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2 October, 2017
The Hong Kong Stock Exchange has issued two consultation papers as a first step in upgrading Hong Kong’s regulatory framework. These consultation exercises follow a broad review by the Stock Exchange and the Securities and Futures Commission (SFC) on the regulation of listed companies in Hong Kong. The first consultation paper proposes amendments to the Listing Rules relating to capital raisings (Capital Raising Consultation). This follows recent regulatory concerns about transactions by certain listed companies where the Stock Exchange and the SFC have questioned whether these were fair to minority shareholders or may adversely affect the orderly market for securities trading. In particular, the proposals seek to address concerns about questionable large scale, deeply discounted share offerings which are potentially unfair to minority shareholders or mask other manipulative conduct.
The second consultation paper proposes amendments to the delisting framework, in particular to deal with companies which have been suspended for a prolonged period of time (Delisting Consultation).
The Stock Exchange has indicated that further consultations will follow as the regulators take steps to maintain Hong Kong’s market quality and reputation. Future consultation exercises will focus on other regulatory hot topics including backdoor listings and ongoing listing criteria.
Key proposals in the Capital Raising Consultation
Restrictions on rights issues, open offers and specific mandate placings – The Stock Exchange is proposing to restrict rights issues, open offers and placings under a specific mandate which would result in a value dilution of 25% or more (although the consultation paper invites comments on whether a different percentage should be used). Value dilution is to be calculated with reference to (i) the offer ratio and (ii) the discount the offer price is to the market price at the time of the offer announcement (being the higher of the closing price on the date of the agreement and the prior five day average trading price). In calculating the value discount, an issuer must aggregate any other rights issues, open offers or placings under a specific mandate within the previous 12 months. The Stock Exchange may be prepared to waive the restriction where there are exceptional circumstances, for instance if the issue is part of a rescue proposal for a company in financial difficulties.
Rule amendments for rights issues and open offers – The Stock Exchange is also proposing a number of changes to the regime for rights issues and open offers to ensure fair and equal treatment for all shareholders. Proposed amendments include:
Requiring minority shareholder approval (excluding controlling shareholders, or where there are none, directors or chief executive) for all open offers, reflecting that open offers provide less protection for shareholders compared to rights issues.
An independent financial adviser’s opinion on the offer will be required.
Rights issues and open offers will no longer need to be fully underwritten. This will give greater flexibility to issuers where the underwriting costs associated with a rights issue or open offer are prohibitively high. The issuer will need to disclose the risks to shareholders and the allocation of funds if the offer is undersubscribed.
Where a rights issue or open offer is underwritten, the underwriters will need to be licensed under the Securities and Futures Ordinance and independent from the issuer and its connected persons. This will help ensure that there are no conflicts of interest in structuring such transactions. The Capital Raising Consultation also proposes that controlling or substantial shareholders can still act as underwriters provided arrangements are made to compensate non-subscribing shareholders. However, it is proposed that the current exemption from the connected transactions regime for a connected person underwriting an open offer or rights issue be removed. Therefore, where a connected person is to act as underwriter or sub-underwriter, independent shareholder approval will be required, together with an independent financial advisers’ opinion on the underwriting agreement.
Upgrading the existing optional arrangements for the disposal of unsubscribed shares in a rights issue or open offer to compulsory requirements. The consultation paper proposes that an issuer must adopt either excess application arrangements or compensatory arrangements, and proposes limits on the excess applications made by controlling shareholders and their associates. These proposals are intended to eliminate the scope for controlling shareholders to take advantage of their privileged situation and inside knowledge to manipulate the excess application process to squeeze out minority shareholders.
Rule amendments for placing of warrants and convertible securities under general mandate – The Capital Raising Consultation proposes that placings of warrants and options for cash consideration will require a specific mandate and will no longer be able to be issued under a general mandate. Additionally, an issuer will only be able to conduct a placing of convertible securities using the general mandate where the initial conversion price is no less than the benchmarked/market price of the underlying shares at the time of the placing. Where there is a greater price discount, a specific mandate will be required.
Mandatory disclosure of use of proceeds in interim and annual reports – The Stock Exchange is proposing to extend disclosure of use of proceeds in a company’s interim and annual reports to all equity fundraising with prescribed information required, including a detailed breakdown and description of the use of proceeds (or proposed use where any amount is unutilised) and whether proceeds have been used in accordance with the originally announced intentions.
Restrictions on share subdivisions and bonus issues – The Capital Raising Consultation proposes to restrict share subdivisions and bonus issues if, following the adjustment, the theoretical share price would be less than either HK$1 or HK$0.50. This is to prevent companies from splitting shares to a level where the low share price is more susceptible to price volatility.
Key proposals in the Delisting Consultation
The Delisting Consultation proposes adding delisting criteria to facilitate the delisting of companies that have been suspended for a prolonged period of time. The Stock Exchange is inviting comments on the appropriate period, being 12, 18 or 24 months for Main Board and 6 or 12 months for GEM listed companies. Additionally, for Main Board issuers, the delisting process will be enhanced to cover all existing delisting criteria under Rule 6.01 of the Listing Rules and provide a clear and consistent framework for companies facing delisting. The Stock Exchange is also proposing some amendments to the trading suspension rules aimed at keeping suspensions as short as possible. For example, the Stock Exchange proposes to delete the specific requirement to suspend trading upon entering into a share or major (or above) transaction and rely on the general requirements for trading halts in the context of inside information disclosure.
Our observations
These consultation papers appear to be part of a general tightening of regulation in Hong Kong driven by recent regulatory concerns about questionable market conduct by certain listed companies and a desire to maintain the quality and integrity of the Hong Kong market. The Stock Exchange has previously issued listing decisions and guidance letters to address immediate concerns surrounding certain issues covered in the consultation papers. For example, LD102-2016 dealt with highly dilutive pre-emptive offers and LD103-2016 dealt with share subdivisions and share consolidations. However, a full review of the issues with proposed rule changes is a welcome step to provide greater clarity to the regulatory position in Hong Kong and certainty for listed companies seeking to structure transactions.
For further information, please contact:
Matthew Emsley, Partner, Herbert Smith Freehills
matthew.emsley@hsf.com
