The announcement by telecoms carrier giant PCCW Limited that it plans to spin-off its telecommunications business marks the first business trust listing with stapling on the Hong Kong Stock Exchange (HKEx). This article explores business trusts and stapled securities in light of the increasing use of innovative business structures for listings in Hong Kong.
A business trust combines elements of a company with aspects of a unit trust. It is created by a trust deed and does not have a separate legal identity. It is controlled by a trustee-manager, typically an affiliate of the company establishing the trust, who has legal ownership of the assets of the business enterprise. Investors hold units rather than shares, and their liability is limited to the amount they paid for those units.
The business trust is a novel concept in Hong Kong, where real estate investment trusts, or REITs, are recognized. However, business trust structures have been adapted for some years in various jurisdictions for listing purposes. For instance, the Singaporean government has enacted the Business Trusts Act, which regulates the structure and registration of business trusts. That law also sets out in detail the roles and responsibilities of the trustee-manager.
Stapling is an arrangement under which two or more securities are combined such that the stapled securities cannot be traded separately. A stapled security enables an investor to own two or more securities, which are generally related and bound together through one vehicle. Under the model adopted by the Australian Stock Exchange, a business trust is issued and traded as a "stapled security" comprising two components:
- A share in a listed company (listco): the legal entity of the stapled security exists in this share unit
- A unit in a unit trust: the unit trust being typically not a legal entity and created by a trust deed
The dividend payout from the share unit is taken from the listco’s profits, whereas the dividend payout from the trust unit can be taken from the listco’s operating cash flow, allowing for a steady payout to long-term investors.
In PCCW’s case, subscribers will be able to subscribe for share stapled units jointly issued by the unit trust and the listco. The share stapled unit will comprise three components: (i) a beneficial interest ordinary share in the listco (where the legal interest is held by the trustee-manager); (ii) a unit in the unit trust; and (iii) a preference share in the listco. All the components of the stapled security will be traded as one on the HKEx. The number of units, ordinary shares and preference shares in issue will be the same at all times. Only a single price quotation will appear on the HKEx, and no price quotations will be given for the individual components.
The three-component model provides three layers of protection, one more than a typical two-component model:
- Preference shares unit: While this unit will not pay dividends or other distributions from the listed company, in the event that the business trust is terminated, holders may be entitled to certain rights over common stockholders.
- Ordinary shares unit: Like other normal ordinary shares, this will pay dividends or other distributions as there is an economic interest in the listco.
- Trust unit: The trust deed (under which the unit trust is created) will require the unit trust to distribute 100 percent of its cash flows from dividends and other distributions, after such cash flows have been applied to pay the operating expenses of the unit trust.
The unit trust will be a fixed single-investment trust, meaning that it can only invest in securities and other interests in the listco. It will confer on its unitholders a beneficial interest in the property held by the unit trust. The trustee-manager will typically be a wholly owned subsidiary of the listco, and it will have legal ownership of the assets of the unit trust, but those assets will be held by the trustee-manager on trust for the beneficial interest of the unitholders. The cost and expenses of administering the unit trust may be deducted from the trust property, but the trustee-manager will not receive a separate management fee.
Ups and Downs
PCCW believes that the business trust structure provides a framework within which a focused distribution policy can be more clearly articulated and pursued, and within which the telecommunications business can more clearly signal its intention to focus principally on distributions. Interestingly, PCCW has identified some downsides of business trusts as well:
- The business trust is a novel structure and has no precedent in the Hong Kong market. The application of the relevant investor protection legislation to the share stapled units structure is subject to the interpretation of the courts.
- Establishing and running a trust incurs some administrative costs.
- There are unknown elements arising out of the trust structure, including as regards the profits tax treatment of distributions made by the trust.
A Regulatory Regime for Stapled Securities in Hong Kong
There is no single piece of legislation or regulation governing the listing by way of business trust and stapled securities and the relevant ongoing supervision. The HKEx and the Securities and Futures Commission (SFC) have been discussing with market practitioners and other relevant parties about the potential listing of business trusts in HK and are considering the matters that should be taken into account in designing the appropriate regulatory framework. To date, several different regimes of legislation, regulations and rules are in place governing different entities and financial activities involved in this model:
- The unit trust (including the trustee-manager) and the listco will be the "listed issuers" under the Listing Rules and will, therefore, be subject to the provisions of the Listing Rules.
- The share stapled units (both the share unit and the trust unit), the unit trust, the trustee-manager and the listco will be subject to the provisions of the Securities and Futures Ordinance (SFO) and the Takeovers Code.
- Repurchases of share stapled units will not be permitted unless and until expressly permitted by the relevant codes and guidelines which may be issued by the SFC from time to time.
For the purposes of ongoing supervision, and in light of the potential increasing applications for listing by utilizing business trust structures, the HKEx and the SFC will have to consider ways to reform the existing regulatory framework to remain competitive with other markets.
The main regulatory concern is that business trusts are created by trust deeds are, therefore, not subject to the provisions on shareholders’ protection under the SFO or Companies Ordinance or other regulations applicable to listed companies. As such, some other measures will have to be put in place to ensure that the unitholders will enjoy the same protection and rights as ordinary shareholders of a listed company. One way to achieve this is to include such matters in the trust deed creating the unit trust, which is the approach taken by PCCW. The trust deed will provide for meetings of unitholders (as well as the shareholders) characterized as meetings of holders of the share stapled units. They will receive notices of meetings, financial statements and other publications in respect of the unit trust and listco. Unitholders will also be entitled to attend and vote at general meetings, casting only a single vote per share stapled unit.
Apart from the need for a shareholders’ protection mechanism, there are also concerns on the Listing Rules and the SFO. The current Listing Rules do not have any specific provisions for listing applications of business trusts. However, the HKEx aims to bring the considerations for such listing applications in line with the other listing applications by adopting essentially the same principles. As such, the current Listing Rules will have to be modified.
As for the SFO, currently, only dealing in the shares of a company listed on HKEx is subject to the SFO investor protection provisions, such as insider dealing and disclosure of interests provisions. Dealing in units of collective investment schemes, such as a business trust listed on HKEx, does not fit neatly within those provisions. It will therefore be necessary to amend the legislation such that the investor protection mechanisms will equally apply to the dealing in units of a business trust listed on HKEx.
In light of the fierce competition among the counterparts of HKEx in other jurisdictions in which the listing of business trusts has been approved for some years, it is not surprising that the HKEx has approved the listing application of business trusts by PCCW. Pending a legislative overhaul, one can expect business trusts to be approved as an investment for the public as a component of a stapled security.