In recent years, fund raising activities in Hong Kong outside of the public markets have been on the rise. From start-ups looking for investments to establish a foothold to mature businesses looking to diversify, short to medium-term funding is most sought-after. On the demand side, emerging high-net-worth individuals or family offices are more open to less traditional investment options that provide more attractive, fixed income returns.
The companies soliciting investment and intermediaries introducing opportunities to potential investors have to be aware of the relevant regulatory requirements, particularly those recent developments noted below.
Straightforward Approach – Making Loans
The more straightforward option remains the giving of loans. The Money Lenders Ordinance (Cap 163) (“MLO”) restricts any person from carrying on business as a money lender without a money lender’s license.
Those who regularly derive income from lending transactions without such license will have to ensure that the loans are exempted. Amongst the exemptions available, investors often choose to obtain a qualifying security. Such security encompasses two main categories, namely security given by a Hong Kong company which is registrable under the Companies Ordinance (Cap 622) (“New CO”) and security given by a non-Hong Kong which would be registrable under that ordinance if such non-Hong Kong company were to be a Hong Kong company. If the borrower company cannot offer any qualifying security, another exemption frequently relied upon is for the borrower to increase its paid up capital to not less than HK$1,000,000. The New CO has clarified that a charge over bank account is not registrable. In addition, the new requirement of the charge instrument to be filed and made available for public inspection will give rise to constructive notice of all the terms in the charge instrument to banks and financial instructions who may reasonably be expected to search for relevant records in the Companies Registry when dealing with corporate entities.
Excessive Interest Rates
Regardless of whether a loan is exempted from the licensing requirement, a lender charging an effective interest rate in excess of 60% per annum commits an offence and, when enforcement is sought, any loan with an effective interest rate exceeding 48% per annum is presumed to be extortionate and thus liable to be re-open by the courts in order to do justice. In situations where the interest rate is between 48% and 60% per annum, the lender may still prove that the transaction is not extortionate given all the special circumstances related to the transaction. The MLO has provisions prescribing how the effective interest rate is determined.
Private Placement – Matters of Domestic Concern and Safe Harbors
Subject to the limit on the number of shareholders, a private company may place its shares or debentures privately pursuant to negotiations with potential investors. The directors and/or advisors of a company will have to ensure that such solicitation of interest will not fall foul of the “offer to the public” requirements under theCompanies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (“CWUMPO”).
In essence, no person may issue a “prospectus” to offer shares or debentures in a company to the public unless the document is exempted or has been registered in accordance with CWUMPO. There is a general exemption which excludes any offer that will not result in the shares or debentures becoming available to persons other than those receiving the offer or invitation, or otherwise as being a domestic concern of the persons making and receiving it. However, such exemption is of limited practical application, as the CWUMPO also provides that the reference to “offer to the public” include an offer made to “any section of the public, whether selected as members or debenture holders of the company concerned or as clients of the person issuing the prospectus or in any other manner”.
Statutory Safe Harbors
As a result, most market players turn to specific carve-outs from the definition of “prospectus” that are listed in Schedule 17 of CWUMPO, which are commonly referred to as safe harbors. Currently, there are 12 safe harbors of which four types have been commonly relied on to facilitate private placement in Hong Kong namely:
- An offer made only to “professional investors”;
- An offer to not more than 50 persons;
- An offer in respect of which the total consideration payable for the shares or debentures concerned does not exceed HK$5 million; and
- An offer in respect of which the minimum investment amount payable by an investor is not less than HK$500,000.
Other than the exemptions in respect of the investment ceiling and floor (namely the last two exemptions listed above), these safe harbors may be used in combination with each other for the entire offer to remain exempted. For example, an offer to 50 non-professional investors and an unlimited number of professional investors in Hong Kong will not trigger the prospectus requirement.
For the purposes of this safe harbor, the scope of professional investors is defined in Schedule 1 of the Securities and Futures Ordinance (Cap 571) (“SFO”). The responsibility of ensuring that an investor is qualified for this safe harbor rests with the company issuing the shares or debentures. As such, an issuer company generally will request an investor to provide relevant warranties and representations that it is within the ambit of qualified professional investors. They can be broadly categorized as institutional professional investors (such as banks and insurance companies), and individual and corporate professional investors who qualify as such by virtue of their asset value or portfolio size.
In May 2013, the Securities and Futures Commission (“SFC”) sought views from the public on whether individual and corporate professional investors should continue to be allowed to take part in private placement activities, and whether the HK$8 million minimum portfolio threshold for individual and corporate professional investors and the HK$40 million minimum total assets threshold for corporate professional investors under the Securities and Futures (Professional Investor) Rules (Cap. 571D) should be increased. The underlying concerns were that these investors are vulnerable as they might not be financially sophisticated. They may also not be in a position to make appropriately informed investment decisions, as information disclosure in private placements is not subject to mandatory content requirements equivalent to those applicable to marketing documentation in public offerings that require SFC approval or authorization.
The SFC concluded in September 2014 that neither of the proposed changes is needed. On the eligibility issue, the SFC agreed with the respondents’ views that the existing private placement regime is comparable to other overseas jurisdictions, including the United States, Australia and Singapore, which allow investors to access private placements solely by reference to monetary criteria. In addition, it is common in private placements to have private placement memoranda, subscription agreements and related transaction documentation which create contractual rights and obligations between issuers and investors. Such documentation usually covers information disclosure, product terms and related risks. Finally, if private placements are conducted through intermediaries, the conduct of the intermediaries is subject to applicable requirements under the Code of Conduct for Persons Licensed by or Registered with the SFC. In respect of the existing monetary criteria, the SFC accepted that the existing thresholds are similar to other major jurisdictions (e.g., the minimum threshold for individual professional investors is higher than that in the United Kingdom though lower than that in Singapore and Australia), and was mindful of the potential adverse impact of increasing the thresholds for private placement activities.
Mandatory warning statement and other practical measures to ensure compliance
Most of the safe harbors require the issuer company to include in the offering document a warning statement in the prescribed form, which is to highlight that the offering document has not been reviewed by any regulatory authority in Hong Kong and encourage the person receiving such offer to seek independent professional advice.
Furthermore, to ensure that the offer is not made to the public and falls within the safe harbors, it is recommended for the issuer to adopt the following practical measures:
- Number each offer document serially, address it individually to a specific offeree and state only that offeree should be capable of accepting the offer and taking up the securities;
- Clearly state in the offer document that it is not an offer to the public and the offer document should not be passed to any other person other than the intended recipient; and
- Avoid any advertising, press release or press conference relating to the proposed offering or the offer document in Hong Kong.