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Corporate voting is a right enjoyed by corporate shareholders allowing them to express their opinions on matters relating to the company they have invested in via their investment vehicle (Special Purpose Vehicle, SPV). Most companies follow the ‘one share, one vote’ principle, but other voting structures are available.
Dual-class stocks, which is a term used to describe stocks with weighted voting rights (‘WVR’), are a feature of companies with at least two classes of shares with differing per-share voting rights. In Hong Kong, WVR exist only for individuals who have been responsible for the growth of the company.
On 31 January 2020, the Hong Kong Stock Exchange (‘HKEx’) released a consultation paper seeking feedback on their proposal to permit corporates in Hong Kong to benefit from WVR (the ‘Proposal’).
The term ‘ecosystem’ used in this context means:
a conglomerate with a lead company which controls other companies and drives the strategic direction of the group of companies;
a co-operation between a group of companies that is interlinked through one lead company allowing for the sharing of resources and transfer of knowledge or findings; and
enhanced value of the parent company through the collective value generated by a group of companies working together rather than individually.
1. WVR Offers Disproportionate Voting
WVR structures enable individuals with minority stakes in a company to maintain control by providing them with voting power disproportionate to their relatively low shareholding in the company.
Entrepreneurs in innovative or start-up companies may hold minority stakes in companies that they have founded or strategically led following rounds of venture capital funding. A WVR structure would benefit them following the listing of their company.
Also, WVR can be useful in ensuring post-listing control arrangements between the corporate, individual founders and other investors.
2. HKEx Targets Emerging, Innovative Sector
The rationale behind proposing corporate WVR beneficiaries stems from the loss of IPOs to US based exchanges and HKEx wanting to ensure diversification of investment opportunities for public investors of Hong Kong. Currently, the financial and property sectors form a significant percentage of the total market capitalisation of Hong Kong.
HKEx is aiming for unlisted Mainland companies that belong to an emerging innovative sector, are associated with an ecosystem and are materially influenced by the strategy and vision of one lead company. Disallowing this lead company from maintaining its control would abruptly affect the performance of the potential listing applicant and the lack of corporate WVR beneficiary rules dampens the appeal of Hong Kong to these companies.
3. WVR Introduction Poses Various Risks
Corporate WVR could pose the following risks:
Increasingly widespread WVR structures
An apparent risk is that WVR structures in companies could become increasingly widespread. Currently, only individuals benefit from WVR. The individuals that benefit from the existing WVR regime are limited in number as only a few can meet the stringent condition of having been materially responsible for the growth of the business by way of their skills, knowledge or strategic direction.
Misalignment of shareholder interests
There is a potential for misalignment of shareholder interests as under a WVR structure control over the company can be maintained by a shareholder, i.e. a controlling shareholder, who holds only a small equity interest in the company compared to other shareholders.
Corporate WVR beneficiaries can have their own controlling shareholders. Thus, allowing the controlling shareholders of corporate WVR beneficiaries the right to exercise majority voting power whilst holding a small and indirect stake in the company.
Therefore, HKEx has stated that there is a ‘greater risk of a misalignment of interest between the ultimate controlling shareholder and the company’s shareholders as a whole’ as the company may be a small part of a large conglomerate and consequently may be insignificant when determining the conglomerate’s overall economic interests.
No stringent conditions
The individuals such as the board or senior management of a corporate WVR beneficiary who exercise WVR could change over time, unlike an individual WVR beneficiary. This would be without having met the stringent conditions imposed on an individual who exercises WVR under the current regime.
Unlimited lifespan
The potential of having unlimited WVR structures under corporate entities without a natural lifespan limit unlike with individuals whose WVR lapses when they die.
4. Maximum of 5 Votes per Share Proposed
Considering the above listed risks, HKEx has proposed the following conditions and safeguards to ensure that a clear benefit is provided by corporate WVR beneficiaries to a potential listing company.
The corporate WVR beneficiary must:
have held a minimum economic interest of 10% and have been materially involved in the listing applicant for a minimum of 2 financial years prior to the listing;
beneficially own 30% and be the single largest shareholder of the applicant at the time of listing; and
maintain 30% shareholding after listing, failing which the WVR lapses. Furthermore, the corporate WVR beneficiary would be entitled to a maximum of 5 votes per share.
