Public Capital Markets Lesson 2 PDF

Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Lesson 2: The Public Capital Markets Introduction This lesson introduces the public capital markets and how they operate in Canada....

Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Lesson 2: The Public Capital Markets Introduction This lesson introduces the public capital markets and how they operate in Canada. You will learn how a security is initially brought to market and then traded in the secondary market. This lesson takes approximately 30 minutes to complete. At the end of this lesson, you will be able to: explain the prospectus requirement discuss the continuous disclosure regime for reporting issuers describe the initial public offering process and how securities are brought to market compare the types of underwriting methods describe the secondary market, including stock exchanges, over-the-counter (OTC) markets and Alternative Trading Systems (ATS) describe the roles of the participants in the public markets Exempt Market Proficiency Course © 2021, IFSE Institute 11  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Primary and Secondary Markets Securities and financial instruments are brought to market and traded in the capital market. The capital market brings together corporations, entrepreneurs, governments, and other organizations seeking capital, with investors and lenders that supply capital. Entities seek to raise capital for various reasons including the need for expansion, research and development, or an increase in working capital for the purpose of repaying debt. The capital market is divided into two markets: the primary market the secondary market The primary market is where securities (like stocks and bonds) are issued or sold to investors for the first time by an issuer, through a public or private offering of securities. After securities are initially sold by an issuer to investors, the securities can then be traded in the secondary market. How Securities are brought to Market How securities are issued for the first time in the primary market depends on whether they are sold under a prospectus or under an exemption from the prospectus requirement. The primary market is divided into two markets: public markets private markets The public market is where the securities of publicly listed companies are offered by prospectus. The private market is where the securities of private (exempt) issuers are offered under an exemption from prospectus requirements. Under Canadian securities legislation, if securities are not sold under a prospectus or a prospectus exemption, it is an illegal distribution. The Public Offering Process When an issuer sells securities in the public market for the first time, it is known as an initial public offering (IPO). The Prospectus Requirement A number of regulatory requirements must be observed before an initial issue of securities may be sold in the public market. The process begins with the filing of a preliminary prospectus. 12 © 2021, IFSE Institute Exempt Market Proficiency Course  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Under securities legislation in Canada, issuers must file a prospectus in order to offer their securities for sale in the public market. The prospectus is an offering document which must be filed with the securities regulator in each province/territory where the securities will be sold. A company that distributes securities under a prospectus is called a reporting issuer. Reporting issuers are subject to certain continuous reporting obligations which require that they provide reports to the securities regulators and to existing investors. For example, a reporting issuer must provide reports including: unaudited quarterly financial reports audited annual financial statements management’s discussion and analysis information circulars in connection with meetings of security holders Reporting issuers must also provide the regulators and existing investors with prompt announcements in connection with any material changes that occur in their business, operations, or capital. The Preliminary Prospectus The preliminary prospectus must carry a bold disclosure in red ink on the cover page which indicates that information in the prospectus is not complete and the securities may not be sold until regulatory approval (i.e. regulatory receipt) has been obtained. Issuers must use the form of prospectus prescribed by the securities regulators. The majority of issuers must use the “long form” prospectus, particularly in the case of IPOs, while different forms of prospectus exist for investment funds, issuers that qualify for short form prospectus, etc. The electronic filing system in Canada for the disclosure documents of public companies and investment funds is the System for Electronic Document Analysis and Retrieval (SEDAR). The preliminary prospectus, final prospectus and any material agreements which are summarized in the prospectus (e.g. agency or underwriting agreement) are to be filed on SEDAR. SEDAR is available to the investing public at www.sedar.com. The offering issuer is also required to file press releases announcing the offering and the closing of the offering, and to file certain other documents required by the securities regulators (e.g. documents affecting shareholders’ rights, reports and consents of experts, etc.). Regulatory Receipt When a preliminary prospectus or a final prospectus is filed with the Canadian securities regulators, it is reviewed for conformity with securities legislation. Following their review, the securities commissions may make comments to the offering issuer and the issuer must respond to these comments. When satisfactory responses have been provided to their comments, the securities commissions issue a receipt. Exempt Market Proficiency Course © 2021, IFSE Institute 13  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Note: A receipt for a preliminary prospectus or a final prospectus does not constitute an endorsement that the securities offered pursuant to it are a good investment. It only means the prospectus has been reviewed for conformity with securities legislation. Passport System In Canada, preliminary and final prospectuses are reviewed under the Passport System. The Passport System streamlines the prospectus filing and registration processes in Canada, the continuous disclosure requirements for public issuers, and applications for prospectus exemptions by private (exempt) issuers. The securities commissions in all jurisdictions have joined the Passport System except Ontario. Under the passport system, the offering issuer deals with only one securities commission, called the principal regulator. In most cases, the principal regulator is the securities commission in the province or territory where the head office of the offering issuer is located. The offering issuer