October 2003 No 6
 


Disclosure of Interests under the Securities and Futures Ordinance - Update



INTRODUCTION

The Securities and Futures Ordinance ('SFO') which came into force on 1 April 2003 has broadened considerably the previous regime governing the disclosure of interests in the shares and debentures of Hong Kong listed companies with a view to enhancing transparency in the Hong Kong market.

The SFC has issued an outline most recently revised on 6 August 2003 (the 'SFC Outline'), which summarises the relevant provisions and contains detailed examples of how they work. The following is intended as a summary of the new regime as it affects substantial shareholders and directors and chief executives of listed companies.

A. DISCLOSURE BY SUBSTANTIAL SHAREHOLDERS

As under the previous regime, the SFO requires disclosure when a person acquires or ceases to have a notifiable interest and when there is a change in the percentage level (ie. the figure rounded down to the next whole number) of his interest.

1. REDUCTION OF SUBSTANTIAL SHAREHOLDING THRESHOLD

The SFO reduces the threshold for disclosure from 10% to 5% of a Hong Kong listed company's issued voting share capital. Where there are more than one class of listed shares, the percentage of each class is taken separately.

2. WHEN IS NOTIFICATION REQUIRED?

2.1 Notifications ĘC Shortening of Notification Period

Section 310(1) requires notification to be made on the occurrence of the relevant events set out in Section 313 which can be summarised as follows:

  1. when a person first becomes interested in 5% or more of the shares of a listed company (ie. when he first acquires a notifiable interest) (Section 313(1)(a));


  2. when a person's interest drops below 5% (ie. he ceases to have a notifiable interest) (Section 313(1)(b));


  3. when there is an increase or decrease in the percentage level (ie. the figure rounded down to the next whole number) of a person's holding above 5% (eg. his interest increases from 6.8% to 7.1% ĘC so the percentage level increases from 6% to 7%) (Section 313(1)(c));


  4. when a person has a notifiable interest (ie. 5%) and the nature of his interest in the shares changes (eg. on exercise of an option) (Section 313(1)(d));


  5. when a person has a notifiable interest and he comes to have, or ceases to have, a short position of more than 1% (eg. he is already interested in 6.5% of the shares of a listed company and takes a short position of 1.7%) (Sections 313(4)(a) and (b)); and


  6. when a person has a notifiable interest and there is an increase or decrease in the percentage level of his short position (eg. he is already interested in 6.8% of the shares of a listed company and increases his short position from 1.7% to 2.2%) (Section 313(4)(c)).

The SFO shortens the notification period for such events from 5 days to 3 business days after the date of the relevant event. If a person is not aware of the relevant event when it occurs, the 3 day limit runs from the date on which he is aware of its occurrence (ie. the date on which he is aware of the facts which constitute the relevant event (eg. a buy-back of shares) and not the date he realises he has a notifiable interest). A 'business day' is defined to mean a day other than a public holiday or a day on which a gale or black rain storm warning is in force. It therefore includes Saturdays but not Sundays.


2.2 Initial Notifications

An 'Initial Notification' does not refer to a notice given on initially crossing the 5% threshold. Instead it refers to a notice required to be given in the following circumstances:

  1. where a person has 5% or more of the shares of a company which is being listed (Section 310(2)(a));


  2. where a person has 5% or more of shares of a class which is being listed or given full voting rights (Section 310(2)(b));


  3. if a person had a notifiable interest when the SFO came into effect which had not already been disclosed under the previous regime; and


  4. if a person has a notifiable interest on either the 5% threshold or 1% threshold for short positions being reduced (Section 310(3)).

Under Section 325(2) the time limit for Initial Notifications only is 10 business days after the relevant event or, if later, the date on which the person concerned is aware of the relevant event (ie. is aware of the facts which constitute the event).

Interests discloseable on the commencement of the SFO were required to be filed on or before 14 April 2003. Please see Schedule 1 for a list of interests which became discloseable upon the SFO coming into force. Any interest already disclosed under the previous regime was not required to be notified on commencement of the SFO.

