Hong Kong: HKEx Clarifies Certain Rule Requirements For Listed Issuers

Last Updated: 5 January 2009
Article by Conrad Chan, Bonnie Cheng and Wendy Lo

On 28 November 2008, The Stock Exchange of Hong Kong Limited (HKEx) published the Frequently Asked Questions on Rule Requirements relating to Notifiable Transactions, Connected Transactions and Issues of Securities by Listed Issuers (FAQs).

In the FAQs, the HKEx sets out interpretive guidance on the provisions in Chapter 14 (Notifiable Transactions), Chapter 14A (Connected Transactions) and Chapter 13 (Continuing Obligations - issues of securities by listed issuers) of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the Listing Rules) in the form of 72 queries and responses. The FAQs also serve as a supplementary guidance to the Frequently Asked Questions on Rule Amendments relating to Corporate Governance and Listing Criteria Issues, which were published by the HKEx on 31 March 2004 and updated on 22 May 2006.

The main purpose of the FAQs is to promote a better understanding of the Listing Rules, particularly in situations not explicitly catered for by the Listing Rules or where further clarification may be desirable. This may be of particular importance to all listed issuers when they are contemplating any notifiable transaction, connected transaction or issue of securities. The FAQs are also an important reading for listed issuers and their directors, senior management and advisers to enhance a better understanding of the Listing Rules and to ensure compliance with the Listing Rules.

These new FAQs contain many useful interpretations of the Listing Rules, and to a certain extent reflect the view of the HKEx on and its prevailing treatment of the various specific scenarios referred to in the FAQs.

We have picked up some of the FAQs and their answers which will be relevant to listed issuers and financial advisers advising listed issuers in planning and structuring prospective transactions:

Alternative tests (Rule 14.20)

Rule 14.20 of the Listing Rules provides that if anomalous result is produced in any of the percentage ratio calculations, listed issuers may submit alternative tests for the HKEx's consideration. FAQ Nos 2, 11 and 12 have provided for some specific scenarios which are useful indicators to listed issuers.

In an internal group restructuring exercise which is commonly found among listed issuers, asset transfers between subsidiaries will sometimes lead in anomalous results in percentage ratio calculations so that it is difficult to classify the transaction under Chapter 14, and hence the difficulty in ascertaining relevant disclosure and approval requirements. FAQ No. 2 is helpful in addressing this and the HKEx has endorsed the principle of taking into account the substance of the relevant transaction and its impact on the listed group as a whole.

Another helpful clarification is that the HKEx has further elaborated in FAQ No. 45 that it may apply the same principle to connected transactions with anomalous results in any of the percentage ratio calculations or where the calculation of certain percentage ratios are inapplicable due to the sphere of activity of the listed issuers.

Size test for joint ventures (Rules 14.04(1)(f) and 14.07)

Joint venture arrangements of listed issuers are considered as notifiable transactions which are subject to the "size test" and the listed issuers are required to consider all the percentage ratios to the extent applicable for classifying the transaction. In conducting "size test" for joint venture arrangements, calculation of profits and revenue ratios may not be possible as a joint venture is usually a new entity which profits and revenue figures are not available.

In FAQ No. 5, the HKEx clarifies that, in respect of the formation of a joint venture, listed issuers will only be required to compute the assets and consideration ratios while the computation of profits and revenue ratios will generally not be required. However, the HKEx suggests that in situation where the formation of a joint venture involves the injection of assets (other than cash) by a joint venture partner and the joint venture is to be accounted for as a subsidiary of the listed issuer (eg. the listed issuer will control more than half of the voting powers in the joint venture), the injection of assets by the joint venture partner would in effect result in an acquisition of assets by the listed issuer and all percentage ratios of such acquisition shall be calculated for classifying the transaction.

Size test for continuing connected transactions (Rules 14A.33 and 14A.34)

Where a continuing connected transaction involves sale or purchase of goods or services or lease of properties by a listed issuer, the calculation of assets ratio and revenue ratio may not appear to be directly relevant to such transaction at the outset.

The HKEx explains in FAQ No. 46 that listed issuers are required to compute the assets ratio, revenue ratio and consideration ratio for a continuing connected transaction using the annual cap as the numerators for the purpose of classifying the transaction in order to assess the size of the transaction relative to that of the listed issuer. That said, listed issuers may consult the HKEx and provide appropriate alternative tests to the HKEx if any percentage ratio produces an anomalous result.

Use of figures in preliminary results announcement for size test (Rules 14.16 and 14.17)

Rules 14.16 and 14.17 of the Listing Rules provide that in conducting the "size test", a listed issuer must refer to the total assets, profits and revenue figures shown in its accounts or its latest published interim report (whichever is more recent), subject to certain adjustments. At times, a listed issuer may enter into notifiable transactions during the interim period when its preliminary results announcement has been published, pending the same to be published in its annual / interim report. Here comes a question as to whether the listed issuer should apply the figures published in the preliminary results announcement or those published in its latest annual / interim report in computing assets, profits and revenue ratios.

