After the Hong Kong Stock HKEX (HKEX)’s rejection of Alibaba’s listing application because of its dual class share structure (also known as Weighted Voting Rights structure, “WVR”) in 2014, the issue as to whether Hong Kong should admit WVR companies to listing has aroused great controversies. Subsequently, the top financial officials in the special administrative region had expressed tremendous regret, and indeed blaming the securities regulators for, having missed the opportunity to embrace Alibaba into the local securities market.
It is against this background that HEX, following release of its consultation conclusions on the concept paper in the end of last year, formally launched a public consultation on the detailed proposal to implement the mechanism to admit dual-class-share companies to listing in Hong Kong. If HKEX’s proposal is seconded, it will amend the Listing Rules by adding a new Chapter 8A to govern the listing of such companies in Hong Kong. Judging from the present circumstances, it is highly likely that the proposal will be implemented in the mid of this year, subject to certain fine-tuning of the proposal following the consultation, so that Hong Kong can capture the opportunities brought about by the next wave of IPOs of China’s innovative enterprises.
The following is a snapshot of the HKEX’s consultation proposal on the issue: –
1. The HKEX proposes that a company would normally be considered suitable for listing in Hong Kong with a WVR structure if it is able to demonstrate the following characteristics:
(a) Nature of the company: the applicant must be an innovative company. The HKEX considers that an innovative company for the purpose of the Rules would normally be expected to possess more than one of the following characteristics:
- its success is demonstrated to be attributable to the application, to the company’s core business, of (1) new technologies; (2) innovations; and/or (3) a new business model, which also serves to differentiate the company from existing players;
- R&D is a significant contributor of its expected value and constitutes a major activity and expense;
- its success is demonstrated to be attributable to its unique features or intellectual property; and/or
- it has an outsized market capitalisation / intangible asset value relative to its tangible asset value.
(b) Success of the company: the applicant must demonstrate a track record of high business growth, as can be objectively measured by operational metrics such as business operations, users, customers, unit sales, revenue, profits and/or market value (as appropriate) and its high growth trajectory is expected to continue.
(c) Contribution of WVR beneficiaries: Each WVR beneficiary must have been materially responsible for the growth of the business, by way of his skills, knowledge and/or strategic direction in circumstances where the value of the company is largely attributable or attached to intangible human capital.
(d) Role of WVR beneficiaries:
- Each WVR beneficiary must be an individual who has an active executive role within the business, and has contributed to a material extent to the ongoing growth of the business; and
- each WVR beneficiary must be a director of the issuer at the time of listing.
(e) External validation: the applicant must have previously received meaningful third party investment (being more than just a token investment) from at least one Sophisticated Investor (which must remain at IPO). Such investors will be required to retain an aggregate 50% of their investment at the time of listing for a period of at least six months post-IPO (subject to exceptions for de minimis investments by specific investors provided that the main investors are in compliance). The HKEX would not normally require an applicant to demonstrate that it has received meaningful third party investment if the applicant is a spin-off from a parent company.
2. the HKEX proposes initially to limit applicants permitted to list with WVR structures to those companies that have an expected market capitalisation at listing of not less than HK$10 billion. If an applicant with a WVR structure has an expected market capitalisation at listing of less than HK$40 billion, the HKEX will also require the applicant to have at least HK$1 billion of revenue in its most recent audited financial year. This requirement is intended to limit applicants to established and high-profile companies that have already received substantial investment from at least one Sophisticated Investor.
3. After listing, issuers with WVR structures will be prohibited from increasing the proportion of WVR in issue or from issuing any further WVR shares. WVR beneficiaries will have a limited right of pre-emption in the case of a pro rata offering to all shareholders (i.e. a rights issue or open offer) or a pro rata issue of securities by way of scrip dividends, or a stock split (or similar transaction), provided that the proportion of WVRs in issue afterwards is not higher than that in issue immediately before the corporate action.
