Session 9: Hot Button Items in Hong Kong Equity Capital Markets: Pre-IPO Investments and Weighted Voting Rights David Neuville Joseph Lee 30 October 2015 11:30 12:30
Pre-IPO Investments Extremely common for Hong Kong initial public offering candidates to have pre-ipo institutional investors, either strategic or financial Hong Kong securities regulators (particularly the Hong Kong Stock Exchange ( SEHK )) have long been suspicious of short-term, highly profitable pre-ipo investments, and have taken actions to limit both the timing of those investments, and their terms The HK regulatory regime now permits pre-ipo investments provided that they are in line with the principles in the Rules Governing the Listing of Securities on the Hong Kong Stock Exchange ( Listing Rules ) and Guidance Letters issued by the SEHK - the issue and marketing of securities must be conducted in a fair and orderly manner; and that all holders of listed securities be treated fairly and equally
SEHK Requirements The Interim Guidance on Pre-IPO Investments issued by the SEHK on 13 October 2010 (Guidance Letter HKEx-GL29-12) stated that: pre-ipo investments must be completed either (a) at least 28 clear days before the date of the first submission of the first listing application form or (b) 180 clear days before the first day of trading of the applicant s securities; and pre-ipo investments are considered completed when the funds are irrevocably settled and received by the applicant Guidance letter HKEx-GL43-12 requires the listing document to include detailed information on pre-ipo investors and terms of the pre-ipo investments together with sponsor s confirmation with basis
Pre-IPO Investments Structure Why do issuers seek pre-ipo investments? Reorganization Working capital Foreign currency Strategic and financial investors Common forms of pre-ipo investments: Ordinary shares Securities (convertible preference shares or convertible or exchangeable notes) which can be converted into or exchanged for ordinary shares upon an IPO
Pre-IPO Investments Structure Pre-IPO issuer Proposed listing vehicle (shares, convertibles) Parent of proposed listing vehicle (exchangeables) Key terms Special rights Covenants Security Lock-up
Pre-IPO Investments Unacceptable Attributes The following terms of a pre-ipo investment would not be allowed as indicated by the SEHK: Strictly prohibited Any price adjustment provisions such as a guaranteed discount to the IPO price or or an adjustment linked to the post-ipo market capitalisation of the shares. The conversion price for CBs may be only at a fixed dollar amount or at the IPO price and any conversion price reset mechanism of CBs should be removed All put or exit options granted to pre-ipo investors to put back the investments to the listing applicant or its controlling shareholder, except when the terms of a pre-ipo investment clearly state that the put or exit option can only be exercised when listing does not take place. However, redemption or early redemption of notes at a fixed IRR prior to conversion/exchange is allowed
Pre-IPO Investments Unacceptable Attributes Strictly prohibited (cont.) Profit guarantees if settled by the listing applicant or if the compensation is linked to the market price or capitalisation of the shares. Allowed if settled by a shareholder and the compensation is not linked to the market price or capitalisation of the shares Compensation for failure to complete a qualified IPO within a specific time is not allowed unless the amount of compensation is set out in the investment agreement or can be derived from the compensation provisions under the agreement
Pre-IPO Investments Unacceptable Attributes Provisions that must be terminated upon listing Any contractual right of a pre-ipo investor to nominate a director, but rights to nominate senior management and committee representatives are allowed provided appointments are subject to approval of the board Contractual rights to exercise veto power over the applicant's major corporate actions such as winding up, amalgamation and merger, and entering into a new business Anti-dilution rights, but rights of first refusal and tag-along rights are allowed Negative pledges unless they are widely accepted provisions in loan agreements, are not egregious and do not contravene the fairness principles in the Listing Rules Prior consent requirements for corporate actions unless the terms are not egregious and do not contravene the Listing Rules
Pre-IPO Investments Unacceptable Attributes Provisions that must be terminated upon listing (cont.) Exclusivity rights and MFN clauses unless the agreement includes an explicit fiduciary out clause Information rights can only survive after listing subject to equal dissemination to the general public No partial conversion of CBs unless all atypical special rights are terminated after listing
