The storm is coming, where can the Greater China Issuers go?


Background

The Stock Exchange of Hong Kong Limited (the “Exchange”) is one of the most popular and active stock exchanges in the world with over HK$300 billion raised in 2019. Meanwhile, the listing requirements in Hong Kong also set a very high bar for many businesses with great potential, which led to a number of IPO plans drifting away from Hong Kong to other jurisdictions. For instance, when tech giants Alibaba Group eyed on the Exchange back in 2014, it gave up Hong Kong and went public on the New York Stock Exchange (the “NYSE”) in the United States (the “US”) becoming the world’s largest IPO. It was not until the introduction of Chapter 19C of the Rules Governing the Listing of Securities on The Exchange (the “Listing Rules”) in April 2018 did Alibaba Group decided to make its recent homecoming debut for a secondary listing. Chapter 19C of the Listing Rules offers a new concessionary route which allows innovative companies that are already primary listed on a Qualifying Exchange, including the NYSE, NASDAQ Stock Market and the Main Market of the London Stock Exchange (the “Qualifying Issuers”), to apply for a secondary listing in Hong Kong.

In the past, secondary listing of an overseas issuer that has its centre of gravity in the Greater China region (the “Greater China Issuer”), whether or not it has a corporate structure involving weighted voting rights (“WVR”), was not allowed via the conventional route prescribed under the joint policy statement (the “Statement”). The Statement, regarding to the listing of overseas companies on the Exchange, was issued jointly by the Securities and Futures Commission of Hong Kong (” SFC “) and the Exchange on 27 September 2013 and subsequently amended on 30 April 2018.

Following an amendment of the Statement that its section 5 no longer applies to secondary listings under Chapter 19C, Alibaba Group, as a Greater China Issuer, successfully listed on the Exchange in November 2019, followed by other Chinese tech giants, NetEase, JD.com and Yum China, in the second and third quarters of 2020. With the growing tension between China and the US and the tightening audit requirements in the US, more China-based companies are considering returning to Hong Kong for a secondary listing. This article aims to provide an overview of Chapter 19C of the Listing Rules as a route to secondary listing in Hong Kong with a focus on Greater China Issuers.

Definition of Greater China Issuers

Chapter 19C of the Listing Rules defines a Greater China Issuer as Qualifying Issuer with its “centre of gravity” in Greater China. When determining whether a Qualifying Issuer’s centre of gravity is in Greater China, the Exchange would look at various factors including but not limited to (i) whether the issuer is listed in Greater China; (ii) the issuer’s jurisdiction of incorporation; (iii) the issuer’s history; (iv) where the issuer is headquartered; (v) the issuer’s place of central management and control; (vi) where the issuer’s main business operations and assets are located; (vii) the location of the issuer’s corporate and tax registration; and (viii) the nationality or country of residence of the issuer’s management and controlling shareholder.

Grandfathered vs. Non-Grandfathered Greater China Issuers

The Exchange has different treatments for Grandfathered and Non-Grandfathered Greater China Issuers. The former are Greater China Issuers primary listed on a Qualifying Exchange on or before 15 December 2017 (being the date the Chapter 19C proposals were published) and the latter are Greater China Issuers primary listed on a Qualifying Exchange after 15 December 2017. The rationale behind such distinction was to prevent companies from listing on a Qualifying Exchange followed by a secondary listing in Hong Kong as a means to circumvent Hong Kong’s primary listing requirements.

Suitability for Secondary Listing on the Exchange

Generally speaking, a Qualifying Issuer seeking a secondary listing is eligible and suitable for listing under Rule 8.04 of the Listing Rules. In particular, for a Qualifying Issuer seeking a secondary listing under Chapter 19C, Rules 8A.04 to 8A.06 on basic conditions for listing and qualifications for listing with a WVR Structure do not apply. A large emerging and innovative company, being a Qualifying Issuer, is normally considered as a suitable candidate for the purpose of secondary listing under Chapter 19C.

According to Guidance Letter HKEX-GL94-18 (the “Guidance Letter”), the Exchange would normally assess the suitability of a candidate by considering whether it has the following characteristics:

  • its success is attributable to the application of new technologies, innovations, and/or a new business model to its core business, which differentiates the applicant from existing players;
  • research and development significantly contributes to its expected value and comprises a major activity and expense;
  • its success is 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.

