Diversity & Inclusion
More than two years have passed since the Listing Committee of The Stock Exchange of Hong Kong Limited (the HKEx) issued the Guidance on Pre-IPO Investments Pending Consultation on Possible Listing Rule Amendments (the Interim Guidance). Despite the suggestion in its title that the Interim Guidance might be a prelude to a consultation process leading to the introduction of a clearer and more comprehensive set of rules governing pre-IPO investments, the consultation process has not yet eventuated and the principal effect of the Interim Guidance largely has been restricted to establishing a bright-line test for the timing of pre-IPO investments,1 with the remaining parameters of pre-IPO investments left to the market to interpret based on the principle of fair and equal treatment set out in Rule 2.03 of The Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the Listing Rules) and a number of listing decisions issued both prior to and after the Interim Guidance. The issue by the HKEx on October 25, 2012 of Guidance Letter GL43-22, “Guidance on Pre-IPO investments” and Guidance Letter GL44-12, “Guidance Letter on Pre-IPO investments in convertible instruments” (together, the Guidance Letters), therefore comes as a welcome development.
The Guidance Letters consolidate several of the rules set out in the various listing decisions and lay out a specific list of what is “allowed” and “disallowed” with respect to some of the commonly encountered terms set out in pre-IPO investment agreements. We set out below a list of these terms, as well as (where relevant) the conditions that must be fulfilled for these terms to be considered acceptable either pre- or post-IPO.
Separately, the HKEx also gave guidance on “Qualified IPO” terms that are regularly contained in pre-IPO investment agreements. These terms typically require the company to complete an IPO of a certain valuation within a specified period of time, failing which the pre-IPO investor’s consent will be required for the IPO to proceed (this consent, as a practical matter, is often provided subject to the payment of compensation to the investor). The HKEx has made it clear that the pre-IPO investment agreement should provide a clear mechanism for the calculation of the amount of compensation payable to pre-IPO investors in the event that the IPO does not meet any “Qualified IPO” criteria. Failing this, if the company is required to negotiate and agree upon a level of compensation with the pre-IPO investors, the HKEx will view that as an amendment to the original terms and therefore the company will need to wait either (a) 28 clear days before filing a renewed listing application or (b) 180 days between the compensation being paid and the IPO proceeding.
Although helpful, the Guidance Letters still leave some questions unanswered. For example, it is unclear whether compensation payable under a profit guarantee can only be paid in cash or whether it can also be paid in shares. It is also unclear whether conversion price reset mechanisms are disallowed in all circumstances or are permissible so long as any resets occur prior to IPO (or the time limits set out in the Interim Guidance). Furthermore, the HKEx did not elaborate on what it viewed as being “atypical” rights of holders of convertible instruments or what terms requiring prior consent from a pre-IPO investor for certain corporate actions it might view as being “egregious."
It is important that pre-IPO investors and potential listing applicants work with their legal advisers to ensure that any investments conform as closely as possible to the requirements set out in the Guidance Letters and other subsisting rules, failing which the HKEx may require the parties to unwind or amend certain provisions. This, in turn, could lead to the HKEx “restarting the clock” on the time between the new terms of the investment being agreed and the IPO proceeding.
1 The bright line-test for the timing of pre-IPO investments established by the Interim Guidance was that pre-IPO investments must be irrevocably settled either (a) 28 clear days prior to the submission of the listing application to the HKEx or (b) 180 clear days before the IPO date.
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