With the surge in investments in PSPCs over the past year, the FCA has issued new listing rules to open up the UK market to PSPCs and protect investors. But is it enough?
The use of Specialty Acquisition Companies (PSPCs) has gained ground over the past year, riding a wave of post-pandemic market activity. Increasingly popular in the United States, the trend has transcended the United Kingdom and the rest of Europe.
Hedge funds have been big investors in PSPCs, fueling the trend that has caught on across the Atlantic. Many hedge fund managers view PSPCs as an attractive investment with moderate risk, where the value of PSPC units will generally increase if the PSPC company succeeds in acquisitions, but investors can redeem their holdings and recover their investment under certain conditions.
PSPCs are companies without commercial operations that are incorporated strictly to raise capital through an initial public offering, with the aim of acquiring an existing company. Richard Branson ended up in a high-profile SPAC deal that saw Social Capital Hedosophia Holdings buy a 49% stake in Virgin Galactic for $ 800 million, before listing the company in 2019.
Despite the offer of investment opportunities in the UK market and the offer of an alternative source of funding, industry watchdogs such as the Financial Conduct Authority (FCA) have warned investors against the risks associated with these investments. Concerns surrounding the use of SPACs involve dilution risks, when it is possible for a company to issue more shares, thereby diluting the percentage of ownership of all existing shareholders.
A conflict of interest regarding sponsor incentives may arise if the SPACs do not disclose the circumstances surrounding a sponsor’s financial incentives and how they may not correspond to those of public investors. In addition, there may be uncertainty regarding the identity and valuation of a target company that the SPAC is to acquire.
The FCA has refined its listing rules to protect investors, lowering the minimum amount that a PSPC must raise on initial listing to £ 100million, an option to extend the limited operating period by two years and remove the presumption that the FCA suspends the listing of an SPAC when it identifies a potential acquisition target.
The domino effect
In the first half of 2021, more than 400 PSPCs scoured U.S. markets for targets, according to British law firm Rahman Ravelli, so it’s no surprise that they want to expand their services across Europe.
Speaking to SFT, Syedur Rahman, General Counsel at Rahman Ravelli, said: “PSPCs have been around for decades, but have recently gained popularity because of how quickly you can bring businesses to market and enable companies to register on public markets. It is obviously quite clear that the UK would like to encourage tech companies to nestle here, which is why changes are being made to the UK listing rules. The aim is really to attract PSPCs to the UK market.
He warns that increasing PSPCs could have catastrophic effects if people are not careful about how they operate, especially for private equity firms. One of the biggest risks comes from the limited two-year operating period, dictating that an SPAC must enter into a deal within that timeframe, otherwise any money raised from public shareholders will have to be returned to those investors.
“This could cause a whole host of problems, as it could mean you have to rush the process,” says Rahman. “The lack of due diligence by PSPC sponsors is one of the many potential litigation risks. There could also be litigation where the target company’s PSPCs could continue due to poor performance or as a result of unsuccessful negotiations, for example. ”
Rahman also mentioned the multiplication of possible “pump and dump” scenarios. This is an illegal scheme to increase the price of a security based on false, misleading or grossly exaggerated statements.
There are other issues with PSPCs, including the FCA’s initial £ 100million listing target. Rahman adds, “PSPCs could potentially inflate the numbers and distort the true financial health of the target company just to complete the acquisition on time. It is a criminal offense if you knowingly or recklessly create a false impression, which in turn causes loss to others.
However, Pascal Rapallino, head of group investment structuring at IQ-EQ, believes that PSPCs are less risky than traditional IPOs. He comments: “The growing popularity of PSPCs can be attributed to the fact that they have created an alternative route to liquidity for investors and businesses keen to avoid a long and expensive IPO process. PSPCs are a faster and arguably less risky path to becoming public, especially for small and medium-sized businesses.
“As a result, in the United States, PSPCs accounted for about 60% of all IPOs in 2020,” says Rapallino. “Although it is starting to slow down in the United States, interest in PSPCs is still at an early stage in Europe. Globally, PSPCs raised nearly US $ 100 billion through IPOs in the first quarter of 2021, already surpassing the whole of 2020. ”
Rahman says it’s far too early to tell if the risks of SPAC outweigh the benefits and we may not know for six months to three years. The key, it seems, is to learn from the US markets, which have had this spark in PSPCs for much longer than the UK. He comments: “I think this is a very good opportunity for the UK and the UK market, but you need to be aware of some of the significant risks that come with it.
“We can see that there are investor protections put in place by the FCA. However, this is similar to what we have seen in the United States, for example, we are already seeing litigation related to PSPC in the United States. I don’t think UK regulators have anticipated this yet.
Despite Rahman’s thoughts on the latest FCA regulations that came into effect on August 10, Andrew Poole, director of the ACA group, welcomes the new rules, saying they provide more flexibility for sponsors.
He says, “The sponsors of PSPCs, which include the private equity market, should welcome these changes. Lowering the minimum amount required to £ 100million provides greater flexibility for sponsors and allows the targeting of private companies of £ 500million.
“In addition, the continued protections offered by the new listing rules should reassure investors, with the takeover offer preventing investors from being locked into a transaction with which they may not fully agree.”
Going forward, Rahman Ravelli predicts an increase in the number of SPACs entering the UK and, more importantly, there will be plenty of cross-litigation. “PSPC sponsors will likely sue its directors or we’ll likely see PSPC shareholders sue their directors for breach of their fiduciary duties,” said Rahman.
Rapallino of IQ-EQ adds, “Private equity firms have always had to compete for high quality assets, even before PSPCs exploded on the scene. There is undoubtedly a potential for overlapping objectives between SPACs and private equity firms, and some companies have expressed justified concerns about the impact SPACs might have on transaction flow and valuations.
According to Rapallino, the existing PSPCs are currently on track to announce deals valued at over US $ 800 billion over the next two years. However, SPACs could offer more opportunities than threats to private equity firms. “Only 8% of fund managers surveyed in November 2020 for the 2021 Preqin Global Private Equity & Venture Capital Report said they were competing with a SPAC for an acquisition, and only 1% of them had in actually lost a deal, ”he said. said.
While the PSPC market in the United States has been hugely successful, the same may not be true for the United Kingdom, according to Harry Stahl, director of strategy and solutions management at FIS.
He comments: “The changes proposed by the FCA would significantly improve the attractiveness of the London Stock Exchange for companies wishing to go public through a SPAC. PSPCs are structured differently in the United States compared to the United Kingdom. With New York-listed SPACs, investors can buy back their shares if they are not happy with the target company. This is not the case in London, where listing is suspended as soon as a merger is announced.
“London is unlikely to ever catch up with Wall Street on this particular trend, but there is certainly a place for the UK in the long-term development of this market. The FCA changes are an important step in this direction.
Only time will tell what effect PSPCs will have on future investors and private equity firms, but many will be cautious, assessing the situation in the UK PSPC market. The International Organization of Securities Commissions (IOSCO) is considering doing so, as it is creating a PSPC network to facilitate information sharing to monitor the situation and it is not alone.
“Regulators across Europe are monitoring the growth of the PSPC market with what can be described as ‘moderate concern’,” comments Poole. ESMA has said that PSPCs ‘may not be suitable for all investors’ due to the inherent conflicts and risk of dilution, areas that the FCA specifically seeks to address.
“It remains to be seen whether changes to UK listing rules will attract the issuance of PSPCs to the London stock exchanges, but the pace at which the UK has adapted its rules may indicate an increased appetite for regulatory flexibility, of especially since “equivalence” is no longer a viable target for UK markets.