LittleLaw Looks At…SPACs: The future of financial regulation?

December 2, 2021

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7 min read

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What’s going on here?

Special purpose acquisition companies (Spacs) have been one of the most popular financial innovations over the last year. After seeing initial success in the US, Spacs are now spreading globally. They enable businesses to supercharge growth and to swiftly reach public markets. Typically Spacs are involved in exciting developing sectors, such as electric vehicles, spaceflight, and fintech. 

This article will hopefully serve as an introduction to Spacs, how they work, the US Spac boom, and how UK regulators are responding to the recent growth in popularity of Spac listing

What are SPACs?

A special purpose acquisition company is incorporated to raise money through an initial public offering (IPO) with the ultimate aim of identifying and acquiring a target business. They are essentially an investment vehicle.

Spacs are referred to as blank cheque companies, they have no commercial operations. The company has a management team that is dedicated to finding a target company within a specific sector to acquire. The management team typically has experience in the targeted sector. Ultimately, Spacs exist only to merge with another company through what is known as a reverse merger. Spacs are considered as ‘cash shell’ companies. This is because the company has no assets aside from money. 

Spacs provide an attractive alternative route to public markets when compared to lengthy and expensive traditional IPOs. For example, Kensington Capital Acquisition Corporation (KCAC) was incorporated in April 2020 and went public as a Spac in June 2020 on the New York Stock Exchange (NYSE). By September that year, the Spac announced its target private company, QuantumScape (an electric vehicle battery supplier). The merger was complete by the end of November 2020 and subsequently, QuantumScape’s shares began trading on the NYSE.

The US Spac Boom

Spacs have existed since the early 2000s but have only recently risen in prominence. For perspective, between the years 2009 – 2019, there were a total of 226 Spac IPOs.¹ In 2020, the US market saw 248 Spacs IPOs. Issuance volume multiplied almost six times from $13.6bn in 2019 to $80.4 billion in 2020.2 Additionally, the number of 2020’s Spac IPOs was eclipsed in 2021’s first quarter. Thus far in 2021, the US has had 463 Spacs IPOs with £131.6bn in gross proceeds being raised.3

Spacs grew in popularity in the US as they represented a faster route for companies to go public and have far greater certainty on pricing than more traditional IPOs. Listing requirements for traditional IPOs are strict in the US which encouraged companies to find a faster, cheaper way to IPO. Spacs have even attracted ‘celebrities’ such as Shaq O’Neal, Bill Gates, and Richard Branson. 

Yet, the Spac market is cooling down. Inevitably, such volume of Spac listings has led to market saturation. Rob Fullerton, global head of leveraged finance at Jefferies, said “The investor base has been overwhelmed”.4 It is becoming increasingly difficult for Spacs to acquire companies which are worthwhile investments as competition has soared. Similarly, increased scrutiny from the US Securities and Exchange Commission (SEC) has heightened levels of investor caution. The Spac craze in the US provides valuable lessons for the UK.

How does the UK Spac market compare?

The US Spac market dwarfs its UK counterpart. During 2020, a mere 4 Spacs were listed in the UK, raising an accumulated total of £30 million.5 This is primarily due to stringent regulatory measures in the UK which aim to protect investors. Many UK companies seek to go public via Spacs, but are reluctant to do so on the London market. Subsequently, UK companies look to list on either the US markets or even EU markets. 

Perhaps the most significant deterrent for investors in UK Spacs is share suspensions. If you have invested in a Spac, your shares are suspended at the point the Spac announces a deal. Investors are then prohibited from trading those shares again until the deal completes, which can be several months. As an investor, this is not an attractive proposition. Jason Manketo, capital markets partner at Linklaters, suggested in February 2021 that “the appeal of doing a Spac is severely limited in the UK”.6 The Financial Conduct Authority (FCA), however, has since demonstrated an attempt to encourage Spacs in the UK through adjusting this concept.

