Hong Kong – Exchange To Tighten Its Grip On Highly Dilutive Capital Raising.

 

2 November, 2017

 

 

Hong Kong Exchanges and Clearing Limited has published the Consultation Paper on Capital Raisings by Listed Issuers , revealing the long-anticipated tightening of regulations on highly dilutive capital raising structures which corporate governance advocates have been flagging concerns. It is interesting to note that the Hong Kong regulators do not consider putting such structures to the vote of independent minority shareholders, or withholding the granting of whitewash waivers in cases where share issuances would result in a change of control, as effective methods to address their concerns. 

 

Rather, they propose to impose a ban on highly dilutive capital raisings, subject to limited exceptions. 

 

The Hong Kong Stock Exchange has said that this consultation paper forms part of the Exchange’s holistic review of its regulations on backdoor listings, continuing listing criteria and capital raising activities. Further consultation papers will be published on backdoor listings and continuing listing criteria in due course.

 

We highlight below several key points relating to the proposed new regulations. 

 

Ban on capital raisings which are considered highly dilutive, and exceptions

 

The consultation paper discusses two types of capital raising that the Exchange considers problematic, being highly dilutive pre-emptive offers and highly dilutive specific mandate placings. 

 

The Exchange proposes to ban pre-emptive offers that would result in a value dilution of 25% or more (“material value dilution ban ”), calculated by reference to the size of the offer and the price discount. 

 

By way of an example, a listed company proposes to raise funds through a 2:1 rights issue at a market price discount of 50%. The value dilution percentage will be 16.667% (1/3 x 50%). If it increases the discount to 75%, the dilution percentage will increase to 25%. This means a one-off 2:1 rights issue offer at a 74.99% price discount is still fine under the proposal. Issuers tend to avoid structuring a preemptive offer at an offer ratio greater than 2:1, because that would trigger the requirement to seek minority shareholder approval under the Listing Rules.

 

Not only would the material value dilution ban apply to pre-emptive offers, the Exchange also proposes to catch (i) specific mandate placings (i.e., placings conducted with specific ad hoc shareholder approvals) and (ii) pre-emptive offers and specific mandate placings that would, either individually or combined within a rolling 12-month period, result in a cumulative value dilution of 25% or more. The Exchange has said that if an issuer can demonstrate to its satisfaction that there are exceptional circumstances, such as where the issuer is in financial difficulty, the material value dilution ban may be dispensed with.

 

Observations

 

• The discussions in the consultation paper concentrate on pre-emptive “share” offers, but presumably the proposed rule changes would also apply to convertible securities. However, it is unclear whether a pre-emptive non-voting, non-convertible securities offer, such as preference shares, are intended to be caught.
• The Exchange should clarify whether the new rules will only apply to placings for cash consideration. Based on the draft rules contained in Appendix I of the consultation paper, it is unclear how the new rules would affect the ability of issuers to structure transactions where the consideration for acquisitions would be settled by the issuance of shares or convertible securities.
• Issue of securities under a general mandate has generally been left untouched, except for the proposals regarding placing of warrants / convertible securities (see further below).

 

Other proposed rule changes to pre-emptive offers 

 

Pre-emptive offers:

 

• Remove the requirement that all rights issues and open offers must be fully underwritten.
• If an offer is to be underwritten, only independent Type 1 licensed persons, or controlling or substantial shareholders of the issuer may be appointed as underwriters.
• All offers must include either (i) excess application arrangements or (ii) compensatory arrangements to dispose of unsubscribed securities and pay any premium to the non-subscribing members. If the controlling or substantial shareholders will be appointed as underwriters, the issuers must adopt compensatory arrangements.
• If an issuer adopts excess application arrangements, the directors must ignore any excess applications made by the controlling shareholders and their associates in excess of the offer size minus their pro-rata entitlements (“excess application restriction”).
• Remove the connected transaction exemption for underwriting and sub-underwriting of offers by connected persons.

 

Open offers:

 

• All open offers to be made subject to independent minority shareholder approvals unless the offer will be made under the authority of a general mandate. This means controlling shareholders (or where there are no controlling shareholders, directors and chief executive) cannot vote in favour of the resolution and the issuer needs to appoint an independent financial adviser to opine on the terms of the offer.