4. The HKEX will require all the beneficiaries of a company’s WVR structure to collectively beneficially own a minimum of at least 10% and a maximum of not more than 50% of the underlying economic interest in the applicant’s total issued share capital at the time of its initial listing. This will help ensure that, at the time of listing, the economic interest in the company held by all WVR beneficiaries, as a group, is large enough, in dollar terms, to align their interests to some extent with those of other shareholders. The HKEX does not propose to impose this requirement on an ongoing basis after listing.
5. Beneficiaries of WVR will be restricted to those individuals who are directors of the issuer at listing and remain directors afterwards. The WVRs attached to a WVR beneficiary’s shares will lapse permanently if a WVR beneficiary: (a) dies; (b) ceases to be a director; (c) is deemed by the HKEX to be incapacitated; or (d) is deemed by the HKEX to no longer meet the requirements of a director set out in the Rules. The WVRs attached to a WVR beneficiary’s shares will also lapse permanently if a WVR beneficiary transfers his beneficial interest or economic interest in those shares, or the voting rights attached to them, to another person (subject to limited exceptions in the case of trust and other structures for estate and/or tax planning purposes).
6. The HKEX will require a WVR structure to be attached to a specific class (or classes) of shares. This class must be unlisted and the WVRs attached to them must confer to a beneficiary only enhanced voting power on resolutions tabled at the issuer’s general meetings. To mitigate expropriation and entrenchment risks, the HKEX will require the voting power attached to WVR shares to be capped at not more than ten times of the voting power of ordinary shares.
7. The HKEX will require that a listed issuer’s WVR structure must enable Non-WVR Shareholders to cast at least 10% of the votes that are eligible to be cast on resolutions at the listed issuer’s general meetings. The HKEX will also require that Non-WVR Shareholders holding at least 10% of the voting rights on a one-share one-vote basis (or such lower threshold as required under the laws of incorporation of the issuer) must be able to convene a general meeting and to add resolutions to the meeting agenda.
8. The HKEX will require the following key matters to be decided on a one-share one-vote basis and WVR beneficiaries will not be able to exercise WVRs on these matters:
(a) changes to the issuer’s constitutional documents, however framed;
(b) variation of rights attached to any class of shares;
(c) the appointment or removal of an independent non-executive director;
(d) the appointment or removal of auditors; and
(e) the voluntary winding-up of the issuer.
Preliminary observations from these proposals are that: –
1. The threshold of HK$10 billion seems quite high, and it is further proposed that if a WVR applicant has a market cap less than HK$40 billion, the Exchange will also require the applicant to have at least HK$1 billion of revenue in its most recent audited financial year. This could deny some small WVR applicants to access Hong Kong’s capital market.
2. There is no clear definition of innovative companies and this could be open to abuse by some non-innovative applicants with WVR to get listed. However, HKEX takes the view that “what is considered “innovative” depends on the state of the industry(ies) and market(s) in which an applicant operates, and will change over time as technology, markets and industries develop and change. For example, a new and “innovative” business model may cease to be so if it is adopted by numerous industry players over time. Conversely, a company may develop an “innovative” way of deploying existing technologies that qualifies it for listing with a WVR structure. Accordingly, the fact that a particular company has qualified for listing with a WVR structure does not necessarily mean that another applicant with a similar technology, innovation or business model will also qualify for listing with a WVR structure.”
3. HKEX acknowledges that “a smaller equity interest may potentially incentivise Controlling Shareholders to move quality assets away from a listed company to other companies in which they have a higher stake, and vice versa (known as “tunneling” or “value shifting”). This may place a greater burden on the connected transaction Rules that aim to prevent such actions”. It is therefore curious that the key matters (that is, those set out in paragraph 8 above) to be decided on a one-share-one-vote basis do not include approval of connected transactions by shareholders?
4. In material transactions (such as very substantial acquisitions or disposals under the Listing Rules) of the WVR company, the WVR beneficiaries possess tremendous decision-making power disproportionate to the relatively low economic risk they have to bear. Accordingly, they are more likely to be motivated to take on risky transactions, since if such transactions fail those who will suffer most of the economic losses will be the ordinary shareholders. It is therefore suggested that the key matters (that is, those set out in paragraph 8 above) to be decided on a one-share-one-vote basis should include approval of such material transactions.