HKEx rules for placements to cornerstone investors

By Fan Xingcheng, Dentons

Pursuant to Guidance Letter HKEx-GL51-13 issued by Hong Kong Exchanges in February 2013, the subject of the guidance is “Cornerstone Investment No Direct or Indirect Benefits to Cornerstone Investors other than Guaranteed Allocation at IPO price”. The objective of these regulations is to restrict issuers from offering direct or indirect benefits to cornerstone investors by side letter or otherwise to participate in the placing tranche of a share offering.

cornerstone investors
Fan Xingcheng
Senior Partner

In the regulations, HKEx expressly states that an issuer is required to follow the following principles when making a placement to cornerstone investors: (a) the placing must be at the IPO price; (b) the IPO shares placed are subject to a lock-up period generally for at least six months following the listing date; (c) each investor will not have any board representation in the listing applicant, and is independent of the listing applicant, its connected persons and their respective associates; (d) details of the placing arrangement, including the identity and background of the investors, are disclosed in the listing document; and (e) notwithstanding the minimum six-month lock-up period, the shares will be part of the public float under Main Board Rule 8.08 (GEM Rule 11.23) provided the investor is a member of the public for the purpose of Main Board Rule 8.24 (Notes 2 and 3 to GEM Rule 11.23).

The “public float” in item (e) is based on Main Board Rule 8.08(a) which states that, “at least 25% of the issuer’s total number of issued shares must at all times be held by the public”. The shares held by the cornerstone investors will be counted as part of the shares held by the public, meaning that when counting whether the shares held by the public reaches the 25% threshold, the shares held by the cornerstone investors are counted as a part thereof, which will affect whether the issuer satisfies the listing conditions.

The foregoing provision expressly clarifies that the shares held by the cornerstone investors constitute shares held by the public provided that the conditions set forth in the Guidance Letter are satisfied. Combined with HKEx Main Board Rule 8.08(3) which states that, “not more than 50% of the securities in public hands at the time of listing can be beneficially owned by the three largest public shareholders, save where: (a) the securities to be listed are options, warrants or similar rights to subscribe or purchase shares; (b) such securities are offered to existing holders of a listed issuer’s shares by way of bonus issue; and (c) in the 5 years preceding the date of the announcement on the proposed bonus issue, there are no circumstances to indicate that the shares of the issuer may be concentrated in the hands of a few shareholders.”

Generally speaking, as cornerstone investors subscribe for a relatively large number of shares, the foregoing provision limiting the concentration of publicly held shares will also often apply to cornerstone investments.

Returning to Guidance Letter HKEx-GL51-13, HKEx expressly prohibits the existence of any act of “receiving some direct or indirect benefits” between an issuer and a cornerstone investor. Paragraph 4.3 of the Guidance Letter states that, it is “misleading to the public if these investors receive some direct or indirect benefits by side letter or otherwise, other than a guaranteed allocation, to take up shares in an IPO and yet being considered cornerstone investors. Accordingly, where there is any form of direct or indirect benefits by side letter or otherwise, other than a guaranteed allocation, given to investors … these investors should be reclassified as pre-IPO investors and the requirements under the Interim Guidance on Pre-IPO Investments issued in January 2012 … apply.”

The overarching provision in the foregoing regulations is the “receive some direct or indirect benefits by side letter or otherwise”, which, in addition to the examples given in the Guidance Letter, does not preclude HKEx, based on the factual circumstances, from finding that the interest compensation clause in a certain transaction constitutes the provision of a benefit.

Furthermore, if a cornerstone investor is found to be a “pre-IPO investor”, HKEx will question the cornerstone investment relationship arising from the transaction, which will have an adverse impact on the market reaction and could affect the ultimate outcome of the listing and offering of the company proposing to list. Secondly, based on the substance of the above mentioned Guidance Letter, the cornerstone investor’s status will be impossible to confirm, which signifies that the cornerstone investor’s status will change to that of a “pre-IPO investor”, making such an investor ineligible for the “cornerstone placement” at the IPO price at the time of the listing.

HKEx considers the terms to which a pre-IPO investor is subject generally to be more favourable than those to which IPO investors are subject, and the risks to which they are exposed also to be lower than those of the latter. The above-mentioned three guidances place strict system restrictions on “pre-IPO investors”, which will have an impact on the listing schedule of the company proposing to list. A failure to complete the investment within the fixed time limit would set back the listing timetable, and a withdrawal of the investment at the time of or after submission of the application would likewise result in a delay in the listing timetable.

Lastly, with respect to the percentage of shares held by the public, as mentioned above, in normal circumstances, the percentage of shares held by the public in an IPO may not be less than 25%, and the cornerstone investors also count towards the share held by the public. If an investor is reclassified as a “pre-IPO investor”, such an investor will not count towards the share held by the public, causing the percentage of shares held by the public to decrease and potentially ultimately fall below the substantive requirement of 25%. If it does fall below that threshold, the listing conditions are no longer satisfied, adversely affecting both the investors and the company proposing to list.

Fan Xingcheng is a senior partner at Dentons

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