The Exchange would expect an innovative company to possess more than one of the above characteristics to demonstrate its suitability for secondary listing under Chapter 19C. The Exchange emphasizes that the superficial application of new technology to a conventional business is insufficient to qualify an applicant for secondary listing unless it exhibits other distinctive features or characteristics. The Exchange will review the facts and circumstances of each case to determine if such applicant has demonstrated that it is an innovative company for the purpose of the Listing Rules.

Qualifications for secondary listing under Chapter 19C

Under Chapter 19C, a Qualifying Issuer must have a track record of good regulatory compliance of at least two full financial years on a Qualifying Exchange. In respect of market capitalization requirement, all Greater China Issuers must have (i) a market capitalisation of HK$40 billion at the time of listing; or (ii) market capitalisation of HK$10 billion at the time of listing and at least HK$1 billion of revenue in its most recent audited financial year.

Standards of Shareholder Protection

All Qualifying Issuers must meet the shareholder protection standards set out in Rule 19C.07. However, the extent of which the Listing Rules apply to Grandfathered and Non-Grandfathers Greater China Issuers differs. For instance, Appendices 3 (on articles of association) and 13 (on additional requirements for memorandum and bye-laws) do not apply to Grandfathered Greater China Issuers.

Where both a Grandfathered Greater China issuer and a Non-Grandfathered Greater China Issuer must comply with Rule 19C.07 as an ongoing condition of its listing under Rule 19C.09 for the former and as required by Appendices 3 and 13 of the Listing rule for the latter, the difference lies in the means they are allowed to use for such compliance. A Grandfathered Greater China issuer is not obliged to amend their constitutional documents to meet Hong Kong’s key shareholder protection standards under Rule 19C.07 as long as they can demonstrate to and satisfy the Exchange under Rule 19.30(1)(b) that their constitutional documents and/or the law and regulations to which they are subject, are at least equivalent to those provided in Hong Kong. A Grandfathered Greater China issuer, however, receives a less lenient treatment from the Exchange and must amend its constitutional documents to meet the Rule 19C.07 standards as required under Appendices 3 and 13 of the Listing Rules.

Variable Interest Entity (” VIE “) Structures/Contractual Arrangements

It is often seen that offshore-listed Chinese companies use VIE structures to indirectly own and control businesses operating in an industry sector that is subject to foreign investment restrictions under PRC law. Grandfathered Greater China Issuers can secondary list on the Exchange with their existing VIE structures in place. Although they will not be required to demonstrate their ability to comply with the PRC Foreign Investment Law (the “FIL”), they must (i) provide the Exchange with a PRC legal opinion confirming that such VIE structures comply with PRC laws, rules and regulations; and (ii) comply with the disclosure requirements set out in Listing Decision HKEx-LD43-3 (the “Listing Decision”). Whereas Non-Grandfathered Greater China Issuers, in addition to the compliance with the requirements set out in the Listing Decision, they may also be required by the Exchange to demonstrate that they are able to comply with the requirements under the FIL. Since the FIL only became effective on 1 January 2020, there are uncertainties over its interpretation and application. These Non-Grandfathered Greater China Issuer applicant would include such uncertainties as a risk factor in the listing document.

Issuers with WVR Structures

With regard to issuers with a WVR Structure, Grandfathered Greater China Issuers are able to secondary list on the Exchange with their existing WVR structure in place. They do not need to comply with, except for disclosure requirements, the ongoing WVR investor protection requirements set out under Rules 8A.07 to 8A.36, 8A.43 and 8A.44 which mainly govern the restrictions on WVR Structures (such as the restriction not to increase the proportion of WVR shares after listing; or the requirement for certain resolutions to be subject to voting on a one vote per share basis).

Non-Grandfathered Greater China Issuers, on the other hand, are required to ensure that its WVR structure complies with the primary listing requirements under Chapter 8A, including ongoing WVR safeguards and disclosure requirements. Where necessary, these issuers have to incorporate certain provisions into its constitutional documents in accordance with Rule 8A.44 in order to satisfy the key shareholder protection standards required thereunder.

