The Exchange published consultation aiming to further regulate backdoor listing

• Under the current regime, the Listing Rules provide for a “principle based test” (as set out in the current MBLR 14.06(6) / GLR 19.06(6)) to allow the Exchange treating as a reverse takeover (“RTO”) an acquisition or a series of acquisitions of assets as constituting (or being part of a transaction or arrangement or series of transactions or arrangements which constitute) an attempt to achieve a listing of the target assets and a means to circumvent the requirements for new applicants under the Listing Rules.

• The principle based test is supplemented by the Exchange’s Guidance Letter GL78-14 (“GL-78-14”). In particular, GL78-14 provides that the Exchange would treat a transaction as a RTO or backdoor listing if it considers that an acquisition or a series of acquisitions is an “extreme” case taking into account the following six assessment criteria:-

(a) the size of transaction relative to the size of the issuer;

(b) the quality of the business to be acquired – whether it can meet the trading record requirements for listings, or whether it is unsuitable for listing (e.g. an early stage exploration company);

(c) the nature and scale of the issuer’s business before the acquisition (e.g. whether it is a listed shell);

(d) any fundamental change in the issuer’s principal business (e.g. the existing business would be discontinued or very immaterial to the enlarged group’s operations after the acquisition);

(e) other events and transactions (historical, proposed or intended) which, together with the acquisition, form a series of arrangements to circumvent the RTO Rules (e.g. a disposal of the issuer’s original business simultaneously with a very substantial acquisition); and

(f) any issue of restricted convertible securities to the vendor which would provide it with de facto control of the issuer.

• Under the proposed regime, MBLR 14.06(6) / GLR 19.06(6) will become MBLR 14.06B / GLR 19.06B, respectively, and the six assessment criteria currently set out in GL78-14 will be codified into the Listing Rules with the following modifications:

(a)  the criterion of “issue of restricted convertible securities” will be extended to include any change in control or de facto control of the issuer;

(b)  the “series of arrangements” criterion will be clarified:

i. to mean any transactions and/or arrangements that are in reasonable proximity (normally within a period of three years) or otherwise related; and

ii. that it is no longer required for the proposed (last) transaction to be an acquisition to trigger the Listing Rules in relation to RTOs.

• Under the current regime, the Listing Rules also provide for a “bright line test” to allow the Exchange to normally treat transactions or arrangements having a particular patterns as RTOs. The bright line tests (as set out in the current MBLR 14.06(6)(a) and (b) / GLR 19.06(6)(a) and (b)) refer to two specific forms of transactions or arrangements as follows:

(a)  an acquisition or a series of acquisitions of assets constituting a very substantial acquisition where there is or which will result in a change in control (as defined in the Codes on Takeovers and Mergers and Share Buy-backs (the “Takeovers Code”)) of the listed issuer; or

(b)  very substantial acquisition(s) of assets (individually or in aggregate) from the new controlling shareholder and/or any of its associates within 24 months following a change in control (as defined in the Takeovers Code).

• In connection with the bright line test, currently, MBLR 14.92 / GLR 19.91 provides that a listed company may not dispose of its existing business for a period of 24 months after a change in control unless the assets acquired from the person or group of persons gaining such control or his/her/their associates and any other assets acquired by the listed issuer after such change in control can meet the trading record requirement of MBLR 8.05 / GLR 11.12A. Where a disposal by a listed issuer does not meet this requirement, the listed issuer will be treated as a new listing applicant.

• Under the Exchange’s proposals, the bright line tests under the current regime will be retained. The aggregation period in the current MBLR 14.06(b) / GLR 19.06(b) will be extended from 24 months to 36 months.

• The Listing Rules will also be 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 injection(s) from the new controlling shareholder (and its associates) and any other person(s) are able to meet the listing requirements under MBLR 8.05, 8.05A or 8.05B / GLR 11.12A or 11.14. Under the proposed regime, the Exchange will also be provided with a discretion to apply the modified MBLR 14.92 and 14.93 (which will be codified and appear as MBLR 14.06E) (or the modified GLR 19.91 and 19.92 (which will be codified and appear as GLR 19.06E for GEM issuers) to a 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 the single largest substantial shareholder of the issuer.