must still file the prospectus in every applicable jurisdiction via SEDAR and pay the filing fees in every jurisdiction. What happens next differs depending upon whether the principal regulator is the Ontario Securities Commission (OSC) or not: If the principal regulator is the OSC, it will review the prospectus and, if satisfied, issue a receipt which will also trigger a deemed receipt in the other applicable jurisdictions. If the principal regulator is not the OSC, the principal regulator will review the prospectus and the OSC will conduct its own review in tandem with the principal regulator using a passport interface mechanism. This is known as a dual review. If the OSC has concerns that it is not able to resolve, it may opt out of the dual review. If the OSC opts out of a review, the offering issuer will need to deal directly with the OSC to address its concerns. If the OSC does not opt out, a receipt issued by the principal regulator will also evidence that the OSC has issued a receipt. In either case, a receipt issued by the principal regulator will trigger a deemed receipt in each other passport jurisdiction where the prospectus has been filed. Under this system, offering issuers do not need to negotiate with thirteen securities commissions in Canada. In most cases, they will need to deal only with the principal regulator. Entering into Agency or Underwriting Agreements As part of a public offering, the offering issuer initially enters into an engagement letter with a lead investment dealer that sets out the terms and conditions of the offering including the size, structure, sometimes the price of the security, the selling commission, expense reimbursement, basic termination provisions, an indemnity in favor of the investment dealer, and other matters. When the preliminary prospectus is filed, the issuer and underwriters enter into an agency 14 © 2021, IFSE Institute Exempt Market Proficiency Course  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market (or underwriting) agreement which supersedes the engagement letter. The agency or underwriting agreement is encompassed in summary form into the prospectus. Role of Underwriters in a Public Offering Investment dealers play an important role as underwriters in connection with securities offered by prospectus in the primary market. Underwriting generally means the process of selling securities for offering issuers. In a prospectus offering, a group of investment dealers (or underwriters) combine their efforts to sell securities through what is called an underwriting syndicate. Working as a group, the underwriters share any risks that may be associated with a particular offering and split the selling commissions. Usually, one investment dealer acts as the lead underwriter of the syndicate. Underwriters are crucial to the primary public market. Their role includes three key activities: advising on the timing and manner of distribution of the securities completing due diligence, assisting in the creation of the prospectus, and advising and setting the price for the new securities selling the new securities to investors Types of Underwritings Generally, there are three types of underwritings: a “best efforts” underwriting a “bought deal” underwriting a “marketed offering” underwriting Best Efforts Underwriting Under a best efforts underwriting, the underwriters agree to use their best efforts to ensure that as much of the offering is sold at the specified price. The underwriters do not guarantee to sell a specified amount of the issue and they do not assume risks for any unsold part of the issue. Generally, no advertising or marketing activities that can be viewed as promoting are permitted prior to the filing of the preliminary prospectus. Bought Deal Underwriting Under a bought deal underwriting, the underwriters in the syndicate guarantee a specified amount of capital to the reporting issuer. The underwriters agree to purchase a specified number of securities, at a specified price, at a specified time. In essence the underwriters act as principals since they buy the securities from the issuer and then resell them into the market. However, if the underwriters are unable to sell all the allotted securities, the underwriters are still obligated to purchase the securities at the agreed upon price. Exempt Market Proficiency Course © 2021, IFSE Institute 15  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market A bought deal involves significant risks for the underwriters since there is no guarantee that the underwriting syndicate will be able to sell all the allotted securities purchased in the offering. It should be noted that exempt market dealers also engage in bought deals in the private markets. Marketed Offering Underwriting Under a marketed offering underwriting, the underwriters act as principals and they buy the securities from the reporting issuer and then resell them into the market. However, unlike a bought deal, the underwriting agreement is not signed until after the preliminary prospectus is filed. Therefore, the number of securities and offering price of the security is not set out in the preliminary prospectus. Once the preliminary prospectus is filed and receipted, the underwriters begin marketing activities in order to assess the market for the securities. After assessing the market for the securities, the number and price of the securities is set. Soliciting Interest for an IPO As advisors to the offering issuer, underwriters want to ensure that a new issue passes through the market successfully. After a preliminary prospectus has been receipted, but before any new securities come to market, investment dealers contact their clients seeking ‘expressions of interest’ to get an idea of whether there is a demand or interest for a particular security. Underwriters are able to use the preliminary prospectus as a marketing tool to assess the demand for the new issue in the marketplace. They are required to document the names of everyone who receives the preliminary prospectus, so that if amendments are made, the potential investors can be notified and receive an amended prospectus, including the final prospectus. The underwriters are limited in what they can do to sell the securities while the preliminary prospectus is being reviewed by the securities commissions. This is called the waiting period. Advertising and Marketing The advertising and marketing that is conducted for new public offerings include: the green sheet the standard term sheet marketing materials road shows Advertising and Marketing – New Public Offerings Green Sheet A green sheet is a simplified summary of the prospectus which is typically provided to registered representatives to assist them in understanding the issuer, the securities, and the offering. 