Toronto Stock Exchange And TSX Venture Exchange Issue Joint Consultation … – Mondaq News Alerts (registration)

Introduction

In December 2012, the Toronto Stock Exchange
(“TSX“) and the TSX Venture Exchange
(“TSXV” and, together with the TSX, the
“Exchanges“) published a Consultation
Paper on Emerging Market Issuers (the “Consultation
Paper“) as part of their review of listing
requirements for issuers with a significant connection to an
emerging market jurisdiction outside of Canada, the United States,
Western Europe, Australia and New Zealand (“Emerging
Market Issuers” or
“EMIs“). The Consultation Paper presents
the potential risks associated with listing Emerging Market Issuers
identified by the Exchanges, provides preliminary guidance to
issuers and their advisors regarding listing considerations
applicable to EMIs and seeks comments from market participants on
matters related to listing EMIs. The Consultation Paper also
contains a proposed TSXV policy document (the
“Policy“), which sets forth specific
guidance and requirements applicable to the listing of EMIs on the
TSXV and seeks to address the risks associated with such listings.
Comments on both the Consultation Paper and the proposed TSXV
policy document are to be submitted by February 28, 2013.

Potential Risks Associated With Listing Emerging Market
Issuers

The Exchanges identified four principal areas of risk associated
with listing EMIs: (1) management and corporate governance; (2)
financial reporting; (3) non-traditional corporate/capital
structures; and (4) legal matters relating to title and ability to
conduct operations.

Management And Corporate Governance

The Consultation Paper outlines the following risks relating to
management’s lack of experience and familiarity with Canadian
securities law and regulatory requirements, communication-related
issues due to language and geographic barriers and management’s
unfamiliarity with local business practices:

• a potential increase in the likelihood of non-compliance
  with, or misunderstanding of, Canadian securities law requirements
  and TSX and TSXV requirements as well as the legal and regulatory
  requirements of the jurisdiction where the EMI principally carries
  out its business;




• inadequate oversight of senior management by the board of
  directors;




• the inability of advisors to adequately communicate with senior
  management and the board of directors;




• the inability of the chief financial officer to properly carry
  out his or her duties;




• the inability of the audit committee to property carry out its
  duties; and




• the inability of senior management to adequately communicate
  with the Exchanges and applicable securities regulatory
  authorities.

Financial Reporting

The Exchanges note the following risks with respect to an
EMI’s financial reporting:

• an increase in the likelihood of errors or oversights in the
  audit process, and correspondingly in financial statements and
  related disclosure, due to the EMI’s Canadian auditors’
  lack of sufficient experience and expertise in the applicable
  emerging market jurisdiction;




• an increase in the likelihood of errors and misstatements in
  financial statements due to inadequate internal controls over
  financial reporting matters; and




• an increase in the likelihood of errors or oversights in the
  audit process and financial statements due to the EMI’s chief
  financial officer or audit committee not having sufficient
  expertise and experience with applicable audit practices and
  procedures.

Non-Traditional Corporate/Capital Structures

The Exchanges identified the following potential risks
associated with the use of complex corporate or capital structures,
which they recognize may be desirable or necessary due to tax or
foreign ownership restrictions:

• if the structure requires that legal ownership of the EMI’s
  operating assets be vested in a non-affiliated entity, title to and
  control over such assets by the EMI may be compromised;




• the structure may limit or otherwise inhibit the ability of
  shareholders to have recourse against the EMI’s assets;
  and




• inadequate public disclosure of the nature, material
  characteristics and risks associated with the structure.

Legal Matters Relating To Title And Ability To Conduct
Operations

The Consultation Paper points out the following risks relating
to the validity of an EMI’s title to its principal operating
assets and its legal right to conduct operations:

• an increase in title risk or difficulty demonstrating the
  legitimacy and certainty of title to the EMI’s principal
  operating assets, which are fundamental requirements for the
  listing of an issuer on the Exchanges; and




• impact on an EMI’s ability to carry out its business
  operations due to the emerging market jurisdiction’s
  requirements for specific permits or business licences.

