With investment in SPACs skyrocketing over the past year, the FCA has published new listing rules to open up the UK market to SPACs and protect investors. But is it enough? Carmella Haswell reports
The use of special-purpose acquisition companies (SPAC) has gained traction in the past year, riding a post-pandemic wave of market activity. Growing in popularity within the US, the trend has transcended across the UK and to the rest of Europe.
Hedge funds have been heavy investors in SPACs, fuelling the trend that has made its way across the Atlantic. Many hedge fund managers view SPACs as an attractive investment with moderate risk, where the value of SPAC units will typically rise if the SPAC company makes successful acquisitions but investors may redeem their holdings and receive their investment back under certain conditions.
SPACs are companies with no commercial operations that are formed strictly to raise capital through an initial public offering, for the purpose of acquiring an existing company. Richard Branson found himself in a high profile SPAC deal that saw Social Capital Hedosophia Holdings buy a 49 per cent stake in Virgin Galactic for US$800 million, before listing the company in 2019.
Despite providing investment opportunities in the UK market and offering an alternate source of funding, industry watchdogs such as the Financial Conduct Authority (FCA) have warned investors about risks associated with these investments. Concerns surrounding the use of SPACs involve dilution risks, where there is potential for a company to issue more stock, thereby diluting the percentage ownership of all the existing shareholders.
A conflict of interest regarding sponsors’ incentives may occur if SPACs do not disclose the circumstances surrounding a sponsor’s financial incentives and how they may not align with those of the public investors. Additionally, there may be uncertainty regarding the identity and valuation of a target company that the SPAC is to acquire.
The FCA refined their listing rules to protect investors, by lowering the minimum amount a SPAC needs to raise at initial listing to £100 million, an option to extend the two-year-time-limited operating period and remove the presumption that the FCA will suspend the listing of a SPAC when it identifies a potential acquisition target.
The domino effect
In the first half of 2021, there were more than 400 SPACs scrutinising the US markets for targets, according to UK law firm Rahman Ravelli, so it comes as no surprise that they wanted to expand their services across Europe.
Speaking to SFT, Syedur Rahman, legal director at Rahman Ravelli, says: “SPACs have been around for decades, but recently gained substantial popularity because of how quickly you can take companies to market and enable companies to list in the public markets. It’s obviously quite clear that the UK would like to entice tech companies to nest here, which is why changes are being made to the UK listing rules. The whole aim is really to attract SPACs into the UK market.”
He warns that the rise in SPACs could have catastrophic effects if people are not careful in how they operate, especially for private equity firms. One of the biggest risks comes from the two-year-time-limited operating period, dictating that a SPAC must complete a deal within this timeframe, or otherwise any money raised from public shareholders will need to be returned to those investors.
“This could lead to a whole host of issues because it might mean that you have to rush the process,” says Rahman. “A lack of due diligence by the SPAC sponsors is one of the many litigation risks. There could also be litigation where the SPACs of the target company might sue each other due to poor performance or as a result of unsuccessful negotiations, for example.”
Rahman also referred to possible “pump and dump” scenarios being on the rise. This is an illegal scheme to boost a security’s price based on false, misleading, or greatly exaggerated statements.
There are further issues surrounding SPACs, including the FCA’s £100 million initial listing target. Rahman adds: “ the SPAC’s could potentially inflate numbers, and misrepresent the true financial health of the target company just to complete the acquisition within the required timeframe. It is a criminal offence if you knowingly or recklessly create a false impression, which then causes a loss to others.”
However, Pascal Rapallino, group investment structuring leader at IQ-EQ, believes SPACs to be less risky than traditional IPOs. He comments: “The growing popularity of SPACs can be attributed to the fact that they have created an alternative path to liquidity for investors and businesses anxious to avoid a long and costly IPO process. SPACs are a faster and, arguably, a less risky path to going public, especially for small to mid-sized companies.
“As a result, in the US, SPACs represented about 60 per cent of all IPOs in 2020,” says Rapallino. “Although this is beginning to slow down in the US, interest in SPACs is still at an early stage in Europe. Globally, SPACs have raised nearly US$100 billion from IPOs in the first quarter of 2021, already surpassing all of 2020.”
Rahman says it’s far too soon to say if the risks that SPACs bring outweigh the benefits and we may not know for another six months to three years. The key, it seems, is to learn from the US markets, who have been experiencing this spark in SPACs much longer than the UK. He comments: “I think it’s a very good opportunity for the UK and the UK market, but you have 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, it’s similar to what we’ve seen in the US, for example, we’re already seeing SPAC related litigation in the US. I don’t think the UK regulators have anticipated that yet.”
Despite Rahman’s thoughts on the FCA’s newest regulations that came into force on 10 August, Andrew Poole, group director of the ACA Group, welcomes the new rules, saying these offer greater flexibility for sponsors.
He says: “Sponsors of SPACs, which includes the private equity market, should welcome these changes. The lowering of the minimum amount required to £100 million provides greater flexibility for sponsors and allows private companies of £500 million to be targeted.
“In addition, the continued protections offered by the new listing rules should give comfort to investors, with the redemption offer preventing investors being locked into a transaction that they perhaps are not fully onboard with.”
Future predictions
Looking forward, Rahman Ravelli anticipates an increase in SPACs coming into the UK, and more importantly, there is going to be a lot of cross litigation. “SPAC sponsors will likely sue its directors or we’re likely to see shareholders of SPACs sue their directors for breach of fiduciary duties,” Rahman says.
IQ-EQ’s Rapallino adds: “Private equity firms have always had to compete for high quality assets, even before SPACs exploded onto the scene. There is undoubtedly potential for overlapping targets between SPACs and private equity firms and some firms have expressed justifiable concern about the impact SPACs could have on deal flow and valuations.”
According to Rapallino, existing SPACs are currently on track to announce deals valued at more than US$800 billion over the next two years. However, SPACs might provide more opportunity than threat to private equity firms. “Only 8 per cent of fund managers surveyed in November 2020 for Preqin’s 2021 Global Private Equity & Venture Capital Report said they had competed with a SPAC for an acquisition, and just 1 per cent of those had actually lost out on a deal,” he says.
Although the SPAC market in the US has found huge success, the same might not be said for the UK, according to Harry Stahl, director of strategy and solutions management at FIS.
He comments: “The FCA’s proposed changes would significantly improve the attractiveness of the London Stock Exchange for companies looking to go public via a SPAC. SPACs are structured differently in the US compared to the UK. With New York-listed SPACs, investors can redeem their shares if they’re unhappy with the target firm. This is not the case in London, where trading is suspended when a merger is announced.
“It’s unlikely that London will ever catch up with Wall Street on this particular trend, but there’s definitely a place for the UK in the long-term development of this market. The FCA’s changes are an important step in this direction.”
Only time will tell what effect SPACs will have on future investors and private equity firms, but many will be cautious, evaluating the situation in the UK SPAC market. The International Organisation of Securities Commissions (IOSCO) are planning to do just that, as they create a SPAC Network to facilitate information sharing to monitor the situation and they’re not the only ones.
“Regulators across Europe are monitoring the growing SPAC market with what may be described as ‘moderate concern’,” Poole comments. “ESMA stated that SPACs ‘may not be appropriate for all investors’ due to inherent conflicts and dilution risk, areas that the FCA is specifically looking to address.
“It remains to be seen if the changes to the UK listing rules will attract SPAC issuance to the London exchanges, but the pace at which the UK has adapted its rules may indicate an increased appetite for regulatory flexibility, especially as ‘equivalence’ is no longer a viable target for the UK markets.”
