Hong Kong Stock Exchange Revises Listing Rules To Tighten Restrictions On Backdoor Listings.

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Asia Pacific Legal Updates


3 August, 2019


Hong Kong Stock Exchange Revises Listing Rules To Tighten Restrictions On Backdoor Listings.


The Hong Kong Stock Exchange has finalised its proposed amendments to the Listing Rules to tighten restrictions on backdoor listings and continuing listing criteria. The changes are aimed at combatting listed company shell activities which have been the subject of ongoing regulatory scrutiny in recent years.


Among the changes relating to backdoor listings, existing rules on reverse takeovers will be revised to codify the principle based approach to applying the rules currently contained in Stock Exchange guidance. The bright line test for identifying reverse takeovers will also be modified to extend from 24 to 36 months the time period during which acquisitions of assets from a person or group of persons gaining control of a listed company will be taken into account. In relation to continuing listing criteria, the requirements on sufficiency of operations to warrant continued listing have been tightened, along with other changes.


The Stock Exchange has made some modifications to its original proposals in the consultation paper as a result of comments in the consultation phase. In particular, the Stock Exchange noted concerns that normal course business may be impacted and has removed references in the Listing Rules to greenfield operations, equity fundraisings and termination of businesses as transactions to be taken into account in determining whether a series of acquisitions may constitute an attempt to list an acquisition target. However, the Stock Exchange has stated in its new guidance that where an issuer conducts shell activities through a series of such transactions it may exercise its rights to impose additional conditions, for example requiring the issuer to comply with the reverse takeover regime.


The revised rules, together with new guidance letters, will come into effect on 1 October 2019. In this bulletin, we highlight the key changes to the Listing Rules.


The Securities and Futures Commission has also simultaneously published a statement to explain its approach to tackling backdoor listings and shell company activities and its ongoing cooperation with the Stock Exchange.


Rule changes relating to backdoor listings


The key changes to the Listing Rules relating to backdoor listings include:


  • Principle based approach - The Listing Rule amendments codify the Stock Exchange’s principle based approach to assessing reverse takeovers, restricting those transactions which are an attempt to achieve a listing of acquisition targets circumventing the requirements for new listing applicants in chapter 8 of the Listing Rules. The revised rules set out the six factors which will normally be taken into account in assessing transactions. These factors are based on those currently contained in Stock Exchange guidance with some modifications. The six factors are: the relative transaction size, target quality, nature and scale of the issuer’s business, any fundamental changes in the issuer’s principal business, changes in control or de facto control of the issuer and aggregation of transactions in a series (specified to normally refer to those within a 36 month period). The Stock Exchange has also published a new guidance letter, GL104-19, on the application of the reverse takeover rules which provides further guidance on the assessment factors under the principle based test.

  • Aggregation period - The revised Listing Rules retain the existing bright line tests as examples of reverse takeovers but modify the aggregation period from 24 months to 36 months during which acquisitions of assets from a person or group of persons gaining control of a listed company will be taken into account.

  • Restriction on disposals after change in control - Existing Listing Rules 14.92 and 14.93 (which prevent an issuer from disposing of its existing business for two years after a change of control) are to be replaced with a new Rule 14.06E which restricts disposals or distributions in specie of all or a material part of an issuer’s existing business for a period of 36 months from any change of control. This restriction will apply unless the remaining group, or assets acquired from the person acquiring control, can meet the financial standards for listing. If these are not met, the listed issuer will be treated as a new applicant.

  • Large scale issue of securities - The revised rules codify existing Stock Exchange guidance into a new Rule 14.06D. This new rule disallows backdoor listings through large scale share issues where there is a change in control and the proceeds from the share issue will be used to acquire or develop a new business that is substantially larger than the issuer’s existing business. The Stock Exchange has released a new guidance letter, GL105-19, which expands upon and supersedes the existing guidance, to provide guidance on large scale issues of securities and sets out examples of equity fundraisings which would normally be caught.

