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Tightening the Rules of Backdoor Listings

  • Hong Kong
  • Corporate


In recent years, there have been growing concerns over backdoor listings and shell activities in Hong Kong as a result of which new businesses have been able to be listed without going through the listing requirements contained in the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the “Listing Rules”). The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) considers that these activities invite speculative trading and may undermine investor confidence and the overall quality of the Hong Kong securities market.

To help address the evolving market practices in backdoor listing, the Stock Exchange has recently tightened the regulation on reverse takeovers (“RTOs”), details of which are discussed this article.

Key changes

Current position

New changes (effective on 1 October 2019)

Principle-based test: The six assessment criteria for determining whether a transaction is an RTO are contained in Guidance Letter GL78-14.

Codifying the six assessment criteria, with two factors slightly modified:

  • change in control or de facto control may be indicated by a change in controlling shareholder or single largest substantial shareholder (change in board or senior management); and
  • transactions to be regarded as a “series” if they take place within 36 months or are otherwise related.
Bright-line tests: An RTO can include a very substantial acquisition which takes place within 24 months of a change in control. Extending the aggregation period from 24 months to 36 months
Disposals: Prohibition on disposals of existing business within 24 months after a change in control. The restriction will apply to “material” disposals and distributions in specie where there is a change in control at the time or within 36 months.
Large scale issue of securities: Prohibition on issuances where funds raised are used for greenfield operations and are means to circumvent the listing requirements. Guidance Letter GL84-15 to be largely codified, and disallowing issuances where proceeds are to be used to develop a substantially larger business.
Extreme very substantial acquisitions (“VSAs”): Guidance Letter GL78-14 provides guidance on “extreme” transactions which fall outside the bright-line tests. To be renamed as “extreme transactions”. The issuer must continue to operate its principal business with substantial size after the transaction or have been under the same control or de facto control for not less than 36 months with no change in control after the transaction.

Requirements for RTOs and extreme VSAs:

  • the enlarged group or the acquisition targets must satisfy the track record requirements; and
  • the enlarged group must meet all the other basic listing conditions.

Additional requirements to be imposed:

  • both the acquisition targets and the enlarged group must be suitable for listing;
  • the acquisition targets must meet the track record requirements; and
  • the enlarged group must meet all new listing requirements (except Rule 8.05).

What is an RTO?

Broadly speaking, an RTO refers to an acquisition (or a series of acquisitions) of assets which results in a change in control of the listed issuer with an attempt to circumvent the new listing requirements under the Listing Rules.

There are two tests under the Listing Rules whereby a transaction would be classified as an RTO:

  1. the principle-based test - designed to prevent the circumvention of the new listing requirements for the assets acquired or to be acquired, and is based on six assessment criteria which will be largely codified; and
  2. the bright-line tests - provide two specific forms of RTOs involving a change of control of the listed issuer and an acquisition of assets from the incoming investor.

If a transaction is classified as an RTO, the listed company will be treated as if it were a new listing applicant which means the acquisition targets must satisfy the suitability and track record requirements, 1 and the enlarged group meeting the new listing requirements under Chapter 8 (except for Rule 8.05) of the Listing Rules. Moreover, if the issuer failed to comply with the new Rule 13.24 regarding sufficient operations and assets, the businesses of both the acquisition targets and the enlarged group must also have a sufficient public interest.2

Principle-based test

One of the key changes among the recent updates is codifying the six assessment factors under the principle-based test, which are currently contained in Guidance Letter GL78-14, into a Note 1 to the new Rule 14.06B. While four of the criteria – (i) size of the transaction, (ii) whether there is any fundamental change in the issuer’s principal business, (iii) nature and scale of the issuer’s business and (iv) quality of the target business – will remain the same, two factors will be slightly modified.

