02 August 2019

Cracking down on backdoor listing

Written by: Gary Lock, Ruth Lau and Eugene Lau.

In response to concerns on rampant “shell activities” involving backdoor structures in recent years, the Hong Kong Stock Exchange (the “HKEx”) published a consultation paper in June 2018 on backdoor listing and continued listing criteria (the “Consultation Paper”).

After a rather prolonged deliberation the HKEx finally published the conclusions (the “Conclusions”), with new rules (the “Rules”) in July 2019. The Rules will take effect in October 2019.

New Rules relating to Backdoor Listing

The following major changes will be implemented:

  1. codifying the following six RTOs assessment criteria in Guidance Letter GL78-14 as notes to Rules 14.06B:
    1. the size of the acquisition or series of acquisitions relative to the size of the issuer;
    2. a fundamental change in the issuer's principal business;
    3. the nature and scale of the issuer’s business before the acquisition or series of acquisitions;
    4. the quality of the acquisition targets;
    5. change in control or de facto control of the issuer; and
    6. series of transactions or arrangements to list the acquisition targets;
  1. Rules 14.92 and 14.93 are modified to restrict any material disposal (or a disposal by way of distribution in specie that amounts to a material disposal) of an issuer’s existing business at the time of or within 36 months after a change in control, unless (i) its remaining business or (ii) the assets acquired from the new controlling shareholder and any other persons, would meet the requirements under Rule 8.05;
  2. codifying the “extreme VSA” in Guidance Letter GL78-14 as Rule 14.06C, and renaming this category of transaction as “extreme transaction” and issuers would only be able to rely on this provision if it (a) has been operating a principal business with substantial size which will continue after the transaction; or (b) has been under the control of the same person for a long period (normally not less than three years); and
  3. codifying Guidance Letter GL84-15, whereby the HKEx may ban large scale issue of new securities if the proceeds are used to acquire new or greenfield businesses that are expected to be substantially larger than the issuer’s existing business.

Modified Rules relating to Continued Listing Criteria

The current Rule 13.24, which requires an issuer to have directly or indirectly, sufficient level of operations OR have assets of sufficient value to warrant the continued listing of the issuer’s securities will be modified. Under the new Rule 13.24:

  1. an issuer is required to have directly or indirectly, a business with sufficient level of operations AND assets of sufficient value to support its operations to warrant the continued listing of the issuer’s securities; and
  2. proprietary trading and/or investment in securities by an issuer and its subsidiaries (other than an issuer which is an investment company listed under Chapter 21 or proprietary securities trading and/or investment activities carried out in the ordinary and usual course of business by a member of an issuer’s group that is a banking company, an insurance company or a securities house) are normally excluded when considering whether the issuer can meet Rule 13.24.

A transitional period of 12 months from the effective date of the Rule amendments will apply to listed issuers that do not comply with the new Rule 13.24.

Other Rules Amendments

Other new or modified other Rules have also been introduced by the Consultation Paper and adopted (with modifications) in the Conclusions, which are relevant for ongoing listing compliance all the issuers:

  1. the revenue exemption under Rule 14.04(1)(g) for purchases and sales of securities will only apply to cases where they are (i) conducted by banking companies, insurance companies and securities houses; and (ii) conducted within their ordinary and usual course of business by those banking companies, insurance companies and securities houses. For any other cases, including securities trading which were previously allowed under Listing Decision LD53-2, will generally be caught as notifiable transactions;
  1. the issuers are required to disclose following details of securities investment that represents 5% or more of the total assets in the annual report:
    1. the name and principal business of the underlying company, the number and percentage of shares held and the investment costs;
    2. the fair value of each investment as at the year end date and its size relative to the issuer’s total assets;
    3. the performance of each investment during the year, including any realized and unrealized gain or loss and any dividend received; and
    4. a discussion of the issuer’s strategy for the significant investments;
  1. new Rule 14.36B, which applies in cases where the issuer acquires a company or business from a person and that person guarantees the profits or net assets or other matters regarding the financial performance of the company or business. In such cases the issuer must issue update announcements if there are any subsequent changes or deviation in performance; and
  1. for announcements under Chapters 14 and 14A:
    1. any notifiable transaction announcement to expressly state the identity of the counterparty (a general description will no longer suffice); and
    2. any connected transaction announcement to disclose on the identities and activities of the parties to transactions and of their ultimate beneficial owners.

Clients are strongly advised to seek advice at an early stage when contemplating any merger and acquisition activities of listed companies in Hong Kong as a platform to expand their businesses. Please reach out to a member of our team should you require further information in relation to any of the above.

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