Performance Securities - A New Need for Independent Expert Reports

28 August 2020

Sherif Andrawes, Global Head of Natural Resources
Partner, Corporate Finance

On 28 August 2020 ASX released a revised Guidance Note 19 Performance Securities (GN19) with a new requirement for an opinion by an independent expert.

What is new in GN19?

The key changes introduced by GN19 are to expand the guidance note to cover performance securities rather than just performance shares (so as to include performance options and performance rights too), to set out expectations of the broad terms of performance securities and to introduce a requirement for an independent expert report.

The revised GN19 introduces the requirement, in certain circumstances, for an independent expert to provide an opinion on whether the issue of the performance securities is fair and reasonable to non-participating security holders.

GN 19 does not apply to performance securities issued in certain circumstances including an issue under an employee incentive scheme or as part of the remuneration package of a director or employee where the issue has been made in the ordinary course of business.

Why are Performance Securities Used?

Performance securities are commonly used when an entity is entering an agreement to acquire another entity, business or asset and the value of that entity, business or asset is uncertain but has the potential to increase substantially in the future. If that future value increase can be linked to a milestone being achieved then performance securities may be appropriate.

A common example would be in the case of a mineral exploration company where, upon a certain inferred, indicated or measured resource being confirmed, the issue of performance securities can allow the vendor of the exploration tenement to receive additional ordinary shares to reward it for the latent value in the tenement.

When will an Independent Expert Report (IER) be required by GN19?

An IER will be required in the following two situations:

  • For a listed entity that proposes to issue performance securities covered by GN19, where the number of ordinary shares that will be issued upon achievement of the milestone is greater than 10% of the number of ordinary shares on issue at the date the performance securities will be issued; or
  • For an entity that is applying to be listed, that proposes to issue performance securities where the number of ordinary shares that will be issued upon achievement of the milestone is greater than 10% of the number of ordinary shares on issue at the date of admission to quotation.

In the latter case, the IER will be included in the entity’s listing prospectus which will be an interesting new element to a prospectus that we have not seen before in Australia.

How will the expert do this?

Two significant issues when considering the impact of performance securities in independent expert reports in other situations have been firstly how to assess the probability of the milestone being achieved and secondly how to assess value at that future date.

GN19 addresses this first issue by stating that the expert is to assume that the relevant performance milestones have been met and then to assess the impact this would have on the value of the entity. Assessing the future value may remain as a challenge for the expert but to what extent will largely be dependent on the nature of the milestone and the entity being valued.

Once the expert has derived this value the final step will be to determine whether the resulting number of ordinary shares to be issued is fair and reasonable in the circumstances.

Taking a broader view?

ASX recognises that the ability to provide a future dated valuation may be difficult and in some circumstances may result in a broader and hence less meaningful valuation range than one would normally expect to see in an IER.

ASX would have no objection to an independent expert expressing a broader view on an issue of performance securities. The example given in GN19 is a statement that while the expert is not able to conclude that the issue is fair or reasonable (as applicable), they regard it as being in the interests of the entity and non-participating security holders to proceed with the issue. 

There is no guidance as to when this approach is appropriate or precisely what ‘in the interests...’ means in this context. However, we anticipate that if ASX sees experts routinely forgoing an objective analysis of the fairness and reasonableness of the proposed issue of performance shares instead relying on a potentially less meaningful ‘broader view’, that this will not meet the expectations of ASX and that such reports may be rejected. We expect to see this form of analysis on an exception basis only.

Appointing the Independent Expert

ASX strongly recommends that entities apply for in-principle advice that the terms of any performance shares will be acceptable before any announcement is made. If an IER is required then that application must either be accompanied by the IER or, if not yet completed, details of the expert must be supplied. This is to allow ASX to be satisfied with the expert’s independence and presumably the expert’s ability to prepare the IER, together with the indicative timetable to produce the IER.

The usual independence requirements set out in ASIC’s Regulatory Guide 112 Independence of Experts apply to IERs prepared for GN19 purposes.

How should the Performance Securities be structured?

A key concept in GN19 is that the number of ordinary shares into which the performance shares will convert if the relevant milestone is achieved must be:

  • Fixed or calculated in such a way that it delivers a fixed outcome; and
  • Objectively fair and reasonable, both in absolute and relative terms compared to the additional value derived if the milestone is met.

This latter point will be the key to how an expert assesses whether the issue of the performance securities is fair and reasonable. The assessment would appear to not just be an absolute assessment of the change in value per share before and after the milestone being met, but also of the relative allocation of that value between existing shareholders and those who will receive the new shares. Contact your local BDO adviser for more information.