In deciding whether there is any change in control or de facto control in the listed company, the Stock Exchange will take into account whether there is a change in the controlling shareholder or the single largest shareholder who is able to exercise effective control over the issuer. A substantial change to the board or senior management could be an indication of a change in control. However, if the new substantial shareholder is merely a passive investor or where are only changes to the directors or senior management and not the controlling or single largest shareholder, this factor may not be applicable.

The last factor looks at whether there is a series of transactions or arrangements3 to circumvent the RTO rules. The Stock Exchange will consider transactions to be part of a series if they take place within reasonable proximity (i.e. within 36 months4 ) or are otherwise related. These could involve various small acquisitions that result in the listing of a new business or re-sequencing transactions to acquire a new business before disposing the original business. In some scenarios, this factor is applied in conjunction with the “change in control” factor, such as in the case of an investor acquiring material shareholding interests in an issuer and subsequently purchasing a new business, along with appointing new directors who only have expertise in the new business.5

Bright-line tests

Under the bright-line tests, there are two specific forms of RTOs, namely:

  1. an acquisition or a series of acquisitions of assets constituting a very substantial acquisition resulting in a change in control of the issuer; or
  2. a very substantial acquisition(s) from an issuer’s controlling shareholder following a change in control.

Note 2 of the new Rule 14.06B will extend the aggregation period in respect of the change in control factor under (2) above from 24 months to 36 months.

Disposal restriction

The new Rule 14.06E restricts a listed company from carrying out a disposal or distribution in specie of all or a material part of its existing business where there is a change in control at the time or within 36 months. The Stock Exchange will make reference to the same six assessment factors used for the principle-based test.

Currently, only disposals that occurred after the relevant change in control will fall under the rules. The new restriction will be able to catch the scenario where a controlling shareholder disposes of its shareholding interest to a new investor, followed by a purchase of a material part of the issuer’s principal business.

Note that the new rule will not apply if the issuer’s remaining business or the acquired assets after the change in control can meet Rule 8.05.6 Furthermore, it is not intended to deter disposals which are conducted for commercial reasons, such as where an investor conducts a series of reorganisations to streamline the underlying business after gaining control.

Large scale issues

Guidance Letter GL84-15, which currently provides guidance on backdoor listing through large scale issues of securities for cash, will also be codified into a new Rule 14.06D. Where there will be a change in control or de facto control, and the proceeds are to be applied to acquire and/or develop a new business that is expected to be substantially larger than the issuer’s original business, the Stock Exchange may refuse to grant approval for the share issuance.

Extreme transactions

The category of “extreme VSAs” will be renamed as “extreme transactions” and codified from a guidance letter into a new Rule 14.06C. An extreme transaction is an acquisition (or a series of transactions) which has the effect of achieving a listing of the acquisition targets but which does not attempt to circumvent the new listing requirements. The Stock Exchange will consider the six assessment factors discussed above in determining whether a transaction falls within this category.

On top of satisfying the suitability and track record requirements for the acquisition targets and the Chapter 8 new listing requirements as in the case of RTOs, in an extreme transaction, the issuer must also have been:

  1. under the control or de facto control of the same person(s) for a long period (normally at least 36 months) without any change in control or de facto control after the transaction; or
  2. operating a principal business of substantial size which will continue after the transaction.

Going forward

Ever since the market consultation on amendments to the backdoor listing rules took place in mid-2018, there has been a noticeable decline in the number of transactions which attempt to list new businesses without going through the new listing criteria. In light of the new rules that are formally in place, we expect this trend to continue in the near future.

1Rule 8.04 or Rule 8.05 (or Rule 8.05A or Rule 8.05B as the case may be).
2Rule 8.07.
3Including changes in control or de facto control, acquisitions and disposals.
4Note however that the transactions outside the 36-month ambit will also be considered if there is a clear nexus or there are concerns about circumventing the RTO rules.
5See Guidance Letter GL104-19.
6Or Rule 8.05A or 8.05B, as the case may be.
7Except for Rule 8.05.