In the first of this two-part article, CGj reviews a recent Institute seminar discussing the new proposals to amend Hong Kong’s treasury share Listing Rules, clarifying the context of the issue and outlining what this will mean for listed companies.

Hong Kong Exchanges and Clearing Ltd (HKEX) issued a consultation on 27 October 2023, which closed on 27 December 2023, on its proposed amendments to the Listing Rules to introduce a new treasury share regime in Hong Kong. These amendments are designed to bring Hong Kong into alignment with international trends, with the aim of enhancing the attractiveness and competitiveness of the city’s stock market, and to give issuers greater flexibility in managing their capital structure through the resale of treasury shares.

Treasury shares – also known as treasury stock or reacquired stock – are the portion of a company’s shares that have been bought back from stockholders by the issuing company and then held in its own treasury. This decreases the total number of outstanding shares on the open market and increases the value for the remaining shareholders. The benefits of holding treasury shares include limiting outside ownership through being held indefinitely by the company or through being retired. Additionally, they can later be resold to the public if capital needs to be raised in the future, or be used in a share scheme. However, treasury shares have no voting rights and do not pay out any dividends during the period in which they are being held by the issuer in treasury.

To help explain the new proposals and what they will mean for Hong Kong’s listed issuers, the Institute invited Billy Wong, Partner of global law firm Morgan, Lewis & Bockius, to speak at a seminar on 11 January 2024.

History and background 

Mr Wong started by giving the history and background of treasury shares, which provided a useful context for why the Listing Rules and the Companies Ordinance in Hong Kong have up to now prohibited the holding of repurchased shares in treasury for later resale, and why the Exchange is now looking to amend the rules.

English law 

The original common law prohibition on treasury shares was unequivocal, as indicated in a judgment handed down by Lord Hershell in Trevor v Whitworth in 1887, in which the resale of repurchased shares was considered ‘trafficking’. The overriding concern was the potential for fraud or abuse if companies were allowed to buy their own shares. Mr Wong described how the UK Companies Act of 1929 and that of 1948 by implication forbade the repurchase of shares.

However, with the establishment of the Jenkins Committee in 1959 to review various aspects of UK company law, the thinking started to change. Greater consideration was given from the 1960s to widening the powers for companies to repurchase their own shares and to hold them in treasury. In fact, the amended Companies Act of 1981 effectively abolished the prohibition on share repurchases, albeit under certain conditions as specified in the Companies Act of 1985.

US law 

In the US, in contrast, the majority of state and federal courts had several lines of reasoning to permit the power to repurchase from as early as the mid-19th century. For instance, while some courts found no express prohibition on share repurchases, other courts thought that the power to repurchase was incidental and necessary to the main object for which a corporation was formed – but such power was subject to limitations. For example, a number of courts said the repurchase had to be made in good faith, while others found that repurchase should be made without prejudice to creditors’ rights. There was concurrently a minority voice among some states that followed the English rule, in which no definite grant of power was given in the statutes to repurchase shares, citing the same concerns as those of the English courts. By the 1930s, a number of states had enacted statues imposing certain conditions on a company’s share repurchase power, but nevertheless gave corporations the right to hold their own shares and to acquire treasury stock for legitimate corporate purposes. The key point, Mr Wong stressed, is that any repurchase of shares must be done in good faith.

In 1982, the US Securities and Exchange Commission actively encouraged share repurchases and, by the 1990s, federal law also encouraged the holding of treasury shares. The law in the US is now codified into a unified set of principles where treasury shares and share buybacks are allowed.

Other jurisdictions 

Mr Wong then referred to the other jurisdictions that currently permit treasury shares, which include Singapore, the Cayman Islands, Bermuda and the Mainland. ‘All these jurisdictions are relevant to the daily practice of many professionals in Hong Kong. There are some differences in the laws relating to each of these, but generally the differences are fine,’ he noted. In Singapore and the Caymans, for example, there are very few, if any, restrictions in regards to treasury shares. In the Mainland, both the holding of treasury shares and share repurchases are allowed, with the China Securities Regulatory Commission having put clear mechanisms in place to embrace both, although there is a strict limit of 10% on the maximum number of shares that can be held in treasury, while these shares must be cancelled three years after repurchase.

The case for Hong Kong 

The Companies Ordinance in Hong Kong loosely mirrors the pre-1980s UK Companies Act and, despite a number of substantive revisions to take account of the particular socioeconomic and market situation in Hong Kong that led to its current form in 2014, it has thus far not been amended in accord with the existing UK company law in relation to treasury shares.

At present, the rules in Hong Kong – under both the Companies Ordinance and, specifically, Rule 10.06(5) of the Listing Rules – mandate the automatic cancellation of repurchased shares for locally incorporated companies. Given that approximately 92% of listed companies in Hong Kong are incorporated in overseas jurisdictions that do allow for the holding of treasury shares and their subsequent resale, this creates significant limitations for overseas issuers, who are thus restricted by the Listing Rules from exercising that option.

