Billy Wong, Partner, Morgan Lewis, provides a clear overview of the recent proposals to introduce a new treasury share regime in Hong Kong and how this would benefit Hong Kong incorporated companies.

Hong Kong Exchanges and Clearing Ltd (HKEX; the Exchange) recently published a consultation paper announcing the launch of a two-month consultation on proposed rule amendments to introduce a new treasury share regime, giving issuers greater flexibility in managing their capital structure through the resale of treasury shares.

HKEX is proposing to remove the requirement to cancel repurchased shares under the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Ltd (the Listing Rules). If such a requirement is removed, listed companies would be able to repurchase shares and hold them in treasury for future resale, if authorised by the laws of their places of incorporation and their constitutional documents.

It is worth noting that such a proposed removal will be accompanied by a framework in the Listing Rules to regulate the resale of treasury shares. The proposed framework will ensure a fair and orderly market, as well as fair and equal treatment of all shareholders on the resale of treasury shares.

HKEX’s proposals apply equally to the Rules Governing the Listing of Securities on GEM.

Treasury shares not currently permitted in Hong Kong 

Currently, upon a listed issuer repurchasing its own shares,  Rule 10.06(5) of the Listing Rules automatically cancels the listing of the repurchased shares and requires the issuer to ensure that the documents of title of the repurchased shares are cancelled and destroyed as soon as reasonably practicable following the settlement of any such repurchase.

Similarly, the Hong Kong Companies Ordinance requires a Hong Kong incorporated company to cancel repurchased shares. Therefore, both the Listing Rules and the Companies Ordinance presently prevent repurchased shares from being held in treasury for later resale.

The main reasons for such limitation are to: 

• safeguard against the risk of market manipulation by issuers repeatedly repurchasing and reselling their own shares on the market, and
• prevent insiders from trading in the shares to benefit from non-public information about share repurchases and resales of treasury shares.

Motivation behind proposed treasury share regime

HKEX’s proposals are triggered by the following factors:

Development of regulatory framework for treasury shares in Hong Kong and overseas jurisdictions

Since the rewriting of the Companies Ordinance in 2008, the laws of various jurisdictions have changed to allow companies to hold treasury shares for future resale. As of today, approximately 92% of issuers listed on the Exchange are incorporated in overseas jurisdictions (for example, Bermuda, the Cayman Islands or Singapore) that allow holding and flexibly using treasury shares.

However, due to the Listing Rules’ requirement to cancel repurchased shares that these overseas issuers must follow as a listed company on HKEX, those overseas issuers are still unable to hold treasury shares despite development in the regulatory framework in their respective place of incorporation.

Meanwhile, the Companies Ordinance in Hong Kong has remained unchanged in this regard since 2008 and listed issuers incorporated in Hong  Kong – accounting for the remaining 8% – are still prohibited from holding treasury shares under the Companies Ordinance.

Therefore, HKEX’s proposals seek to address this inconsistency by aligning the Listing Rules with the prevailing regulations in other jurisdictions that permit treasury shares.

Benefits of a treasury share regime 

On the one hand, HKEX acknowledges that repurchasing shares can serve various purposes for companies, including: 

• returning cash to shareholders
• adjusting the debt-to-equity ratio
• increasing earnings per share or other metrics based on the number of outstanding shares
• facilitating the exit of shareholders from the company, and
• signalling to the market that its shares are undervalued.

On the other hand, HKEX’s proposals aim to allow issuers to hold repurchased shares in treasury for subsequent resale when market conditions allow. This would provide an alternative means of raising funds through reselling treasury shares
in small lots on the market at full market price, rather than via a placing that involves new shares typically sold at a discount.

As a result, issuers would have greater flexibility in adjusting their capital structure quickly, thereby potentially reducing their cost of capital.

HKEX’s proposals for the Listing Rules

We discuss below the key features of the proposed amendments to the Listing Rules relating to treasury shares.

Proposal to remove requirement to cancel repurchased shares

HKEX proposes to amend the Listing Rules to remove the requirement to cancel repurchased shares. By doing so, HKEX would enable issuers to hold repurchased shares in treasury subject to the laws of their places of incorporation and their articles of association or equivalent constitutional document.

Proposals to treat resale of treasury shares as new shares

Since a resale of treasury shares impacts existing shareholders in a similar manner as an issuance of new shares, HKEX proposes to amend the Listing Rules to apply the current requirements for an issuance of new shares to a resale of treasury shares by a listed issuer.