The HKEx indicates in FAQ No. 10 that where the preliminary results announcement is published based on audited financial statements or accounts which have been agreed with the auditors of the listed issuers, figures in preliminary result announcement should be applied in the "size test" computation. Listed issuers should ensure that the assets, profits and revenue ratios are calculated based on figures from the right source so that the transaction will be appropriately classified and the disclosure and approval requirements for the classification applicable to the transaction can be ascertained.

Aggregation of transactions (Rule 14.22)

Rule 14.22 of the Listing Rules requires the aggregation of certain series of transactions (eg. transactions entered by a listed issuer with the same party, interests acquired or disposed of by a listed issuer are part of one company or one asset) completed by a listed issuer within a 12 month period and all such transactions should be treated as one transaction. As such, listed issuers are required to comply with the requirements for the relevant classification of the transaction when aggregated (the Aggregated Classification). For example, a proposed acquisition by a listed issuer on an isolated basis does not constitute a notifiable transaction, but when such acquisition is aggregated with an earlier acquisition transaction completed by the listed issuer, the major transaction or very substantial acquisition requirements under Chapter 14 of the Listing Rules may become applicable to the proposed acquisition. Listed issuers should carefully consider if a proposed transaction will be subject to the requirements for the Aggregated Classification where there are previous transactions completed by it in the preceding 12 months which require to be aggregated.

The HKEx further explains in FAQ Nos. 14 and 15 that although only the proposed transaction will be subject to the requirements for the Aggregated Classification, adequate information relating to the previous transactions should also be disclosed in the announcement and circular of the proposed transaction in order to facilitate the shareholders in making informed decisions.

Contracts of Continuing Connected Transactions (Rule 14A.35(1))

According to Rule 14A.35(1) of the Listing Rules, any non-exempt continuing connected transaction agreement must be in form of a written agreement of a fixed term and contains normal commercial terms and shall not exceed 3 years unless under special circumstances. Listed issuers should note that a written agreement in respect of a connected transaction for a term of 3 years which will be automatically renewed unless otherwise agreed by the parties will not be regarded to have a fixed term under the Listing Rules. The HKEx indicates in FAQ No. 49 that the term of the agreement will not be treated as a fixed term because the renewal of the agreement is not at the discretion of the listed issuer nor subject to further approval of its independent shareholders.

Shareholders' Approval (Rule 14.40)

Under Rule 14.40 of the Listing Rules, a major transaction must be made conditional on approval by shareholders of a listed issuer. Occasionally, listed issuers may wish to amend the terms of a transaction after shareholders' approval has been sought.

Although shareholders' resolutions passed may have authorised directors of the listed issuers to take all steps necessary to implement the transaction, the listed issuers should note the view of the HKEx in FAQ No. 16 that by reason of the materiality of the changes, a listed issuer may be required to obtained shareholders' approval for the transaction again based on the amended terms. Listed issuers should be cautious in amending any terms of an approved transaction as re-approval of the shareholders may be required if the changes are material which would in substance constitute a new transaction.

Deeming provision (Rule 14A.06)

Under Rule 14A.06 of the Listing Rules, the HKEx is given the specific power to deem a person to be connected. FAQ No. 41 provides guidance on how this deeming provision works. The HKEx would take into account all relevant facts and circumstances surrounding the transaction and particular regard would be given to the substance rather than the form of the transaction, including whether any connected person is able to exert influence over the terms of the agreement and whether there is or may be a transfer of benefit, directly or indirectly, to the connected person or its associates.

Issue of securities under general mandate (Rule 13.36(2)(b))

Rule 13.36(2)(b) of the Listing Rules provides that the issue of securities under an existing general mandate granted by the shareholders does not require consent of shareholders in general meeting. FAQ No. 62 reiterates this position but stresses that the listed issuer must demonstrate that its existing general mandate is sufficient to cover the number of new shares that may be issued. In case of issue of shares upon full conversion of the convertible notes based on the terms of the notes, the listed issuer should take into account the lowest possible conversion price, i.e. the maximum number of new shares that may be issued.

Warrants (Chapter 15)

Issue of options, warrants and similar rights to subscribe or purchase shares of listed issuers are governed by Chapter 15 of the Listing Rules. FAQ No. 66 refers to a case of a PRC issuer with H shares listed on the HKEx and A shares listed on a PRC stock exchange which proposes to issue bonds in the PRC with bonus warrants to subscribe for new A shares. Despite the fact that bonds are to be issued in the PRC and the warrants attached to the bonds are rights to subscribe for new A shares which are listed on a PRC stock exchange, the HKEx takes the view that Chapter 15 of the Listing Rules would apply to warrants issued by a listed issuer to subscribe or purchase equity securities of that listed issuer (Rule 15.01 of the Listing Rules). The rationale is to avoid material dilution on the shareholding of the listed issuer resulting from the issue of the warrants. The same principle should also apply to options and other similar rights issued by a listed issuer.

The full text of the FAQs is available at the HKEx's website.

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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