Hong Kong Capital Market Developments

October 31, 2011

Listing Applicants not to Pass Material Information to Analysts

SFC Launches New Rules on Pre-Deal Research on IPOs

The Hong Kong Securities and Futures Commission has tightened up regulation on the preparation of “pre-deal research” in a Hong Kong initial public offering (“IPO”). This refers to investment research written on an entity shortly to be listed on the Hong Kong Stock Exchange (“HKEx”). The new rules, embodied in a relevant consultation paper, will apply to all listing applications submitted on or after 31 October 2011.

Among other reforms, the regulator has tightened up the prohibition against an investment analyst seeking or obtaining material non-public information about the listing applicant, if such information is not reasonably expected to be included in the prospectus. In response to this, IPO sponsor firms will put operational procedures in place to minimise the risks of the listing applicant intentionally or unintentionally passing such information to analysts.

The rationale for this prohibition is to ensure that the initial public offering will be made solely on the basis of the Hong Kong prospectus, and to preserve the independence of research analysts who, as is common Hong Kong market practice, may cover a listing applicant in their research report in the period leading up to the listing, based on their own investigations and independently of the listing applicant.

If You Have Committed Illegal Acts in the Past, Can You Apply for Listing?

HKEx Considers the Effects of Irregular Activities during Track Record Period

What happens if a Hong Kong listing applicant has had irregular or even illegal dealings during its track record period? HKEx recently considered this in its listing decision LD19-2011.

In this case, the listing applicant had, during its track record period, engaged in certain “non-compliant bill financing arrangements” involving potentially false invoices. The company was able to procure some comfort by way of a legal opinion that there were unlikely to be punitive consequences, as well as certain indemnities from the controlling shareholder. However, the practice might have had some impact on the company’s financials.

HKEx did not reject the listing applicant outright, but decided to impose a 12-month cooling period before the applicant could apply for listing, so as to demonstrate the company’s ability to operate independently of the problematic financing. HKEx also imposed a number of additional safeguards such as audit, disclosure and internal control review requirements before the company could be considered for a Hong Kong listing.

Pre-IPO Investment by Way of Loan and Warrant

Applying the 28-Day Rule in a Structured Investment

Since October 2010, HKEx has had a “28-day rule” on pre-IPO investments. This rule, in essence, requires all pre-IPO investments to be completed at least 28 days before the first submission of the listing application. In its recent listing decision LD15-2011, HKEx considered the implication of this rule in a “loan and warrant” structured investment.

In this case, the investors would lend money to the listing applicant in exchange for warrants issued by the controlling shareholders. The warrants enabled the investors to purchase up to 12% of the company’s shares at a pre-determined price upon listing, and some more shares (less than 1%) for free. The investors could opt for cash payment in lieu of shares. The loan had been fully drawn down more than 28 days before A1 filing, but the warrants remained exercisable.

HKEx took the view that the loan and the warrants were separate transactions, although the loan was conditional on the issue of the warrant. As such, the injection of the loan was not considered full settlement of the consideration for the shares, and the 28-day requirement had not been complied with.

If you have questions regarding this publication, please contact any of the lawyers listed below or your regular Davis Polk contact.

Eugene C. Gregor +81 3 5561 4566
Bonnie Y. Chan +852 2533 3308
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Paul Chow +852 2533 3318
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