Introduction

On 31 October 2022, the Securities and Futures Commission of Hong Kong (“SFC”) issued a circular regarding virtual assets (“VA”) ¹futures exchange traded funds (the “Circular”). The Circular sets out the requirements under which the SFC may consider authorising exchange-traded funds (“ETFs”) that obtain exposure to VAs primarily through futures contracts (“VA Futures ETFs”) for public offering in Hong Kong under sections 104 and 105 of the Securities and Futures Ordinance (“SFO”).
As noted in the Circular, the SFC is prepared to accept applications for authorisation of VA Futures ETFs. The SFC will keep in view and closely monitor the development of the VA market and its regulatory landscape regarding the appropriateness of authorisation of ETFs that invest directly in spot VAs.
The Circular was published soon after the Hong Kong government issued a policy statement on the development of VA (the “Policy Statement”) relating to, among others, non-fungible token issuance, green bond tokenisation, and e-HKD (see our news update on the Policy Statement here).

Key Authorisation Requirements for VA Futures ETFs

General Requirements
VA Futures ETFs seeking SFC authorisation to enable the public offering of interests in Hong Kong should meet the applicable requirements in the Overarching Principles Section and the Code on Unit Trusts and Mutual Funds in the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products.

Additional Requirements
VA Futures ETFs which seek SFC authorisation for public offering in Hong Kong shall meet additional requirements set ou the Circular as summarised below:

Management Companies
The management company of a VA Futures ETF must have (i) a good track record of regulatory compliance; and (ii) demonstrate at least three years of proven track record in managing ETFs. The SFC will also consider relevant experience in managing the same or similar type of products from the group of companies to which the management company belongs. The SFC may also consider accepting delegation or co-management of a VA Futures ETF, provided that the management company in the case of delegation or at least one of the management companies in the case of co-management complies with the relevant requirements.

Eligible Futures
Only VA futures traded on conventional regulated futures exchanges are allowed, subject to the relevant management company demonstrating (i) the relevant VA futures have adequate liquidity for the operation of the VA Futures ETF; and (ii) the roll costs of the relevant VA futures contracts are manageable which includes how roll costs will be managed. Initially, only Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange will be permitted. The SFC shall consider expanding the scope of eligible VA futures markets in the future as appropriate.

Investment Strategy
The management company of a VA Futures ETF is expected to adopt an active investment strategy to allow flexibility in portfolio composition (such as diversification of futures positions with multiple expiry dates), rolling strategy and handling of any market disruption events. The net derivative exposure of a VA Futures ETF shall not exceed 100% of the total net asset value of the relevant ETF.

Disclosure
The product key facts statement of a VA Futures ETF should contain upfront disclosure of the investment objective and key risks associated with investment in VA futures contracts, including (1) risks concerning potentially large roll costs of VA futures; and (2) operational risks, such as margin risk and risk associated with mandatory measures imposed by relevant parties.

Distribution
Since VA Futures ETFs are derivative products and VA-related products, intermediaries are subject to the applicable requirements under the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”) and related guidelines including the Joint Circular on Intermediaries’ Virtual Asset-Related Activities (the “Joint Circular”) issued by the SFC and the Hong Kong Monetary Authority in January 2022 (see our news update on the Joint Circular here). In particular, intermediaries shall comply with the existing conduct requirements for derivative products as set out under paragraphs 5.1A and 5.3 of the Code of Conduct, as well as the VA-knowledge test requirement.

Investor Education
The management company of a VA Futures ETF should carry out extensive investor education before launching the VA Futures ETF in Hong Kong.

Please contact our Partner Mr. Rodney Teoh and associate Mr. Calvin KW Lo for any enquiries or further information. Rodney would like to thank Ms. Adrienne Leung (Intern) for her contribution to this news update.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

¹ VA refers to digital representations of value, which may be in the form of digital tokens, such as utility tokens, stablecoins, security-backed tokens or asset-backed tokens, or any other virtual commodities, crypto assets or other assets of the same nature, irrespective of whether or not they amount to “securities” or “futures contracts” as defined under the SFO but excludes digital representations of fiat currencies issued by central banks.

On 30 August 2022, our Partner Gordon Tsang and Associate Gary Kwok were invited by LexOmnibus to give a CPD course on the topic “Rules and Recent Developments on Special Purpose Acquisition Companies”.

Special Purpose Acquisition Companies (“SPAC”) is a new listing regime in Hong Kong. It allows SPAC promoters to source target companies with potential in listing for merger and acquisition to acquire a listing status through an unconventional initial offering.

