This Hong Kong regulatory update provides an overview of key regulatory developments in the past three months relevant to companies listed (or planning to list) on The Stock Exchange of Hong Kong Limited (HKEx) and their advisers. These updates cover amendments to the Rules Governing the Listing of Securities on HKEx (Listing Rules) and announcements, guidance and enforcement-related news from HKEx and the Securities and Futures Commission (SFC), as well as other recent market developments.
HKEx announced that it has reached an agreement with the Shanghai and Shenzhen Stock Exchanges to permit companies with dual-class share structures listed in Hong Kong — referred to as weighted voting rights (WVRs) companies — to be traded by Mainland-based investors through the Stock Connect program. This will be welcome news to the two WVR companies currently listed in Hong Kong — Xiaomi Corporation and Meituan Dianping (Skadden advised on both these IPOs in 2018) — as well as other aspiring WVR listing applicants. HKEx is working on detailed rules to implement the agreement, and these rules should be announced to the market for implementation by mid-2019.
The Stock Connect program enables Mainland-based investors to trade directly in certain HKEx-listed securities (southbound trading) while also permitting Hong Kong-based investors to trade directly in certain securities listed on the Shanghai and Shenzhen stock exchanges (northbound trading). To qualify for southbound trading, the company must be a constituent of the Hang Seng Composite Index. Hang Seng Indexes Company Limited, the company responsible for formulating the Hang Seng indexes, already had announced that “Greater China” WVR companies, including those with either a primary or secondary HKEx listing, are eligible for inclusion in the Hang Seng Composite Index. The forthcoming rules following this latest HKEx announcement will be the final step in opening these companies to Mainland investors through Stock Connect.
As listed companies move into annual reporting season, HKEx has issued helpful guidance in the form of its annual review of listed companies’ annual reports and new guidance on environmental, social and governance (ESG) reporting.
HKEx reported the following as key areas where there is room for improvement:
HKEx has also updated its how-to guide on preparation of ESG reports, which is required under Appendix 27 of the Listing Rules. The guide suggests the following steps:
Updated frequently asked questions (FAQs) provide additional guidance on ESG reporting where companies adopt other international standards or guidelines. In particular, the FAQs provide specific references to provisions in international standards or guidelines that are comparable to, and enable compliance with, the ESG Reporting Guide. Other international standards or guidelines that companies may consider are:
HKEx also clarified that printed copies of the ESG report need not be sent to shareholders (unless specifically requested) if the report is in the form of a standalone report or published on the company’s website.
HKEx has indicated it intends to publish a consultation paper on proposed changes to the ESG reporting framework in mid-2019. Listed companies should be alert to future changes in this evolving area.
HKEx listed companies will need to ensure they have updated their corporate governance policies to take account of changes to HKEx’s Corporate Governance Code (Code) and related Listing Rules that came into effect as of 1 January 2019. The key changes are as follows:
“Comply or explain” matters (Code Provisions):
Recommended best practices (for which compliance is voluntary):
Changes to the accounting treatment of leases under recent amendments to HKFRS/IFRS have implications for how these transactions will be treated under the Listing Rules. Under new HKFRS/IFRS 16, a lessor continues to account for a lease as either an operating lease or a finance lease. However, a lessee should recognise a right-of-use asset (its right to use the leased asset) and a lease liability (its obligation to make lease payments).
HKEx has published a set of frequently asked questions (FAQs) on the implications of these changes for lessees where the lease transactions are notifiable or connected transactions under Chapters 14 and 14A of Listing Rules. The most notable points for listed companies entering into lease transactions as lessees are as follows:
These changes will apply only to new lease agreements entered into following the adoption of HKFRS/IFRS 16 for financial years commencing on or after 1 January 2019.
The SFC recently sent a strong message to the market that it will not hesitate to hold sponsors accountable for their conduct by reprimanding and fining several banks an aggregate amount of HK$786.7 million for failing properly to discharge their obligations as sponsors in recent IPOs. The SFC also partially suspended one bank’s licence to advise on corporate finance for one year and the licence of an individual sponsor principal for two years.
The SFC’s statements on these enforcement actions provide some key indications of the standard of due diligence expected of sponsors under the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC and the Practice Note 21 to the Listing Rules.