5. Ecosystem Must Have Meaningful Scale
Further, HKEx has proposed numerous measures to reduce the likelihood of corporate WVR structures becoming commonplace in Hong Kong.
Continuing Contribution of WVR Beneficiary
The listing applicant and corporate WVR beneficiary must demonstrate that an ecosystem exists between them with the following mandatory minimum conditions:
(a) the corporate WVR beneficiary owns or operates a community of companies that has grown and evolved around a technology or know-how platform or a set of products and services;
(b) the companies of the ecosystem both benefit from and contribute to it by sharing data, users or technology;
(c) the ecosystem must have achieved meaningful scale;
(d) the corporate WVR beneficiary controls the company to be listed and core components within the ecosystem of companies; and
(e) the listing company will continue to materially benefit from being part of the ecosystem and its growth and success are materially attributable to being a part of the ecosystem.
In addition to these requirements, HKEx proposes that the corporate WVR beneficiary’s shares lapse if their contribution to the listing applicant is substantially terminated or materially disrupted or suspended for a period exceeding one year.
Furthermore, HKEx proposes having a half annual or annual confirmation from the listing applicant that their corporate governance committee is unaware of any grounds for the corporate beneficiary’s WVR to be terminated for lack of contribution.
Size of Corporate WVR Beneficiary
The corporate shareholder must have a market capitalisation of at least HK$200 billion:
on the date of listing; and
based on average market capitalisation over the preceding 3 months.
Nature of Corporate WVR Beneficiary
The listing applicant must be experienced in emerging and innovative sectors and must be a company listed on the SEHK (Stock Exchange of Hong Kong), or a qualifying exchange (i.e. the LSE or NYSE) with a premium listing.
Corporate Representative
At least one director of the listing applicant must be a Corporate Representative as defined in the Companies Ordinance (Cap. 622) at the time of listing.
HKEx has provided for the following circumstances where corporate WVR would lapse permanently:
the corporate WVR beneficiary does not have a Corporate Representative on the company’s board of directors for a continuous period of 30 days; or
the Corporate Representative is disqualified by a court or tribunal or found by HKEx to be unsuitable as a director; or, as an exception, where the corporate WVR beneficiary demonstrates that the representative was acting out of authority; or
the corporate WVR beneficiary is convicted of an offence involving fraud or dishonesty.
Sunset Clause
To deal with the problem of a corporate WVR beneficiary’s unlimited lifespan, a sunset clause with a maximum of 10 years followed by renewals of 5 years is being proposed.
Corporates and Individuals Shall Benefit
It has been proposed that there shall be no prohibition on concurrently having both a corporate WVR beneficiary and individual WVR beneficiaries if suitability requirements are met.
Moreover, there shall be no sunset clause that is mutually applicable to the corporate WVR and individual WVR beneficiaries.
Corporate WVR Sunset
Where the corporate WVR beneficiary’s shares diminish at the end of a sunset period, any individual WVR beneficiary must convert part of their own shares into ordinary shares to ensure the same control of voting power both before and after the corporate WVR beneficiary.
6. Proposed Safeguards Insufficient
Conditions on Minimum Economic Interest
The conditions that the corporate WVR beneficiary must have held an economic interest of 10% for 2 years prior to the listing and maintain a 30% shareholding after listing are problematic.
A corporate WVR beneficiary may face difficulties in increasing their shareholding by 20% immediately prior to listing. In addition, by maintaining a 30% shareholding the corporate WVR beneficiary would be classified as the de facto controlling shareholder, thus defeating the purpose of WVR in holding a smaller stake for disproportionate voting power. For other listing applicants, a three-year track record period is required, whereas for a corporate WVR beneficiary there is an unconventional two-year requirement. This condition should be aligned with the traditional three-year requirement.
If the corporate WVR beneficiary is entitled to 5 votes per share and must hold a 30% shareholding at the time of and after listing, it would hold an immediate majority in terms of voting rights in the company. The minimum economic interest should be reduced to 20% to allow the corporate WVR beneficiary to command 55.6% of votes and maintain majority control.