During the 3-hour webinar, Gordon and Gary gave an in-depth introduction to the listing requirements of traditional IPOs and SPAC, as well as the De-SPAC Transaction and De-Listing Mechanism of SPAC. They also compared the SPAC listing requirements between the U.S., Hong Kong and Singapore. Lastly, they concluded the course by discussing the advantage and potential risks of SPAC Listing in Hong Kong.

Due to the pandemic, the course was delivered via a webinar, and positive feedback was received from the audience.

Please contact Partner Gordon Tsang for any enquiries or further information about this course.

Background

On 2 August 2022, The Securities and Futures Commission (the “SFC”) published an Agenda for Green and Sustainable Finance (the “Agenda”) outlining its further steps to support Hong Kong’s role as a regional green finance centre. The SFC will continue supporting the development of green and sustainable finance in Hong Kong and the transition to a greener economy through enhancing the quality of information available, increasing transparency and building trust for investors. The three main areas of focus are:

(1) Enhancing corporate disclosures;
(2) Monitoring the implementation of and enhancing existing measures relating to environmental, social and governance (ESG) funds and expectations for fund managers; and
(3) Identifying an appropriate regulatory framework for any proposed carbon markets.

Corporate disclosures

In relation to disclosures, the SFC is strongly aligned with the approach adopted by the International Organization of Securities Commissions (“IOSCO”) and acknowledges how the International Sustainability Standards Board (“ISSB”) could set out a path, with its proposed climate standard, which is built on the Task Force on Climate-related Financial Disclosures (“TCFD”) framework, forming a comprehensive global baseline for climate-related disclosures. The SFC shall continue to support the work of the new ISSB and sustainability disclosures more generally, including:

• Continuing to work with The Stock Exchange of Hong Kong Limited (“SEHK”) on a proportionate approach to corporate disclosure requirements that are aligned with global baseline standards.
• Working with other Cross-Agency Steering Group (“CASG”) members to consider how the requirements in the new ISSB climate standard Exposure Drafts could be adopted as part of Hong Kong’s domestic reporting framework.
• Engaging with the China Securities Regulatory Commission (“CSRC”) on the use of the ISSB climate standard to enhance cross-border consistency.
• Continuing to participate in the work of IOSCO on corporate sustainability disclosures.

In particular, a SFC-SEHK joint working group will continue to examine the readiness of listed companies to report under the proposed ISSB climate standard and the challenges faced by them, and to consider a framework aligned with the ISSB climate standard for Hong Kong. Other longer-term considerations include the digitalisation of climate reporting information, capacity building needs, and the development of an assurance framework in Hong Kong.

Internationally, the SFC will continue to participate in IOSCO’s work on reviewing the ISSB Exposure Drafts and considering assurance issues, as well as monitoring the work being done by the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) Workstream on bridging the data gaps.

Monitoring the implementation of and enhancing existing measures

Asset management

The SFC has implemented measures to require fund managers to take climate-related risks into consideration in their investment and risk management processes as well as to make appropriate disclosures to meet investors’ demand for climate risk information and to combat greenwashing. Going forward, the SFC will continue to monitor the implementation of the measures and seek to enhance regulatory supervision in order to align with international regulatory development trends, including (i) continuing to consider the issues concerning the data underpinning asset manager disclosures, and (ii) maintaining regular dialogues with the industry to monitor the progress of licensed fund managers’ incorporation of new climate-related risks conduct and disclosure requirements, and provide the necessary clarification and guidance to the fund managers.

ESG funds

The SFC will continue to monitor ESG funds’ compliance with the requirements set out in its June 2021 circular. It will also continue its engagement with stakeholders, including hosting industry workshops to provide guidance, as well as working with the Investor and Financial Education Council (“IFEC”) to enhance investors’ awareness of ESG funds.

Taxonomy

One of the CASG’s action points is to aim for the adoption of the Common Ground Taxonomy (“CGT”) in Hong Kong. As a member of both the International Platform on Sustainable Finance (“IPSF”) and its Working Group on Taxonomies, the SFC will continue to monitor developments in this area, with a view to considering how the adoption of the CGT could complement the SFC’s existing regulatory and supervisory measures.