The New Guidance

The FCA’s new rules and guidance, published on 27 July 2021, targets a more flexible policy approach for Spacs. The more flexible policies aim to be more competitive with other international markets. The FCA claims that the new regulations will “strengthen the protections for investors while maintaining the smooth operation of the market”.7  The recently published guidelines, which came into force on 10th August 2021, have removed the presumption that trading of shares in a Spac will be suspended on the announcement of a potential acquisition, subject to the following criteria being met8:

Size Threshold 

The Spac must raise a minimum of £100m from public shareholders at its initial admission, excluding any IPO proceeds received from the Spac’s sponsors, founders, or directors. In theory, fundraising of this scale will likely involve detailed due diligence concerning the proposed acquisition. This is a measure aimed at protecting investors.

Ringfencing

Monies raised are ring-fenced to either fund or acquisition, or be returned to shareholders. 

Acquisition Deadline

The Spac’s constitution must set a time limit to acquire a target, this is generally 2 years but can be extended to 3 years with shareholder approval.  The FCA has introduced an option to extend the proposed deadline by 6 months, without the need to get shareholder approval. This extension is available in limited circumstances, such as where the Spac is in advanced acquisition talks. 

Board Approval

Board approval of any proposed acquisition, excluding from the Board discussion and vote any Board member that has a conflict of interest in relation to the acquisition.

Fair & Reasonable Statement

In the event of any Spac directors having a conflict of interest, a ‘fair and reasonable’ statement must be published, reflecting advice from an appropriately qualified and independent adviser. This acts as an investor safeguard.

Shareholder Approval

Shareholder approval is required for any proposed acquisition. This excludes founders, directors and sponsors. This provides investors with a significant degree of control concerning the authorisation of an acquisition.

Redemption Option

A ‘redemption’ option must be available to allow investors to exit their shareholding before any acquisition is completed. 

Sufficient Disclosures

Investors must be given sufficient disclosure on key terms and risks from the Spac IPO through to the announcement and conclusion of any acquisition. 

Spac issuers unable to meet these conditions, or choosing not to, will continue to be subject to a presumption of suspension. These changes aim to reflect the FCA’s key objectives: Consumer protection; market integrity, and competition in the interest of consumers.

There is concern, however, that despite this shift towards adapting listing restrictions, the UK market remains shrouded in uncertainty.  London firms have warned the FCA that, as the regulations stand, they deem the listing regulations to be lacking clarity.9

LittleLaw’s verdict: The door is beginning to open for UK Spacs

 There is mounting pressure on UK regulators to continue encouraging Spac listings on the London Stock Exchange. This pressure comes at a time when the UK government is keen to show an ambitious strategy to make London a more attractive financial hub after Brexit. Certainly, Spacs have the potential to be a driving force in the UK’s financial market. The combination of post-Brexit regulatory freedoms coupled with the unique opportunity to act on lessons observed from US markets could provide the UK with a working formula to become the Spac ‘hub’ across the pond. 

It will be interesting to see how regulations develop to strike an appropriate balance between optimal market operation and investor protection. Regulatory reform of listing rules will make it easier for companies to access capital and for London to preserve its role as a global financial centre. The fuel for recovery following the pandemic will be equity. Spacs present an opportunity to inject new equity into the UK economy. This access to liquidity could have a profound effect on corporate Britain. Yet the FCA is adamant that any regulatory changes will be approached with caution. It will continue to monitor developments, looking at a range of indicators that could influence future legislation. Consumer protection will remain central to any policy decisions.   

Ultimately, the measured approach by the FCA represents a new chapter for Spacs in the UK. Following the US Spac boom, it would be wise for the FCA to adopt an incremental approach concerning the development of listing rules in the UK. This will enable the FCA to provide more flexibility to Spacs while simultaneously observing investor protections and upholding market integrity. But, being able to compete with the steadily growing EU Spac market may be a priority for ministers in the aftermath of Brexit. This could apply pressure on the FCA to enact more drastic policy changes.

Report written by William Sutcliffe

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