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8 November, 2019
How the recent changes will impact restructurings of listed companies
As part of its efforts to combat shell related activities, the Hong Kong Stock Exchange (Stock Exchange) has issued a raft of amendments to its Listing Rules and issued numerous related guidance letters. The latest amendments, which took effect on 1 October 2019 relate to backdoor listings and continuing listing criteria. Other amendments include changes to the rules governing delisting of companies from the Stock Exchange and changes to the rules relating to capital raisings, which took effect in 2018. Additionally, the Stock Exchange has ratcheted up its scrutiny of suitability for listing of new listing applicants. These changes primarily target shell related activities. However, these changes also have an impact on other restructurings, including those arising from insolvency of listed companies.
In this briefing we share some observations on some of the changes and their impact on restructurings of insolvent listed companies. This briefing does not address all of the changes to the Listing Rules but rather focuses on a few specific items that would particularly impact such restructurings.
The Delisting Regime
Since August 2018, the previous 3-stage delisting process under Practice Note 17 to the Listing Rules has been replaced by a simpler approach whereby the Stock Exchange may delist a company that has been suspended for 18 months.
Previously, a resumption proposal had to be submitted to the Stock Exchange prior to the expiry of the third delisting stage (being 18 months after the commencement of the first stage). However, typically a suspended company would take much longer (between 3 and 5 years has been common) to actually implement the proposal and resume trading in its shares. At the end of the third delisting stage, the threat of delisting can be staved off merely with the submission of the resumption proposal. Now, if a company has not resumed trading within 18 months of first being suspended, the threat of delisting is very much live.
Where a suspension is triggered by insufficiency of operations or issues surrounding suitability for listing, the Stock Exchange may write to a listed issuer requiring them to resolve the underlying issues within a certain time period, failing which the Stock Exchange may delist the company. The time given may be less than 18 months (although for issues surrounding sufficiency of operations, 18 months would commonly be given).
The changes have the effect of significantly reducing the amount of time available to a listed issuer to implement the resumption proposal and the transactions contemplated. While it appears that the changes may result in an increase in the number of companies being delisted, the addition of a definitive deadline may also have the effect of pushing companies to act faster to implement the resumption proposal and the transactions contemplated, so that the company’s listing status (which is often a significant asset in itself) can be preserved.
Sufficiency of operations
Listing Rule 13.24 requires listed companies to maintain sufficient assets and operations to justify continued listing. Failure to maintain such sufficient assets and operations is a ground for suspension and delisting.
With effect from 1 October 2019, Listing Rule 13.24 requires sufficiency of assets and operations (previously sufficiency of assets or operations would satisfy the requirement). Listing Rule 13.24 now explicitly requires listed issuers to have a business that has substance and which is viable and sustainable. The assessment is made by reference to the particular nature, business model, mode and operating scale and history, source of funding, size and diversity of customer base and internal control systems and would take into account norms and standards of the relevant industry. Circumstances that may lead to concerns from the Stock Exchange in this regard include financial difficulties which seriously impair a listed issuer’s ability to continue its business, insolvency (including appointment of liquidators or provisional liquidators), loss of major operating subsidiaries, reliance on a limited number or source of customers, businesses that are asset-light and/or have low barriers of entry and questionable basis for revenue generated.
The onset of insolvency remains a clear ground for a listed issuer to be regarded as failing to meet Listing Rule 13.24. Now, a significant scaling down of operations or significant disposals of assets or businesses may itself, even without insolvency, be grounds for a listed issuer to be regarded as failing to meet Listing Rule 13.24. Given the imminent threat of suspension and delisting, in circumstances where listed issuers start to significantly scale down their operations, they should pre-emptively think about any restructuring that may be required to maintain a sustainable and viable business of substance and sufficient assets to support such business.
RTOs
Typically, for a restructuring transaction to be of sufficient value to warrant a resumption of trading in the company’s shares, the transaction would likely be classified as a very substantial acquisition of the listed issuer.
In most cases it would also involve a change of control of the listed issuer. In such cases the transaction would be a reverse takeover (RTO) and the Stock Exchange will treat the listed issuer as a new listing applicant when vetting the transaction.
However, where the transaction qualifies as an ‘extreme transaction’, the Stock Exchange will not treat the listed issuer as a new listing applicant. The transaction will qualify as an ‘extreme transaction’ if
- the acquisition targets satisfy the suitability requirement under Listing Rule 8.04 and the financial eligibility for listing criteria under Listing Rule 8.05;
- the enlarged group meets all the new listing requirements in Chapter 8 of the Listing Rules; and
- it can be demonstrated to the Stock Exchange that the transaction is not an attempt to circumvent the listing requirements for the acquisition targets.
To be satisfied that the transaction is not an attempt to circumvent listing requirement for the acquisition targets, the Stock Exchange would expect that:
- the issuer has been operating a principal business with substantial size which will continue after the transaction;
- the issuer has been under the control or de facto control of the same person or group of persons for more than 36 months; and
- the transaction would not result in a change of control or de facto control.
Assessment of suitability
In an attempt to prevent companies that may be vulnerable to shell-related activities from being listed in the first place, the Stock Exchange has recently ratcheted up its scrutiny of suitability for listing of new listing applicants. In most restructuring of insolvent listed companies, the acquisition targets and enlarged group would be assessed for suitability for listing.
The Stock Exchange is increasingly asking demanding questions surrounding a listing applicant’s commercial and business rationale for listing. An insolvent listed company, the potential ‘white knight’ investor and/or any provisional liquidators trying to implement a restructuring of a insolvency listed company will need to be able to demonstrate a commercial rationale for listing that is consistent with the history, prospects and circumstances of the acquisition targets. Disclosures made in announcements and listing documents should clearly demonstrate such rationale.
Takeaway points
The recent changes to the Listing Rules are primarily aimed at combating shell related activities. However the changes will inevitably also have an impact on restructuring of listed companies because such restructurings typically involve RTO transactions and an intervening period of suspension of trading.
We anticipate that the changes may motivate listed issuers in financial distress (and their creditors) to think about potential restructurings at an earlier stage, even before the commencement of formal insolvency proceedings. The threat of a loss of a significant asset, the listing status, should hopefully push companies and other interested stakeholders to act faster to propose and implement solutions so that operations and trading in the shares of the company can be resumed.
For further information, please contact:
Paul Westover, Partner, Stephenson Harwood
paul.westover@shlegal.com