Education and training

Effective investor protection must include measures to educate investors. The SFC will continue to work with the IFEC to support investor education in this field, through regular updates via online and social media platforms, publicity campaigns, press events, public talks and stakeholder collaborations. The SFC will also continue to support the CASG’s efforts in relation to the GSF Centre and to contribute to IOSCO’s capacity building work, both through the IOSCO’s Sustainable Finance Task Force (“STF”) workstream on promoting good practices and the IOSCO Asia-Pacific Regional Committee (APRC).

Technology and innovation

The SFC will continue to work with other CASG members and stakeholders to facilitate the development of technologies to support green and sustainable finance initiatives locally, regionally and internationally. In particular, there is a plan to create a free and publicly accessible greenhouse gas (GHG) emissions estimation tool, with clearly-disclosed methodologies, that companies can use as an alternative source of information.

Regulatory framework for carbon markets

Hong Kong has a strategic role in adding value to carbon market development. There are two key types of carbon markets – voluntary carbon markets (“VCM”) and compliance markets or emissions trading schemes (“ETS”). At present, ETS only cover a small part (around 16%) of total global emissions. For corporates that do not fall under ETS, VCM may enable them to neutralise their emissions as they work on emissions reduction, and help channel capital to underlying projects to generate carbon credits. The SFC will focus on identifying the appropriate regulatory framework for the proposed business models. In addition, the SFC will continue to participate in the IOSCO STF’s carbon market workstream, with a view to supporting international developments in the transition to a greener global economy and considering the relevance of such developments to Hong Kong.

Analysis and takeaways

Jurisdictions worldwide have sought to respond to the urgent need to address the impact of climate change. Environmental issues have become a key focus for governments in different countries and it is recognised that private sector investment is vital to help fund the move towards a greener global economy. The SFC has been at the forefront of efforts to develop an effective regulatory framework for green finance in Hong Kong. The Agenda aims to enhance the quality of information available, increase transparency and build trust for investors, thereby supporting investment flows into sustainable projects that will drive forward net zero targets.

Please contact our Partner Mr. Rodney Teoh and Associate Ms. Angela Lau for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

1. Introduction

With increasing overseas operational activities coupled with more accommodating and flexible regulations regarding disclosure and registration procedures for issuing overseas bonds, there has been a rapid increase in offshore bond issuances from China in the past decade. These offshore bonds from PRC enterprises can be denominated in renminbi or other currencies (such as US dollars and euros), though US dollar bonds account for the largest portion. Furthermore, as shall further discussed below, they can be issued directly by Chinese domestic enterprises as well as their offshore subsidiaries or branches.

2. Hong Kong’s offshore bond market

Hong Kong’s debt capital market has experienced steady growth over the years. Mainland entities’ offshore offerings by Mainland authorities and private Mainland issuers have been one of the key drivers, with new issues amounting to almost RMB60 billion of bonds in the offshore renminbi market in 2021. In particular, Shenzhen Municipal Government was the first Mainland municipal government to issue RMB5 billion offshore multi-tranche bonds on The Stock Exchange of Hong Kong Limited (the “Exchange”) in 2021 ¹. In the past decade, China’s offshore bond issuance has grown exponentially with China responsible for almost 38% (or USD711 billion) of the Asia-Pacific international USD corporate bond market oustandings in 2020. The issuance showcases that Hong Kong keeps on striving to be a leading bond hub in Asia.

3. PRC regulations on offshore bond offering

We summarise the major PRC regulations governing offshore bond offerings as follows:

3.1. National Development and Reform Commission (“NDRC”) Regulations

Pursuant to “Notice of the National Development and Reform Commission on Promoting the Administrative Reform of the Recordation and Registration System for Enterprises’ Issuance of Foreign Debts” (《国家发展改革委关于推进企业发行外债备案登记制管理改革的通知》) issued in September 2015 by the NDRC, PRC enterprises and/or its respective offshore subsidiaries are required to register with the NDRC and obtain the registration certificate prior to the offshore bond offering, setting out the currency, volume, interest rate and planned usage of proceeds, among other details. Also, there are subsequent reporting requirements for filing information on the bond issuance with the NDRC within 10 working days after each offering, where issuers must demonstrate a good credit record, sound corporate governance and risk control systems, along with sufficient debt repayment ability without defaulting on existing obligations.

3.2. Regulations of the State Administration of Foreign Exchange (“SAFE”)

SAFE rules were amended in 2014 to allow for greater flexibility in encouraging PRC entities to seek offerings offshore. Prior restrictions on onshore entities guaranteeing offshore bond offerings were lifted and prior approval from SAFE was no longer required. Instead, the PRC parent company is only subject to the registration requirement that they shall file and register the offshore financing agreements and/or the guaranteed agreement with the local SAFE branch within 15 days from the execution of such agreements, pursuant to “the Measures for Foreign Debts Registration and Administration” (《外债登记管理办法》).

