1.1 The Stock Exchange of Hong Kong Limited (the Exchange) has recently released two papers to consult the market on capital raisings by Hong Kong-listed companies (the Capital Raising Consultation Paper) and the delisting framework for Hong Kong-listed companies (the Delisting Consultation Paper). The consultation period for both papers will close on 24 November 2017.
1.2 The papers propose to make changes to the Hong Kong Listing Rules that will impact on: (A) capital raisings by listed companies (i.e., rights issues, open offers and placings of securities (including convertible securities and warrants)); (B) disclosure of equity fundraisings in annual and interim reports; (C) share subdivision and bonus share issues; and (D) the delisting and suspension framework.
1.3 This note’s main focus is the proposals in the Capital Raising Consultation Paper, which seek to close off some of the loopholes in the capital raising regime that can used by “insiders” to the detriment of non-subscribing shareholders.
2. Capital Raisings
2.1 In the Capital Raising Consultation Paper, the Exchange notes that while access to capital is an important market function, there have been patterns of abuse by a small number of listed companies using share issuances not for genuine capital raising, but for various ulterior purposes or to facilitate insiders in making gains that may not be in the interests of the listed company and all its shareholders.
2.2 The examples noted by the Exchange involved large scale and deeply discounted share issuances that often lacked commercial rationale – such issuances materially diluted the voting rights and value of non-subscribing public shareholders’ investments, whilst appearing to benefit “insiders” (e.g., by transferring value to new subscribers at a low price). These transactions, while structured to be compliant with the capital raising regime in the Listing Rules, raised regulatory issues regarding the fair treatment of minority shareholders and an orderly market for securities trading.
2.3 Certain issues with the current regime were highlighted by the Exchange, including the lack of a mandatory excess application or compensatory arrangement for unsubscribed shares (allowing the underwriter – who may be a substantial shareholder or other non-SFC licensed person – to “sweep” up all unsubscribed shares at the deeply discounted price). The Exchange appeared to indicate that low shareholder turnout and potential “warehousing” of shares by nominees of insiders mean shareholder approval should not be relied upon as the sole means of minority shareholder protection.
2.4 An overview of the proposals under the Capital Raising Consultation Paper(together with the existing position) is set out in Appendix 1 to this note.
2.5 A key proposal being mooted is to prohibit a listed issuer from conducting any: (A) rights issue (RI); (B) open offer (OF); or (C) placing of securities outside the general mandate (Specific Mandate Pleacing), which (individually or with any other such capital raising in a rolling 12-month period) has a "theoretical dilution effect" of 25% or more, unless there are exceptional circumstances such as financial difficulty. The 25% dilution threshold will not cover issuances under general mandates, for which the existing limits will continue to apply1.
2.6 Theoretical dilution effect takes into account the dilution effect of both the offer size and any discout to market price. A proposed formula is:
To illustrate, an offer of 5 new shares for each existing share at a price discount of 30% would result in a theoretical dilution effect of 25% and be prohibited. The same result applies to an offer of 1 new share for each existing share at a price discount of 50%.
2.7 The 25% threshold would be calculated on a cumulative basis to capture any RIs, OFs and Specific Mandate Placings conducted over a rolling 12-month period. The cumulative value dilution is calculated by reference to: (A) the total number of shares issued during the 12-month period compared to the number of issued shares immediately prior to the first offer / placing; and (B) the weighted average of the price discounts. The formula is:
2.8 Other proposals include requiring all RIs and OFs to have an excess application arrangement or compensatory arrangement for non-subscribed shares. Issuers can choose between the two options, unless a controlling or substantial shareholder is acting as an underwriter for the offer – in which case, it must implement a compensatory arrangement3.
2.9 The Exchange also proposes to make underwriting an RI or OF optional, but where an underwriter is appointed, it must be: (A) an SFC-licensed independent party; or (B) a controlling or substantial shareholder (provided a compensatory arrangement is in place and the connected transaction rules have been complied with).
2.10 Unlike RIs, OFs are non-renounceable (i.e., there is no ability for non- subscribing shareholders to sell their entitlements to the shares on the market). The Exchange believes this justifies a more stringent approval process for OFs relative to RIs and therefore proposes requiring minority shareholder approval (at 50%) for all OFs outside the general mandate. This means any controlling shareholder and its associates (or, if there are no controlling shareholders, executive directors and their associates) would not be able to vote in favour of the OF and an independent financial adviser must be appointed. There was no suggestion of imposing a similar requirement for Specific Mandate Placings even though existing shareholders would not have the opportunity to participate in such placings. Ordinary shareholder approval would therefore continue to be sufficient for Specific Mandate Placings, RIs (that do not exceed the existing 50% threshold under Listing Rule 7.19(6)) and general mandates.
2.11 It is proposed that the use of general mandates will be prohibited in the case of placings of warrants and restricted in the case of placings of convertible securities. In the latter case, a general mandate can only be used if the initial conversion price of the convertible security is no less than the benchmarked price of the underlying exceptional circumstances) immediate shares at the time of the placing. Otherwise, the placing will require a specific mandate.
3. Delisting Framework
3.1 The primary motivation behind the Delisting Consultation Paper is to address the issue of prolonged trading suspension. Delistings may result in minority shareholders holding shares in an unlisted vehicle with no exit – therefore, the existing framework is more focussed on requiring issuers to take remedial steps to resume trading, rather than facilitating delisting. However, the market has been left with companies that have been subject to prolonged suspensions with no certainty about whether and when they would be relisted or delisted. The Exchange views this situation as undermining the proper functioning and reputation of the market.
3.2 The Exchange proposes to add a new delisting criteria to allow the Exchange to delist an issuer after a continuous suspension exceeding a prescribed fixed period (Fixed Period Criteria). The Exchange is seeking feedback on whether this fixed period should be 12, 18 or 24 months in the case of Main Board issuers, or 6 or 12 months in the case of GEM issuers.
3.3 It is proposed that for issuers falling
under the existing delisting criteria under Listing Rule 6.01 (e.g., no longer suitable for listing, insufficient public float or insufficient operations / assets), the Exchange may publish a delisting notice specifying either a remedial period or (in exceptional circumstances) immediate delisting. Practice Note 17 dealing with issuers with insufficient operations / assets will be deleted.
3.4 The Exchange envisages that it would normally apply the Fixed Period Criteria to give issuers a reasonably long period of time to remedy issues and resume trading. Where appropriate, it may give an issuer some other remedial period under Listing Rule 6.01. Only in exceptional circumstances would the Exchange specify immediate delisting.
4.1 Although there are existing Exchange guidance materials that address various aspects of the capital raising regime, the Capital Raising Consultation Paper seeks to address potential abuses in a comprehensive manner and via specific changes to the Listing Rules. It is of note that both the Exchange and the Securities and Futures Commission (SFC) have broad discretion to object to follow-on equity offerings and have exercised these rights on recent highly dilutive fundraisings. By introducing a bright line test in the form of a 25% dilution threshold, listed companies and their advisers will be able to obtain more clarity on how they should structure their capital raisings in a manner that is less likely to raise concerns with the Exchange and the SFC.
4.2 However, it remains to be seen whether market feedback considers the proposed threshold has been set at a level that appropriately balances minority shareholder protection and listed companies’ genuine capital raising needs.