Herbert Smith Freehills LLP reviews the Hong Kong Stock Exchange’s new regulatory framework for capital raisings by listed companies.
Hong Kong’s listing rules are to be amended from Tuesday 3 July 2018 to enhance the regulatory framework for capital raisings by listed issuers.
The rule changes target highly dilutive capital raisings by disallowing rights issues, open offers and placings under specific mandates which would result in a material value dilution of 25% or more (individually or cumulatively over a rolling 12-month period) unless exceptional circumstances exist. Placings of warrants under a general mandate will be disallowed. The use of general mandates for the placing of convertible securities will only be permitted where the initial conversion price is no less than the benchmarked price of the shares at the time of the placing.
The Stock Exchange is also implementing a number of changes to the regime for rights issues and open offers to ensure fair and equal treatment for all shareholders. These include removing the existing exemption from the connected transactions regime for connected persons underwriting a rights issue or open offer and changes to the underwriting requirements.
The listing rule changes, summarised in more detail below, have been made to address regulatory concerns about certain transactions by listed companies where the Securities and Futures Commission and the Stock Exchange have questioned whether the transactions were fair to minority shareholders or may have adversely affected the orderly market for securities trading.
Summary of the key changes to the listing rules
Below is a summary of the key changes to the listing rules which will become effective on 3 July 2018.
Restrictions on rights issues, open offers and specific mandate placings
The listing rules will be amended to add a new Rule 7.25B which restricts rights issues, open offers and placings under a specific mandate which would result in a ‘theoretical dilution effect’ of 25% or more. The theoretical dilution effect is defined as the difference between the ‘theoretical diluted price’ and the ‘benchmarked price’ of the shares.
- ‘Theoretical diluted price’ means the sum of (i) the issuer’s total market capitalisation (by reference to the ‘benchmarked price’ and the number of issued shares immediately before the issue), and (ii) the total funds raised and to be raised from the issue, divided by the total number of shares as enlarged by the issue.
- ‘Benchmarked price’ means the higher of (i) the closing price on the date of the agreement involving the issue, and (ii) the average closing price in the five trading days immediately prior to the earlier of (1) the date of the announcement of the issue, (2) the date of the agreement involving the issue, and (3) the date on which the issue price is fixed.
In calculating the theoretical discount effect, an issuer must aggregate any other rights issues, open offers or placings under a specific mandate announced within the 12 months prior the date of the announcement of the proposed issue (or prior to such 12-month period if dealings in the shares announced earlier commenced within that 12-month period) together with any bonus securities, warrants or other convertible securities granted or to be granted in relation to such capital raisings. The Stock Exchange has issued FAQs to assist the market in calculating the cumulative dilution effect.
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.
Under a new Rule 7.27C, the Stock Exchange retains discretion to withhold approval for (or to impose additional requirements on) any rights issue, open offer or specific mandate placing not falling under Rule 7.27B if, in the Stock Exchange’s opinion, the issue is inconsistent with the general principles in the listing rules (including that shareholders are treated fairly and equally). Rule 7.27C gives examples of a very large issue size or price discount as terms which may trigger this rule.
Rights issues and open offers no longer need to be fully underwritten
Existing Rules 7.19 and 7.24 will be amended to provide that rights issues and open offers, respectively, do not need to be underwritten. This will give greater flexibility to issuers where the underwriting costs associated with a rights issue or open offer are prohibitively high.
Where a rights issue or open offer is underwritten, the amended Rule 7.19 provides that the underwriters will need to be licensed under the Securities and Futures Ordinance (with a Type 1 licence and include as their ordinary business the underwriting of securities) and be independent from the issuer and its connected persons. This will help ensure that there are no conflicts of interest in structuring such transactions.
Alternatively, controlling or substantial shareholders can also act as underwriters (provided arrangements are made to compensate non-subscribing shareholders). However, as discussed in the next paragraph, the current exemption from the connected transactions regime for a connected person underwriting an open offer or rights issue is to 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.