Some of the key lessons on due diligence standards to emerge from these enforcement actions include the following:
The SFC has commenced proceedings in two cases where listed companies delayed publishing profit warning announcements in a timely manner, as required under the disclosure of inside information regime set out in the Securities and Futures Ordinance (Cap. 571) (SFO). Proceedings also were commenced against directors of those companies for failing to take reasonable measures to ensure that proper safeguards existed at the companies to prevent the alleged breaches, or for their reckless or negligent conduct causing the alleged breach by the companies.
In the proceedings against CMBC Capital Holdings Limited (formerly known as Mission Capital Holdings Limited (Mission Capital)), the SFC alleges that the directors of Mission Capital were in possession on 13 October 2014 of unaudited management accounts for the five months ending 31 August 2014, which showed a significant improvement in financial performance against prior periods, but did not issue a profit alert announcement until 7 November 2014.
In the proceedings against Health and Happiness (H&H) International Holdings Ltd (formerly known as Biostime International Holdings Ltd (Biostime)), the SFC alleges that Biostime’s consolidated management accounts for the first five months of 2015 became available in mid-June 2015 and revealed that both the revenue and the net profit had significantly decreased (by 13.7 percent and 28.9 percent, respectively) when compared with the corresponding period in 2014, but the directors of Biostime did not issue a profit warning until 23 July 2015.
These proceedings show that the SFC takes listed companies’ obligations to disclose inside information “as soon as reasonably practicable” seriously and that delays of even a few weeks will be regarded as a breach of those obligations.
Listed companies and their directors are reminded (i) to ensure all announcements are accurate and complete in all material respects and not misleading or deceptive, and (ii) to cooperate with the HKEx on regulatory investigations, in order to avoid potential enforcement actions.
Shenji Group Kunming Machine Tool Company Limited (Shenji Group) published an announcement in November 2015 relating to a potential disposal of shares in Shenji Group by a substantial shareholder. The announcement did not disclose (i) the conditions precedent to the share transfer, including the need for approval from certain PRC authorities, and (ii) the long stop date beyond which the share transfer agreement would terminate automatically if those conditions were not fulfilled. Shenji Group subsequently announced on 5 February 2016 that the necessary approvals had not yet been obtained and that the share transfer was actually subject to a three-month long stop date that would expire on 8 February 2016. On 17 February 2016, Shenji Group announced the termination of the share transfer agreement. The former director, who was involved in preparing and publishing the announcement, did not cooperate with the HKEx in a responsive manner during the investigation process. The Listing Committee decided to censure Shenji Group and the former director for the omissions in the announcement.
It is crucial that companies and their directors seek proper legal advice on compliance with the Listing Rules whenever entering into new transactions. Recently, the Listing Committee censured Golden Meditech Holdings Limited (Golden Meditech) and two executive directors, and criticized four other directors, for failure to comply with the disclosure and shareholders’ approval requirements with respect to a complex series of transactions involving Golden Meditech’s interest in a company called Funtalk China Holdings Limited (Funtalk), which ultimately resulted in Golden Meditech making an impairment provision in the amount of approximately HK$760 million.
The Listing Committee found that (i) the two executive directors had relied upon incorrect calculation of the “size tests” under the Listing Rules, resulting in the transactions being wrongly classified, and the company mistakenly believing that disclosure and shareholder approval were not required; in addition, those directors had failed to understand fully or consider the implications of all aspects of the transaction, and had not obtained any proper professional advice nor consulted the board of directors; and (ii) the four other directors of Golden Meditech had failed to apply their own independent judgment by relying upon the information provided by the two censured executive directors and failed to consider Golden Meditech’s compliance with the Listing Rules.
On 21 February 2019, the SFC published SFC Regulatory Bulletin: Listed Corporations (Bulletin) to highlight some of the SFC’s recent actions against market misbehaviour. The case studies illustrate how the SFC intervenes at an early stage where it has serious concerns about IPO applications or post-IPO corporate transactions.
In the IPO cases, the SFC queried the robustness or sustainability of listing applicants’ business models. In the two cases highlighted:
In both cases, the applicants were unable to provide satisfactory responses to the SFC queries and their listing applications were withdrawn or lapsed.
In the cases relating to companies already listed on HKEx, the SFC has actively intervened in a number of proposed transactions by listed companies:
The Bulletin reminds directors to exercise reasonable care, skills and diligence when evaluating, proposing or approving corporate transactions. Directors have a duty to exercise their own judgement and should not over-rely on third-party opinions or advice.
Prepared with the assistance of associates Joanne Loi, Steven Lee, Paul Lau and Gabriel Lee.