As the 2023 proxy voting season closes, UK company boards are reflecting on the changes brought about by the Financial Reporting Council’s (FRC) Pre-Emption Group’s new guidance on pre-emptive rights, under which existing shareholders can purchase newly issued shares before third parties can.
The Pre-Emption Group’s revised guidance has now doubled the amount of shares UK-listed companies can request approval for—up from 10% to 20% of issued share capital—bypassing pre-emptive rights that would otherwise give current shareholders priority. This requires shareholder approval through a special resolution with 75% support. The 20% threshold is split into two components: 10% for general authority and 10% specifically for acquisitions or specified capital investments.
Understanding pre-emptive rights
Pre-emptive rights help to safeguard and prevent excessive dilution of shareholder investments and allow existing shareholders to have some control over any potential new investors. Each new issuance of shares to new investors reduces the percentage of equity owned by existing investors.
Historically, the yearly limits of the authority sought for non-pre-emptive or disapplication issues was up to 10% of issued share capital.
During the Covid-19 pandemic, the Pre-Emption Group temporarily raised thresholds for disapplication, allowing companies to issue up to 20% of issued capital. This provisional measure offered UK-listed companies a secondary capital-raising option to potentially offset the results of business challenges caused by the pandemic.
The Pre-Emption Group made this measure permanent in November 2022 following a review of UK Secondary Capital Raising by the Treasury.
To gain more support, companies must demonstrate responsible use of the new authority to issue shares without pre-emption rights. The revised guidelines offer a pathway to long-term success and resilience. Board members of major UK companies will want to optimise this change to help them navigate the ever-evolving market effectively and remain competitive.
However, while companies seek to have these authorities in place, in most cases the approvals are almost never used to issue shares. The intention behind the disapplication is to provide flexibility in case the need arises, rather than a guarantee of issuing new shares.
Responses from proxy advisers and investors
Proxy advisers, such as Institutional Shareholder Services (ISS) and Glass Lewis, quickly adopted the new Pre-Emption Group guidance as standard.
ISS updated its UK and Ireland proxy voting guidelines in December 2022, including stating that they would generally support a resolution to authorise the issuance of equity unless:
“The routine authority to disapply pre-emption rights exceeds 20 percent of the issued share capital, provided that any amount above 10 percent is to be used for the purposes of an acquisition or a specified capital investment.”
ISS only recommended against a single case where historical practices did not align with approved guidelines, and Glass Lewis supported all increases.
Despite proxy advisers’ overwhelming support for the new guidelines, investors have been more cautious in their approval. More than 20 FTSE 100/FTSE 250 companies (excluding investment trusts) received opposition of more than 10% ‘against’ the new disapplication proposals, with one company receiving 40% shareholder opposition and therefore failing to secure the required 75% shareholder approval.
The primary concern of investors seems to revolve around the dilution of their existing shareholding. To gain investor support for increased authority to issue shares, companies may need to improve how they demonstrate responsible use of this power and show value addition and long-term sustainability through thoughtful transactions and disclosures.
Building trust through engagement
As we approach the 2024 voting season, investors may soften their approach towards the disapplication of pre-emptive rights. The way in which the board engages shareholders, past behaviour and decision-making process may all influence this shift. If companies can prove they will use these powers judiciously and transparently, investors are likely to be more supportive.
It is likely that investors will carefully consider their approach to these new guidelines. While major continental European markets maintain a 10% limit on pre-emptive rights, the UK’s 20% threshold provides companies with greater flexibility to raise capital.
As with voting in support of individual directors and the analysis around executive remuneration, approval is not just based on a stated policy but includes company engagement and—potentially—previous behaviour and decisions made by the board. Investors could make use of the same approach here, by looking at how companies have used their new authorities to issue shares without pre-emptive rights during 2023.
By aligning their practices with shareholder-approved guidelines and demonstrating transparency in their decision-making, boards can build trust and garner greater support for such resolutions in the future. As a result, investors may soften their stance if they trust the board to use the authorities judiciously.
Daniele Vitale is head of ESG UK/Europe and Daniel Veazey is corporate governance manager, both at Georgeson