KOR

Periodicals

OPINION

NYSE Rule Changes to Facilitate Direct Listing and Implications
2020 Dec/08
NYSE Rule Changes to Facilitate Direct Listing and Implications Nov. 10, 2020 PDF
Summary
Direct listing is one of the paths including IPOs and SPACs via which a firm goes public and becomes a public company. It directly lists the existing shares held by the existing shareholders on a stock exchange without any primary offering. The benefits of such a path include a simple process and a less cost paid to investment banks because direct listing does away with conventional IPO procedures such as a roadshow, book building, allotment to institutional investors, etc. However, its absence of capital raising is viewed as a critical drawback. For the past few years, direct listing has garnered attention as firms such as Spotify, Slack, and Palantir chose direct listing to float their shares on the NYSE. Another important event is the SEC’s approval on the NYSE rule change that allows for primary offering and selling of those shares in direct listing.

If finalized, the revised rule that enables firms to raise capital via direct listing could offer an effective alternative to IPO and broaden the choice of firms thinking about going public. Because direct listing involves no underwriter, an increase in this listing path could impose a significant impact on investment banks’ operation. Institutional investors—who used to be allotted shares by the lead manager before listing in an IPO deal—will be faced with a direct listing environment where they have to participate in an opening auction with other investors.

Although there has been no case of direct listing in Korea in the 2000s, it’s important to devote ceaseless effort to improvement that is to provide more benefits to investors and firms seeking to go public, while closely keeping an eye on developments in overseas markets.
Direct listing is one of the paths including initial public offering (IPO) and the special purpose acquisition company (SPAC) via which a firm chooses to float their shares on a stock exchange and becomes a public company. However, it has received only limited attention because very few companies have chosen the path, compared with IPO and SPAC. However, it is receiving growing interest as some of the unicorns such as Spotify in 2018 and Slack in 2019 opted for direct listing to be listed on the New York Stock Exchange (NYSE). More recently on September 30, 2020, data analytics firm Palantir also got listed on the NYSE via direct listing. Earlier on August 26, 2020, the US SEC approved a change in the NYSE rule that would allow primary offering in direct listing,1) while Nasdaq is also working on a similar rule change. This article tries to explore the process of direct listing on the NYSE and the differences between direct listing and IPO, and to discuss why a firm chooses direct listing instead of conventional IPO for going public. Based on the findings, the content and the implications of the NYSE’s modified rule will be discussed. 


Characteristics and implications of direct listing

Direct listing refers to listing a firm’s shares (existing shares) on a stock exchange for trades without primary offering, while in an IPO deal a firm issues new shares and sells them to investors. Because no share is newly issued, no capital is raised, which makes up the largest difference between the two. The gist is that direct listing provides liquidity to the existing shares and therefore helps existing shareholders to exit their investment more easily.
 
In an IPO deal where new shares are issued and sold to investors, the issuer firm should go through a set of procedures—filing the registration statement (S-1) with the relevant authority, a roadshow to market new shares, book building, setting the offer price, and allotting shares to institutional investors participating in book building. In every procedure, investment banks play a crucial role of working on every detail, underwriting new shares, and selling them to institutional investors. By contrast, direct listing has a simpler process without issuing and selling new shares, although it requires the same level of information disclosure as IPOs such as the registration statement. That reduces the role of investment banks in a direct listing deal from an underwriter to a financial advisor who offers advice and files the registration statement.2) 

Unlike an IPO deal where the offer price is determined by institutional investors via book building, the “reference price” in a direct listing on the NYSE is set via consultation between the NYSE and the investment banks acting as a financial advisor. Based on the reference price, the NYSE’s designated market maker determines the opening price via an opening auction on the first trading day.3)

As compared with IPOs, direct listing has benefits such as a simpler process, a shorter period of time without a waiting period after the filing of the registration statement, a lower financing cost due to lower fees paid to investment banks, no share dilution from additional stock issuance, no lockup period allowing the existing shareholders to sell their shares right after the listing, etc. On the other hand, there are some critical drawbacks as well. Among others, direct listing raises no additional capital. Furthermore, it comes without any price stabilization measure, a function usually provided after listing by an underwriter in an IPO deal. This could make the price volatility of directly listed stocks much higher than IPO stocks, which could damage investors. Also, there’s also a possibility where a firm’s existing shareholders try to pursue their private interest by selling their own shares without raising additional capital for the firms. Also pointed as a drawback is that direct listing is useful for only few companies that barely need financing and investment banks’ marketing support.  

It is still unclear whether companies choose direct listing over IPO due to the aforementioned benefits despite some critical drawbacks or not.4) Stewart Butterfield, CEO of Slack that chose direct listing to go public on the NYSE, said going for direct listing instead of IPO did not save much cost and the cost was not a primary reason behind the decision.5) Rather than cost saving, dissatisfaction about IPO’s intransparent book building process between investment banks and institutional investors could have been the major incentive for firms to choose direct listing.6) It is well known that underpricing exists in IPO. Firms view this as a structure that is designed to provide almost certain returns to institutional investors who in book building purchase newly issued shares at discount.7) In other words, it’s possible to infer that firms expect their value to be more accurately reflected in the opening price via direct listing that does away with the process where the lead manager underwrites new shares and allots them to institutional investors.