 

Observations

 

• We encourage further examination (with market statistics) of whether the proposed requirement that underwriters must be Type 1 licensed persons would really bring to bear the perceived benefits of greater discipline in the pricing and allocation of the offer.
• “Controlling shareholders” is defined in the Listing Rules. The Exchange has also published guidance letter GL89-16 which serves to assist the interpretation of such definition. The Exchange should clarify on how the proposed rule changes may impact the application of GL89-16, in particular, the excess application restriction and controlling shareholders being appointed as underwriters.
• If the policy rationale in introducing the excess application restriction is to remove the perceived advantage available to controlling shareholders when making an excess application through their knowledge of the level of subscription, it is unclear why the restriction should only apply to controlling shareholders and not all connected persons. If it is intended that controlling shareholders and their associates should be inhibited from squeezing out other shareholders’ excess applications if the offer is under-subscribed, shouldn’t the same restriction apply to all shareholders for fair and equal treatment of all shareholders?

 

Placing of warrants under the authority of a general mandate

 

• Codify the Exchange’s current practice that issuers may not issue warrants or options for cash consideration under the authority of the general mandate.

 

Observations

 

• The discussions in the consultation paper focus on the placing of warrants or options for cash by themselves (i.e. not part of a wider capital raising initiative). It is unclear whether a bond or loan offering that is combined with a placing of warrants or equivalent structures would be caught by the proposed rules. 
• Where the placing of warrants takes place as part of a loan/bond issue, there are a couple of differences worth highlighting: (i) issuers would receive significant funds immediately upon issue of the loan/bond and warrants (which contrasts with the typical nominal subscription proceeds received on a placing of warrants alone) and (ii) the rate of interest on the loan/bond would be expected to be lower than that for a straight bond issue by the same issuer and on the same terms.
• The Exchange should take into account the differences highlighted above when considering whether the proposed changes for placing of warrants should apply to these types of loan/bond plus warrant structures. The differences do bring to light the question of whether these types of structures should be categorised separately from the types of placing of warrants discussed in the consultation paper and it may be more appropriate to classify these types of loan/bond plus warrant structures in the same category as the convertible securities discussed below.

 

Placing of convertible securities under the authority of a general mandate

 

• Allow issuers to issue convertible securities under the general mandate only if the initial conversion price is at least, or higher than, the benchmark market price of the underlying shares at the time of placing. If the proposal does not get adopted, the Exchange will nevertheless amend the general mandate rules to clarify that the 20% price discount limit also applies to the initial conversion price.

 

Observations

 

• The proposed rules appear unduly onerous on convertible securities when compared to equivalent requirements on shares. If the proposed rules are implemented, issuers will not be able to issue convertible securities under general mandate even where the 20% price discount limit is adhered to. However, the issue of new shares under the same circumstances would be acceptable.
• The Exchange should further consider whether it would be more appropriate to just amend the general mandate rules to clarify that the 20% price discount limit also applies to the initial conversion price. This would be a fairer outcome and still address the Exchange’s concerns. This observation applies equally to the loan/bond plus warrant structures discussed above. 

 

Other proposed changes contained in the capital raisings consultation paper

 

• The use of proceeds from all equity fundraisings must be disclosed in both the interim and annual reports.
• The theoretical share price (after adjustment) of the shares of an issuer who proposes a share subdivision or bonus issue of shares must be higher than a minimum price (proposed to be HK$1 or HK$0.50) for a period of six months before the announcement of the subdivision or bonus issue.

 

Tougher rules regarding the delisting of issuers with prolonged suspensions

 

The Exchange has issued another consultation paper seeking comments on proposals which will give the Exchange more power and a robust process to delist an issuer with prolonged suspensions.

 

• The Exchange will have additional powers to cancel the listing of an issuer with a prescribed period of continuous suspension. The Exchange is seeking opinions on whether the prescribed period should be 12, 18 or 24 months.
• The Listing Committee will have the discretion to extend the prescribed period in exceptional circumstances, for example, where an issuer has substantially implemented the resumption proposal but needs extra time to tie up loose ends.
• Should the proposals be adopted, the prescribed period would apply to issuers which securities are already in continuous suspension. The deemed commencement date of the prescribed period would depend on how long the relevant securities have been suspended from trading:
  • If it is shorter than 12 months: the prescribed period would commence on the effective date.
  • If it is 12 months or longer: the prescribed period would be regarded as having commenced 12 months before the effective date if the prescribed period is to be 24 months; if the prescribed period is to be 12 or 18 months, it would be regarded as having commenced 6 months before the effective date.

 

The Exchange envisages that, should the proposals relating to delisting be adopted, it would normally cancel the listing of an issuer under the continuous suspension limb as it allows a reasonable period for issuers to take remedial actions and resume trading. This seems to suggest that the Exchange would in practice exercise its new power and existing delisting power on a mutually exclusive basis, that is, if it has invoked a cancellation of listing process due to a continued suspension, it would not delist an issuer for other offending issues, and vice versa.

 

 

For further information, please contact:

 

Andrew Malcolm, Partner, Linklaters

andrew.malcolm@linklaters.com