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Hong Kong corporate finance regulation 2014 and 2015 – IPO sponsor due diligence regime update

Hong Kong corporate finance regulation  2014 and 2015 – IPO sponsor due diligence regime update

4. Improved Regulatory Regime for Funds

New Open-ended Fund Company Structure proposed for Investment Funds

As a step towards enhancing Hong Kong’s legal and regulatory frameworks to strengthen its position as a major international asset management centre, the Government held a three-month public consultation on introducing a new open-ended fund company (OFC) structure for investment funds.

Open-ended investment funds require the flexibility to vary their capital to satisfy investor applications and redemptions. Currently, an open-ended investment fund can be established under Hong Kong law in the form of a unit trust, but not in corporate form due to various restrictions on capital reduction under the Companies Ordinance (Cap. 622). Internationally, however, the corporate fund structure is more popular than unit trusts and it is therefore proposed to allow an OFC structure under the Securities and Futures Ordinance (Cap. 571) to attract more mutual funds and private funds to domicile in Hong Kong. Continued growth in the number of Hong Kong-domiciled funds is also expected to be driven by the China-Hong Kong Mutual Recognition of Funds scheme which, when implemented, will only allow Hong Kong-domiciled funds to be sold in China under the scheme.

The Government has yet to publish its consultation conclusions, but these should be issued fairly soon given that the cut-off date for responding to the consultation was 19 June 2014.

  • Stamp Duty Waiver for all Hong Kong-listed ETFs from 13 February 2015

Exchange Traded Funds (ETFs), one of the fastest growing products in the asset management industry, had a record year in Hong Kong in 2014 with turnover reaching a record high of HK$1.2 trillion. The number of Hong Kong-listed ETFs has risen significantly: there are currently 141 listed ETFs compared with 69 at the end of 2010. Nevertheless, Hong Kong’s position as a regional ETF hub is considered to face serious challenges from other exchanges in the Asia-Pacific region.

A further measure aimed at fostering Hong Kong’s asset management industry is a stamp duty waiver for all exchange traded funds (ETFs) listed on HKEx, irrespective of the percentage of Hong Kong stocks in their portfolios. The previous waiver did not apply to ETFs comprising more than 40% Hong Kong-listed stocks which meant that 26 of Hong Kong-listed ETFs were previously subject to stamp duty. The waiver was implemented by the Stamp Duty (Amendment) Ordinance 2014 which took effect on 13 February 2015.

  • Extension of Profits Tax Exemption for Offshore Funds to Private Equity Funds Proposed

A briefing paper was tabled before Legco in January 2015 setting out proposals to extend the exemption from profits tax which currently applies to offshore funds to offshore private equity funds. This will involve extending the exemption to transactions in private companies which are currently excluded from its scope. The paper also contains proposals to relax the current requirement that transactions must be conducted by or through SFC-licensed intermediaries and will allow the exemption where the fund is a “qualifying fund” since the managers of private equity funds may not be SFC-licensed.

5. Full Implementation of New Regulatory Regime for Hong Kong IPOs

1 October 2014 marked the first anniversary of a more stringent regulatory regime for Hong Kong IPOs, setting a higher bar for prospectus disclosure and the due diligence expected of IPO sponsors and other professionals involved in Hong Kong IPOs. The Hong Kong market is unique in that the overwhelming majority of its listed companies are incorporated offshore, primarily in Mainland China, which means that in the event of wrongdoing, the company and its directors are often beyond the reach of the Hong Kong courts.

Concerns that prospectus disclosure was sometimes falling short of the standard expected, led to a new requirement that issuers must publish the draft prospectus (the Application Proof) on the HKEx website on submitting their listing application, long before there is any certainty that listing approval will follow. An Application Proof which is found not to be “substantially complete”, may be rejected by HKEx and the issuer and sponsor “named and shamed” by publication of the fact of the rejection on the HKEx website. Keen to avoid a box-ticking mentality, the SFC also imposed new sponsor due diligence obligations as broadly written duties rather than concrete steps, which has been criticised for effectively precluding any degree of certainty that “all reasonable” due diligence has been conducted. The regime’s various transitional arrangements, including HKEx’s “Initial 3-Day Check” of Application Proofs, also fell away on 1 October 2014. Yet with HKEx retaining its second place ranking for IPO funds raised in 2014, the new regime does not appear to have damaged the attractiveness of HKEx.

