Earlier this year, the Hong Kong Stock Exchange (the Exchange) updated its 2005 listing decision by elaborating on the listing / disclosure requirements for businesses conducted through a Variable Interest Entity (VIE) structure.
The VIE structure has been a popular mechanism whereby businesses seek to bypass mainland PRC restrictions on foreigners having interests in strategic industry sectors. A typical methodology would be to channel all the financial benefit of a business into an offshore holding company, whilst not transferring to it any proprietary interest of such business. A series of contractual arrangements would enable foreign investors to have control over businesses that they do not own. The telecoms / internet sectors stand out in this regard ─ Alibaba, Sina, Baidu, Focus Media, Tudou etc all used VIE structures to go public in the US.
The case before the Exchange involved a company which was a short-term financing service provider in the PRC. This industry was strictly regulated. Due to certain licensing restrictions, the listed group did not itself hold the required licenses. Instead, the business was operated under various contract-based arrangements which gave the group in essence control over the business. The contract-based arrangements gave it all economic benefit of the business and control over all voting rights of the underlying PRC operating companies, without a direct or indirect equity shareholding in the underlying companies.
The question was whether this business, which had the features of a typical VIE, would satisfy all conditions for listing in Hong Kong.
Pre-set Standards of Review
The Exchange had previously set the following standards of review (Listing Decision LD 43-3):
- the Listing Rules and Listing Division policies would be strictly construed;
- contractual arrangements would be narrowly tailored to achieve an applicant’s business purposes and minimise the potential for conflict with PRC laws and regulations. Wherever possible, the listing applicant would be required to demonstrate genuine efforts to comply with applicable laws and regulations;
- the Exchange would undertake a broad review of all relevant facts and circumstances of the applicant, including its legal and compliance history (if any), management systems and corporate governance practices, shareholder protection record and financial resources to ensure compliance with laws and regulations. Any material uncertainties in the business would mandate a higher level of assurance with respect to the arrangements; and
- subject to availability and practicability, appropriate regulatory assurance would be obtained from the relevant regulatory authorities. In the absence of such regulatory assurance, the applicant’s legal counsel would be required to make a statement to the effect that in its legal opinion all possible actions or steps taken to enable it to reach its legal conclusions had been taken. In consultation with the applicant and the sponsor, other relevant forms of assurance could be considered.
Further Elaboration on Standard of Review
In the 2011 listing decision, the Exchange added that:
- If non-restricted businesses are involved, the Listing Division will normally refer the case to the Listing Committee.
- The listing applicant and its sponsor should explain the reasons for the use of contractual arrangements in its business operation.
- The listing applicant should unwind the contractual arrangements once they are legally allowed to operate the business without them.
The listing applicant must ensure that the contractual arrangements contain:
- a power of attorney by which the shareholders of the restricted business grant to the applicant’s directors and their successors (including a liquidator replacing the directors) the power to exercise all rights of the shareholders of the applicant;
- dispute resolution clauses that provide for arbitration and remedies over the shares or land assets of the restricted business, injunctive relief or winding up of the restricted business;
- jurisdiction clauses which provide the courts of Hong Kong, the place of incorporation of the applicant and the restricted business and the place where the principal assets of the applicant or the restricted business are located with the power to grant interim remedies in support of the arbitration pending formation of the arbitral tribunal or in appropriate cases; and
- provisions that grant the right to dispose of the assets of the restricted business.
In the case before it, given that there would be full disclosure of the contractual arrangements in the prospectus, the Exchange did not disentitle the applicant from listing by reason of the use of the contractual arrangements. The Exchange also required that VIE listing applicants should make prescribed detailed prospectus disclosure.
This listing decision provides potential PRC businesses with some doorways to pursue an IPO in Hong Kong, but the standards set by the Exchange are stringent and those involved in non-restricted businesses are less likely to be able to point to this case as a precedent. We are keeping a close watch on how this area develops.