The January, 2020 SFC licensing circular suggests some activities undertaken by private equity firms may trigger SFC licensing obligations
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Hong Kong is an international financial center with deep capital markets tied to China. Total equity funds raised through initial public offerings (“IPOs”) in 2010 exceeded US$57 billion, ranking the Stock Exchange of Hong Kong (“SEHK”) as the global leader in equity fund raising through IPOs. By comparison, in the same year, total equity funds raised through IPOs on the New York Stock Exchange and Stock Exchange of London was less than US$35 billion and US$16 billion, respectively.
Companies around the world outside of the Greater China region are increasingly looking towards Hong Kong as a listing venue, particularly where such companies have significant China operations. In 2010, Russian aluminum maker United Co. Rusal and French cosmetics company L’Occitane listed on the SEHK. In 2011, commodities producer Glencore listed on the SEHK and luxury fashion house Prada and baggage maker Samsonite have, as of writing, already begun the listing process.
For shareholders, listing brings more liquidity and increased freedom to deal with their shareholding interest.
For a company, a listing means greater public scrutiny and accountability, some loss of control and flexibility with the introduction of public shareholders as well as ongoing costs (both in terms of management time and money) to comply with regulatory requirements. However, a listing brings a number of advantages to the company:
Access to Capital. Listing facilitates access to capital, both locally and overseas. The prospect of listing is attractive to private equity investors who, in the period of months and years prior to a listing, often take an equity interest in potential listed companies. Moreover, the actual listing itself is a capital raising process. Finally, listing brings access to a broader range of opportunities for future financing and facilitates exposure to a wider range of investors.
Enhanced Ability to Recruit and Retain Employees. Listing enhances opportunities for employee compensation through share options which can, in turn, enhance the ability the recruit and retain employees.
Improved ability to complete mergers and acquisitions. Listing enables a company to complete mergers and acquisitions, both through share swaps and through the ability to raise funds required to complete deals through the sale of additional equity.
Higher Profile and Greater Prestige. Listing will often increase a company’s exposure to the public and can enhance credibility and prestige.
Hong Kong is widely perceived as the financial gateway to China and China is widely perceived as the next economic superpower. While markets in Shanghai and Shenzhen remain in many ways closed to international investors, the Hong Kong market enjoys a broad international base of investors who have historically welcomed companies with a strong China story, whether in the form of a strong brand presence in China or strong levels of business with China. At the same time, there is growing evidence that the Hong Kong market may serve as the gateway for international companies to tap the Chinese capital markets.
Hong Kong offers a legal and regulatory framework that is both balanced and credible:
Broadly, to qualify for listing on the Main Board of the SEHK, a company must satisfy the SEHK that it and its businesses are suitable for listing and, unless waived or modified by the SEHK, the company must have a track record that meets prescribed benchmarks.
There is no single test of suitability. However, where a company fails to comply with laws and regulations and such non-compliance may affect the viability of the business of the company, it is unlikely that the SEHK would regard the company as being suitable for listing.
Similarly, where a company is unable to carry on its business independently, the SEHK is unlikely to regard the company as being suitable for listing. Thus, for example, the SEHK may regard as unsuitable a company which relies predominantly on a single customer or a single supplier, particularly where this reliance is expected to continue post-listing and such reliance is unusual within the company’s industry. Equally, for example, the SEHK may regard as unsuitable for listing a company which relies on support from a related party.
A company whose assets consist wholly or substantially of cash or short-dated securities (such as bonds, bills or notes which have less than one year to maturity), will not normally be regarded as suitable for listing except where the company is an investment company (i.e. a collective investment scheme) or the company or group is solely and mainly engaged in the securities brokerage businesses.
To meet SEHK minimum track record requirements, a company must satisfy one of three tests, namely the “profits test”, the “market capitalization/revenue/cash flow test”, or the “market capitalization/revenue test”.