Removal of existing exemption from the connected transaction regime for connected persons acting as an underwriter for a rights issue or open offer
Rule 14A.24(6) is to be amended to clarify that underwriting or sub-underwriting an issue of securities is included under the definition of ‘transactions’. Rule 14A.92(2)(b), which currently provides the underwriting exemption from the connected transaction regime, is to be repealed. From 3 July 2018, where a controlling shareholder is to underwrite a rights issue or open offer, Chapter 14A will need to be complied with and an independent financial adviser appointed to opine on the terms of the arrangement. This reflects the Stock Exchange’s view that connected persons are in a position to exercise significant influence over such capital raising exercises and could transfer benefit to themselves.
New requirement for minority shareholder approval for all open offers (save those conducted under a general mandate)
A new Rule 7.24A will be added which provides that minority shareholder approval is required for all open offers save for those where the securities will be issued under a general mandate. Rule 7.27A provides that minority shareholder approval requires the approval of shareholders excluding controlling shareholders, or where there are none, directors (excluding non-executive directors) and the chief executive, and their respective associates). The Stock Exchange also reserves the right to require certain other parties to abstain from voting.
This reflects the Stock Exchange’s view that open offers provide less protection for shareholders compared to rights issues. An independent financial adviser’s opinion on the offer will be required.
Upgrade of existing optional arrangements for the disposal of unsubscribed shares in a rights issue or open offer to compulsory requirements
Currently Rule 7.21 and Rule 7.26A set out optional provisions for excess application arrangements or compensatory arrangements for rights issues and open offers, respectively, to deal with unsubscribed securities. From 3 July 2018, these rules will become mandatory requiring the issuer to either put in place excess application arrangements or compensatory arrangements. Where the issue is underwritten by a controlling or substantial shareholder, the listing rules are to be amended to require that the issuer must put in place compensatory arrangements.
Limits on the excess applications made by controlling shareholders and their associates
Rule 7.21(3)(b) and Rule 7.26A(3)(b) are to be added in respect of rights issues and open offers, respectively, to require that excess applications made by controlling shareholders and their associates are to be disregarded where they exceed the total number of shares offered less such persons’ assured entitlements. This change will still allow a controlling shareholder to apply for all the shares not taken up by the other shareholders but will eliminate any perceived advantage the controlling shareholder may have from knowing subscription levels.
Restricting placings of warrants and convertible securities under a general mandate
A new Rule 13.36(7) will prohibit placings of warrants and options for cash consideration under a general mandate. After 3 July 2018, such transactions will require a specific mandate.
Additionally, new Rule 13.36(6) provides that an issuer will only be able to conduct a placing of convertible securities using a general mandate where the initial conversion price is no less than the benchmarked price (as defined in Rule 13.36(5)) of the underlying shares at the time of the placing. Rule 13.36(5) defines the benchmarked price to be the higher of (a) the closing price on the date of the relevant placing, and (b) the average closing price in the five days prior to the earlier of the announcement of the placing, the date of the placing agreement or the date on which the placing price is fixed. Where there is a price discount to the benchmarked price, a specific mandate will be required.
Mandatory disclosure of use of proceeds in interim and annual reports
Paragraph 11(8) of Appendix 16 of the listing rules will be amended to require disclosure of the use of proceeds in a company’s interim and annual reports for all equity fundraisings 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 the proceeds have been used in accordance with the originally announced intentions.
Restrictions on share subdivisions and bonus issues
A new Rule 13.64A will restrict share subdivisions and bonus issues if, following the adjustment, the company’s share price would be less than HK$1 (based on the lowest daily closing price of the shares in the six-months prior to the announcement of the subdivision or bonus issue). This is to prevent companies from splitting shares to a level where the low share price is more susceptible to price volatility. The threshold of HK$1 was set following feedback on the consultation paper.
Other developments on the horizon
These changes are 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. At the same time as it consulted on the above changes relating to capital raisings, the Stock Exchange also issued a consultation paper on proposed amendments to the delisting framework, which considers delisting criteria to facilitate the delisting of companies that have been suspended for a prolonged period of time.
The Stock Exchange has also 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.
Herbert Smith Freehills LLP
The Stock Exchange’s consultation conclusions setting out the amended listing rules, together with relevant FAQs, are available on the Hong Kong Exchanges and Clearing Ltd website: www.hkex.com.hk.
Copyright: Herbert Smith Freehills LLP