Resale of treasury shares to be conducted on a pre-emptive basis or with a shareholders’ mandate. HKEX proposes that a resale of treasury shares shall:

• be subject to pre-emption similar to an issuance of new shares under the Listing Rules, and
• be offered to all shareholders on a pro rata basis or, alternatively, approved by shareholders under a specific mandate or a general mandate approved in advance by shareholders.

Share scheme. Under HKEX’s proposal, a share scheme using treasury shares to satisfy share grants would be treated as a share scheme funded by new shares under the Listing Rules.

Other proposals for resale of treasury shares. HKEX proposes the following additional requirements on the resale of treasury sales to ensure the protection of shareholders:

• a resale of treasury shares to a connected person subject to the same connected transaction requirements as an issue of new shares under the Listing Rules
• a requirement for issuers to disclose their resale of treasury shares and any movement in the number of treasury shares under different parts  of the Listing Rules in relation to the announcement, listing document, next-day disclosure return, monthly return and annual report, and
• a requirement for issuers to comply with the documentary requirements under the Listing Rules for its resale of treasury shares.

Risk mitigation proposals  

Currently, the Securities and Futures Ordinance (SFO) restricts all activities, including any dealings by a listed issuer in its treasury shares, that amount to stock market manipulation and insider dealing. In addition to the SFO’s restriction, HKEX proposes additional requirements to ensure that a fair and orderly market is maintained after the proposed relaxation.

Proposed 30-day moratorium period for share repurchases and resales of treasury shares. HKEX proposes to impose a 30-day moratorium period on:

• any resale of treasury shares (whether on or off market) after a share repurchase, and
• an on-Exchange share repurchase after an on-Exchange resale of treasury shares.

The proposed restriction on resale ensures that resales do not take place at a price that has been affected by the issuer’s previous share repurchase. Further, the proposed constraint on on-Exchange share repurchase deters issuers from repeatedly repurchasing and reselling their own shares on the market to make a trading profit or manipulate the share price.

Dealing restrictions for resale of treasury shares on the Exchange. HKEX proposes to prohibit a resale of treasury shares on the Exchange:

• when there is undisclosed inside information
• during the one-month period preceding a results announcement, or
• if the resale is knowingly made with a core connected person – however, HKEX proposes that an on-market resale of treasury shares to a connected person without knowledge would be fully exempt from the Listing Rules relating to connected transactions.

New listing applicants

Under HKEX’s proposals, new listing applicants can retain their treasury shares upon listing but must disclose details of its treasury shares in its prospectus.

HKEX also proposes a lock-up requirement to restrict new listing applicants from reselling their treasury shares or entering into any agreement for resale within six months after listing.

Amendments in other parts of the Listing Rules 

Voting rights attached to treasury shares. Despite voting rights attached to treasury shares normally being suspended by law, HKEX’s proposals make it clear under the Listing Rules that issuers (being holders of treasury shares) should abstain from voting on matters that require shareholders’ approval under the Listing Rules. This would also prevent controlling or substantial shareholders from using treasury shares as a means to consolidate their control of the issuer.

Excluding treasury shares in the calculation of issued shares. As treasury shares are held by issuers themselves and the rights attached to them are normally suspended by law, HKEX proposes to exclude treasury shares when calculating an issuer’s issued shares and voting shares for the purposes of determining:

• the issuer’s public float
• the issuer’s market capitalisation
• the equity capital ratio for size test calculation
• the size limit for issuing or purchasing securities as a percentage of the issued shares
• a person’s percentage of rights to vote at a general meeting of the issuer, and
• a person’s percentage interest in the issuer.

Disclosure of an issuer’s intention to hold treasury shares.  HKEX proposes to require an issuer to disclose in the explanatory statement its intention as to whether the repurchased shares will be cancelled or kept as treasury shares. This would enable shareholders to understand the potential impact of the proposed share repurchases and to vote accordingly.

Resale of treasury shares through agents or nominees. HKEX proposes to clarify that a resale of treasury shares by an issuer or its subsidiary through an agent or nominee would also be subject to the proposals set out in the consultation paper.

Conclusion

While affording more flexibility for issuers to hold treasury shares, HKEX’s proposals also include several important regulatory safeguards for preventing market manipulation and ensuring fair shareholder treatment.

The comprehensive proposals of the treasury share regime are therefore a positive development in optimising the attractiveness of Hong Kong’s listed market. The two-month consultation ended on 27 December 2023.

Billy Wong, Partner

Morgan Lewis

Copyright © Morgan Lewis, October 2023