Jurisdiction - Hong Kong
Reports and Analysis
Hong Kong – An Overview Of The Recent Developments On Connected Transaction Rules.

28 April, 2014

 

Legal News & Analysis – Asia Pacific – Hong Kong – Capital Markets

 

Highlights

 

This client alert gives an overview of the recent developments on connected transaction requirements applicable to companies listed on The Stock Exchange of Hong Kong Limited:

 

  • the amendments to the connected transactions rules that will be effective from 1 July 2014;
  • the Stock Exchange’s guidance on the pricing policies for continuing connected transactions and their disclosure (as per HKEx Guidance Letter HKEx-GL73-14 (March 2014)); and
  • the Stock Exchange’s guidance on the application of the connected transaction rules in various scenarios involving the provision of financial assistance by or for the benefit of listed issuers (as per Frequently Asked Questions Series 28 (released on 21 March 2014)).
 

Amendments To The Connected Transaction Rules – Effective from 1 July 2014

 

On 21 March 2014, The Stock Exchange of Hong Kong Limited (the “Stock Exchange“) published the consultation conclusions on “Review of Connected Transaction Rules” (the “Consultation Conclusions“) following its consultation on a number of proposals to refine the connected transaction rules as discussed in its consultation paper published in April 2013.

 

For the full text of the Consultation Conclusions, please click here

 

The amendments to the connected transaction rules set out in Chapter 14A of the Rules Governing of the Listing of Securities on the Stock Exchange (the “Main Board Listing Rules“) and Chapter 20 of the Rules Governing of the Listing of Securities on the Growth Enterprise Market of the Stock Exchange (the “GEM Listing Rules“) for implementing the proposals adopted by the Stock Exchange will be effective from 1 July 2014.

 

Comparison Between The Current And Revised Rules

 

The table below sets out a comparison between the current connected transaction rules and the revised connected transaction rules effective from 1 July 2014.

 

Current Rules Revised Rules
(effective from 1 July 2014)
Plain Language Amendments
(1) The current rules governing connected transactions are set out in Chapter 14A of the Main Board Listing Rules (or Chapter 20 of the GEM Listing Rules). 

The Stock Exchange issued the “Guide on Connected Transaction Rules” in April 2012 (the “Guide“) which illustrates the connected transaction requirements in plainer language with diagrams and examples. This guide does not have the status of guidance/practice notes to the Listing Rules.

A revamped version of Chapter 14A of the Main Board Listing Rules (or Chapter 20 of the GEM Listing Rules) will be adopted. This revamped version is based on the plain-language Guide with diagrams and examples, with minor modifications on drafting. 

  • For the full text of the revised Chapter 14A of the Main Board Listing Rules, please click here
  • For the full text of the revised Chapter 20 of the GEM Listing Rules, please click here

 

As the numberings of the provisions in Chapter 14A of the Main Board Listing Rules (or Chapter 20 of the GEM Listing Rules) have been revised, the following reference tables are published:

 

  • For Table of destination – from current to new Main Board Chapter 14A, please click here
  • For Table of destination – from current to new GEM Chapter 20, please click here
  • For Table of derivation – new Main Board Chapter 14A, please click here
  • For Table of derivation – new GEM Chapter 20, please click here
Scope of connected persons
(2) Connected transactions with persons who are connected persons by virtue of their relationship(s) with the listed issuer’s “insignificant” subsidiary or subsidiaries are fully exempt from the reporting, announcement, circular and independent shareholders’ approval requirements, subject to a 10% restriction on the consideration ratio for any transaction of a capital nature between the insignificant subsidiary and the persons connected with that subsidiary. 

A subsidiary is an “insignificant subsidiary” for the purpose of this exemption if its total assets, profits and revenue are less than (a) 10% under the relevant percentage ratios for each of the latest three financial years; or (b) 5% under the relevant percentage ratios for the latest financial year.

Persons connected with insignificant subsidiaries of the listed issuer will no longer be connected persons.
(3) An associate of a director, chief executive or substantial shareholder of the listed issuer is a connected person of the listed issuer. The definition of “associate” includes the trustees acting in their capacity as trustees of any trust of which a director, chief executive or substantial shareholder of the listed issuer (or if such person is a natural person, any of his immediate family) is a beneficiary. A trustee of an employees’ share scheme or occupational pension scheme established for a wide scope of participants will not fall within the definition of “associate” if the connected persons’ interests in the scheme are together less than 30%.
(4) The definition of “associate” includes an entity in which a connected person has 30% or more direct or indirect interest (“30%-controlled company”). However, an entity which is a 30%-controlled company held by a connected person only because that connected person has an indirect interest in the entity through its shareholding in the listed issuer’s group is not a connected person. The exemption is modified such that a “30%-controlled company” held by a connected person will not be regarded as his/its associates (and will therefore not a connected person) only if the interests held by the connected person and his/its associate(s) in that company, other than those indirectly held through the listed issuer’s group, are together less than 10%.
Scope of connected transactions
(5) The following types of transactions between a listed issuer and a third party involving a controller (i.e. a director, chief executive or controlling shareholder of the listed issuer or any of its subsidiaries) are connected transactions for the listed issuer: 