Automatic waivers

Greater China Issuers will enjoy automatic waivers from full compliance with the Listing Rules under Rule 19C.11 which would otherwise be burdensome for them. These waivers, including those concerning connected transactions, notifiable transactions and the Corporate Governance Code under Appendix 14, are granted on the basis that the securities of these issuers are traded in Hong Kong as secondary market and therefore not to be taken advantage of to circumvent the Listing Rules that they would otherwise be subject to. If subsequent to its secondary listing, the majority of trading in a Greater China Issuer’s listed shares, i.e. 55% or more of the total worldwide trading volume (by dollar value) of its shares migrate to Hong Kong in the most recent fiscal year, the Exchange will regard such Greater China Issuer as having a dual-primary listing status and the automatic waivers will no longer apply.

There will be a grace period of 12 months for a Greater China Issuer to comply with the applicable requirements. Such grace period will commence from the Exchange’s written notice of its decision that majority of trading in the Greater China Issuer’s listed shares have migrated permanently to Hong Kong. Failure to comply within the grace period may result in disciplinary action by the Exchange, including a de-listing of the listed shares of the Greater China Issuer.

Unusual Provisions in Qualifying Issuers’ Constitutional Documents

Under Rule 19C.10, a Qualifying Issuer must prominently disclose in its listing documents any provision in its constitutional documents relating to its governance that are unusual compared with normal practices in Hong Kong and are specific to the issuer (rather than a consequence of the laws and regulations to which it is subject), and how such provisions affect its members’ rights. This would require disclosure of “poison pill” arrangements and provisions imposing restrictions on quorums for board meetings.

Confidential Filing of Secondary Listing Applications

Paragraph 18 of Practice Note 22 to the Listing Rules requires new listing applicants to submit the Application Proof of their listing document to the Exchange for publication on the Exchange website. However, a new applicant which has been listed on a recognised overseas exchange for at least five years and has a significantly large market capitalisation at the time of filing its listing application is entitled to make a confidential filing of its Application Proof. Such applicant is not subject to the publication requirements unless requested to comply with them by the Exchange or the SFC. All other requirements under the Listing Rules apply unless a waiver is granted.

Tightening audit requirements in the US

Under the US laws, auditors of companies whose shares are registered with The Securities and Exchange Commission (” SEC “) and traded publicly in the US must be registered with the US Public Company Accounting Oversight Board (“PCAOB”). PCAOB has a duty under the US laws to conduct regular inspections to assess compliance of these companies with applicable professional standards. However, most of the auditors of Greater China Issuers are located in China – a jurisdiction where the PCAOB had not been able to conduct inspection without the approval of the Chinese authorities. In May 2020, the US Senate passed the Holding Foreign Companies Accountable Act (often known as the “Kennedy Bill”) which, if eventually enacted, would direct the SEC to prohibit securities of any registrant from being listed on any of the US securities exchanges if the auditor of the registrant’s financial statements is not subject to PCAOB inspection for three consecutive years after the law becomes effective. There has been increasing concerns among these Greater China Issuers in the fear of being delisted from the NYSE or Nasdaq if they are unable to resolve the situation and meet the PCAOB inspection requirement within the prescribed timeframe. The Hong Kong securities market is a good alternative for these Greater China Issuers should they want to move or expand into the secondary market.

Conclusion

With the recent growing tension between China and the US, coupled with the tightened audit requirements above, the new Chapter 19C seemed to have come in time. The relieve on the stringent requirements for secondary listing in Hong Kong definitely makes the Exchange more attractive to Qualifying Issuers, especially those Greater China Issuers, when considering pursuing a secondary listing. Up to the publication of this article, there are around 15 Grandfathered Greater China Issuers listed on either the NYSE or NASDAQ. Four of them, namely Alibaba Group, NetEase, JD.com and Yum China, have already listed on the Main Board of the Exchange under Chapter 19C regime and the rest of the eligible candidates will hopefully follow. Their oversubscriptions reflect a high demand for these tech giants in the market. We believe that the mentioned listing reforms paves way for US-listed mainland tech giants to list in Hong Kong, and the IPO market shall welcome the homecoming of more Greater China Issuers.

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