16 © 2021, IFSE Institute Exempt Market Proficiency Course  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Advertising and Marketing – New Public Offerings Standard Term A term sheet provides potential investors with the contact information for the underwriters, Sheet a brief description about the issuer and the securities offered, and a legend with cautionary language. Marketing Materials An underwriter can provide certain other marketing materials to a potential investor during the waiting period, subject to strict conditions and disclosure requirements. Marketing materials include any written communication that contains material facts other than the prospectus, a prospectus amendment/notice, or the standard term sheet. Road Shows A road show is a presentation to potential investors regarding a distribution of securities under a prospectus. Setting the Share Price and other Security Features Underwriters advise issuers on the price of the security being offered, the rate of interest and term to maturity (in the case of fixed income), and the dividend rate (in the case of a preferred shares). Other recommendations may include call features or convertible features. The Final Prospectus The preliminary prospectus is reviewed by the securities regulators and, where required, amendments are made to the prospectus. Where a minimum offering is established, and satisfied, the final prospectus and the agency agreement (with the underwriting syndicate) is filed. If there are any material changes made to a preliminary prospectus, the issuer will be required to file an amended preliminary prospectus and provide it to investors. Agency Preliminary Regulatory Advertising Final Agreement Prospectus Receipt and Marketing Prospectus (Underwriting) Investor Rights Securities legislation in Canada imposes a rigorous standard of responsibility and liability in connection with a prospectus offering. Where a prospectus contains a “misrepresentation”, each investor is deemed to have relied on the misrepresentation and has a right of action for damages against the offering issuer and possibly against each underwriter, director, officer, promoter or expert who signs the prospectus. Under secondary market civil liability, if an issuer releases a document that contains a misrepresentation, an investor who acquires or sells the issuer’s security between the time when the document was released and the time when the misrepresentation was publicly corrected has a right of action for damages against the issuer and certain other parties. The misrepresentation may be in any document, including a continuous disclosure document. Exempt Market Proficiency Course © 2021, IFSE Institute 17  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market Secondary market civil liability also applies where an issuer fails to make a timely disclosure of a material change. Where timely disclosure has not been made, an investor who acquires or sells the issuer’s security between the time when the material change was required to be disclosed and the time when it was subsequently disclosed has a right of action for damages against the issuer and certain other parties. The Secondary Market After securities are initially sold to investors in the primary market, they are then traded in the secondary market by individual and institutional investors. There are three main types of secondary markets: Stock Exchanges Over-the-counter (OTC) markets Alternative Trading Systems Most equity trades take place on an exchange. However, the majority of bond trades take place on the OTC market. Stock Exchanges Stock exchanges are the most publicly recognized places for buying and selling shares in the secondary market. The common and preferred shares of publicly listed companies are traded on the stock exchanges. Companies must apply to be listed on an exchange. If accepted, the company must comply with the exchange's listing requirements including the rules concerning the disclosure of information for reporting issuers. Some of the benefits of listing on an exchange include: increased marketability of shares due to greater market exposure increased public confidence in the company an active secondary market that can broaden a company’s shareholder base The investment dealers who trade listed securities on the stock exchanges must become members of the exchange and must comply with the Universal Market Integrity Rules (UMIR) governing trading in the public secondary markets in Canada. Over-the-counter Market Over-the-counter (OTC) markets have no central location. Instead, individual dealers create liquidity in the market by negotiating amongst themselves. No intermediary or facility is used to match the buy and sell orders. 18 © 2021, IFSE Institute Exempt Market Proficiency Course  Unit 1: Overview of the Capital Markets Lesson 3: Private or Exempt Capital Market OTC markets are less transparent than exchanges. In the case of an exchange, all bids and offers are entered into the exchange’s order book and are visible to market participants. This is known as pre-trade transparency. In the case of an OTC market, there is no central order book and the only way to obtain quotes is to contact each dealer individually. Bonds are typically traded in the OTC market. Alternative Trading Systems An Alternative Trading System (ATS) is an automated secondary trading marketplace. Like an exchange, an ATS matches buy and sell orders. However, unlike an exchange, an ATS does not: require issuers to become listed on the ATS guarantee a two-sided market for a security on a continuous basis govern the conduct of its subscribers other than in connection with trading on the ATS discipline its subscribers other than to exclude a subscriber from participation in the ATS in appropriate circumstances Roles in the Public Market The participants that make up the public market are summarized in the table below. Public Market Participants Issuers Governments and corporations who raise capital in the public market by offering securities by prospectus Investment Dealers Registered firms who: act as underwriters in the primary market sell prospectus securities to investors in the secondary market trade prospectus securities with each other as principals in the over-the-counter (OTC) market Mutual Fund Dealers Registered firms that sell prospectus investment funds to investors Dealing Representatives Individual registrants who recommend and sell prospectus securities to investors on behalf of their investment dealers and mutual fund dealers Stock Exchanges and Alternative Trading Intermediaries that facilitate trades of publicly listed securities in the Systems (ATS) secondary market Securities Commissions/Regulators The securities commissions (or equivalent) in each of the provinces/territories who have oversight over the issuers, investment dealers, mutual fund dealers, Dealing Representatives, stock exchanges, and ATSs Exempt Market Proficiency Course © 2021, IFSE Institute 19