  • acquisition or disposal by the listed issuer of an interest in a company where a substantial shareholder of that company is (or is proposed to be) a controller or an associate of a controller;
  • acquisition by the listed issuer of an interest in a company of which a controller or an associate of a controller is (or will become) a shareholder where (i) the interest being acquired is of a fixed income nature; (ii) shares are to be acquired on less favourable terms than those granted to the controller or its associate; or (iii) shares to be acquired are of a different class from those held by (or to be granted to) the controller or its associate;
  • subscription by a controller or its associate of shares in a company in which the listed issuer is a shareholder (i) on specially favourable terms; or (ii) where the shares are of a different class from those held by the listed issuer.
The only type of transactions between a listed issuer and a third party involving a controller which constitute connected transactions is where the listed issuer acquires an interest in a company where a substantial shareholder of that company is (or is proposed to be) a controller at the listed issuer level or an associate of a controller at the listed issuer level. 

The other types of transactions set out on the left column are no longer connected transactions.

Exemptions for connected transactions
(6) Connected transactions between the listed issuer’s group and connected persons at subsidiary level are subject to the reporting, announcement, circular and independent shareholders’ approval requirements unless they fall within any of the exemptions under the provisions of Chapter 14A of the Main Board Listing Rules (or Chapter 20 of the GEM Listing Rules) or a waiver is granted by the Stock Exchange. Transactions between the listed issuer’s group and connected persons at subsidiary level will be exempt from the circular and shareholders’ approval requirements.
(7) A connected transaction is fully exempt from all the connected transaction requirements if each or all of the percentage ratios (except the profits ratio) is/are: 

  • less than 0.1%;
  • less than 1% for transactions with persons connected with the issuer’s subsidiary only;
  • equal to or more than 0.1% but less than 5% and the total consideration is less thanHK$1 million.
The monetary threshold for fully exempt connected transactions is increased to HKD 3m.
(8) Provision to or receipt from connected persons of consumer goods or services are fully exempt from all the connected transaction requirements, subject to certain conditions, among other things, the consideration or value involved being less than 1% of the listed issuer’s total revenue or total purchases. The condition of 1% cap on transaction value is removed.
(9) Granting an indemnity by a listed issuer for the benefit of a director is a connected transaction. However, the Stock Exchange may, on a case-by-case basis, exempt from the connected transaction requirements indemnities granted by a listed issuer in favour of its directors against any claims that may arise from the proper discharge of their duties. Indemnities provided to, or purchase of insurance for, directors against liabilities incurred in the course of performing their duties are fully exempt from all the connected transaction requirements, provided that the indemnity or insurance is in the form permitted under the laws in Hong Kong and the place of incorporation of the company providing the indemnity or insurance. 

Note:
A listed issuer cannot apply the directors’ service contract exemption even if the directors’ service contract covers provision of indemnity or insurance.

Option arrangements
(10) The termination of an option by a listed issuer will be treated as a transaction and classified by reference to the percentage ratio (other than the profits ratio), unless the termination is in accordance with the terms of the original agreement entered into by the listed issuer and does not involve payment of any amounts by way of penalty, damages or other compensation. The termination of an option will be classified as if the option has been exercised, unless the termination is made under the terms of the original agreement and the listed issuer has no discretion over the termination.
(11) The transfer or non-exercise of an option (the exercise of which is at the listed issuer’s discretion) by a listed issuer will be classified as if the option has been exercised. The exercise price, the value of the underlying assets, the revenue attributable to such assets and (if applicable) the premium for transferring the option will be used for the purpose of the percentage ratios. 

The current rules do not specify how to calculate the percentage ratios for termination of an option.

The classification rules for the termination of an option are aligned with those applicable to the transfer or non-exercise of an option such that the transfer, non-exercise or termination of an option will be classified by using the exercise price, the value of the underlying assets, the revenue attributable to such assets and (if applicable) the consideration for transferring the option, or the amount receivable or payable by the listed issuer’s group for the purpose of the percentage ratios. 