Under each test, the company (or its group) must have been under substantially the same ownership for at least the most recent audited financial year and must have a trading record of not less than three years under substantially the same core management. Whether or not the company meets these requirements for management and ownership continuity depends in practice in part on whether the SEHK considers that it and investors are able to make an informed assessment of the ability of company management to manage the business and the likely performance of that business in the future.
However, the SEHK has agreed to relax the requirement for management continuity and trading record in a number of cases.
A first and critical step for a company in the IPO process is to assemble a team of professionals and to assign executives within the company to work with these professionals. The executives should have sufficient seniority to facilitate the flow of information between these professionals and the company and to make decisions concerning structural issues.
Separate law firms should advise the prospective company on the one hand and the sponsor and underwriter on the other.
Lawyers for the company play a key role in advising on and implementing any pre-IPO restructuring of the company’s group and negotiating any pre-IPO investments. They will advise the company on the SEHK Listing Rules and laws applicable to the listing and the share offer and will draft the listing application and the prospectus (known as a listing document). They will negotiate the underwriting agreement and provide the company with crucial independent advice.
Lawyers for the sponsor will advise the sponsor so as to enable it to discharge its regulatory obligations. They will play a key role in the sponsor’s due diligence of the company, checking the company’s compliance with the SEHK Listing Rules and leading the process of verifying the listing document. Where the sponsor acts as an underwriter, they will represent the sponsor in negotiating the underwriting agreement.
If the listing includes an offering in jurisdictions outside Hong Kong, lawyers qualified in those jurisdictions should advise on requirements in those jurisdictions. If the company is incorporated outside of Hong Kong, lawyers qualified in that jurisdiction should advise on corporate matters applicable in that jurisdiction. If the company has business activities in jurisdictions outside of Hong Kong, lawyers qualified in those jurisdictions should assist with local due diligence and advise on local legal and regulatory requirements affecting the listing (e.g. companies with business activities in China may be required to obtain state approvals).
The company’s sponsor advises the company on the structure, timing and pricing of the IPO. It liaises with the SEHK and in this regard, it lodges the formal listing application and all supporting documents with the SEHK and deals with the SEHK on all matters arising in connection with the application.
The sponsor owes particular regulatory duties to the SEHK. It must assess the suitability of the company for listing and the SEHK expects the sponsor to conduct due diligence to satisfy itself that:
The sponsor will often serve as the lead underwriter for the securities which are the subject of the offer and listing and accordingly, as the key distributor of these securities. As an underwriter, it will be responsible for subscribing for any securities which are not sold under the offer. The SEHK reserves the right to reject a listing application where it is not satisfied that an underwriter will be able to meets its underwriting commitment.
Typically, the sponsor is an SFC regulated investment bank independent of the company applying for listing.
Following listing, a company must appoint a compliance adviser to assist the company in complying with the SEHK Listing Rules. A sponsor may serve as the compliance adviser but frequently, this role is undertaken by a different SFC regulated investment bank.
The listing document must include an accountant’s report containing, amongst other things, the company’s financial results, a balance sheet, a cash flow statement and a statement of changes in equity. The report must be prepared to a standard comparable to that required in Hong Kong or under International Standards on Auditing or China Auditing Standards.
The accountants must be qualified under Hong Kong law for appointment as auditors of a company to be listed. However, in the case of a PRC company, the SEHK may accept accountants approved by the China Ministry of Finance and the China Securities Regulatory Commission. The accountants must be independent of the company.
Other parties to a listing will include (i) the registrar, who will maintain the register of shareholders, (ii) property valuers, who will prepare the valuations of the company’s interest in land and buildings as required by the SEHK Listing Rules, (iii) receiving bankers, who receive and process share applications, (iv) printers, and (v) pubic relations firms.
Ahead of listing, a company will often undergo a reorganization, not only to ensure compliance with the SEHK Listing Rules but also to ensure that the structure of the business meets public market expectations. Broadly, a pre-IPO reorganization will involve a reorganization of the corporate group, changes in corporate governance and internal controls and a restructuring of the capital structure of the company.