HKEX’s recent proposals therefore seek to align the Listing Rules with the prevailing regulations in other jurisdictions, subject to the issuer’s place of incorporation and the company’s articles of association.

One of Hong Kong’s concerns has always been the potential for abuse if treasury shares are allowed, along with the danger that some stakeholders might not receive fair treatment. If – as Mr Wong believes will happen – the requirement to cancel repurchased shares is removed under the Listing Rules, both on market and off market, HKEX would simultaneously introduce a framework to ensure that market manipulation is prevented, and that fair and equal treatment of all shareholders is guaranteed.

The other proposal – to allow for the resale of treasury shares – also comes with certain conditions. Moreover, the resale must be approved in advance by shareholders, either under a specific mandate or a general mandate, or will be subject to pre-emption rules similar to an issuance of new shares, as under Rule 13.36, and be offered to all shareholders on a pro rata basis.

‘Many of the amendments to the treasury share regime will make treasury shares very similar to the issuance of new shares under the existing rules,’ Mr Wong explained. So any on-market resale of treasury shares under a general mandate would be subject to a maximum price discount of 20%, while off-market resale will be subject to the same price discount limit as an issuance of new shares. Further, any share grants using treasury shares would be treated in the same way as a share scheme funded by new shares under Chapter 17 of the Listing Rules.

Additional requirements and restrictions 

HKEX is proposing additional requirements for the use of treasury shares, many of which, according to Mr Wong, are very relevant to the daily practice of governance professionals. As he emphasised, these are very important to bear in mind because it will require careful advance planning to avoid being caught out.

Connected transactions. To prevent abuse, any resale of treasury shares to a connected person will be subject to the same connected transaction requirements as for the issuance of new shares under Chapter 14A. This dealing restriction applies to both on-market and off-market resale of shares. However, if the on-market resale of treasury shares is shown to have been made unknowingly to a connected person, this will be exempted from the prohibition.

Disclosure. Issuers will need to disclose any resale of treasury shares and the movement in the number of treasury shares by issuing an immediate announcement prior to the commencement of trading the next day, as well as through the listing document, next day disclosure return, monthly return and annual report.

Documentary requirements. Issuers will need to comply with the documentary requirements under Rules 9.18 to 9.23 for the resale of treasury shares.

Moratorium period. Despite several other jurisdictions having no such restrictions, HKEX is proposing a moratorium period of 30 days on the resale of treasury shares, whether on or off market, after a share repurchase, as well as a 30-day moratorium on an on-Exchange share repurchase after an on-Exchange resale of treasury shares. Any resale would be strictly prohibited during these 30-day periods. ‘While imposing a moratorium period may be seen as a slightly controversial proposal, this is one of the mechanisms that HKEX is proposing as a safeguard to ensure consistent and equitable treatment of shareholders,’ Mr Wong stated.

Inside information. Less controversial – as this is already enshrined in current legislation – is the proposal to prohibit a resale of treasury shares during any period in which there is undisclosed inside information, as set out in the market misconduct rules of the Securities and Futures Ordinance.

Brokers. As under Rule 10.06(2)(d), any broker or agent appointed by the issuer to resell treasury shares will also be required to disclose that information to the Exchange, including any on-market resale of treasury shares, and will also be subject to the same proposed requirements and restrictions as issuers.

New listing applicants. For new listing applicants, there will be a six-month lock-up requirement prior to reselling or entering into an agreement to resell treasury shares, while any new listing applicant already holding treasury shares at the time of listing may retain those shares, but must disclose all relevant details in their prospectus.

Voting rights. Voting rights attached to treasury shares will be suspended – as is common practice under the law in all jurisdictions – and, as would be expected, treasury shares will be excluded when calculating a listed company’s issued shares. As Mr Wong indicated, this is important to remember when planning corporate action.

Issuer’s intention. Mr Wong then clarified that the explanatory statement, as required by the Listing Rules for the share repurchase mandate, must also state the issuer’s intention as to whether the repurchased shares will be cancelled or kept as treasury shares. ‘I personally find this quite interesting. As a lawyer, we are in a good position to help companies draft their intentions in this regard,’ he said.

Part 2 of this article, which offers practical tips for governance professionals to prepare for these changes, will be published in next month’s edition of CGj. 

The hybrid seminar reviewed in this article – Proposed Amendments to Treasury Share Listing Rules – was held on 11 January 2024. More information on the Institute’s ECPD seminars is available on its website: https://www.hkcgi.org.hk/.

Credits

The Institute would like to thank everyone involved in the seminar reviewed in this article.

• Speaker: Billy Wong, Partner, Morgan, Lewis & Bockius
• Panellist: Polly Wong FCG HKFCG(PE), Company Secretary and Group Financial Controller, Dynamic Holdings Ltd
• Chair: Wendy Ho FCG HKFCG(PE), Executive Director of Corporate Services, Tricor Hong Kong