18 Jan 2018

HKEX Consultation Conclusions on the New Board Concept Paper

Posted by Editor

Introduction

On 15 December 2017, Hong Kong Exchange and Clearing Limited (“HKEX”) published the Consultation Conclusions on the New Board Concept Paper. Instead of creating a stand-alone board, the conclusions confirmed the previous “signals” to drop the plan and adopt an alternative by adding new chapters to the listing rules to welcome issuers from the emerging and innovative sectors. The reform will benefit weighted voting rights (“WVR”) companies, pre-revenue Biotech companies and also overseas issuers pursuing a secondary listing.

HKEX is in the process of finalising the details of the proposals, and has started drafting the proposed amendments to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the “Main Board Listing Rules”). Formal consultations on the rule amendments are expected in the first quarter of 2018.

Highlights: Proposed Way Forward

HKEX to extend the existing listing regime to allow the listing of:

issuers from emerging and innovative sectors that have WVR structures with a minimum expected market capitalisation of HK$10 billion at the time of listing; and

pre-revenue Biotech issuers with a minimum expected market capitalisation at the time of listing of HK$1.5 billion.

HKEX to create a new concessionary secondary listing route, to attract overseas issuers, especially issuers with a “centre of gravity” in Greater China (“Greater China Companies”), from emerging and innovative sectors that have a primary listing on either the NYSE, NASDAQ or on the “premium listing” segment of the LSE’s Main Market

HKEX to issue a guidance letter on the characteristics to be used for defining “innovative” companies to provide guidance to the market. The guidance letter would be applicable to issuers with WVR structures or issuers going for the new concessionary secondary listing route.

Issuers with a WVR Structure

HKEX proposes to allow the listing of high growth and innovative companies with WVR structures. The main entry requirements are set out below:

Entry Requirements for Issuers with a WVR Structure

Financial Requirements

has a minimum expected market capitalisation of HK$10 billion
if below HK$40 billion of market capitalisation, meets higher revenue test of HK$1 billion in the most recent audited financial year

Eligibility and Suitability Requirements

Success – has a track record of high business growth as measured by operations, users, customers, unit sales, revenue, profits, market value, etc., with a continuing trajectory
Nature – fits the definition of an “innovative” company (please refer to the section “Definition of ‘New Economy’” below)
Contribution of WVR Holders – each WVR holder must have been materially responsible for the growth by way of skills, knowledge or strategic directions
Responsibility of WVR Holders – each WVR holder must have an active executive role and assume the role of directors at the time of listing
External Validation – issuer must have received meaningful third party funding from sophisticated investors, who must retain 50 percent of their investment at time of listing for at least six months after the IPO
Eligibility and Suitability requirements will be evaluated on a principled basis, and satisfaction of above characteristics on superficial basis will not automatically ensure suitability for listing
HKEX may reject issuers with extreme case of non-conformance with governance norms (e.g. ordinary shares with zero voting rights)

Safeguards

Issuers must have suitable shareholder’s protection mechanisms (please refer to the box “Safeguards over WVR” below)

Since companies with WVR structures potentially carry additional risks to investors, the following safeguards will be put in place (note that this WVR safeguards are mostly exempted if the issuers are eligible in the concessional secondary listing route discussed below):

Safeguards over WVR

Ring-fencing:

Only new applicants may list with a WVR structure. After listing, issuers will be prohibited from increasing the proportion of WVR in issue or issue more WVR shares.

Eligible persons only:

Beneficiaries of WVR will be restricted to those who are directors of the issuer. The WVR attached to a beneficiary’s shares will lapse permanently if he (i) ceases to be a director; (ii) dies or is incapacitated; or (iii) if the shares are transferred to another person. WVR holders will also be subject to a minimum equity threshold at IPO.

Limits on WVR powers:

The rights attached to WVR shares and ordinary shares must be the same in all aspects other than voting rights, and the voting power attached to WVR shares must be capped to not more than 10 times of the ordinary shares. Non-WVR shareholders must hold at least 10% of the votes eligible to be cast at general meeting. Certain key governance matters are to be determined on a “one-share, one-vote” basis.

Enhanced disclosures:

Appropriate warnings will be included in the issuer’s corporate communications. The listing documents must contain warning language and a full description of the issuer’s WVR structure, rationale and associated risks must be disclosed.

Enhanced corporate governance:

Issuers with a WVR structure are required to have a corporate governance committee consisting of independent non-executive directors. A compliance advisor is also required to be engaged on a permanent basis.

Constitutional backing:

The prescribed safeguards must be incorporated into the issuer’s constitutional documents to allow private legal actions taken against breach of the safeguards.

Anti-avoidance and Enforcement:

Anti-avoidance provisions will be added to the Main Board Listing Rules to prevent the circumvention of the prescribed WVR safeguards. A breach of the WVR safeguards to be built into the Main Board Listing Rules by WVR issuers will be enforced in the same way as any other breach of the Main Board Listing Rules by any listed issuer.