If the corporate WVR beneficiary is entitled to 5 votes per share and must hold a 30% shareholding at the time of and after listing, it would hold an immediate majority in terms of voting rights in the company. The minimum economic interest should be reduced to 20% to allow the corporate WVR beneficiary to command 55.6% of votes and maintain majority control.
Vague Wording Used in Proposal
Under the mandatory minimum conditions of the ‘ecosystem’, HKEx has stated that ‘the ecosystem must have achieved meaningful scale’ and the ‘listing company will continue to materially benefit from being part of the ecosystem.’ Moreover, the nature of the corporate WVR beneficiary must be such that it ‘must be experienced in emerging and innovative sectors.’
The terms ‘meaningful scale’, ‘materially benefit’ and ‘experienced’ are vague terms that provide no objective criteria against which a potential corporate WVR beneficiary can be examined. To ensure complete clarity, HKEx should provide an indication of how ‘meaningful scale’, ‘materially benefit’ and ‘experienced’ will be assessed objectively.
Corporate Beneficiary’s Unlimited Lifespan
HKEx has attempted to reconcile with the issue of the perpetuity of corporate entities by mandating time-defined sunset clauses of 10 years. However, the mandated period can be technically overridden by the ability of shareholders to renew every five years after the expiration of the previous terms.
7. Grandfathering Arrangement Widened
On 31 October 2020, HKEx issued a consultation conclusion paper regarding the Proposal. While a majority of the respondents agreed in principle that corporate WVR beneficiaries should be permitted, HKEx decided to give more time for the market to further understand WVR and its regulatory regime. Thus, HKEx introduced a new grandfathering arrangement to widen the application of corporate WVR in Hong Kong.
Originally, if GCIs wanted to access the market and raise capital in Hong Kong, they would have to go under the existing grandfathering arrangement, and only Grandfather GCIs (GCIs that primary listed on a Qualifying Exchange on or before 15 December 2017) that meet the eligibility requirements under Chapter 19C of the Main Board Listing Rules (‘Listing Rules’) can secondary list in Hong Kong. With the new grandfathering arrangement, GCIs that are i) controlled by corporate WVR beneficiaries, and ii) primary listed on a Qualifying Exchange on or before 31 Oct 2020 will also be able to secondary list in Hong Kong without having to amend their existing WVR structures, including corporate WVR structure, even if they are incompatible with Hong Kong’s requirements.
Not all GCIs can secondary list in Hong Kong under the new grandfathering arrangement, aside from the abovementioned requirements. Chapter 19C of the Listing Rules provides a range of strong investor protection safeguards, these restrictions will continue to apply to the additional arrangement.
For example (non-exhaustive) the Issuer must:
meet a minimum market capitalisation threshold of at least $40 billion, or at least $10 billion with at least $1 billion of revenue for its most recent audited financial year;
be an ‘innovative company’.
Nonetheless, in its forthcoming consultation, HKEx wishes to normalise the eligibility requirements that apply to GCIs that do not have WVR structures and seek to secondary list under Chapter 19C of the Listing Rules.
8. Market Agrees in Principle
While corporate WVR benefits listing applicants and diversifies the investment opportunities for investors in Hong Kong, various risks are involved, and it could potentially damage shareholders’ interests and challenge the existing WVR structure. To address the risks involved, conditions and safeguards were proposed by the HKEx to limit the extent of participation by corporate WVR beneficiaries, but their effectiveness remains in question.
As the new consultation conclusion paper has just rolled out, the market’s welcoming attitude was confirmed, though with hesitation. To consolidate the future application of corporate WVR in Hong Kong, HKEx has decided to let the market develop a better understanding of the WVR system through further expanding the current grandfathering arrangement. But as problems remain unresolved, it is anticipated that controversies over the Proposal will continue in the foreseeable future.
This article is co-authored by Stefan Schmierer and Anna Lau.
Whilst every effort has been made to ensure the accuracy of this article it is general in nature and does not constitute legal advice of any kind. You should seek your own personal legal advice before taking legal action. We accept no liability whatsoever for loss arising out of the use or misuse of this article.