Australia: New ASX placement rules for small to mid caps: will they work?

Junior miners and other small to mid cap companies on the ASX can now raise up to 25% of their issued capital via private placements. It's a strategic move by the ASX intended to make it easier and faster for smaller companies to access much needed capital.

But, there's a catch. The rule requires companies to hurdle difficult eligibility requirements that will curtail its effectiveness and purpose for some companies.

New listing rule 7.1A allows most small to medium cap companies (with a market cap of less than $300mil provided they are not part of the ASX 300 index) to place an additional 10% of their issued capital on top of the customary 15%, provided they obtain shareholder approval at an annual general meeting.

ASX's move to increase the placement limit has been largely driven by competition from overseas exchanges for listings of Australian small to mid caps. ASX's main competitor stock exchanges in the mining sector, Toronto, Hong Kong, London and Singapore, all have effective placement limits of between 20% to 25%.

Small and medium cap companies typically have limited access to debt funding and venture capital, a narrow range of shareholders (and thus limited use for pro rata rights issues) and experience trouble raising funds due to their speculative nature and limited capacity to return capital to shareholders.

As such, these companies (particularly miners) tend to rely primarily on private placements for their secondary capital needs. The upshot is this new listing rule will be welcome news for many smaller companies outside of the ASX300.

However, this new opportunity to place additional capital is not without its hurdles. These come in the form of extensive eligibility rules and disclosure requirements which are intended to protect minority shareholders by making it difficult for companies to easily and regularly use the additional headroom.

A key requirement of the new listing rule is that companies must get 75% shareholder approval at an AGM (not any general meeting) and must exclude any shareholders who are likely to benefit from any subsequent placement under the rule. This could make approval difficult given that any large institutional shareholders on the register (who would likely stand to benefit from the issue) would be excluded from voting.

Institutional investors are unlikely to be pleased by this somewhat ironic scenario, given that smaller caps often struggle for institutional support which might be how their need for capital arose in the first place. The same rule may have application for controlling shareholders who may operate as in-house underwriters of transactions.

Further, companies must, in advance of their AGMs, disclose the purpose for which funds raised will be used and provide an allocation policy describing to whom the shares are likely to be issued. These two requirements are likely to be contentious in the coming years and much will depend on the interpretation of the regulator.

ASX guidance on how specific the purpose must be is perhaps understandably vague. The concept raises a challenge of drafting a purpose broad enough (possibly without a specific transaction in mind) to cover a capital raising need that arises, but narrow enough to satisfy the rule. And there will be an issue of what purpose means: does it mean one transaction or foreshadowed new transaction(s)? Is it enough to use terms like 'need for working capital during year' or 'anticipated acquisition'? In practice, the new rule lends itself to regulatory discretion as to what constitutes a satisfactory description of the purpose. The Notice of Meetings of companies in this reporting season will be no doubt scrutinised carefully to determine how the ASX will view this requirement.

The allocation policy will also require some thought as a company must detail how it 'intends to decide who to offer securities' in as much detail as is 'reasonably practicable in the circumstances'. These phrases acknowledge a practicality issue – how will a company know to whom it will issue shares possibly months after it has received shareholder approval?

ASX's contentious original proposal for the listing rule

The eligibility and disclosure requirements of new listing rule 7.1A weren't always so onerous. In its original form the proposed rule was far more liberal, making the additional placement capacity available with an ordinary resolution of shareholders at any general meeting.

However, this drew a barrage of criticism, largely focused on retail shareholders who could potentially find themselves substantially diluted under a larger placement without an opportunity to participate.

Critics pointed out that a 25% placement would enable a company on a diluted basis to issue around 20% of its shares to a placee; this is generally seen as the takeover threshold and the argument ran by the critics was that this would enable a company to effect a change of control without recourse to shareholders. Market integrity, these critics charged, required preservation of the existing rule.

Much of the criticism seems overblown. In an ideal world perhaps all share offers should be by renounceable entitlement offer. But we do not live in an ideal world and stock markets are intended to be as much a tool to allow capital efficiency as well as preserve market integrity.

The ASX's position that enhancing placement capacity for smaller companies assists that process is entirely defensible. Toronto, London, Hong Kong and Singapore stock exchanges all have effective placement limits of 20% to 25%. Not many would suggest that all these exchanges fail market integrity tests – indeed their approach to regulation is in many respects stricter than Australian compliance requirements.

While the new placement rule will give junior miners and other mid to small caps a much needed boost to their capital raising capacity, the rule's eligibility requirements will arguably curtail its effectiveness and purpose. In particular, the attainment of 75% shareholder approval may be difficult where existing institutional investors are prevented from supporting capital raising resolutions.

However, these requirements will likely not dissuade those companies intent on using the additional headroom and we expect that the purpose and allocation disclosure rules will operate as insurance policies for the ASX more than anything else. While they may have been introduced to placate the critics, they do give the ASX ammunition if there is wide-spread non-compliance or evidence that companies are taking advantage of retail shareholders. Whether or not the ASX takes a different approach and enforces these strictly remains to be seen.

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