Kalifa Review – Proposed Fintech Investment Reforms

White & Case LLP

On 26 February 2021, the Kalifa Review of UK Fintech published its much anticipated report on the state of the UK fintech industry. The report recognizes fintech's current importance to the UK economy and potential material opportunities in driving growth as part of Global Britain in a post-COVID environment, including potential investment reforms impacting Fintech investors and companies

Summary of the Review and Investment Recommendations 

The Kalifa Review's report sets out a Five Point Plan through which the UK can maintain its position as a leading fintech hub and further build on this to benefit the UK economy. The plan comprises sections on policy and regulation, workforce skills, investment in fintechs, international matters and national connectivity, and we've focused on fintech investment for this alert. The Report also helpfully draws widely on input from many of the UK's leading fintechs, as well as several influential trade bodies. 

Principally, the report recommends: (i) expanding R&D tax credits, and investment tax reliefs such as (S)EIS and VCT to encourage further investment in fintech startups; (ii) the creation of a £1bn Fintech Growth Fund to provide domestic post-Series B funding; and (iii) reforming the listing environment to encourage more Fintech listings on the LSE. While it is undeniably positive that a cohesive strategy has been laid out for fintech in the UK and in particular to encourage domestic investment, key questions remain over the implementation of these measures, and their appropriateness given the rise of SPAC transactions which are making their way across from the US to the UK and EU.

1. Tax Credits and Reliefs

R&D tax credits cannot currently be claimed for costs associated to the collation and maintenance of financial data sets, a critical piece of the fintech ecosystem. However, the report proposes amending this to achieve two key objectives – firstly to provide tax relief to start ups for whom direct or indirect monetization of financial data sets represents a key revenue stream, but who do not have the upfront capital to collate these sets. And secondly, to promote partnerships between financial incumbents who hold significant amounts of data and fintechs, allowing the fintechs to scale up on an accelerated basis. We would expect this change to be in some cases transformative for existing fintechs, and unlikely to be objected to by either fintech companies or investors. 

EIS, SEIS, and VCT reliefs have been a critical factor in driving investment in UK fast growth companies in the past few years. However, some fintechs have been unable to offer investors these reliefs as they carry out an "excluded activity" under the relevant legislation e.g. dealings in shares, securities or other financial instruments, or banking, insurance, money-lending, debt-factoring, hire-purchase financing or other financial activities. While a change in the legislation is unlikely to be relevant to scale-ups at the Series B stage, allowing new startups who provide these services to offer investments which are (S)EIS or VCT compliant will hopefully lead to new and innovative companies being incorporated with sufficient capital to get to the Series B stage, and again, cannot see any fintech companies or investors objecting to this change. 

2. Fintech Growth Fund

The Report also calls for the creation of a £1bn Fintech Growth Fund ("FGF") to provide post-Series B stage companies with a domestic source of capital from which to raise funds to accelerate their growth up to a pre-IPO stage. Currently, the June 2020 Growth Capital report estimates there is a £2bn p.a. funding gap for post-Series B companies in the UK, forcing such companies to raise funding from foreign investors, which reduces the likelihood of those companies listing on UK markets. The FGF is proposed to be modelled on the Business Growth Fund, albeit with a mandate to invest in fintechs and with a dedicated investment team setting the investment strategy, as opposed to the BGF's shareholder driven approach. 

While a dedicated UK Fintech fund is a positive step, many questions remain as to what fintechs can expect from the FGF. The Government should provide details on whether the FGF is intending to take a lead investor position on post-Series B funding (with the customary board seat and suite of investor rights) or a passive minority stake along side other established investors (with a more limited set of fundamental vetoes). Further clarity should be provided on whether the FGF will be flexible on its form of funding i.e. that it will be open to provide funds as equity investments, as well as convertible debt, or indeed whether it will only provide funding on a convertible debt basis similar to the Future Fund scheme.

3. Public Markets

The Report notes that since 2015, only 6.7% of fintechs have chosen to list on the LSE, versus 29.3% for NASDAQ and 24% for NYSE, and that the reasons for this are primarily due to more favourable listing regimes in other jurisdictions, and lack of comparable listed fintechs on the LSE (as well as other factors such as investor boards being populated by foreign investors who prefer to list outside the UK). There are four key proposals to encourage more LSE listings, although we have not discussed the proposal for a Fintech index below given its non-legal nature.

