Ask the Expert November 2013
Q: We are planning to launch an employee share incentive scheme – what are the trends in Hong Kong and China?
A: Over the past 10 years in Hong Kong and China, there has been a dramatic increase in the types of share plans being implemented as compensation tools to incentivise, motivate and attract staff. Prior to 2005, the use of employee share plans was limited to cash-settled stock appreciation rights (SARs), which are essentially a cash payout based on an increase in the underlying share price. With SARs the employee is never a ‘shareholder’ and for all intents and purposes, it is a cash bonus plan.
In 2005, the PRC State Administration of Foreign Exchange (SAFE) promulgated its first circular (Circular 78) regarding the registration and funds process flow required for a PRC employee to participate in overseas listed share plans. In 2006, PRC State Administration of Taxation also released ‘Circular 35’ which not only clarified how gains from employee share plans should be taxed, but also provided PRC employees with the ability to spread the gain over several months.
With these two regulatory clarifications, coupled with the increasing shortage of qualified staff and high turnover rates in both Hong Kong and China, employee share incentive plans have quickly evolved into one of the primary tools used by companies to address employee attraction, motivation and retention.
Initially, the primary plan designs implemented were stock option plans that were granted primarily to executives and senior managers. In line with the global trend, a few years later there was a shift away from stock options towards full-value restricted share awards, as well as an increase in the number of employees receiving share awards. This was because stock options have the potential to be demotivating if they are ‘underwater’ whereas restricted stock awards always hold value for the employee. These were also preferable to shareholders and issuers as they typically create less shareholder dilution.
At about the same time there was a noticeable shift in the vesting criteria applied to these awards. Historically, the majority of vesting schedules were time-based. In line with the global trends, an evolution towards performance-based vesting emerged: the participant must not only remain employed but individual or company targets must be achieved. Performance- based vesting is generally the preference of boards and remuneration committees as well as shareholders.
Since 2010, employee share purchase plans (ESPP) have been rolled out in Hong Kong and China; not only demonstrating a dramatic evolution of share plans in the region but also dramatically increasing the number of participants. Unlike stock options, restricted shares and performance-based plans; with
an ESPP the entire employee population is eligible to participate – everyone from the tea lady to the CEO can elect to invest a portion of their salary into a pool to purchase shares, usually on a monthly or quarterly basis. Companies provide either matching shares or a discount on the purchase price, as well shouldering the associated administration and purchase costs. ESPP plans have proven to be enormously popular in China with participation rates exceeding global results and some companies achieving nearly 60% participation.
Employees in Hong Kong and China are increasingly considering a company’s share plan when deciding who to work for, so having the right plan in place will become more and more important.
Seth Bohart, Managing Director Computershare Plan Managers