceptions) and be applicable in votes only on director elections and takeovers.
The proposals would provide founders with a ‘transition period’ during which they are protected from hostile takeovers or activism in the early years of being public, explains the review. After this time, companies could either follow the full rules of the premium segment, switch to another market segment or adjust their share structure via a shareholder vote.
The Hill Review says these changes would be ‘in line with the great majority of submissions we have received’ and recognize the need ‘to make sure we attract companies in vital innovative growth sectors such as technology and life sciences.’
Relaxing the environment for dual-class shares would bring the UK more in line with a range of international markets. In the US, for example, shares with different voting power are relatively common. Hong Kong and Singapore have allowed this approach since 2018 under certain circumstances. In Europe, there is a variety of approaches, but the EU is looking at proposals to ease restrictions across the bloc (see EU approach to dual-class shares).
Claire Keast-Butler, a partner at Cooley who backs a relaxation of the rules around dual-class shares to boost the UK’s competitiveness, says the Hill Review’s proposals ‘offer a more restricted approach to dual-class structures than is typically seen in the US’, meaning companies considering both markets will still see a distinction.
‘The Hill Review suggests limiting the high-vote class to people who are directors of the company, whereas in the US we typically see all pre-IPO shareholders holding high-vote shares,’ she explains. ‘And in the US you have the high vote on all matters other than certain limited areas to protect the public shareholders. Lord Hill is recommending limiting the matters where the high vote kicks in to allow holders to ensure they remain as directors and can block a takeover.’
Keast-Butler says there is more alignment between the UK proposals and current US practice around sunset clauses. ‘We more typically see a seven-year sunset in the US,’ she says. ‘But five years is a sensible proposal, in terms of saying you can have these protections but there is a natural end-date to them.’
Any adjustments related to dual-class shares in the UK will need to pass through an FCA consultation before being brought in. The regulator has said it aims to consult on the proposals by the summer and bring in any changes before the end of 2021.
Changes to the FCA’s listing rules would not automatically allow companies with varied share classes to enter key indexes: index providers set their own standards. For example, S&P Global has refused to add companies with dual-class shares to the S&P 500 since 2017. FTSE Russell, which manages the key benchmarks in the UK market, says it will conduct a consultation with members soon after the FCA’s consultation.
Claire Keast-Butler, Cooley
Split views While the FCA has yet to start its consultation on dual-class shares, some investors have already made their thoughts known. Their opinions underline the difficulty companies will face if they bring shares with unequal voting rights to London.
Legal & General Investment Management (LGIM), the UK’s largest asset manager, says it will argue against the proposed changes.
‘As a matter of principle, we continue to push the FCA on the issue of one share, one vote and have strongly recommended that companies with unequal voting rights structures are not included in the premium indices,’ says the firm in an emailed statement released to IR Magazine.
‘It is important to protect minority and end-investors against potential poor management behavior that could lead to value destruction and avoidable investor loss.’
Aberdeen Standard Investments also has concerns. ‘While we have strong reservations about allowing dual-class share structures into the premium segment, we welcome the additional safeguards recommended by Lord Hill to protect the interests of minority shareholders,’ says Andrew Millington, head of UK equities, in an emailed statement. ‘We look forward to seeing how these measures work in practice.’
By contrast, Schroders says it is ‘in full support’ of the review. ‘There is a balance to be struck between ensuring the highest standard of governance and supporting the growth of companies and the UK economy,’ says Peter Harrison, group CEO at Schroders, in a statement. ‘Lord Hill’s review achieves that balance. We are pleased that government and regulators are now taking this forward.’
The split opinions create the potential for future clashes in the UK equity market between growth companies making use of looser regulations and institutional investors holding high expectations around shareholder democracy.
The recent case of Deliveroo underlines the risk of listing shares with differentiated voting rights. Much excitement preceded the IPO given the rarity of a large, tech listing in London. But the shares ended up pricing at the bottom of their range and then fell 30 percent on the first day of trading.