A company applying for listing must be incorporated in Hong Kong or a jurisdiction where the standards of shareholder protection are at least equivalent to those provided in Hong Kong. Thus, as part of a pre-IPO reorganization, the company’s lawyers will consider the holding structure of the company’s business with a view to determining which legal entity in which jurisdiction will list.
It is common to create a new top level holding company in a jurisdiction which is known to be acceptable to the SEHK to serve as the listing vehicle. Overseas jurisdictions which are expressly permitted under the SEHK Listing Rules include Bermuda, the Cayman Islands and the PRC.
However, it may be nevertheless be possible to list a company which is incorporated neither in Hong Kong nor these jurisdictions. In this case, the company will need to demonstrate that the company laws in the jurisdiction of its incorporation afford protection equivalent to that available in Hong Kong. Where applicable company laws do not, the SEHK may nevertheless accept the jurisdiction if the company amends its constitutional documents to provide equivalent protection. As of the date of this guide, the SEHK has also accepted Australia, the British Virgin Islands, Canada (Ontario and British Columbia), Cyprus, Germany, Jersey, Luxembourg, Singapore, Italy and the UK.
Depending on location, overseas companies may be restricted to an extent from listing on the SEHK due to local regulations. In particular, companies incorporated in the US should consult local legal advice on possible domestic securities law issues.
Apart from deciding which legal entity to list, a company should consider its group structure, including which business divisions to include in the listing and how business operations should be divided amongst legal entities. Most significantly, a company should consider (i) whether the inclusion or exclusion of certain businesses may positively or negatively affect the ability to market the securities offer and to comply with track record and other requirements under the SEHK Listing Rules, and (ii) whether the business to be listed is capable of operating independently of its controlling shareholders. It may be desirable at this time to look as well at whether certain high-risk businesses should be ring-fenced and whether holding arrangements appropriate for tax efficiency in a private company context remain appropriate.
A group reorganization may involve the incorporation of new subsidiaries or holding companies, the transfer of assets from one legal entity to another, the conversion of a legal entity from one form to another and the winding-up of some legal entities. These activities may take some time to complete, particularly if third party consents are required.
Legal and regulatory considerations relevant to a pre-IPO group reorganization will include:
A company should consider whether it (together with its corporate group) has all legal and contractual rights necessary to conduct its business properly following listing and whether the arrangements it has with its employees, shareholders, suppliers and customers are appropriate. Particular attention should be given to the following:
The SEHK requires that a listed company have in place procedures, systems and controls (including accounting and management systems) which enable the company’s directors to make a proper assessment of the financial position and prospects of the company.
A company applying for a primary listing on the SEHK must have a sufficient management presence in Hong Kong. This will normally mean that at least two of its executive directors must be ordinarily resident in Hong Kong.
However, the SEHK may, at its discretion, waive this requirement for a PRC company where there are adequate arrangements for maintaining regular communication with the SEHK. In this regard, the SEHK will take into account the company’s compliance adviser’s access to the company’s authorised representatives, directors and other officers and the accessibility by the SEHK of the alternates to the company’s authorised representatives.
Directors of a listed company are collectively responsible for the management and operations of the company and collectively and individually for compliance by the company with the SEHK Listing Rules. Every director must satisfy the SEHK that he has the character, experience and integrity and is able to demonstrate a standard of competence commensurate with his position as a director of a listed company.
Directors must meet obligations both under the law and under the SEHK Listing Rules. These obligations include:
Every board of directors of a listed company must include at least 3 independent non-executive directors, at least one of whom must have appropriate professional qualifications or accounting or related financial management expertise.
Every listed company must establish an audit committee comprised only of non-executive directors. The committee should have at least 3 members, one of whom is an independent non-executive director with appropriate professional qualifications or accounting or related financial management expertise. The chairman of the committee must be an independent non-executive director.