6. SFC Drops Proposed Amendments to Sponsors’ Statutory Liability for Prospectus Misstatements

The SFC however decided not to proceed with proposals to make explicit that sponsors may be subject to criminal and civil liability for deficiencies in IPO prospectuses under what is now the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32). The SFC’s Supplemental Consultation Conclusions on the Regulation of IPO Sponsors – Prospectus Liability” published in August 2014, concluded that the legislative amendments were unnecessary as sponsors are already included in the existing category of “persons who authorise the issue of a prospectus” who are potentially liable for prospectus inaccuracies under the ordinance.

7. New Companies Ordinance implemented 3 March 2014

Hong Kong’s updated and modernised Companies Ordinance (Cap. 622) (the CO) came into effect on 3 March 2014 after a seven-year rewrite aimed at enhancing Hong Kong’s attractiveness as a leading international business and financial centre.

Some of the key improvements under the new legislation are:

  • Allowing companies to dispense with AGMs by unanimous shareholders’ consent.
  • A new court-free procedure for reduction of capital based on a solvency test.
  • Facilitating simplified financial reporting by small and medium enterprises.
  • Abolition of par value for company shares.
  • Abolition of the requirement for Hong Kong companies to have a memorandum of association.
  • Requiring all private companies to have at least one director who is an individual.
  • A new statutory duty of care, skill and diligence for directors, subject to both a subjective and an objective test.
  • A reduction in the shareholding requirement for demanding a poll to 5% (from 10%).
  • Requiring public and large private companies and guarantee companies to prepare more comprehensive directors’ reports including an analytical and forward-looking “business review”. Private companies may opt out by special resolution.
  • A new requirement for approval by disinterested shareholders where shareholders’ approval is required for connected party transactions of directors of public companies and their subsidiaries.
  • For schemes of compromise or arrangement, the court has a new discretion to dispense with the headcount test in appropriate circumstances.

8. New Mandatory Reporting Obligations for OTC Derivatives expected in 2015

Draft rules for reporting over-the-counter (OTC) derivatives transactions published by the SFC and Hong Kong Monetary Authority are to be submitted to Legco for negative vetting, and are expected to be implemented in 2015, according to the SFC/HKMA Consultation Conclusions and Further Consultation on the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules (OTC Derivative Rules) published in November 2014.

The OTC Derivative Reporting Rules will implement the first phase of a new regulatory regime for Hong Kong’s OTC derivatives market, the framework for which is set out in the Securities and Futures (Amendment) Ordinance 2014 passed in March 2014. The detailed requirements for the new regime will be set out in subsidiary legislation of which the OTC Derivative Reporting Rules will be the first to be implemented.

The new regime will be introduced in phases; starting with mandatory reporting, followed by mandatory clearing and finally mandatory trading. The record keeping obligation will be implemented in phases at the time the relevant mandatory obligation takes effect (i.e. the record keeping obligation with respect to mandatory reporting will be introduced in the first phase with mandatory reporting).

9. Significant Disciplinary Actions

  • Court Orders Ernst & Young to Produce Chinese Accounting Records to the SFC

In May 2014, the Court of First Instance ordered Ernst & Young (EY) to hand over to the SFC accounting records relating to its work as the reporting accountant and auditor on the failed listing application of Standard Water Limited. The Court rejected EY’s argument that it was prevented from handing over the accounting records by PRC state secrecy laws. EY is appealing the court order to produce documents held by its Mainland affiliate, EY Hua Ming, having produced a disc of documents held by it in Hong Kong.

  • IPO Sponsor fined HK$12 million and has licence suspended

In January 2014, the Securities and Futures Appeal Tribunal affirmed the SFC’s disciplinary decision against Sun Hung Kai International Limited for deficiencies in its sponsor work on the listing of Sino-Life Group Limited on HKEx’s Growth Enterprise Market in 2009.

  • SFC Disciplines Moody’s for Red Flags Report on Chinese Companies

Moody’s Investors Service Hong Kong Limited (Moody’s) was fined HK$23 million and publicly reprimanded for breach of provisions of the SFC’s code of conduct for SFC-regulated entities involved in its publication of a report which identified red flags in terms of potential governance or accounting risks at 61 Chinese non-financial companies. The nature of the allegations against Moody’s is not known as the SFC’s decision notice of 3 November 2014 is not yet publicly available. Moody’s is appealing the decision.