In the run-up to the listing, a range of asset managers highlighted perceived problems with the food-delivery business, including the fact that founder Will Shu would hold shares with 20 times the voting rights of ordinary stock. Investors were also worried by potential regulatory changes that could affect the company’s gig workforce and reports over treatment of riders. Deliveroo did not respond to a request for comment.
Aviva Investors, LGIM, M&G Investments and Standard Life are just some of the firms that shunned the deal. Some investors made their opposition known prior to the IPO, heaping additional pressure on the listing. Given the current rules on dual-class shares, Deliveroo was also prevented from joining the LSE’s premium segment, which saw it miss out on FTSE index inclusion and related passive investment flows.
The US market shows that firms with dual-class shares can remain highly popular with investors – examples include Google, Facebook and Berkshire Hathaway. Voting inequalities, however, can become a lightning rod for investor concerns if management attempts to hoard excessive power or operational issues afflict the company. Snap received heavy criticism during its IPO in 2017 when it became the first firm to sell shares with no voting rights attached.
Different strokes Advisers point out that there are different approaches companies can take to dual-class shares. More moderate arrangements are less likely to generate controversy. The Hut Group (THG), which listed on the LSE in September 2020, issued a special share for founder Matthew Moulding that allows him to block takeovers for three years. Moulding is also the joint CEO-chairman, another unusual governance arrangement for the UK market. Yet the shares soared 30 percent on their first day of trading.
Investors are usually ‘comfortable with founders using such devices to maintain a degree of control,’ Phil Drury, an investment banker at Citigroup, which worked on the THG listing, told the Financial Times last year.
As companies approach a listing, they should be able to explain their use of dual-class shares, says Keast-Butler. If a high-growth firm wants the ability to ward off activists or takeovers in the early stages of being public, that will be easier for investors to get comfortable with, she explains: 'If you’re set on having a broader dual-class structure that gives the holders voting control over all matters, subject to a limited set of things you carve out, the onus is on the company to justify why it needs that.'
While there has been hesitancy over shifting away from one share, one vote in the UK, attitudes may change, adds Keast-Butler: ‘If more firms choose to list in London with a dual-class structure and perform well, and fund managers benefit from those investments, that may change the viewpoint.'
Like its former member the UK, the EU is on a mission to improve the appeal of its equity markets, aiming to achieve this through the Capital Markets Union (CMU), a project focused on creating a single market across all 27 member states. In September 2020 the EU launched a new CMU action plan, which includes the goal of supporting small and medium-sized enterprise financing by simplifying listing rules and lowering costs.
As part of this process, the EU commissioned a report by Oxera, a consultancy, on equity markets in Europe. Published last November, the study suggests a raft of measures for policymakers to weigh up, including ‘encouraging flexibility’ around dual-class shares in member states where they are currently restricted.
‘One approach is to allow dual-class shares on a time-limited basis, through sunset clauses, to encourage more family-owned firms to seek a listing on public markets,’ suggests the report. ‘Among the 14 EU member states analyzed in depth in the study, 5,000 family-run companies above €50 mn ($61 mn) in size remain unlisted – this could be a significant source of new listings.’
EU nations have a patchwork of approaches to dual-class shares. They are allowed in some countries like Denmark, France and Sweden but prohibited in others like Germany, Portugal and Spain, according to Oxera. The report notes that some markets, like the UK, allow shares with different voting rights but domestic institutional investors might avoid companies that employ them.
Tatyana Panova, head of the CMU unit at the European Commission, said during a webinar in March that her team is looking into the topic of dual-class shares, which could be an interesting ‘add-on’ for equity markets. But she noted that the issue cannot be viewed solely from the perspective of companies. ‘We need to ensure that whatever is out there – whether a dual or single-class share arrangement – it is still attractive to investors,’ she said during the event organized by EuropeanIssuers, a trade body for public companies.
