The European Securities and Markets Authority has warned about the prospectus disclosure and investor protection issues raised by special purpose acquisition companies and about risks arising from payment for order flow.
ESMA, the European Union’s securities markets regulator, said in a statement that SPAC transactions may not be appropriate investments for all investors due to risks relating to dilution, conflicts of interests in relation to sponsors’ incentives and the uncertainty as to the identification and evaluation of the target company. SPACs are shell companies that are admitted to trading on a trading venue with the intention to acquire a business and are often referred to as blank check companies.
In addition, ESMA emphasised the importance of the proper application of the MiFID II product governance rules and their role in ensuring investor protection.
Anneli Tuominen, Interim Chair of ESMA, said in a statement: “There has been a significant rise in SPAC activity in EU capital markets this year, and with this comes growing interest from investors. Therefore, it is essential that investors are provided with the information necessary to understand the structure of SPAC transactions before making any investment decisions.”
This week the US Securities and Exchange Commission announced charges against Stable Road, a SPAC, and its merger target, Momentus, for misleading investors.
SEC Chair Gary Gensler said in a statement: “This case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors. The fact that Momentus lied to Stable Road does not absolve Stable Road of its failure to undertake adequate due diligence to protect shareholders. Today’s actions will prevent the wrongdoers from benefitting at the expense of investors and help to better align the incentives of parties to a SPAC transaction with those of investors relying on truthful information to make investment decisions.”
Payment for order flow
ESMA also reminded its regulated firms that the receipt of payment for order flow (PFOF) raises significant investor protection concerns and highlighted key MiFID II obligations aimed at ensuring firms act in their clients’ best interest when executing their orders.
PFOF is the practice of brokers receiving payments from third parties for directing client order flow to them as execution venues. PFOF causes a clear conflict of interest between the firm and its clients, because it incentivises the firm to choose the third party offering the highest payment, rather than the best possible outcome for its clients when executing their orders according to ESMA.
The regulator said: “It is unlikely that the receipt of PFOF by firms from third parties would be compatible with MiFID II. In addition, ESMA also addresses specific concerns regarding certain practices by zero-commission brokers.”
The US SEC is also reviewing payment for order flow. In the US retail trades are not executed on exchanges but most are sold by retail brokers to market makers under PFOF agreements, allowing the brokers to offer no-commission trading to retail. The market makers internalize the flow and capture the majority of the spread, in return for offering retail investors a slight improvement on the exchange price.
Gensler said in a speech last month that he has asked staff to consider the impact that technology has made in fixed income and equity markets, including payment for order flow. He said 47% of equity trading volume is not displayed on the US lit markets.
“It’s executed by alternative trading systems, which include dark pools, and by off-exchange wholesalers,” Gensler added. “Thus, significant trading interest on these platforms is not necessarily being reflected in the commonly cited National Best Bid and Offer quote. I’ve asked staff to consider whether this equity market structure, as currently composed, best promotes efficiency and competition.”
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