This is the latest in our series of articles about the EDB’s new regulatory framework for capital levies, debentures and nomination right fees collected by private and international schools in Hong Kong (Other Charges).
In our previous article, we mentioned that securities law review and legal sign off is now required by the Hong Kong Education Bureau (EDB) as part of the new approval mechanism in EDB Circular No. 15/2023.
We have subsequently received a number of queries from schools and operators about whether their Other Charges are subject to Hong Kong’s securities laws, and if so, what should they do?
We answer that question in this article.
Background
An application for approval of “Other Charges” under the EDB’s new mechanism requires the supervisor of the school to sign a declaration (the Declaration):
1. confirming that legal advice has been sought (and naming the lawyer who provided that advice) about the contract or terms and conditions of the Other Charges;
2. confirming that the collection of the Other Charges, including the issue and transfer of the Other Charges, complies with certain laws, including the:
- Securities and Futures Ordinance (Cap. 571) (SFO); and
- Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO); and
3. undertaking that the handling and management of Other Charges complies with certain laws, including the CWUMPO and SFO.
Securities regulation in Hong Kong
The SFO is the principal law regulating securities in Hong Kong.
The SFO’s definition of “securities” includes “debentures”.
“Debenture” is broadly defined in the SFO to include “debenture stocks, bonds, and other debt securities of a corporation, whether constituting a charge on the assets of the corporation or not.”
Relevantly, the CWUMPO deals with offers to the public to acquire shares and debentures.
Like in the SFO, the CWUMPO has a wide definition of “debenture” which “in relation to a company, includes debenture stock, bonds and any other debt securities of the company, whether or not constituting a charge on the assets of the company”.
When are Other Charges regulated as securities?
There is no exhaustive test in the SFO or CWUMPO for whether an Other Charge constitutes a “debenture”.
Effectively, given the broad definitions, any Other Charge with debt-like features, or which has other securities-like characteristics, is at risk of being a “debenture” (and accordingly, subject to the SFO and CWUMPO).
Any Other Charge that is refundable, transferrable, depreciating, interest-bearing or redeemable, or is recorded on a register or evidenced with a certificate, will have some debt-like and securities-like characteristics, and is accordingly at risk of being a “debenture”.
The more of these features an Other Charge has, the more likely it is a “debenture”.
It is necessary to carefully examine the fundamental legal and commercial characteristics of an Other Charge (as detailed in the contract or terms and conditions of that Other Charge) on a case by case basis to make an assessment of whether that Other Charge risks being a “debenture”.
We have reviewed dozens of Other Charges from Hong Kong schools. In our experience, most debentures, nomination rights (individual and corporate), foundation certificates and capital contributions charged by Hong Kong schools have features that put them at risk of being regulated as “debentures” under the SFO and CWUMPO.
What if an Other Charge is a regulated security?
If an Other Charge is a “debenture” under the SFO and CWUMPO, then any offer of that charge is regulated by the SFO and CWUMPO.
Under the SFO, carrying on a business “dealing in securities” requires a Type 1 licence. A school issuing and marketing “debentures” to parents is likely to be dealing in securities. Conducting a business of dealing in securities without a licence or otherwise exempted under the SFO is a criminal offence punishable by a fine of at least HK$500,000 and imprisonment for at least 2 years.
Under the SFO, issuing a document which is or contains an invitation to the public to enter into an agreement to acquire “debentures” or other securities without prior authorisation of the SFC or otherwise exempted under the SFO may constitute a criminal offence punishable by a fine of at least HK$100,000 and imprisonment of at least 6 months (unless the issue is authorised).
Offering a debenture to the public without a prospectus that complies with the CWUMPO’s requirements or is otherwise exempted is a criminal offence punishable by a fine of HK$100,000.
The principal regulator for the SFO and CWUMPO is the Securities and Futures Commission of Hong Kong. The EDB has no role in administering or enforcing the SFO or CWUMPO.
Safe Harbour exemptions available
Complying with the requirements of the SFO and CWUMPO is a costly and complicated process.
There are, however, a range of safe harbours in the SFO and CWUMPO that may exempt a school from complying with the relevant sections of the SFO and CWUMPO. If the safe harbour exemptions apply, the Other Charge would remain a “debenture”, but it would not be regulated by the SFO and CWUMPO.
The availability of the safe harbour exemptions depends on several factors, including whether:
- the Other Charge is offered to no more than 50 people
- no more than HKD 5,000,000 will be raised from the Other Charges
- the price of the Other Charge is more than HKD 500,000
- the Other Charge is explicitly non-negotiable or non-transferrable
- the issuer of the Other Charge is a charity
- proceeds of the Other Charge will be used for specified purposes
- documents constituting the Other Charge include the relevant warning statement
While a case by case analysis of the terms and conditions for an Other Charge and the nature of the issuer of that Other Charge is necessary, in our experience most schools in Hong Kong have been able to make use of the safe harbour exemptions.
Our thoughts
The requirement for Other Charges to comply with the SFO and CWUMPO is not new – compliance with the laws of Hong Kong has always been required of schools.
Indeed, we have worked with schools over many years to ensure the safe harbour exemptions apply to their Other Charges.
What is new is that for the first time, the EDB is requiring schools to obtain professional advice on this issue and the Supervisor is required to sign the Declaration.
With the EDB’s new approval mechanism, schools and their Other Charges are now in the spotlight.
In this context, we think the regulatory risk for schools is now higher – especially since schools (and parents) are on notice.
It is therefore important that schools carefully deal with this matter.
Top Tips
Schools are advised to thoroughly consider the nature of their Other Charges with their legal advisors.
Where an Other Charge risks being regulated as a “debenture”, we suggest schools review and revise the contract or terms and conditions for the Other Charge to:
1. remove debt-like and securities-like features to reduce the risk of the Other Charge being considered a “debenture”; and
2. take advantage of the safe harbour exemptions outlined above.
For Other Charges which are a low risk of being regulated as a “debenture”, we suggest schools revise the terms of those Other Charges to further reduce the risk they could be considered a “debenture”.
Under this pathway, schools can mitigate the potential risks of contravening the SFO and CWUMPO, and Supervisors can confidently sign the Declaration.
Additionally, where a school is not using a Collection Agreement (see our previous article for details), the EDB now requires several provisions be included in the contract or terms and conditions for each Other Charge. Schools may therefore need to revise their Other Charges to not only manage the SFO / CWUMPO regulatory risk, but also to include the EDB’s required terms.
Given the case by case analysis needed for each Other Charge, and with the EDB’s November 2024 application deadline fast approaching, we advise schools to begin work now.
*For purposes of this article, “Hong Kong” means “Hong Kong Special Administrative Region of the People's Republic of China”, and “China”, “onshore” or “PRC” shall mean the People’s Republic of China excluding Hong Kong, Macau Special Administrative Region and Taiwan.
