In recent years, the popularity of backdoor listings has resulted in a substantial increase in the value of a company solely for its listing status, leading to extensive activities related to investors acquiring control of listed issuers for their listing status (rather than the underlying business) with a view to backdoor listings, and listed issuers undertaking corporate actions, such as disposals of businesses, to facilitate the sale of the listed shells.
On 26 July 2019, the Hong Kong Stock Exchange (the “Exchange”) published its consultation conclusions on backdoor listings, continuing listing criteria and other rule amendments. This consultation conclusion codifies some of the guidance letters on backdoor listings and addresses specific concerns about circumvention of the requirements for new applicants under the Listing Rules (the “LRs”). A summary of the consultation conclusions is set out below.
1. Amendments Relating to Backdoor Listing
(i) Reverse takeover (“RTO”) – Principle-based test
The new LR 14.6B will codify and set out the principle-based test which allows the Exchange to treat an acquisition or series of acquisitions of assets constituting an attempt to achieve a listing of the target assets, and a means to circumvent the requirements for new applicants under the Listing Rules (i.e. a reverse takeover). This principle-based test codifies the assessment factors in Guidance Letter GL78-14, with modifications made to the last two factors:
- the transaction size;
- target quality;
- nature and scale of the issuer’s business;
- fundamental change in the issuer’s principal business;
- a change in control or de facto control of the listed; and/or
- series of transactions and/or arrangements which includes acquisitions, disposals and/or change in control or de facto control that take place in reasonable proximity (normally within 36 months) or are otherwise related.
(ii) RTO – Bright line tests
The bright line tests are modified to (i) apply to very substantial acquisitions (“VSAs”) from an issuer’s controlling shareholder within 36 months from a change in control of the issuer; and (ii) restrict disposals of all or a material part of the issuer’s business proposed at the time of or within 36 months after a change in control of the issuer. The Exchange may also apply the restriction to disposals at the time of or within 36 months after a change in de facto control (as set out in the principle-based test) of the issuer.
(iii) Backdoor listing through large scale issue of securities
The new LR codifies Guidance Letter GL84-15 to disallow backdoor listings through large scale issues of securities for cash that result in a change in control of the issuer, where the proceeds will be applied to acquire and/or develop new business that is expected to be substantially larger than the issuer’s existing principal business.
(iv) Extreme transactions
In addition, the new LR now (i) codifies the “extreme VSA” requirements in Guidance Letter GL78-14 and renames this category of transactions as “extreme transactions”; and (ii) imposes additional eligibility criteria on the issuer that may use this transaction category: (a) the issuer must operate a principal business of substantial size; or (b) the issuer must have been under the control or de facto control of the same person(s) for a long period (normally not less than 36 months) and the transaction will not result in a change in control or de facto control of the issuer.
(v) Requirements for RTOs and extreme transactions
The new LR is modified to require the acquisition targets in a RTO or extreme transaction to meet the requirements of LR 8.04 and LR 8.05 (or LR 8.05A or 8.05B), and the enlarged group to meet all the new listing requirements in Chapter 8 of the LR except LR 8.05. Where the RTO is proposed by an issuer that does not meet LR 13.24, the acquisition targets must also meet the requirement of LR 8.07.
2. Amendments to Continuing Listing Criteria for Listed Issuers
(i) LR 13.24 (sufficient operation)
The Exchange amended LR 13.24 to require an issuer to carry out a business with a sufficient level of operations and to have assets of sufficient value to support its operations to warrant its continued listing (and not sufficient operations or assets set out in the current LR). Proprietary securities trading and/or investment activities by an issuer’s group (other than a Chapter 21 company) are normally excluded when considering whether the issuer can meet LR 13.24 (except for those carried out by a member of the issuer’s group that is a banking company, an insurance company, or a securities house that is mainly engaged in regulated activities under the Securities and Futures Ordinance).
(ii) LR 14.82 and 14.83 (cash companies)
The new LR aims to (i) extend the definition of “short dated securities” in LR 14.82 to cover investments that are easily convertible into cash and rename it as “short-term investments”; and (ii) to confine the exemption under LR 14.83 to cash and short-term investments held by members of an issuer’s group that are banking companies, insurance companies or securities houses.
(iii) Transitional Period
The Exchange is allowing a transitional period of 12 months from the effective date (1 October 2019) for listed issuers to comply with the amendments to the continuing listing criterias.
How can we help?
The amendments to the Listing Rules could significantly affect listed issuers and participants in the capital markets. We are ready to assist clients in understanding the changes made, the client’s obligations and implementing changes that may be required.