3. DISCLOSURE OF INTERESTS IN EQUITY DERIVATIVES

Under the previous regime, the disclosure requirements applied only to physically settled derivatives. The SFO extends the disclosure obligations of substantial shareholders to interests in the unissued shares of listed companies which, if issued, would carry the right to vote and also to cash settled derivatives. Hence, interests in the 'underlying shares' of all equity derivatives (whether issued or unissued) are discloseable, including interests in options, subscription warrants, convertible bonds, ADRs and stock futures.

A holder, writer or issuer of equity derivatives will be taken to have a long position in the underlying shares and must add these to his other interests in determining his disclosure obligations if:

  1. he has a right to take the underlying shares;


  2. he has an obligation to take the underlying shares; or


  3. he has a right to receive money or to avoid or reduce a loss, if the price of the underlying shares increases,

before or on a certain date or within a certain period (whether the right or obligation is conditional or absolute) (Section 322(8)).

4. DISCLOSURE OF SHORT POSITIONS

The SFO extends the disclosure obligations of substantial shareholders to cover 'short positions'. Under Section 308 a person is regarded as having a short position in shares if he:

  1. holds, writes or issues financial instruments under which:

    1. he can require another person to take the underlying shares;


    2. he is obliged to deliver the underlying shares; or


    3. he has a right to receive money or to avoid or reduce a loss if the price of the underlying shares declines,

    before or on a certain date or within a certain period (whether the right or obligation is conditional or absolute); or

  2. he borrows shares under a securities borrowing and lending agreement.

Hence the writing of a call option, holding of a put option and stock borrowings will be discloseable. However a person (not being a director) with a short position will only be required to disclose it if he already has a 5% interest in a class of a listed company's voting share capital ie. he must be a substantial shareholder before he has a duty to disclose a short position (Section 313(4)). Further the short position must be at least 1%. Thereafter, as with long positions, a change in the short position will only require disclosure if it results in the short position crossing a percentage level or in the person ceasing to have a short position of at least 1% (Sections 313(4)(b) and (c)).

Short positions cannot be netted off against long positions and the percentage figures for short and long positions must be calculated and notified separately.

4.1 Options

The SFC Outline confirms that the SFC takes the view that when a listed company allots shares or issues an instrument under which it agrees to allot shares, or grants an option over its own shares, it is not taking a position in its own shares, short or long, but is simply issuing or agreeing to issue the shares. Hence there is no disclosure obligation for the company. Likewise, since the listed company is not taken to have a short position, a controller of the company will not be deemed to have a short position under the deeming provisions of the SFO and no disclosure is required. This view would appear to be at odds with a strict interpretation of the legislation and its wide definition of the term 'short position'. It therefore seems likely that this view has been adopted more on the basis of the spirit of the legislation whose focus is primarily on the disclosure of positions held in other listed companies.

The holder of an option or other right to receive shares will however acquire a long position in the shares which must be disclosed.

Where a company grants an option over the shares of another listed company, then it is taking a short position which must be disclosed if the former company already holds a 5% interest and the short position amounts to 1% or more.

Note also that where a listed company grants an option over its own shares or debentures to a chief executive or director of that company, it is required to record details of the grant in its register of the interests of directors and chief executives (as described under Section C below).

5. HOW MANY SHARES IS A PERSON TAKEN TO BE INTERESTED IN IN THE CASE OF EQUITY DERIVATIVES?

Holders, writers and issuers of equity derivatives are taken to be interested in, or have a short position in, the number of shares to be delivered, or by reference to which the amount payable is derived or (in the case of stock futures only) the relevant contract multiplier (Section 322(12)).