Some Of The Proposed Requirements

Pre-Filing Conferences

In light of the risks associated with the listing of EMIs, the
Exchanges strongly recommend that any EMIs contemplating listing on
either the TSX or the TSXV arrange a pre-filing meeting with the
applicable Exchange. The EMI must satisfy the applicable Exchange
that it is able to meeting all applicable listing requirements and
mitigate the potential risks.

Internal Controls

The TSX is also contemplating requiring comfort around internal
controls in the form of a certification, management report or other
similar report on internal control systems to be submitted by an
auditor at the time of listing of EMIs. Similarly, the TSXV has
proposed that an EMI’s internal controls over financial
reporting be reviewed and evaluated by the EMI’s auditors prior
to listing.

Related Party Transactions

Related party transactions may be prevalent among EMIs that have
a controlling security holder and such transactions may not
necessarily meet the definition of “related party
transactions” under securities law. The TSX is contemplating
classifying EMIs that have a controlling security holder as
“non-exempt” and be subject to additional oversight for
related party transactions or taking an expanded view of
“related party transactions”. The TSXV policy document
also proposes that EMIs be required to adopt specific internal
written policies in respect of related party transactions and
transactions with non-arm’s length parties that would address
matters such as independent director oversight and approval,
adequate timely disclosure to the public, adequate disclosure in
the financial statements and compliance with all applicable
regulatory requirements.

Sponsorship

Historically, sponsorship may have been waived for certain
applicants completing an IPO or brokered financing, or graduating
from the TSXV. However, the TSX has indicated that in assessing
EMIs, sponsorship may be particularly helpful and the TSX is
unlikely to waive the requirement. Similarly, the TSXV policy
document would make certain modifications to the sponsorship
requirements including changes to the availability of certain
sponsorship exemptions. The TSXV would more actively request
detailed sponsor reports where sponsorship of an EMI is
required.

Ongoing Requirements

The TSX may, in its discretion, require supplemental ongoing
requirements to mitigate particular risks; such requirements could
include pre-clearance of a change of auditors and pre-clearance of
new board members or new senior management. The TSX would impose
any supplemental ongoing requirement at the time of listing and
could periodically re-consider these requirements as the EMI’s
risk profile changes over time. Similarly, the TSXV would require
all EMIs to continue to comply with the EMI requirements on an
ongoing basis and for EMIs to be mindful of corporate actions that
may impact continued compliance. The TSXV may from time to time, at
its discretion, require an EMI to satisfy the TSXV that it remains
in compliance with the applicable requirements.

McMillan Thoughts And Perspectives

We are in general agreement with the TSX and TSXV with the need
to apply increased regulatory scrutiny to issuers engaged in
emerging markets in order to both protect investors and to preserve
the integrity of Canadian capital markets. However, we have a
number of concerns with the proposed Policy which are both
specific, a number of which are outlined below, and general.

Our general concern is that it will invariably be difficult, and
perhaps impossible, to draft a set of prescriptive rules that will
apply and be effective in regulating a wide variety of Emerging
Market Issuers that will range greatly in terms of business size,
nature of business operations and management sophistication across
a wide variety of emerging markets, each of which will have their
own characteristics and risks. Accordingly, we are of the view that
the Exchanges should retain flexibility in how to apply their rules
and policies and will need to actively tailor their review of
Emerging Market Issuers in order to address specific risks
applicable to each issuer. In other words, there is no “one
size fits all” set of rules or policies that should be applied
and the TSX and TSXV are going to have to focus their reviews on a
“case by case” basis, with as much transparency to
issuers as is possible. For instance, if the definition of Emerging
Market Issuer is narrowed in a specific case to include other
acceptable countries or regions, the decision of an Exchange should
be published. Also, we suggest that the TSX and TSXV retain
discretion as to how and to what extent to apply the requirements
in their rules and policies, rather than impose up-front strict
requirements that may not be necessary in all circumstances and
that can only be avoided by way of waiver.