The SEHK recommends that every listed company establish a nomination committee to make recommendations as to board appointments and a remuneration committee to make recommendations as to the remuneration of directors and senior management. The majority of the members of these committees should comprise independent non-executive directors. Listed companies who do not establish these committees are required to disclose and justify the basis for not doing so.
Generally, a listed company must have a company secretary who has the requisite knowledge and experience to discharge the functions of a secretary of the company. In this regard, the company secretary must either be a solicitor, barrister or a professional accountant, or an individual who, by virtue of his academic or professional qualifications or relevant experience is, in the opinion of the SEHK, capable of discharging those functions.
Except in the case of a PRC listed company, the SEHK generally requires that the company secretary be ordinarily resident in Hong Kong.
The SEHK requires that every listed company appoint two authorised representatives to act at all times as the company’s principal channel of communication with the SEHK. The two authorised representatives must be either two directors or a director and the company’s secretary unless the SEHK, in exceptional circumstances, agrees otherwise.
Prior to listing, a company will normally reorganize its capital structure so that its securities may be effectively marketed and efficiently subscribed to by investors. This may involve a simplification of the share capital structure into a single class of shares as well as conversion of outstanding shareholder debt into equity.
The company will wish to consider the appropriate size of the share issuance under the IPO, bearing in mind that generally, a newly listed company may not issue further shares (or issue securities convertible into shares) in the 6 month period following listing.
Broadly, all shares in a listed company should carry voting rights which bear a reasonable relationship to the equity interest represented by such shares. Thus, for example, it is not possible for controlling shareholders to hold special shares with super voting powers.
The period leading up to an IPO may see pre-IPO investments in a company to raise capital as well as to add credibility and management experience. Where these investments place pre-IPO investors in a position of advantage, they may affect the ability of the company to list.
In principle, holders of listed securities must be treated fairly and equally. Whilst there is no bright line test and each case is determined on its own merits, in general terms, the greater the level of real investment risk assumed by the pre-IPO investor (often measured by the time period between investment and listing) and the greater the benefit brought by the pre-IPO investor to the listing applicant, the more likely it is that particular rights will survive. These rights may include, for example, a right to acquire shares to be listed at a discount to the IPO price (e.g. by way of conversion at a prescribed price in the case of convertible securities) as well as the right to appoint a director and to veto certain corporate actions (such as the petitioning for a winding up, amendments to constitutional documents, declaration of dividends, the sale of a part of the company’s business and changes in directors).
Under interim guidance issued by the SEHK, in the absence of exceptional circumstances, pre-IPO investments should be completed (i.e. funds irrevocably settled and received by the unlisted company) either (i) at least 28 clear days before the date of the first submission of the first listing application form, or (ii) 180 clear days before the first day of trading of the listed company’s securities.
Listing on the SEHK is often achieved by way of an offer for subscription targeted at the retail public in Hong Kong. Such an offer may be made in conjunction with an international institutional share placement.
An offer for subscription is an offer to the public by or on behalf of a company of its own shares for subscription. In an offer for subscription, the company issues a prospectus and a form of application for shares. Investors who wish to subscribe for shares apply for shares on the form of application. An offer for subscription must be fully underwritten.
A share placement is the obtaining of subscriptions for or the sale of shares by a company or intermediary, typically an investment bank, primarily from or to persons selected or approved by the company or intermediary. Typically, the subscribers will be institutional clients of the intermediary.
The SEHK will not permit a company to be listed by way of a placing if there is likely to be significant public demand for the securities. In this regard, where, as is commonly the case, a share placement occurs in conjunction with an offer for subscription, the SEHK dictates the proportion of shares to be made available under the placing tranche and the public subscription tranche based upon the demand in the latter. As a starting point, a minimum of 10 per cent. of the shares offered in the IPO must be offered to the public subscription tranche. However, if the public subscription tranche is oversubscribed:
Conversely, where there is insufficient demand for shares in the public subscription tranche to take up the initial number of shares allocated to the public subscription tranche, shares may be allocated from the subscription tranche to the placing tranche.