In addition, pursuant to Article 10 of the “Notice of the People’s Bank of China on Matters concerning the Macro-Prudential Management of Full-Covered Cross-Border Financing” (《中国人民银行关于全口径跨境融资宏观审慎管理有关事宜的通知》), the PRC company shall report the information on the execution of cross-border financing agreements to SAFE for filing after the date of execution of such agreements but no later than three working days before the withdrawal date.

4. Typical transaction structure of an offshore bond issuance

The following are the four typical transaction structures typically utilised by PRC entities for issuing offshore bonds:

4.1. Direct issuance by onshore companies

Onshore PRC entities, such as state enterprises or large financial institutions, may choose to issue the bonds offshore directly. A trustee is usually appointed to hold the bonds on behalf of the investors to exercise their rights. This method contains the simplest form without seeking a cross-border guarantee.

4.2. Guarantee by onshore parent companies

Some Mainland incorporated companies choose to issue offshore bonds through its overseas subsidiaries or a special purpose vehicle (“SPV”). The onshore parent company would provide a guarantee for the performance of the bond by the offshore entity. Credit ratings of the offshore bond would usually be tied to the parent company’s rating.

4.3. Standby letter of credit issued by banks

PRC entity could also offer bonds backed by a standby letter of credit (the “SBLC”) issued by a commercial bank (the “LC bank”) to serve as a cross-border guarantee in favour of the trustee acting on behalf of the bondholders. If the issuer cannot repay the bonds, the repayment obligation is on the LC bank, who is jointly and severally liable for the principals and interests. The bond’s credit rating would link to the LC bank’s credit which generally boasts better ratings than the issuer.

Although this method is more complicated than a direct issuance, or an onshore entity’s guarantee, the SBLC allows Chinese issuers to strengthen investors’ recognition without employing additional international credit rating agencies, which allows a significant lowering of the cost and interest rate of the bond.

4.4. Keepwell deeds and equity purchase undertakings deeds

Keepwell deeds is another credit enhancement mechanism frequently employed by Chinese entities when offering offshore bonds. In a keepwell deed, the onshore parent company provides a written undertaking that the offshore subsidiary or SPV would remain solvent with sufficient credit reserves during the tenor of the bonds. Unlike serving as a regular guarantee for paying off the debt in default, it only permits creditors to demand the credit enhancement to supplement the issuer’s liquidity for bond repayment. Equity purchase undertakings (“EIPU”) may be supplemented such that, in the event of default risk, the parent company would purchase the equity interest or assets in their offshore subsidiary to cover the debt repayment.

However, in the landmark Peking University Founder Group (“PUFG”) case, the legality and enforceability of the keepwell agreements were challenged. We note that the PRC administrators in that case refused to recognise the keepwell deeds in Mainland insolvency proceedings. However, the Hong Kong Courts allowed judgment against PUFG on a declaratory basis. It is yet to be decided how the Mainland and Hong Kong Courts shall cooperate with regards to such jurisdictional challenges. For more details, please see our litigation law update on this topic here.

5. Listing of Offshore Bonds on the Exchange

There are two main types of debt offering which can be listed on the Exchange: (i) debt securities which can only be offered to professional investors under Chapter 37 of the Rules Governing the Listing of Securities on Main Board of The Stock Exchange of Hong Kong Limited (the “Listing Rules/LR”); and (ii) debt securities which can be offered to public investors in a retail offering under Chapter 22 to Chapter 36 of the Listing Rules.

In Hong Kong, Chapter 37 is typically utilised in recent years for PRC issuers, given its shorter timeframe for obtaining listing approval and the simplified disclosure requirements. Some of the key requirements under Chapter 37 and the relevant guidance letter published by the Exchange are as follows:

• The issuer must have minimum net assets of HK$1 billion (LR 37.05) and must have produced audited accounts for the 2 years before the listing application made up to a date at most 15 months before the intended date of the listing document (LR 37.06). If an issuer is (a) a Supranational or a State corporation (as defined under the Listing Rules); or (b) a company listed on the Exchange; it shall be exempted from the above requirements;
• The debt securities must be freely transferable with a denomination of at least HK$500,000 (or equivalent in other currencies) (LR 37.09), be duly authorised (LR 37.10), and comply with the law of the place where the issuer is incorporated and the memorandum and articles of association of the issuer (LR 37.11);
• A minimum issue size of HK$100 million (or equivalent in other currencies). However, the minimum issue size requirement does not apply to: (a) tap issuances; and (b) unlisted issuances under a listed Medium Term Note programme (LR 37.09A); and
• Issuer is expected to disclose: (a) the terms and conditions of the debt securities; (b) financial information of the issuer; (c) risk factors, relating to the issuer, its business and the debt securities; (d) a description of the use of proceeds from the issuance of the debt securities; (e) business disclosure on the issuer; (f) a summary of the key taxation consequences associated with dealings in the debt securities; (g) restrictions on the subscription and sale of the debt securities (if any); and (h) other material information.

Please contact our Partner Mr. Rodney Teoh for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

¹ “The Hong Kong Bond market in 2021”, March 2022, Hong Kong Monetary Authority, https://www.hkma.gov.hk/media/eng/publication-and-research/quarterly-bulletin/qb202203/fa1.pdf

Background

We note that the Stock Exchange of Hong Kong (the “Exchange”) published an information paper (the “Information Paper”) back in April 2022 outlining the amendments to the Rules Governing the Listing of Securities on the Exchange (the “Rule Amendments”) to complement the Securities and Futures Commission’s (the “SFC”) new Code of Conduct¹ provisions on the conduct of issuers and intermediaries involved in book building and placing activities. As such, this article serves as an apt refresher of the rule amendments involved. The capitalised terms used herein shall have the same meaning as defined in the Information Paper.

The Rule Amendments apply to:

(a) a placing of Equity Interests² to be listed on the Exchange, including:

• (i) a placing in connection with a New Listing³ (whether by way of a primary listing or secondary listing); and
• (ii) a placing of Equity Interests of a class new to listing or new Equity Interests of a class already listed under a general or specific mandate; and

(b) a placing of listed Equity Interests by an existing holder of Equity Interests if it is accompanied by a top-up subscription by the existing holder of Equity Interests for new Equity Interests in the issuer.

Key Rule Amendments

Transitional arrangements and effective date

The Rule Amendments will apply to listed issuers and new applicants which submit (or re-file) their listing applications on or after 5 August 2022 in respect of their proposed offerings. Main Board new applicants are reminded to observe the transitional arrangements to avoid any delay in their listing timetable.

New applicants who have submitted a listing application prior to 5 August 2022 will not be required to comply with the new requirements in the Rule Amendments before such application lapses, is withdrawn or is otherwise terminated, even if their bookbuilding, placing or allocation activities conducted in connection with their proposed offerings take place on or after 5 August 2022.

Analysis and Takeaways

As hinted in our previous news update on the relevant SFC’s new Code of Conduct proposal, the implementation of the proposal for bookbuilding code and sponsor coupling may possibly lead to a change in the executory structure of IPO deals and bring the interest of the sponsor and overall coordinator into better alignment.

The complementary and consequential Rule Amendments proposed by the Stock Exchange will allow advisers to comply with this change in structure in a more holistic manner and a clearer fashion by providing the Listing Rules based instructions to all parties involved.

Please contact our Partner Mr. Rodney Teoh and Associate Ms. Angela Lau for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

¹ The Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.
² equity securities, interests in a REIT, stapled securities and securities of an investment company (as defined in Rule 21.01)
³ has the meaning in Rule 1.01 (GEM Rule 1.01) in the Rule Amendments, that is, a new listing of Equity Interests issued by a new applicant, irrespective of whether there is an offering of Equity Interests. For the avoidance of doubt, “New Listing” includes a reverse takeover of a listed issuer which is a deemed new listing under Rule 14.54 (GEM Rule 19.54) and a transfer of listing of Equity Interests from GEM to Main Board under Chapter 9A of the Listing Rules, but does not include any other new listing of Equity Interests issued by an issuer whose Equity Interests are already listed on a stock market operated by the Exchange.
⁴ has the meaning in Rule 1.01 (GEM Rule 1.01) in the Rule Amendments, that is, any corporation or authorised financial institution, licensed or registered under the SFO that engages in specified activities under paragraph 21.1.1 of the Code of Conduct, including, without limitation, a capital market intermediary appointed pursuant to Rule 3A.33 (GEM Rule 6A.40) in the Rule Amendments. An overall coordinator is also a capital market intermediary.
⁵ Appendix 6 to the Listing Rules (GEM Rules 10.12 to 10.16B).