Specific concerns that we have include the following:

• Definition Of An Emerging Market Issuer: The
  current draft of “Emerging Market Issuer” captures
  issuers across the globe with principal business operations or
  operating assets located outside of North America, the UK, Western
  Europe, Australia and New Zealand. Accordingly, issuers based in a
  number of advanced and sophisticated economies, notably Hong Kong,
  Japan and Korea, are classed as Emerging Market Issuers. While many
  of the laws and cultures of these jurisdictions are clearly
  distinct from “Western” countries, many of these
  jurisdictions do have sophisticated legal systems and business
  cultures where the perceived risks associated with emerging markets
  are not present.




• Carve-Out For “Excluded Resource
  Issuers”: We appreciate the rationale for carving out
  “Excluded Resource Issuers” from the full application of
  the policies for Emerging Market Issuers. However, we have two key
  concerns:




• • Qualification as an “Excluded Resource Issuer” is
    tied to residency outside of Emerging Market Jurisdictions with
    respect to senior officers, directors and control persons. We are
    concerned that residency is not an accurate determination of the
    ability of the officers, directors or control persons to
    effectively manage the business of a public company. For example, a
    TSXV company with mining operations in Peru and majority South
    American management may be far more effective with appropriate
    education, professional qualification and designation and local
    management and mining expertise than a TSXV company with mining
    operations in Chile where the majority of management is based in
    North America but where the same standards of education,
    professional qualification and designation and local management and
    mining expertise are not met.

  
  

  • The distinction between an “Excluded Resource Issuer”
    and an “Emerging Market Issuer” becomes based on the
    business operations of the issuer, rather than factors that are
    directly relevant to management of the issuer and risk factors
    associated with potential fraud or mismanagement. For example, an
    issuer with a gold mine in China may be exempt from many of the
    Emerging Market Issuer policies, whereas an issuer with a
    manufacturing facility next door to the mine and with a similar
    management and governance structure as the mining company may find
    itself caught by the policies in full.




• Auditor Review Of Interim Financial
  Statements: We agree with the TSX and TSXV that the
  reliability of an Emerging Market Issuers internal controls over
  financial reporting are key to reliability of financial reporting
  and financial statements. Accordingly, we generally agree with the
  proposed requirement that auditors be required to review the
  interim financial statements of Emerging Market Issuers following
  listing. However, we question whether this obligation should be
  ongoing for issuers in higher risk jurisdictions rather than only
  being required for two years following listing, as proposed, given
  that we see the risks associated with financial reporting as being
  ongoing for these issuers, and not just in the initial years
  following listing. It may therefore be appropriate to consider
  extending the time period beyond two years for specific regions or
  on a “case by case” basis, with as much transparency as
  is appropriate.




• Internal Controls Over Financial Reporting: We
  agree with the TSX and TSXV as to the need for increased scrutiny
  over the internal control over financial reporting
  (“ICFR”). However, we have a number of comments on the
  proposed requirements for Emerging Market Issuers:




• • First, the Policy calls for an issuer to have its ICFR reviewed
    and evaluated by its auditor prior to listing. We are unclear as to
    what would be the nature of this review and evaluation. The
    proposed Policy is clear that the review will not rise to the level
    of a SOX 404 auditor attestation report, however we would suggest
    that the TSX and TSXV provide more guidance on what is anticipated
    in order that Emerging Market Issuers have more clarity on this
    point and can better judge the required process and consequential
    expense.

  
  

  • Second, the Policy calls for TSXV issuers that would be
    “venture issuers” under Canadian securities laws to file
    the full CEO and CFO certifications required for TSX issuers in
    order that they are forced into a higher standard of reporting on
    their evaluation on ICFR and any material weaknesses, if
    applicable, as a TSX issuer. We agree with this approach but again
    question whether it should only be for the two years following
    listing for Emerging Market Issuers in high risk jurisdictions as
    the ICFR risk may be ongoing for these issuers.