For the transfer, non-exercise or termination of an option granted by a connected person, listed issuers may disregard the above percentage ratios and calculate the assets ratio and the consideration ratio based on the higher of:

 

  1. (i) in the case of a put option, exercise price less assets value; or
    (ii) in the case of a call option, assets value less exercise price; and
  2. the consideration or the amount payable or receivable by the listed issuer’s group.

 

The above alternative tests would be allowed only if the following conditions are satisfied:

 

  • the Stock Exchange has given consent to the use of such alternative tests;
  • the assets’ valuation is provided by an independent expert using generally acceptable methodologies#; and
  • the independent non-executive directors (“INEDs“) and an independent financial adviser have confirmed that the transfer, non-exercise or termination of an option is fair and reasonable and in the interests of the listed issuer and its shareholders as a whole and their views are disclosed in an announcement.

 

# Examples of acceptable valuation standards include International Valuation Standards, Hong Kong Institute of Surveyor Valuation Standards on Trade-related Business Assets and Business Enterprise, The Hong Kong Business Valuation Forum Business Valuation Standards.

Others
(12) A listed issuer must engage its auditors to review its continuing connected transactions every year and issue a letter confirming that the transactions: 

  • have been approved by the listed issuer’s board of directors;
  • are in accordance with the pricing policies of the listed issuer’s group if the transactions involve provision of goods or services by the listed issuer’s group;
  • have been entered into in accordance with the relevant agreement governing the transactions; and
  • have not exceeded the cap.

 

In practice, the Stock Exchange accepts auditors’ confirmation prepared according to Practice Note 740 “Auditor’s Letter on Continuing Connected Transactions under the Hong Kong Listing Rules” issued by the Hong Kong Institute of Certified Public Accountants, despite that the confirmation is expressed in the form of negative assurance.

The requirement on the auditors’ confirmation on continuing connected transactions is aligned with Practice Note 740 such that the auditors should confirm whether anything has come to their attention that causes them to believe that the transactions: 

  • have not been approved by the listed issuer’s board of directors;
  • were not, in material respects, in accordance with the pricing policies of the listed issuer’s group if the transactions involve provision of goods or services by the listed issuer’s group;
  • were not entered into in accordance with the relevant agreement governing the transactions; and
  • have exceeded the cap.
(13) For connected transactions subject to independent shareholders’ approval, the listed issuer is required to establish an independent board committee to advise the independent shareholders as to: 

  • whether the terms of the relevant transaction are fair and reasonable; 
  • whether such a transaction is in the interests of the listed issuer and its shareholders as a whole; and
  • how to vote.
The independent board committee’s opinion on a connected transaction should also cover whether the transaction is: 

  • on normal commercial terms; and
  • in the listed issuer’s ordinary and usual course of business.

 

Transitional Arrangements

 

The Frequently Asked Questions Series 28 released by the Stock Exchange on 21 March 2014 (the “New FAQ Series“), which is designed to provide further guidance on the revised rules effective from 1 July 2014, explains the following transitional arrangements relating to the application of the new exemptions available under the revised rules:

 

  • One off transactions – The new exemptions under the revised rules are not available for connected transactions entered into by listed issuers before the revised rules become effective even if all the exemption conditions are satisfied. Listed issuers should comply with the connected transaction requirements applicable at the time of entering into the agreement. However, the Stock Exchange may consider waivers from the shareholder approval requirement.
  • Continuing connected transactions – If before the revised rules become effective, a listed issuer has entered into an agreement for certain continuing connected transactions, and has complied with the announcement, circular and/or shareholders’ approval requirements applicable to the agreement at that time, it may announce that it will apply the exemption(s) available under the revised rules in respect of the reporting or annual review requirements for its next annual report(s) to transactions to be conducted under the agreement after the revised rules take effect if they can meet all the exemption conditions.
 

For the full text of the New FAQ Series, please click here

 

Guidance On The Pricing Policies For Continuing Connected Transactions

 

One of the areas on which the Stock Exchange has sought market views in its consultation paper on “Review of Connected Transaction Rules” concerned disclosure in relation to continuing connected transactions conducted under framework agreements. As stated in the Consultation Conclusions, the Stock Exchange decided not to introduce additional requirements in this regard. Instead, it published HKEx Guidance Letter HKEx-GL73-14 (March 2014) – “Guidance on pricing policies for continuing connected transactions and their disclosure” (the “Guidance Letter“) to provide guidance on the disclosure of pricing terms or mechanism for continuing connected transactions to assist listed issuers to comply with the rules.

