Hong Kong: Amendments to the Connected Transaction Rules of the Hong Kong Stock Exchange Listing Rules

Last Updated: 12 October 2010

In May 2010, the Hong Kong Stock Exchange (the "Exchange") released its Consultation Conclusions on proposed changes to connected transaction rules which included a review on the definition of connected person, provided exemptions for connected transactions which are immaterial or involve persons not in a position of significant influence, etc. The proposal did not exclude persons connected at the subsidiary level from the definition of connected person, and the connected transaction rules will continue to govern transactions with connected persons on a revenue basis.

The amendments to the Listing Rules which have significant effect on issuers' continuing obligations have become effective on 3 June 2010.

We now briefly summarize the Amendments as follows :-

1. Exemption for transactions with persons connected with "insignificant subsidiaries" (Rule 14A.31(9))

(a) To reduce the issuers' compliance burden on transactions with connected persons at the subsidiary level, transactions between the issuer and a connected person are exempted if he is connected to the issuer only by virtue of his relationship with an "insignificant subsidiary".

(b) A subsidiary is "insignificant" if :-

  1. the values of its total assets, profits and revenue represent less than 10% of the issuer's total assets, profits and revenue based on the accounts for each of the latest three financial years (or if less, the period since the establishment of the subsidiary); or
  2. the values of its total assets, profits and revenue represent less than 5% of the issuer's total assets, profits and revenue based on the accounts for the latest financial year.

(c) If the person is connected to more than one subsidiary, the total assets, profits and revenue of all the relevant subsidiaries would be aggregated.

(d) If any percentage ratio calculation produces an anomalous result, the Exchange may disregard the calculation and consider an alternative test.

(e) The exemption is not available if the insignificant subsidiary is itself a party to the transaction or its securities/assets are the subject of the transaction, the transaction is capital in nature and the transaction's size is 10% or more based on the consideration ratio.

2. De minimis thresholds that trigger disclosure or shareholders' approval requirements for connected transactions (Rules 14A.31-14A.34 and Rules 14A.65 to 14A.66)

To strike a proper balance between shareholder's protection and compliance where the size of a connected transaction is immaterial to the issuer, the percentage thresholds for the de minimis exemptions have been revised :-

(a) from 0.1% to 1% for fully exempt transactions which involve persons connected only at the subsidiary level; and

(b) from 2.5% to 5% for exemption from shareholder approval requirements.

3. Exemption for revenue transactions with associates of a passive investor (Rule 14A.31(10))

To lessen the issuers' compliance burden in circumstances where the potential for a substantial shareholder to abuse its position is small, a connected transaction of a revenue nature in the ordinary and usual course of the issuer's business and on normal commercial terms has been exempted where :-

(a) the transaction is a connected transaction only because it involves an associate ("Relevant Associate") of a substantial shareholder of the issuer; and

(b) the substantial shareholder is a passive investor in the issuer and meets the following criteria :-

  1. it is a sovereign fund, or a unit trust or mutual fund authorised by the Commission or an appropriate overseas authority;
  2. it has a wide spread of investments other than the securities of the issuer and the Relevant Associate;
  3. it and the Relevant Associate are connected persons only because it is a substantial shareholder of the issuer;
  4. it is not a controlling shareholder of the issuer;
  5. it does not have any representative on the board of directors of the issuer, and is not involved in the management of the issuer (including any influence over the issuer's management through negative control (e.g. its veto rights) on material matters of the issuer); and
  6. it is independent of the directors, chief executive, controlling shareholder(s) and any other substantial shareholder(s) of the issuer.

4. Modification of exemption for provision of consumer goods or consumer services (Rule 14A.31(7)(b))

To reduce the issuers' compliance burden, Rule 14A.31(7)(b) has been amended to allow an issuer to acquire consumer goods or consumer services from connected persons for the purpose of or in connection with the issuer's business if :-

(a) there is an open market and transparency in pricing the goods or services concerned and all; and

(b) all other conditions for the exemption have been fulfilled.

5. Definition of associate in Rule 1.01 (for non-PRC issuers) and Rule 19A.04 (for PRC issuers) (Rule 1.01 and Rule 19A.04)

Since it is unlikely that the connected person can exert significant influence over the entities described in (1) and (2) below and take advantage in the transactions between the issuer and these entities, the following persons have been removed from the definition of associate :-

(a) the holding company of an investee company, or a fellow subsidiary of this holding company; and

(b) a company controlled by the investee company (not being a subsidiary of the investee company), and its subsidiary, holding company or fellow subsidiary.

6. Extended definition of associate in Rule 14A.11(4) (Rules 14A.11(4))

To address the potential loophole where the connected person may take advantage in a transaction between the issuer and a company under the control of his relatives, the scope of associate in each of Rules 14A.11(4)(b) and (c) has been expanded to a company in which any relative referred to in Rules 14A.11(4)(b) and (c) has a majority control (i.e. control of more than 50% of the voting power at the company's general meetings or the composition of a majority of the board of directors of the company).

The Exchange will consider the interests of the connected person and his relatives in the company to determine whether they together have a majority control over the company.

7. Definition of connected person (Rule 1.01, Rule 14A.11, Rule 19A.04, Rule 19A.19)

Since the risk of potential abuse by the persons or entities in (1) and (2) below is low and the provisions for PRC Governmental Body in Chapter 19A of the Listing Rules should equally apply to non-PRC issuers because some non-PRC issuers encountered problems in identifying their connected persons, changes have been made to the definition of connected person :-

1. to restrict the circumstances in which a non-wholly owned subsidiary is a connected person by:

a. excluding a non wholly-owned subsidiary which is connected only because it is (i) a substantial shareholder of another subsidiary or (ii) an associate of a person connected only at the subsidiary level; and

b. introducing an exemption for intra-group transactions between a "connected subsidiary" (as defined in Rule 14A.11(5)) and its subsidiaries or between subsidiaries of this connected subsidiary;

2. to remove "promoter" from the definition of connected person for PRC issuers; and

3. to exclude "PRC Governmental Body" from the scope of connected persons for non-PRC issuers.

8. Exemption for small transaction involving issue of new securities by subsidiary (Rule 14A.31 and Rule 14A.32)

The de minimis exemptions have been extended to apply to the issue of securities by an issuer's subsidiary (i.e. deemed disposal).

9. Exemption for financial assistance provided on a pro-rata basis (Rule 14A.13(2)(a), Rule 14A.65(3))

As the risk of potential abuse is remote in the specific circumstances described in 14A.65(3), financial assistance given by an issuer to a company which is a connected person will be exempted for the benefit of (i) "commonly held entity", or (ii) a connected person in which the issuer is a shareholder, as long as the financial assistance provided is on normal commercial terms and on a several and pro-rata basis.

10. Transactions with third parties involving joint investments with connected persons (Rule 14A.13(1)(b)(i))

Since the risk that the substantial shareholder of the target company can exert significant influence over the issuer or the third party is remote, a disposal where a substantial shareholder of the disposal target is a controller only because of its position and/or shareholding in the disposal target immediately prior to the disposal will be exempted, but there must be no change in the substantial shareholder's interest in the disposal target as a result of the issuer's disposal or other transaction or arrangement related to the disposal.

11. Annual review of continuing connected transactions (Rules 14A.33-14A.35, Rules 14A.37-14A.38)

Since it is unclear whether the annual review requirements under Rules 14A.37 and 14A.38 apply to all continuing connected transactions, amendments have been made to clarify that the annual review requirements under Rules 14A.37 and 14A.38 apply to continuing connected transactions that are subject to reporting, disclosure and independent shareholders' approval requirements in Chapter 14A.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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