  • Extreme transactions - The regime codifies the compliance requirements in existing Stock Exchange guidance for extreme VSAs (to be renamed “extreme transactions”) with certain modifications. The revised rules require the issuer to appoint a financial adviser to perform due diligence on the acquisition targets and make a declaration (in the form set out in a new Appendix 29). The declaration covers matters including the ability of the targets and the enlarged group to meet the Listing Rule requirements and the circular content. The revised rules also impose additional eligibility criteria for transactions classified as extreme transactions such that the issuer must either (i) operate a principal business of a substantial size which will continue after the transaction; or (ii) have been under the control of the same person or group of persons for at least three years and the transaction must not result in a change of control. This requirement has been modified from the original proposal to address concerns raised by mid or small sized issuers. General guidance is included in the new GL104-19 as to the meaning of a principal business of a substantial size, which is expressed may include an issuer with annual revenue or total asset value of HK$1 billion or more based on the latest published financial statements.

  • Suitability for listing - For both reverse takeovers and extreme transactions, the revised rules add a requirement that the acquisition targets must meet the suitability for listing and financial track record listing criteria in Rules 8.04 and 8.05 and the enlarged group must meet all of the Chapter 8 new listing requirements (except Rule 8.05). If a reverse takeover is proposed by an issuer that does not meet the requirements in Rule 13.24 that the company have sufficient operations to warrant a continued listing, the acquisition target must also meet the requirements in Rule 8.07 that there must be an adequate market for the securities.


Rule changes related to continued listing criteria to tackle listed shell companies


The key changes to the Listing Rules tackle listed shell companies include:


  • Sufficiency of operations to warrant continued listing - Rule 13.24 is to be amended 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 continued listing. Currently these are alternative tests. Proprietary securities trading and investment activities are normally excluded in determining whether these tests are met, other than for banking and insurance companies and securities houses. The onus is on the issuer to provide relevant information for the Stock Exchange’s assessment and demonstrate compliance. The Stock Exchange has also published a guidance letter, GL106-19, which provides guidance on the general application of the sufficient operations rules and the specific application to shell activities.

  • Cash companies - The existing cash company rules provide that a company that consists wholly or substantially of cash or short-dated securities following a notifiable transaction will not be regarded as suitable for listing and will be suspended. The rule changes amend the reference to short-dated securities to short-term investments to cover investments that are easily convertible into cash. The exemption to the cash company regime in Rule 14.83 for securities brokerage businesses has also been modified to confine the scope of the exemption to banking and insurance companies and securities houses. This change has been made to address regulatory concerns that the existing exemption applying to securities brokerage businesses can be used to circumvent the rules.


Securities and Futures Commission statement


The Securities and Futures Commission also simultaneously published a statement to explain its approach to tackling backdoor listings and shell company activities and its ongoing cooperation with the Stock Exchange. It notes that it will not hesitate to use its statutory powers, including its investigation powers, to take action and sets out the factors it will consider in exercising its powers, including whether there are any red flags indicating a possible scheme to mislead regulators or the public or to circumvent rules or suggesting any other serious misconduct.


Some of the factors that are likely to be relevant include whether there are indications that arrangements or understandings (for instance relating to a change of control) are being concealed, or whether an issuer has disclosed the true nature or extent of its business, affairs or plans. Other factors cited focus on whether appropriate due diligence has been carried out, whether the directors have fulfilled their fiduciary duties and whether there are any issues relating to injected assets that cause regulatory concern.


This approach is in line with the Securities and Futures Commission’s statement earlier this month on the conduct and duties of directors when considering corporate acquisitions or disposals, covered in our recent e-bulletin.


Changes to notifiable and connected transactions rules and other rule changes


As part of the consultation exercise, the Stock Exchange is also implementing a number of other rule changes. These cover areas including significant distributions in specie, treatment of securities transactions and announcement requirements on guaranteed profits together with annual report disclosures on such guarantee’s performance and on significant investments. We will cover these changes in a follow up bulletin.


Commencement date and resources


1 October 2019 has been set as the date when the rule changes will take effect. A transitional period of 12 months from that date will apply to the changes to the continued listing criteria to enable companies to comply to the extent that non-compliance is caused only as a result of the rule changes.


The consultation paper, which includes the revisions to the Listing Rules and the new guidance letters, can be accessed here.


herbert smith Freehills


For further information, please contact:


Matt Emsley, Partner, Herbert Smith Freehills

[email protected]