 

Salient points of the guidance are highlighted below:

 

  • It would not be sufficient to describe pricing policies in generic terms, such as “prevailing market price” or “prices based on arm’s length negotiations” or “prices on normal commercial terms”.
  • When entering into agreements with connected persons, listed issuers should agree on specific pricing terms (e.g., fixed monetary consideration or a pre-determined formula or fixed per unit consideration) and disclose them in its announcement and (if applicable) circular.
  • If it is not commercially practical for the listed issuer to agree on a specific unit price or contract sum, it should disclose:
 
      1. in its announcement and (if applicable) circular:
        – the methods and procedures that the management will follow to determine the price and terms of the transactions; and
        – why its directors consider that the methods and procedures can ensure that the transactions will be conducted on normal commercial terms and not prejudicial to the interests of the listed issuer and its minority shareholders; and
      2. in its annual report whether the policies and guidelines disclosed in announcements and (if applicable) circulars have been followed when determining the price and terms of the transactions conducted during the year.
 
  • If the pricing is determined based on a reference price such as government prescribed price, the listed issuer should disclose the name of government authority or organisation publishing the price, and how and where the price is disclosed or determined, and the frequency of update to the reference price.
  • If the agreement covers transactions of different nature, the listed issuer should clearly set out the pricing policy for each type of transactions, instead of using generic “boilerplate” pricing mechanism.
  • Listed issuers should ensure that it has an adequate system of controls to safeguard the connected transactions, and to provide information for the INEDs and auditors to properly review the transactions annually.
  • The INEDs should ensure that: 
    • the pricing mechanism and the terms of the transactions set out in the agreement are clear and specific;
    • the annual caps are reasonable taking into account historical transactions and management projections;
    • the methods and procedures established by the listed issuer are sufficient to ensure that the transactions will be conducted on normal commercial terms and not prejudicial to the interests of the listed issuer and its minority shareholders;
    • appropriate internal control procedures are in place, and its internal audit would need to review these transactions; and
    • they are provided by the management with sufficient information for the discharge of their duties.

 

 

For the full text of the Guidance Letter, please click here

 

Guidance On The Application Of The Connected Transaction Rules In Various Scenarios Involving The Provision Of Financial Assistance By Or For The Benefit Of Listed Issuers

 

While the New FAQ Series mainly discuss the rules amendments to be effective from 1 July 2014, some of the questions contained in this series have also clarified, among other things, the application of the connected transaction rules in various scenarios involving the provision of financial assistance by or for the benefit of listed issuers.

 

Scenario 1:

 

 

 

Q: Does the provision of the indemnity by the Listed Issuer to its Substantial Shareholder constitute a connected transaction for the Listed Issuer?

 

A: No. The indemnity is a financial assistance provided by the Listed Issuer in favour of its wholly-owned subsidiary, and is not a connected transaction.

 

Scenario 2:

 

 

 

Q: Will the provision of the guarantee by the Listed Issuer be regarded as provision of financial assistance to Mr. A on the basis that he is not required to provide any guarantee for the loan facility in proportion to his interest in the Subsidiary?

 

A: No. The guarantee is provided by the Listed Issuer for the benefit of the Subsidiary. It is not regarded as provision of financial assistance to Mr. A.

 

Scenario 3:

 

 

 

Q: The provision of the guarantee for the bank loan obtained by the Connected Subsidiary constitutes a connected transaction for the Listed Issuer.

 

Both the current and revised rules provide for an exemption from the connected transaction requirements for financial assistance provided by a listed issuer’s group to a connected person if it is conducted (i) on normal commercial terms; and (ii) in proportion to the listed issuer’s equity interest in the connected person, and in case of a guarantee given by the listed issuer’s group, it must be on a several basis.

 

Can the Listed Issuer apply the above exemption on the basis that the Controlling Shareholder has agreed to provide the counter-guarantee?

 

A: No. The exemption applies only if the guarantee provided by the Listed Issuer is in proportion to its interest in the Connected Subsidiary and on a several basis.

 

Scenario 4:

 

Q: A listed issuer proposes to obtain a loan from its controlling shareholder on normal commercial terms and such loan will be secured by certain assets of the listed issuer. Can the listed issuer apply the de minimis exemption, and if so, how should the size tests be computed?

 

A: The listed issuer may apply the de minimis exemption.

 

It should compute the assets ratio and consideration ratio based on the principal amount of the loan and the revenue ratio based on the annual interests payable to its controlling shareholder.

 

Given the loan is to be secured by the listed issuer’s assets, the listed issuer should also compute the asset ratio and consideration ratio based on the value of the assets and also the revenue ratio based on any identifiable revenue stream generated from the assets.

 

Deacons

 

For further information, please contact:


Sabrina Fung, Partner, Deacons

sabrina.fung@deacons.com.hk

 

Deacons Capital Markets Practice Profile in Hong Kong

  

 

Comments are closed.