• Under the current regime, paragraph 8 of GL78-14 provides that a transaction would be treated as an extreme very substantial acquisition (the “Extreme VSA”) where the Exchange considers it “extreme” by reference to the six assessment criteria, but the assets to be acquired can meet the minimum profit requirement under MBLR 8.05 (or the positive cash flow requirement under GLR 11.12A for GEM issuers). In the scenario of such Extreme VSAs, the Exchange does not regard circumvention of new listing requirements would be a material concern, and these Extreme VSAs are presented to the Listing Committee for its decision.

• Under the proposed amendments, the Extreme VSA will be renamed as “extreme transactions”, and the current extreme VSA requirements in GL78-14 will be codified into the Listing Rules.

• Two additional requirements will be imposed for issuers who wish to rely on the extreme transaction category to avoid the acquisition transactions from being treated as a RTO:

(a)  the issuer has been operating a principal business with substantial size which will continue after the transaction (as a general guidance, this may include a principal business with annual revenue or total asset value of HK$1 billion or more, excluding any revenue or assets not attributable to the issuer’s original principal business); or

(b)  the listed issuer has been under control of a large business enterprise for a long period of time (normally not less than three years), and the transaction forms part of a business restructuring of the group and would not result in a change in control.

• Further, under the proposed amendments, issuers proposing an extreme transaction must (a) comply with the disclosure requirements applicable to a new applicant; and (b) appoint a financial adviser to perform due diligence on the assets subject to the acquisitions who is required to submit a declaration for the due diligence conducted.

• Under the proposed amendments, additional requirements as follows will be imposed and applicable to transactions classified as RTOs and extreme transactions:-

(a) Both the acquisition target(s) and the enlarged group must be suitable for listing (pursuant to MBLR 8.04 / GLR 11.06).

(b) The acquisition target(s) must also meet MBLR 8.05 (or 8.05A or 8.05B) / GLR 11.12A (or GLR 11.14)).

(c) In case an issuer has failed to comply with MBLR 13.24 / GLR 17.26) regarding its sufficient operations, each of the acquisition target(s) and the enlarged group must meet all the new listing requirements of Chapter 8 MBLR / Chapter 11 GLR.

• The current Listing Rules requires an issuer proposing a RTO to comply with the procedures and requirements for new listing applications as set out in Chapter 9 MBLR / Chapter 12 GLR. Where the RTO involves a series of acquisitions, both the completed acquisition(s) and the proposed acquisition forming part of the RTO are subject to documentary requirements, including the production of accountants’ reports and pro forma financial information. As these acquisitions may have taken place over a few years, the current Listing Rules do not provide guidance on how the track record of the acquisitions would be determined and the financial information to be presented.

• Under the proposed regime, a new MBLR 14.57A / GLR 19.57A will be introduced: where a RTO or extreme transaction involves a series of acquisitions, the circular or listing document must contain pro forma income statement (or pro forma cash flow statement for GEM issuers) of all the acquisition target(s) in the series of acquisitions for the track record period, which would be referenced to the latest proposed transaction covering three financial years (and two financial years for GEM issuers) immediately prior to the issue of the circular or listing document.

• Under the current practice set out in Guidance Letter GL84-15 (“GL84-15”), where the Exchange considers that a proposed fundraising would involve investors injecting substantial amounts of cash into an issuer and result in the issuer’s assets consisting substantially of cash upon completion, the cash company rules (MBLR 14.82 to 14.84 / GLR 19.82 to 19.84) would apply, and under MBLR 14.82 (or GLR 19.82 for GEM issuers), the issuer would not be regarded as suitable for listing and trading in its securities would be suspended. MBLR 14.84 / GLR 19.84 would require the issuer to comply with all new listing requirements and issue a listing document to lift the trading suspension.

• The practice set out in GL84-15 will be codified as the proposed MBLR 14.06D / GLR 19.06D under which the Exchange may refuse to grant listing approval for a large scale issue of new shares where the proceeds are raised to acquire and/or develop a new business through future acquisitions in addition to greenfield operations as described in GL84-15 which, in the opinion of the Exchange, is a means to circumvent the new listing requirements and to achieve a listing of that new business.  The rule, however, will not normally apply to an issue of securities if, taking into account the proceeds from the issue, less than half of the issuer’s assets would consist of cash as a result of the fundraising, unless there are specific concerns about circumvention of the rule.