6. CALCULATION OF A PERSON'S INTEREST

Long Positions

The percentage figure of an interest in shares should be determined using the following formula:

nominal value of shares in which a person is interested * x 100
nominal value of the issued shares of the listed company of the same class

Short Positions

To calculate whether a short position constitutes 1% or more, a similar formula can be used:

nominal value of shares in which a person has a short position * x 100
nominal value of the issued shares of the listed company of the same class

* Note that this will include all issued shares and shares underlying equity derivatives whether issued or unissued.

The forms require the percentage figure to be rounded to 2 decimal places. To find the percentage level of the interest the percentage figure is rounded down to the next whole number.

The date for calculating the relevant percentage is the date of occurrence of the relevant event and the number of shares in which a person is interested and the total number of issued shares should be determined on that day.

7. NOTIFICATION OF CHANGES IN THE NATURE OF INTERESTS

Any change in the nature of an interest already notified is required to be disclosed under Section 313(d). The situations in which there is considered to be such a change are extensive and include a change in the nature of a person's title to shares, any of the person's interest whether legal or equitable or any of the person's interest in the underlying shares of equity derivatives on the exercise of rights thereunder (whether by or against him).

Common situations requiring notification of a change in interest will include:

  1. the exercise of rights (by or against a person) under options and other derivatives;


  2. the lending of shares under a securities borrowing and lending agreement (unless the Securities Borrowing and Lending Exemption applies - see paragraph 12.9 below); and


  3. the giving of shares as security to another person.

There is not considered to be a change in the nature of an interest under Section 313(13) and Section 5 of the Securities and Futures (Disclosure of Interests - Exclusions) Regulation:

  1. where a purchaser takes delivery of shares, if he has previously disclosed his equitable interest arising on contracting to buy the shares;


  2. where a vendor of shares enters into a contract for sale, if the sale is required to be completed within 4 days on which the Stock Exchange is open for business;


  3. where there is a change in the terms on which rights under equity derivatives may be exercised which results from a change in the number of underlying shares in issue;


  4. on the exercise of rights to subscribe for or on delivery of shares under a rights issue;


  5. where a 'qualified lender' comes to have a security interest in a person's shares (see paragraph 12.4 below); and


  6. where the person is a holding company and the transfer is of shares from one wholly owned subsidiary to another (see paragraph 12.5 below).

8. WHAT CONSTITUTES AN INTEREST IN SHARES?

The definition of an 'interest in shares' is extremely broad and includes the situations set out in Schedule 2 hereto.


8.1 Buying and Selling Shares

A buyer of shares acquires an interest in shares at the time when he contracts to buy and therefore is required to give notification within 3 business days of the contract. No further notice is required when the buyer takes delivery of the shares.

A seller of shares will normally only cease to have an interest when he actually transfers the shares to the buyer and is therefore required to notify the cessation of his interest within 3 business days after the settlement date (ie. the date of the actual transfer). If the contract for sale of the shares provides for settlement within 4 days on which the Stock Exchange is open for business, notification by the seller is not required on the entering into of the contract.

If in fact a seller ceases to be interested in the shares on the date of the contract for sale (eg. due to the operation of the clearing system), then notice should be filed within 3 business days of the contract for sale.

If a contract for sale specifies a settlement date which is 5 or more days on which the Stock Exchange is open for business after the date of the contract, then 2 notices are required: first, a notice of change in nature of the interest which must be filed within 3 business days of the contract and second, a notice of cessation of interest to be filed within 3 business days of delivery of the shares.

9. DEEMED INTERESTS

There are a number of circumstances where the interests and derivative interests (including short positions) of others in a listed company's shares must be added to a person's own interest in calculating the number of shares in which they are interested.

9.1 Family and Controlled Company Interests (Section 316)

As under the previous legislation the interests of a person's spouse and children under 18 are attributable to him.

Also, as previously, a person will be deemed to be interested in the interests of any company which he 'controls' (ie. a company of which he controls, either directly or indirectly, one third or more of the voting power at general meetings or if the company or its directors are accustomed to act in accordance with that person's directions).

