The ASX introduced Guidance Note 19, dealing with performance shares, on 28 April 2014.
For tax and other reasons, ‘performance shares’ (as opposed to performance rights and options) are not often used in LTI and other equity plans. This situation is likely to continue now that ASX has highlighted the additional Listing Rules issues associated with the use of performance shares. However, the fact that Guidance Note 19 exists indicates that ASX has concerns over the potential for performance shares to be used for “funny business”. Be aware.
According to ASX, a performance share is a share that has limited rights but which converts into a given number of ordinary shares if a performance condition is met. Performance shares raise more Listing Rules issues than performance rights or performance options because they involve an initial issue of shares that might otherwise confer rights as a shareholder. In contrast, a performance right is a contractual right to receive a given number of ordinary shares if a nominated performance milestone is achieved. A performance option is an option to subscribe for or purchase ordinary shares that can be exercised if a performance condition is achieved.
It is a struggle to identify any circumstances in which the use of ‘performance shares’ has advantages over performance rights providing ordinary shares in executive or director remuneration, particularly as they convert to ordinary shares when the performance conditions are satisfied.
While ASX Guidance Note 19 states that performance shares “…can be especially useful for cash-strapped start-up ventures that have no other practical means of remunerating key individuals for the substantial efforts required to get the venture up and running profitably”, so can share rights and options.
The relevant Listing Rules are:
Listing Rule 6.1, which provides that the terms that apply to each class of equity securities of a listed entity must, in ASX’s opinion, be appropriate and equitable, regardless of whether the securities are quoted or unquoted.
Listing Rule 12.5, which imposes an ongoing obligation on a listed entity to have a structure that is appropriate for a listed entity (Listing Rule 1.1 condition 1 similarly requires an entity seeking admission to the official list as an ASX Listing to have a structure that is appropriate for a listed entity.)
Some of the key points made by ASX that could impact the use of performance shares include:
- In assessing whether Listing Rules 6.1, 12.5 and 1.1 condition 1 are met, ASX has regard to the principles on which the Listing Rules are based, as set out in the introduction to the Listing Rules. One of these principles is that securities “should have rights and obligations attaching to them that are fair to new and existing security holders”.
- Issues of performance shares must comply with Listing Rule 7.1, which (subject to certain exceptions) requires security holder approval for issues of securities over a 12-month period in excess of 15% of an entity’s ordinary capital.
- Issues of performance shares must also comply with Listing Rule 10.11, which (subject to certain exceptions) requires security holders to approve issues of securities to a related party or anyone whose relationship with the entity or a related party is, in ASX’s opinion, such that security holder approval should be obtained.
In practice, ASX will generally require the issue of performance shares to be approved by security holders in all cases, although that approval can be bundled with any approvals required for the purposes of Listing Rules 7.1 and 10.11.
ASX strongly recommends that:
- a listed entity which is proposing to issue performance shares apply to ASX for in-principle advice that the terms of the performance shares will satisfy Listing Rules 6.1 and 12.5 before it issues the shares or enters into any legally binding agreement to do so.
- an applicant for listing which has already issued, or which is proposing to issue, performance shares prior to listing, apply to ASX for in-principle advice that the terms of the performance shares will satisfy Listing Rule 1.1 condition 1.
The onus is on the applicant for in-principle advice to satisfy ASX that the terms of the performance shares are appropriate and equitable and therefore should be acceptable to ASX (Guidance Note 17 Waivers and In- Principle Advice contains further guidance on applications for in-principle advice).
The ASX is unlikely to consider that a performance share meets the requirements of Listing Rules 6.1 and 12.5 or Listing Rule 1.1 condition 1 if performance shares:
- are transferrable (or quoted on ASX or any other exchange)
- confer any right to vote, except as otherwise required by law
- confer any entitlement to a dividend, whether fixed or at the discretion of the directors
- confer any right to a return of capital, whether in a winding up, upon a reduction of capital or otherwise
- confer any right to participate in the surplus profit or assets of the entity upon a winding up
- confer any right to participate in new issues of securities such as bonus issues or entitlement issues
Performance shares can also have ‘change in control’ provisions, as long as in aggregate they do not convert into more than 10% of the issued ordinary capital of the entity at the time of the conversion.