Listing of Pre-revenue Biotech Issuers

To widen market access, HKEX proposes to facilitate the listing of pre-revenue new economy companies, but this would be limited to Biotech issuers for the time being. Pre-revenue biotech issuers should meet the following requirements:

Entry Requirements for Pre-revenue Biotech Issuers

has a minimum expected market capitalisation of HK$1.5 billion
essentially engages in research and development (“R&D”) to develop new and innovative products, processes and technologies
has unique features of innovation or intellectual property that reasonably expected to give rise to commercialisable patents, copyrights, etc.
has at least one product, process or technology beyond the concept stage
has as its primary reason for listing the raising of funds for R&D to commercialise its products, processes or technologies
has a portfolio of durable patents, registered patents
has previously received investment from at least one sophisticated investor (including financial institutions)
meets the enhanced working capital requirements (125% of the issuer’s current requirement over the next 12 months)
has two years’ record of operations in the current business
provides enhanced risk disclosures to inform investors of the business and R&D risks
meets the minimum initial public float requirement for listing (i.e. 25%) without taking into account the shares held by cornerstone investors

HKEX will continue to look at whether other types of new economy companies may also be permitted to list under the pre-revenue regime.

Concessionary Route to Secondary Listing

HKEX aims to widen the market for secondary listings by creating a new concessionary route for secondary listing requirements in addition to the existing route currently in the Main Board Listing Rules and the 2013 Joint Policy Statement (“2013 JPS”). The new concessionary route targets overseas issuers from emerging and innovative sectors that have a primary listing on a Qualifying Exchange (as defined below). Greater China Companies, currently not allowed to secondary list with HKEX, will be able to apply through the new concessionary route for secondary listing as long as it satisfies the relevant requirements.

Issuers satisfying the requirements below may consider a secondary listing on the new concessional route:

Entry Requirements for the Concessional Secondary Listing Route

has a minimum expected market capitalisation of HK$10 billion
if below HK$40 billion of market capitalisation and with a WVR structure and/or a centre of gravity in Greater China (as defined in the 2013 JPS), meets higher revenue test of HK$1 billion in the most recent audited financial year
fits the definition of an “innovative” company (please refer to the section “Definition of ‘New Economy’” below)
is primary listed on a Qualifying Exchange (Either a Recognised US Exchange (e.g. the NYSE and NASDAQ) or the “premium listing” segment of the LSE’s Main Market)
has two years’ record of good compliance

In light of the above, HKEX has classified companies seeking secondary listings in Hong Kong into three categories:

Grandfathered Greater China Companies – Greater China Companies that are primary listed on a Qualifying Exchange on or before the publication of the Consultation Conclusions
Non-Grandfathered Greater China Companies – Greater China Companies that are primary listed on a Qualifying Exchange after the Consultation Conclusions
Non-Greater China Companies – Companies that are not Greater China Companies

Equivalence Requirement
It will not be necessary for Grandfathered Greater China Companies and Non-Greater China Companies to demonstrate Hong Kong equivalent shareholders protection standards (“Equivalence Requirements”) by amending constitutional documents. They will only be required to comply with the Key Shareholder Protection Standards set out in the 2013 JPS (which will be written into the Main Board Listing Rules), such as a super-majority vote of members required to approve of fundamental matters, and issuers must hold an AGM at least every 15 months.

WVR Structures
Furthermore, both Grandfathered Greater China Companies and Non-Greater China Companies with a WVR structure are eligible to be secondary listed in Hong Kong without the need to change their WVR structures or meet the proposed WVR safeguards (as set out in the section “Issuers with a WVR Structure” above), apart from disclosure requirements.

Non-Grandfathered Greater China Companies
Non-Grandfathered Greater China Companies will not be granted concessions regarding Equivalence Requirements and WVR Structures granted to Grandfathered Greater China companies and Non-Greater China companies

The requirements for the three types of potential candidates under the concessional secondary listing route are briefly summarised as follows:

	Grandfathered Greater China Companies AND Non-Greater China Companies	Non-Grandfathered Greater China Companies
*Shareholder protection standards*	Required to comply with the Key Shareholder Protection Standards (to be written into the Main Board Listing Rules)	Required to change constitutional documents (as necessary) to meet equivalent standards
*WVR structures* *(if applicable)*	No need to meet WVR safeguards nor change WVR structure to meet primary listing requirements	Must meet WVR safeguards and WVR structure must conform with primary listing requirements

Definition of “New Economy”

At present, HKEX considers that an “innovative” company would normally contain more than one of the following characteristics:

has been successful due to the application of new technologies, innovations, or business models in the core business
has R&D as a significant contributor to value and also as a major activity and cause of expense
has had its success demonstrably attributable to unique features of innovation / intellectual property
has an outsized market capitalisation or intangible asset value relative to tangible value

HKEX proposes to issue a guidance letter on the characteristics to be used for defining “innovative” companies to provide guidance to the market, as opposed to putting in place a fixed definition.

Implications

The question of dual class shares and pre-revenue companies have been contentious issues, being intricately tied with HKEX’s initiatives in maintaining competitiveness compared to other prominent exchanges. Many market players have long anticipated a way forward for the issue, and may have wished that the regulators lead the market to a broad consensus sooner rather than later.

Nevertheless, the blueprint just released sets out a robust framework and is in many ways a commendable effort. HKEX has taken a measured approach in drawing out the parameters of the initial target companies, which is appropriate, as balancing market development and shareholders’ protection has always been a challenge in Hong Kong.

A consensual framework that works to make Hong Kong a realistic listing venue for new economy companies while giving the regulators a suitably firm grip on the reins will always be a difficult task. With this encouraging first step towards liberalisation, we look forward to seeing our market grow in prosperity and diversity.

This newsletter 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.

Please contact our Eric Lui or Rodney Teoh for any enquiries or further information.