For controlling shareholders, an IPO may represent an opportunity to realize some of their holdings in the listed company. The SEHK Listing Rules permit shareholders to offer their shares for sale as part of the IPO but restrict dealings by controlling shareholders both before and after listing.
The marketing of the shares to be listed is an important task both to enable compliance with SEHK requirements as to an adequate market for the shares and to raise capital. The marketing of the shares must not only comply with the SEHK Listing Rules and applicable company and securities laws in Hong Kong, but also applicable securities laws in any jurisdiction in which the shares will be sold.
In general terms, the SEHK will not grant a listing unless it is satisfied that there will be sufficient interest in the business of a company and in the securities of the company for which listing is sought.
Hong Kong company law and the SEHK Listing Rules prescribe minimum disclosures for a listing document at length and in some detail. These disclosures must include sufficient particulars and information to enable a reasonable person to form a valid and justifiable opinion of the shares to be offered under the IPO and the financial condition and profitability of the company at the time of the issue of the listing document taking into account the nature of the shares offered, the nature of the company and the nature of the persons likely to consider acquiring such shares.
In Hong Kong, both the SEHK and the SFC will review the listing document ahead of the granting of a listing.
Hong Kong company and securities laws restrict publicity of a share offer in Hong Kong. In broad terms, any publicity which could amount to an offer or invitation to the public to subscribe for or purchase shares requires prior regulatory approval. However, a company may make a limited statement to raise investor awareness of the offer shortly before the launch of the offer provided that, amongst other things, the statement does not promote the shares under offer.
The SEHK vets all publicity materials relating to a share issuance in an IPO (which excludes materials promoting the company’s products or brand) to ensure that investors acquire shares on the strength of the information in the listing document alone.
Once the SEHK has confirmed that it has no further comments on the listing document and has approved the listing application, the sponsor and the underwriter typically begin a road show to pre-market the shares under the IPO to institutional investors using the listing document (known as a red-herring prospectus) approved by the SEHK.
The SEHK vets profits forecasts, including any statement quantifying or estimating future profits or losses and any valuation of assets (other than land and buildings) based on discounted cash flows or projections of profits, earnings or cash flows. A profit forecast must be clear and unambiguous. It must be presented in an explicit manner and the principal assumptions, including commercial assumptions, upon which it is based, must be stated. These assumptions, so stated, must enable an investor to form a view as to the reasonableness and reliability of the forecast.
Furthermore, a profit forecast must be prepared on a basis that is consistent with the accounting policies normally adopted by the company. The reporting accountants must examine and report on the accounting policies and calculations for the forecast and their report must be set out in the listing document. The sponsor must be satisfied that the forecast has been made by the directors after due and careful enquiry.
Any pre-IPO research issued by the sponsor, each of the underwriters or their respective associates must not incorporate any profit forecast or other forward looking statements unless such statements are included, in substantially the same form, in the new applicant’s listing document.
The directors of a newly listed company are responsible for the content of the listing document and may bear civil or criminal liability in the event of any misstatement. Each listing document must include a statement to the effect that the directors, having made all reasonable enquiries, confirm that to the best of their knowledge and belief the information contained in the listing document is accurate and complete in all material respects and not misleading or deceptive and there are no other matters the omission of which would make any statement in the listing document misleading.
In light of these liability considerations (as well as the sponsor’s desire to discharge its regulatory obligations), the directors will wish to verify that the statements in the listing document are true and complete. In this regard, the sponsor will require a formal, thorough and detailed verification of the statements in the listing document.
Founded in 2004, TIMOTHY LOH LLP is an internationally recognized Hong Kong law firm focused on mergers & acquisitions, litigation and general financial markets and financial services matters. The firm is a leader in banking, financial regulation, corporate finance, capital markets and investment funds as measured by its rankings and those of its lawyers in leading independent editorial publications. The firm routinely acts for Fortune Global 500 companies. For more information, visit www.timothyloh.com.
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