Free Float Requirements

Firstly, a reduction of the LSE's 25% minimum free float requirement, or a switch to a value based threshold rather than a percentage of share capital threshold. In contrast to the LSE, both the NYSE and NASDAQ have a free float value threshold ($40-60m) rather than a shareholding threshold, offering much more flexibility to companies to list a smaller percentage of shareholding on an IPO and therefore raise funds with a minimal impact on the existing capital structure. 

The impact of introducing reduced shareholding or alternative value thresholds may be limited however by existing investment documentation, which in some instances will contractually require a listing to hit either a minimum free float shareholding percentage or a listing date proceeds return to a lead investor for the listing to proceed without lead investor consent. Fintechs should carefully consider these provisions in the light of any changes to the listing regime, and we would expect further consultation with fintechs ahead of any proposed changes so that it can be determined whether the reductions will actually encourage more fintech IPOs or maintain the status quo of investor sign-off.  

Dual Share Class Listings

Secondly, the removal of the  "one vote, one share" concept on premium listings to permit dual class structures i.e. structures giving founders or investors entrenched rights or weighted voting rights, as the LSE currently requires premium listed entities to limit themselves to one class of securities for all shareholders (subject to certain exemptions). The Report notes that dual class structures are currently permitted on "all other major stock exchanges, such as the NYSE, NASDAQ, Euronext, the Hong Kong Stock Exchange, and the Singapore Stock Exchange", and a shift to permit these types of listings should remove a major barrier to fintechs seeking a premium listing in London. 

However, there is much debate currently around whether dual class or golden share structures are indeed desirable given their concentration of power in the hands of a limited number of individuals. In some high profile cases, dual class structures have concentrated power solely in a single founder, allowing them to effectively bypass any collective board-based decision making processes. We would therefore expect any move to permit such structures contain necessary constraints e.g. which prevent founders approving their own related party transactions, or where such rights fall away following a founder no longer being operationally involved on a day to day basis. 

Pre-Emption Right Relaxation

In 2020, the Pre-Emption Group (an active trade body which publishes best practice guidelines for listed companies) recommended between April and November 2020 that investors support listed companies wishing to issue up to 20% of their share capital (over a 12 month period) for general corporate purposes on a non pre-emptive basis, in response to the COVID-19 pandemic and its impact on company finances. Typically, UK listed entities are permitted to raise only up to 5% in any 12 month period for such purposes on a non pre-emptive basis, and the Report has recommended reinstating this relaxation of pre-emption rights on a permanent basis to avoid fintechs being put off from listing on the LSE for fear of then being unable to raise further capital without complying with full pre-emption rights. 

We would expect that investors would be better served assessing any waiver of pre-emption rights in listed fintechs on a case by case basis. The recent change in market sentiment towards non pre-emptive issues has been driven by a highly impactful macro-economic event, and while its effects will linger for the foreseeable future, investors may be less willing to permit capital raises as the immediate economic dangers of the pandemic become less severe.

Final Thoughts

The Kalifa Review offers a compelling vision for the future of UK fintech, not least as it addresses a diverse and ambitious package of recommendations across not only capital investment, but also regulation, international strategy, the UK's workforce and IP and technical infrastructure. The Report has received a warm reception and appears to be fully backed by the UK Government. As set out above, it is critical that further detail is provided to ensure that some key issues around forms of FGF investment and potential listing regime changes are adequately dealt with, and we hope that further stakeholder interaction will be encouraged. 

However, a key area of consideration not addressed by the Report is the growing wave of SPAC transactions taking place in the US, and the comparative lack of such transactions in the UK. Such transactions can amount to a private company achieving listed status without having to undertake a traditional IPO, or without the fintech itself being the subject of investor interest with regard to capital structures. Given that the Kalifa Review intentionally adopts a long term view, this omission is not unexpected, and we look forward to the upcoming UK Listings Review which it is hoped will address certain key issues regarding SPACs and the UK listing regime, such as the free float and dual share class structures referred to above, as well as the critical issue of suspension of a SPAC's shares between announcement of acquisition and publication of the re-listing prospectus. 

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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