• Non-Traditional Corporate/Capital Structures:
  We anticipate the challenges faced by the TSX and the TSXV in
  listing issuers with complex non-traditional corporate structures,
  particularly issuers that conduct business in China through
  “variable interest entities” (“VIE’s”).
  These structures are now being scrutinized by regulators globally,
  particularly by the SEC in the United States. With regards to the
  proposed policies, we have the following comments:




• • It is proposed that the TSXV have the right to refuse listing
    of an Emerging Market Issuer where the Exchange is not satisfied
    that the non-traditional structure is “necessary”. We
    submit that necessity is the incorrect test to apply to these
    structures. Rather, we submit that the Policy should focus on
    whether the non-traditional structure presents risks that the TSXV
    would consider unacceptable for a public company.

  
  

  • It is proposed that the TSXV require legal opinions on the
    validity of the non-traditional structures addressing the concerns
    noted in the Policy. On this point, we suggest that the Policy more
    clearly focus on the types of opinions that will be required in
    order that Emerging Market Issuers can better focus their
    professional advisors to address these legitimate listing concerns.
    Opinions as to title of key properties and necessary permits and
    licenses are specifically required, however there are a number of
    opinions that could also be sought by the TSXV where specific risks
    are present. For example, opinions as to enforceability of
    contracts underlying VIE’s and the ability to repatriate funds
    from overseas operations to the listed parent are opinions that the
    TSXV may want to consider obtaining in certain situations.
    Accordingly, we suggest that the Policy expand the specific types
    of opinions that that may be sought and provide guidance as to the
    factors that the TSXV will apply in determining which opinions will
    be required by the TSXV.




• Sponsorship: The TSXV has proposed in its
  Policy to remove the availability of certain exemptions from the
  sponsorship requirements for Emerging Market Issuers. We propose
  that removal of these exemptions is not appropriate for the
  following reasons:




• • Section 3.1(a) of Policy 2.2 provides an exemption where an IPO
    is completed where the prospectus is executed by at least one
    Member. We believe that removal of this exemption will not be
    required given the anticipated increased standards to be imposed on
    underwriters by the Ontario Securities Commission as part of its
    implementation of high regulatory standards for Emerging Market
    Issuers. 

  
  

  • Section3.4(a)(ii) of Policy 2.2 provides an exemption where a
    bank or other major financial institution is involved in the
    transaction or the completion or a concurrent brokered financing
    where due diligence is conducted. Again, we anticipate that the
    anticipated increased standards to be imposed on underwriters by
    the Ontario Securities Commission as part of its implementation of
    high regulatory standards for Emerging Market Issuers should serve
    to address the concerns of the TSXV and remove any requirement to
    remove this exemption for Emerging Market Issuers.




• Other:




• • We especially support the use of pre-filing conferences and the
    potential need for corporate governance or reporting issuer
    management courses. Such training is required in connection with a
    listing on the Stock Exchange of Hong Kong, for instance, and is
    very useful in raising awareness. It is important that that there
    is an appropriate “tone at the top” of the listed entity
    that understands best practices of corporate governance, including
    respect for the Board and its decisions.

  
  

  • We also believe that sponsors and agents should consider the
    use and application of the tools used in the private equity market
    to monitor and provide for consequences should there be instances
    of fraud or to guard against fraud or theft. These mechanisms could
    include:




• more stringent controls over bank account signing
  authority,




• supervision of use of proceeds,




• maintenance of some level of minimum working capital in
  Canada,




• forfeiture of shares in cases of malfeasance,




• security for key representations made by principals, and




• using appropriate dispute resolution forums whose judgments are
  enforceable in the jurisdiction where the business is located (for
  instance the use of Hong Kong’s Arbitration Centre in
  connection with disputes involving business operations in Mainland
  China).

In conclusion, we believe the proposed Policy is a forward step
in providing guidance to Emerging Market Issuers and their advisors
that will help to remove much of the current uncertainty in the
current marketplace as to how the listing of Emerging Market
Issuers will be regulated. Again, we are of the view that the TSX
and TSXV will need to be creative in creating governance structures
that will address the particular risks faced by each particular
Emerging Market Issuer on a case-by-case basis.

The foregoing provides only an overview. Readers are
cautioned against making any decisions based on this material
alone. Rather, a qualified lawyer should be consulted.

© Copyright 2013 McMillan LLP

Specific Questions relating to this article should be addressed directly to the author.