The Stock Exchange of Hong Kong Limited ("the Exchange") recently published two separate consultation papers on (i) Capital Raisings by Listed Issuers, and (ii) Delisting and other Rule Amendments, proposing changes to the Exchange's Listing Rules, amongst which includes prohibition of capital raisings that would result in a material value dilution of 25% or more; imposition of mandatory minority shareholders' approval for open offers; removal of the mandatory underwriting requirement and the connected transaction exemption available to connected persons acting as underwriters for all rights issues and open offers; and automatic delisting for issuer whose shares dealing has been suspended continuously for a prescribed period.
The 25% Value Dilution Threshold
Potential abuses related to large scale deeply discounted capital raising activities has raised market concerns in recent years. In an attempt to address such abuses, the Exchange proposes that a Hong Kong listed issuer may not undertake any rights issues, open offers or specific mandate placings (i.e., placing conducted pursuant to shareholders’ mandate specific to the proposed share offer) that would, either individually or aggregated within a rolling 12-month period, result in a cumulative value dilution of 25% or more, unless there are exceptional circumstances, such as the issuer is in financial difficulty.
Under the proposal, value dilution is calculated by reference to (i) the offer ratio and (ii) the price discount (i.e., the discount of the offer price to the market price before the offer announcement) as set out in the following formula:
As an illustration,
Number of existing shares before offer = 200
Number of new shares to be issued = 100
Percentage price discount = 70%
If everything remains the same but the size of the offer is doubled (i.e., 200 new shares to be issued), this revised offer will not be allowed:
Mandatory Minority Shareholders’ Approval for Open Offers
Save where the new shares are to be issued under the authority of an existing general mandate, it is proposed that minority shareholders’ approval should be required for all open offers. Controlling shareholders (or where there are no controlling shareholders, directors and chief executive) cannot vote in favour of the resolution and an independent financial adviser would be required to opine on the terms of the offer.
Underwriting of Rights Issues and Open Offers
As the Exchange explained in the consultation paper, there are concerns that the underwriter (a nonlicensed person) could acquire new shares through the underwriting arrangement, to acquire or consolidate control or for other ulterior purposes. Where the controlling or substantial shareholder underwrites the offer, a conflict of interest exists as it may be driven by personal motives, raising questions whether the terms of the offer are in the interest of the issuer and all shareholders as a whole. The following changes are proposed in response:
• remove the mandatory underwriting requirements to better align with other major markets, such as the UK, Australia and Singapore, which do not have compulsory underwriting requirement.
• if issuers choose to engage underwriters, they should be persons licensed by the SFC, and be independent from the issuers and their connected persons (save for controlling shareholders). Non-licensed independent persons cannot act as underwriters.
• remove the connected transaction exemption for underwriting and sub-underwriting of pre-emptive offers by connected persons. Consequently, if controlling or substantial shareholder proposes to act as an underwriter, independent shareholders’ approval and appointment of independent financial adviser would be required. It is further proposed that in such circumstances, compensatory arrangements must be made available for the unsubscribed offer shares.
Mandatory Arrangements for the Disposal of Unsubscribed Offer Shares
Issuers must adopt either excess application arrangements or the compensatory arrangements for the disposal of unsubscribed shares in rights issues or open offers (save where controlling or substantial shareholders act as underwriter, compensatory arrangement is mandatory). In adopting excess application arrangements, issuers must disregard any excess applications made by the controlling shareholders and their associates in excess of the offer size minus their pro-rata entitlements.
Other Proposed Changes
• the use of general mandate may be allowed for placing of convertible securities if the initial conversion price is no less than the market price of the shares at the time of placing; but it will not be allowed for placing of warrants or options for cash consideration.
• the use of proceeds from all equity fundraisings must be disclosed in interim and annual reports.
• subdivisions or bonus issues of shares will not be allowed if the theoretical share price after adjustment is less than a minimum price (proposed to be HK$1 or HK$0.50).
• add a separate delisting criterion to allow the Exchange to delist an issuer after its continuous suspension for a prescribed period (proposed to be 12, 18 or 24 months)