9.2 Limited Liability Partnerships

The SFC Outline confirms that the SFC regards a limited liability partnership as a company for the purposes of Part XV. Hence interests in shares held by a limited liability partnership should be disclosed by the general partner as interests in shares of a controlled corporation (rather than as joint interests of each partner).

9.3 Trusts

The interests of a trust of which a person is a trustee must also be aggregated with his own interests (with the exception of a trust of which he is a bare trustee (ie. his only powers or duties are to transfer the underlying shares according to the directions of the beneficial owner - see paragraph 12.7 below).

A beneficiary of a trust must include the interests of the trust in calculating his own interest (Section 322(4)(a)). The interest of a beneficiary under a discretionary trust is however disregarded (Section 323(1)(a)(iii) provided that he is not also a director of the relevant listed company or a 'founder' of the trust (see paragraph 9.4 below).

9.4 'Founders' of Discretionary Trusts

The SFO has introduced new provisions so that the interests of a 'discretionary trust' will be attributed to the 'founder' of such trust (Section 322(4)(b)). The term 'founder' is very widely defined and essentially will catch anyone who has procured the creation of the trust and (i) whose consent is a condition of a trustee's exercise of his discretion or (ii) in accordance with whose wishes a trustee is accustomed or expected to act (whether, in either case, legally enforceable or not).

9.5 Concert Party Agreements (Section 317)

The SFO broadens the previous provisions relating to concert party agreements. In essence, those provisions apply where two or more persons agree to acquire shares in a target company and the agreement dictates the manner in which any one or more of the parties may exercise the rights attached to those shares or dispose of them. Each party to the agreement must include the interests of all other parties to the agreement in determining whether they together hold 5% or more of the listed company. If so, each party will be considered to be a substantial shareholder whose interests must be disclosed.

Under the SFO those provisions are extended to any arrangement whereby a 'controlling person' or director of a listed company makes a loan to a person on the understanding that the money will be used to acquire interests in shares in that company and shares are in fact acquired. A 'controlling person' for these purposes is any person who, either alone or with associates, controls at least 30% of the voting power at general meetings, can nominate any of its directors or veto or modify any resolution of a general meeting.

The effect of extending the provisions to the borrower and controlling shareholder is to create an irrebutable presumption that the loan or funding will be provided pursuant to an agreement dictating how the borrower may deal with his shares.

There is an exemption where a 'controlling person' or director makes the loan in the ordinary course of his business as a 'qualified lender' (as defined under paragraph 12.4 below).

Where 2 or more persons are interested in the same shares they must each make separate disclosure of their interests. Hence if X controls Y Ltd. which holds 6% of a listed company and Y Limited acquires a further 1%, then X, his spouse and Y Limited must each file a separate notice.

10. DISCLOSURE OBLIGATIONS RESULTING FROM SHARE REPURCHASES AND PLACEMENTS

Disclosure obligations may also arise from actions taken by others. For example, if a listed company buys back shares thereby reducing the number of shares in issue, an increase in the percentage level of the interests of the remaining shareholders will be discloseable.

Conversely, in the case of a placement and top-up, where new shares are issued to a major shareholder to replace the shares he has placed with a third party, the number of shares in issue increases. The consequent reduction in the percentage level of the interests of the other shareholders will then be discloseable.

In both cases, the 3 business day time limit for disclosure runs only from the date the person concerned became aware of the facts that led to the change in the level of his interest ie. the date on which he became aware that the number of issued shares had reduced/increased.

11. CESSATION OF INTERESTS (SECTION 322(10))

A person is regarded as having ceased to be interested in shares if:

  1. he delivers them to another person (or to his order) pursuant to a contract for sale, in fulfilment of his obligations under a call option, or on exercising his rights under a put option;


  2. his right to subscribe for or call for the delivery of shares lapses or he assigns such right to another;


  3. his obligation to take shares lapses or he assigns that obligation to another;


  4. he receives an amount from another person, or avoids or reduces a loss, on the assignment or settlement of any cash settled equity derivatives.


 
 
 
 
     
 
 
 
 

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