Pre-IPO Investments Changes and Modifications Post-application changes to investment agreements made to satisfy SEHK requirements must not constitute new agreements, or the rule that the investment must be completed at least 180 clear days before listing will apply. A legal opinion is required
Weighted Voting Rights ( WVRs ) Background Alibaba Group foregoes HK listing for United States IPO, New York Stock Exchange listing in September 2014, in what proves to be largest IPO ever Principal reason for choosing US thought to be SEHK s prohibition of corporate governance structures that vary from one share, one vote Alibaba has a partnership structure in which management insiders holding about 10% of the stock (pre-ipo) can name a majority of the members of the board of directors SEHK (a self-regulatory organisation) publishes a consultation paper in August 2014 seeking market input on whether to permit companies with WVR structures to list and, if so, whether to restrict structures and/or companies permitted to utilise them
Weighted Voting Rights Background (cont.) Consultation conclusions published in June 2015: Detailed qualitative and quantitative analysis SEHK undertook to provide specific proposals, again for public comment, to permit WVRs subject to certain limitations (3rd quarter, 2015) Within a week, HK Securities and Futures Commission ( SFC ) (government) published a one page statement rejecting use of WVR structures by Hong Kong listcos The Board of the SFC has unanimously concluded that it does not support the draft proposal for primary listings with WVR structures On 5 October 2015, the Listing Committee of the SEHK issued a news release saying in light of the SFC statement, it would not proceed with the specific proposals, but would keep this matter under review
Weighted Voting Rights SEHK Conclusions Arguments for and against WVRs: For: Enhance SEHK global competitiveness Ensure continuity of management Increase diversity of companies listing in Hong Kong Potential abuses controllable by safeguards Enables HK investors to invest in PRC businesses in home market Most HK listcos effectively controlled by a single shareholder or group, anyway
Weighted Voting Rights SEHK Conclusions (cont.) Against: Unreasonable to separate economic control and voting power One share, one vote is a SEHK competitive advantage WVRs can serve as an anti-takeover device, entrenching management Disincentivizes minority shareholders to engage with management HK legal, regulatory regimes don t allow shareholders to protect themselves from abuses, as in U.S. Permitting WVRs would add complexity, making it more difficult to properly value companies
Weighted Voting Rights SEHK Conclusions (cont.) Virtually no one argues either (A) WVRs can actually benefit some companies (strong entrepreneurs, highly technical businesses), or In U.S., probably most often used by highly technical technology companies (B) Market is capable of showing disapproval of use of structures, where appropriate, by discounting pricing, making over-use of WVRs less likely
Weighted Voting Rights SEHK Conclusions (cont.) Practical proposals - Permit only for new listings Note U.S. Rule 19c-4 Limit to companies with pre-determined characteristics (size and history), meeting higher eligibility standards Mandate limitations such as sunset provisions, minimum shareholding requirements Not to be limited by industry, listing board, overseas/domestic status or nature (e.g. innovative ) of companies Class action litigation potential not required
Weighted Voting Rights Differences in U.S., Hong Kong approaches U.S.: Full disclosure Allow free market to operate Assure enforcement and remedies, public and private Hong Kong: Disclosure but is quality level sufficient? Free market Regulators have a far more paternalistic approach Inability of investors to protect themselves?
Weighted Voting Rights Next Steps SEHK/SFC conflict extraordinary, both in terms of degree and public nature Unable to quantify either harm to HK s competitiveness of prohibition, or prospective harm to investors if WVRs were to be permitted SFC s position has shut down discussion, at least for now, on use of WVRs for either primary or secondary listing SEHK noted that it will monitor market developments, and may choose to reopen discussion in future Enable private enforcement of shareholder protections?
Speakers David Neuville Partner, Hong Kong T +852 2583 8345 E david.neuville@simmons-simmons.com Joseph Lee Partner, Hong Kong T +852 2583 8368 E joseph.lee@simmons-simmons.com
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