On the Korea Exchange, direct listing has been chosen by an extremely limited number of firms thus far, including Kenny Commerce in February 1991, Korea Exchange Bank in April 1994, and KT in December 1998. It appears that the decisions to go public via direct listing were made under somewhat exceptional policy considerations such as the government selling its shares as part of its privatization drive, etc. 


NYSE rule changes

In 2019, the NYSE submitted to the SEC a revised direct listing rule that allows companies to issue and sell new shares for raising capital. The revision was finally approved by the SEC on August 26, 2020, under which a firm that wants to issue new shares and sell them for raising capital via direct listing can sell its shares only once at the opening price in the opening auction on the first trading day.8) In the opening auction, firms can sell either new shares only, or new and existing shares.9) It means that direct listing leaves out the whole IPO process, in which the offer price of new shares is determined before they begin trading on the exchange via book building, and investment banks underwrite those new shares to allot them to institutional investors.

The core difference between IPO and direct listing lies in how the offer price is determined: While the offer price is set before trading in an IPO, in direct trading it is determined in the opening action. Institutional investors participating in book building in IPO buy shares at the offer price, which is different from the opening price on the first trading day. On the other hand, the opening price equals to the offer price (the selling price) of new shares in direct listing, which makes the size of capital raised be the opening price multiplied by the number of new shares. The NYSE (2020) argues that firm value is more accurately reflected if the price is determined by an auction participated by all investors, not just institutional investors only.10)
 
Not all firms pursuing direct listing on the NYSE are allowed to issue new shares. Primary offering in direct listing is possible for only those whose new shares are worth over $100 million, or who sell over $250 million worth of new and existing shares combined. They also should meet the NYSE’s listing requirements and abide by other procedures such as the filing of the registration statement as well.

 
Implications

Direct listing has not taken hold widely because without primary offering it can be used by only those who have no financing need. However, if finalized, the NYSE’s rule change allowing for primary direct listing will eliminate the critical drawback of direct listing, encouraging more firms to opt for direct listing. As a significant alternative to IPO, direct listing could broaden the choice of companies that are planning to go public. 

Notably, a significant increase in the number of firms choosing direct listing could primarily impact investment banks. More concretely, such a change could contract the demand for underwriting business that is the backbone of investment banking. This also means a fall in underwriting fee revenues. In another aspect, an increase in direct listing also implies the intensified competition between investment banks and stock exchanges because direct listing lets a stock exchange, not investment banks, set the reference price. Investment banks acting as a lead manager in the whole IPO process play some critical economic functions: They not only produce information on the issuer and provide it to investors to reduce information asymmetry between firms and investors, but also forecast investor demand for proper price discovery. What’s important for the future of direct listing is how well firms and stock exchanges can fill up those economic functions.

At the same time, direct listing will force institutional investors to face a new environment where they—instead of being allotted new shares at the offer price before listing via IPO—participate in the opening auction to purchase shares at the opening price as other investors do.
 
For now, it is hard to predict how direct listing will take hold and what changes it will bring going forward because, as mentioned above, there have been only few cases of direct listing and the institutional framework for primary direct listing has just been in place. Although Korea has no case of direct listing in the 2000s, it’s important to devote ceaseless effort to improvement that is to provide more benefits to investors and firms seeking to go public, while closely keeping an eye on the developments in overseas markets.
 
1) SEC, 2020. 8. 26, Order Approving a Proposed Rule Change, as Modified by Amendment No.2, to Amend Chapter One of the Listed Company Manual to Modify the Provision Relating to Direct Listings, Release No.34-89684.
     On August 31, 2020, the SEC stayed the approval of the revised rule as the Council of Institutional Investors said it would submit a petition.
2) Nickerson, B.J., 2019, The underlying underwriter: An analysis of the Spotify direct listing, The University of Chicago Law Review, 985-1025.
     Investopedia, 2020, IPO vs direct listing: What’s the difference?. 
     Economist, August 22, 2020, Silicon Valley v Wall Street.
3) NYSE, 2020, Choose your path to public: Direct listings with a capital raise, only on the NYSE.
4) There are only very few studies on the motive behind a firm’s decision to choose direct listing presumably because the number of direct listing cases is too small to construct a significant sample. 
5) 1BusinessWorld, June 20, 2019, Slack CEO explains why the company didn’t go public with a traditional IPO.
6) Slack’s CEO describes IPO as a “closed-door process of raising capital from private investors”.
7) Economist, October 25, 2019, If you see Sid, tell him.
8) Such an arrangement is called “primary direct listing” as it includes direct listing and the issuance of new shares.
9) NYSE (2020)
10) The problems inherent in primary direct listing are still unclear. The CII submitted to the SEC a petition to oppose the NYSE’s approval of the rule change on September 8, 2020. In the petition, the council argued that traceability concerns with regard to the shares purchased by investors in the opening auctions could give rise to investor protection issues.
       CII, 2020. 9. 8, Petition for Review of an Order, Issued by Delegated Authority, and Brief in Opposition to Motion to Lift the Automatic Stay.