‘Anti dilution’ provisions that adjust the number of ordinary shares into which the performance shares convert in the event of a share split or consolidation, or a bonus or entitlement issue or other capital reconstruction, are also acceptable.
Though it is unlikely to be an issue for an incentive plan, it is worth noting that ASX generally will not permit a listed entity to issue performance shares if the number of ordinary shares into which the performance shares will convert if the applicable milestone is achieved (plus the number of ordinary shares that will be issued if any options or convertible securities are all converted) is greater than the number of ordinary shares in the entity on the date of issue.
The following conditions must be satisfied for ASX to regard the performance conditions attached to a performance share as ‘appropriate and equitable’:
- there must be an appropriate link between the performance milestone and the transaction or purpose for which the performance share is to be issued;
- the performance milestone must be clearly articulated by reference to objective criteria so that investors and analysts can readily understand, and have reasonable certainty as to, the circumstances in which the performance milestone will be taken to have been met;
- the number of ordinary shares into which the performance share will convert if the relevant milestone is achieved must be fixed or calculated by reference to a formula that delivers a fixed outcome so that investors and analysts can readily understand, and have reasonable certainty as to, the impact on the entity’s capital structure if the milestone is achieved (ASX has rejected a performance condition under which the number of ordinary shares into which a performance share converted was calculated by reference to the market price of the ordinary shares at the time of conversion, without any floor on the market price for these purposes); and
- the performance share must have an expiry date by which the relevant milestone is to be achieved and, if the milestone is not achieved by that date, either the performance share must be cancelled or bought back for no or nominal consideration only or else the total number of performance shares on issue must convert into a nominal amount of ordinary shares only (ASX does not usually permit performance shares with an expiry date longer than 5 years from the date of issue)
Service conditions in order to retain the services of a director are not considered appropriate (because this is not a meaningful performance hurdle). This guideline would seem to be another disincentive for new listings from high technology companies and explorers that would prefer to provide stock in lieu of cash salary. Also considered inappropriate are performance shares that convert into ordinary shares if the director is removed from office before a nominated date, primarily because it is potentially a deterrent to shareholders exercising their right to remove a director from office and potentially rewards the director for poor performance.
ASX does not object to performance conditions related to the market price of an entity’s securities in appropriate cases, but recommends that a security price hurdle should be based on the volume weighted average market price over a reasonable period (e.g. 20 consecutive trading days over which the entity’s securities have actually traded).
Unless the intention to undertake the issue was clearly disclosed in the entity’s listing prospectus or PDS, ASX will generally consider it appropriate and equitable, and therefore impose a condition, that a listed entity obtain the approval of the holders of its ordinary shares to the issue of the performance shares and that a voting exclusion statement apply in relation to any person who may participate in the issue.
In all cases ASX will also generally consider it appropriate and equitable, and therefore impose a condition, that the terms of the performance shares, including the applicable milestone that has to be satisfied before the performance shares may be converted into ordinary shares, must not be changed without the prior approval of the holders of the entity’s ordinary shares and that a voting exclusion statement apply in relation to any holder of the performance shares.
Finally, an entity that has performance shares on issue should make appropriate disclosures.
- Immediately upon satisfaction of the performance condition that triggers conversion into ordinary shares
- If the condition is not satisfied by the expiry date
- In the notes to the statement of financial position in its annual report, preliminary final report (Appendix 4E) and half-year report and also in any Appendix 5B quarterly report it may give to ASX.
ASX Guidance Note 19 can be seen HERE.© Guerdon Associates 2023 Back to all articles