Challenges to governance - A listing regime for companies from emerging and innovative sectors

Patrick Rozario, Hermes Liang

At this age of “New Economy”, we are transiting from industrial to a new technology based economy with increased automation in factories, vehicles, offices and homes. The Internet of Things, Cloud Computing, and Big Data are accelerating global automation of every aspect of human existence. Biotechnology and life sciences developments support sustainable development, public health, and environmental protection.

Many studies have shown that the traditional means of investment and funding are generally not adequate, neither the quality nor timing and coverage of financing have been sufficient to meet the needs of “New Economy” companies. The competitive international financial markets are transforming to meet such needs. HKEX is proposing a listing regime that will enhance Hong Kong’s attractiveness to these “New Economy” companies as well as investors.

Following the conclusions as set out on 15 December 2017 in the New Board Concept Paper, the HKEX on 23 February 2018 has published a second consultation paper on changing the Main Board listing rules to allow listings of biotechnology companies that do not meet any of the financial eligibility tests; innovative companies with weighted-voting right (WVR) structures; and secondary listing of foreign listed Greater China and international companies.

The issuers that will list under the proposed biotech chapter bring additional risks to investors as they would not meet the financial performance requirements and given that WVR is inherently designed to dilute external oversights, these pose substantial challenges in protecting the interests of other stakeholders. Accordingly, HKEX has proposed additional safeguards to enhance the governance of these companies.

HKEX has included detailed eligibility and suitability criteria for the biotech chapter, a higher market capitalisation requirement, enhanced disclosure requirements as well as restrictions on fundamental changes of business in the proposal. On innovative issuers with WVR structures, an applicant will be required to demonstrate that it is eligible and suitable for listing with a WVR structure, including the nature of the company and the contribution of the proposed WVR beneficiaries. HKEX has proposed safeguard including limits on WVR power and measures to protect non-WVR holders’ right to vote, as well as enhanced disclosure requirements.

Nevertheless, certain inherent issues could be further elucidated. The reliance on suitability judgements for both pre-profit / pre-revenue biotechnology and WVR issuers would certainly lead to challenge and will open HKEX to criticism for being unfair, arbitrary and subjective. This new proposed regime deviates from HKEX’s traditional clarity and reliance on rules and may open-up uncertainly in the market. In fact, SFC has raised the same concern in 2015 on the subjectivity of the criteria in the 2014 WVR’s consultation.

In the proposal, there is the requirement that WVR issuers will need to incorporate in its constitutional documents to facilitate private legal actions against them. However, due to the inadequate legal remedies available to minority investors and high litigation costs in Hong Kong, the effectiveness of private enforcement will be limited.

One of the safeguards, the time-based sunset clause that would see the WVR structure expires after a period of years, or undergo a general vote by shareholders for renewal is not included in the consultation paper. The HKEX indicated that a sunset clause would create uncertainty for both companies and investors and it would be difficult for companies to embark on long term development plan. However, such clauses are becoming best practice for WVR issuers in the US, where there have been many debates about the risks of WVR in perpetuity.

The public consultation of this new regime ended on 23 March 2018, the HKEX would like to bring forward the reform in late April 2018. In maintaining Hong Kong as an international financial market, it is important that Hong Kong could meet the changing demands of the financial markets, enhance its competitiveness and at the same time protect the interests of all stakeholders.  If the proposed new “Listing Regime for Companies from Emerging and Innovative Sectors” is implemented, it will have significant impacts to the Hong Kong financial market and governance standards. We will keep an eye on how the new listing regime develops in the coming months.