  • SFC Starts Market Misconduct Proceedings over Alleged False Research Report

The SFC started proceedings before the Market Misconduct Tribunal against the head of a US-based research company in December 2014, alleging that information contained in a research report on Chinese property developer, Evergrande Real Estate Group Limited, was false or misleading. The proceedings under section 277 of the SFO relate to the disclosure of false or misleading information likely to induce dealings in securities where the person making the disclosure knows that the information is false or misleading, or is reckless or negligent as to whether that is the case.

  • SFC Disciplines Investment Banks for Regulatory Breaches

The SFC reprimanded and fined ICBCI Capital and ICBCI Securities HK$12.5 million each for failing to ensure the independence of placees for the subscription of shares of Powerlong Real Estate Holdings Limited on its 2009 listing on HKEx. It also reprimanded and fined Deutsche Bank HK$1.6 million for regulatory breaches and internal control failings in relation to its failure to disclose changes to its percentage holdings of Up Energy Development Group Limited shares.

10. Other Regulatory Developments

A number of other Hong Kong regulatory initiatives in 2014 aim to ensure Hong Kong’s continued success as Asia’s leading financial centre by ensuring that its regulatory framework is on a par with those in other leading international markets. The following are among the key developments in 2014.

  • Hong Kong Lays Basis for Uncertificated Securities Market

A bill5 to allow investors to choose to hold and transfer securities without paper documents and register the securities kept in the CCASS in their own names, has been introduced to Legco for consideration. It is proposed that the regime will initially cover shares listed or to be listed on HKEx, while listed debentures and unit trusts will be covered at a later stage. If passed, the bill will amend the SFO and empower the SFC to make the necessary subsidiary legislation to provide for the operation and regulation of the uncertificated securities market.

  • FSTB Moves to Increase Independence of Regulatory Regime for Listed Entity Auditors

The Financial Services and the Treasury Bureau published a consultation paper in January 2014 on proposals that would make the Financial Reporting Council (FRC) the independent oversight body for auditors of Hong Kong listed entities. The FRC would also be given disciplinary and inspection powers to complement its existing investigatory powers. The proposals seek to ensure that Hong Kong qualifies for membership of the International Forum of Independent Audit Regulators, to which entry is restricted to regulators that are independent of the audit profession and professional bodies. Under the proposals, the Hong Kong Institute of Certified Public Accountants, the professional body, would perform various statutory functions such as registration, setting standards on professional ethics, auditing and assurance and stipulating common professional development requirements.

  • SFC Consults on Regulation of Alternative Liquidity Pools

The SFC published a consultation paper in February 2014 setting out proposals to regulate operators of alternative liquidity pools (ALPs), also known as “dark pools”, on which trades are executed anonymously outside of “lit” markets. The SFC has proposed regulating ALPs’ operations by imposing requirements under the SFC’s code of conduct for regulated entities similar to the conditions currently imposed on the licences of ALP operators.

  • Hong Kong Government Consults on Resolution Regime for Failing Financial Institutions

In response to the G20 consensus that member jurisdictions should establish a “resolution regime” giving authorities powers to deal with failing financial institutions while ensuring that the costs of failure are borne by shareholders and creditors rather than taxpayers. Hong Kong’s regulatory authorities published proposals for the establishment of such a regime in Hong Kong in a consultation paper published in March 2014.

  • Improvements to Hong Kong’s Corporate Insolvency Law and Proposed New Statutory Corporate Rescue Procedure

The FSTB published consultation conclusions on its proposals to modernise and streamline Hong Kong’s corporate insolvency provisions in May 2014 and plans to introduce an amendment bill to Legco in 2015. The aims of the amendments to relevant provisions of the Companies (Winding Up and Miscellaneous Provisions) Ordinance are to facilitate more efficient administration of the winding-up process and increase protection for creditors.

  • Introduction of 3 Days’ Statutory Paternity Leave from 27 February 2015

From 27 February 2015, male employees will be entitled to 3 days’ statutory paternity leave at 80% of their average daily wages under recent amendments to the Employment Ordinance. The entitlement is subject to the condition that the employee must have been employed for at least 40 weeks under a continuous contract. Employers who fail to grant paternity leave or pay eligible employees for paternity leave are liable to prosecution and may be fined HK$50,000.

5 The Securities and Futures and Companies Legislation (Uncertificated Securities Market Amendment) Bill 2014.


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