Hong Kong Stock Exchange proposes SPAC listing regime with strict criteria

The Hong Kong Stock Exchange has launched a consultation paper on proposals to create a listing framework for special purpose acquisition companies (SPACs) in Hong Kong. The paper compares these to the SPAC regimes in other key jurisdictions such as the US, the UK and Singapore. In their e-bulletin, our team in Hong Kong consider the key proposals for the new SPAC regime in Hong Kong, which aim to introduce a regime for Hong Kong that is competitive but includes sufficient shareholder protections to uphold the quality and integrity of the Hong Kong market.SPACs are shell company vehicles with no business operations or assets that raise funds through IPOs. Once listed, the SPAC will seek to use the IPO proceeds to carry out a business combination or merger with an operating business to take it public. The merger and listing of the successor company is known as a “de-SPAC”.

Background

Since the beginning of 2020, there has been a huge surge in SPAC listings in the US and, despite signs that interest may be dipping, this is driving other markets to permit similar listings. In August, the UK adjusted its SPAC rules in a bid to make it a more attractive jurisdiction for SPAC listings. In September, the Singapore Exchange introduced a new SPAC listing framework. Hong Kong is now following, with its own proposals for a SPAC listing regime.

Given Hong Kong’s efforts over recent years to combat market misconduct stemming from shell company activity, it is not surprising that Hong Kong has taken a more conservative approach to its proposed SPAC regime. With continuing interest in SPAC listings in the region, the Stock Exchange is seeking to balance its need to remain a competitive international financial centre with the importance of maintaining the quality and reputation of the market. The proposed SPAC regime is, as a result, more stringent than that in the US, setting high entry criteria for SPAC listing applicants, as well as for the subsequent acquisition targets. Significantly for the Hong Kong market, given the typically high level or retail involvement, only professional investors will be able to subscribe for or trade in SPAC securities prior to completion of the de-SPAC transaction.

In this bulletin we summarise the key proposals for Hong Kong’s SPAC regime. We have split this into three sections: (1) the SPAC listing; (2) the de-SPAC transaction; and (3) liquidation and de-listing.

The SPAC listing

In relation to the listing of the SPAC vehicle, the Stock Exchange proposes the following:

Professional investors only – A SPAC’s securities will be restricted to professional investors only prior to the de-SPAC transaction. There will be a minimum board lot size and subscription size of at least HK$1 million for SPAC shares. SPACs will need to demonstrate to the Stock Exchange that the intermediaries involved in selling securities on their behalf can be satisfied that each placee is a professional investor. For secondary trading, the Stock Exchange is proposing an approval process for exchange participants wishing to use the Exchange’s trading system to trade SPAC securities with additional monitoring and enforcement measures to ensure that only professional investors can subscribe for and trade in SPAC securities.

Spread of investors – With the restriction to only professional investors, there will be a smaller pool of eligible subscribers. As such, the Stock Exchange is proposing that SPACs must distribute SPAC shares and SPAC warrants respectively to at least 75 professional investors, of which 30 must be institutional (rather than individual) professional investors. 75% of the SPAC shares and SPAC warrants must be issued to institutional investors. SPACs will also be subject to the same rules as other listing applicants to ensure not more than 50% of the securities in public hands at the time of listing are held by the three largest public holders and that at least 25% of the SPAC shares and SPAC warrants are in public hands (with equivalent dispensations down to 15% for SPAC issuers with an expected market capitalisation of over HK$10 billion). However, the requirements to demonstrate sufficient public interest and to ensure the securities are freely transferable to the public will be waived.

Offer size – A SPAC’s IPO will be expected to raise at least HK$1 billion. Setting the minimum fund raising size at this level is linked to ensuring the size and quality of the SPAC’s acquisition target will be sufficient to ensure that the successor company following the de-SPAC transaction will meet the listing criteria. In addition, requiring a large commitment by professional investors will be evidence of support for the SPAC promoter team.

Funds held in trust – 100% of the gross proceeds from the SPAC IPO (excluding the proceeds from the issue of the SAC promoter shares and warrants) must to be paid into a ring-fenced trust account in Hong Kong. Such funds must be held in the form of cash or cash equivalents and, together with accrued interest, will only be permitted to be released to meet resumption requests, to complete a de-SPAC transaction or to return funds to shareholders upon liquidation.

SPAC promoters – SPAC promoters are the professional managers who set up and manage a SPAC. Given the reliance investors will place on SPAC promoters and their critical role in finding a suitable acquisition target and managing the de-SPAC process, the Stock Exchange is proposing that they meet suitability and eligibility requirements. A SPAC will be required to have at least one SPAC promoter which is a firm holding either a Type 6 (advising on corporate finance) or Type 9 (asset management) license issued by the Securities and Futures Commission. That promoter should also hold at least 10% of the promoter shares, being the separate class of SPAC shares that are issued to the promoters as a financial incentive for them to set up and manage the SPAC. Shareholders (excluding the SPAC promoter and close associates) will have the right to vote on any material changes to the promoters. This will be coupled with a right for those shareholders who vote against the change to redeem their shares at the IPO price plus accrued interest. A majority of the SPAC directors are expected to be officers of the SPAC promoters who nominate them.

Cap on promoter shares and warrants – To manage excessive investor dilution, promoter shares will be capped at 20% of the total number of SPAC shares in issue on the IPO date. If approved by shareholders, further promoter shares representing no more than 10% of the total number of SPAC shares in issue on the IPO date may be issued as an earn-out incentive following completion of a successful de-SPAC transaction, subject to the successor company meeting objective performance targets. There will also be caps on warrants issued exclusively to promoters; a SPAC will be prohibited from issuing such promoter warrants if their exercise would result in the issue of more than 10% of the number of shares in issue at the time such warrants are issued.

Other dilution caps – SPAC warrants are issued to investors alongside SPAC shares as a sweetener to give holders the right to purchase SPAC shares at a set exercise price, usually out of the money at the time of issue. Warrants that entitle the holder to more than a third of a share upon exercise will be prohibited. In addition, a SPAC will also be prohibited from issuing warrants in aggregate (including promoter warrants) that, if exercised, would result in the issue of more than 30% of the number of shares in issue at the time such warrants are issued.

Trading Arrangements – Due to the higher volatility of warrants compared to shares, the Stock Exchange is seeking market feedback on whether separate trading of SPAC shares and SPAC warrants should be permitted from the initial offering date. The consultation paper sets out two proposed options for additional trading arrangement measures for SPAC warrants to mitigate the risk of volatility and a disorderly market.

The de-SPAC transaction

In relation to the de-SPAC transaction once the SPAC has identified an acquisition target, the Stock Exchange proposes the following:

Listing requirements same as for a traditional IPO applicant – Following the de-SPAC transaction, the merged successor company will need to meet all of the requirements for a new listing applicant. This includes meeting the minimum market capitalisation requirements, financial eligibility thresholds and management and ownership continuity requirements. The successor company will need to appoint at least one IPO sponsor at least two months prior to the listing application date. One sponsor must also meet the independence requirements in the Listing Rules. The sponsor(s) will be expected to conduct sponsor due diligence to enable the sponsor(s) to make the same sponsor declarations as are required for a traditional IPO. The de-SPAC will be treated in the same way as a reverse takeover, needing to comply with documentary requirements equivalent to those required for a new listing, including the need for a fully compliant listing document meeting the prospectus requirements.

Independent third party investment required for de-SPAC – The SPAC will be required to obtain independent third party investment for the purpose of completing the de-SPAC transaction, which must constitute at least 25% of the expected market capitalisation of the successor company. This can be reduced down to at least 15% where the market capitalisation of the successor company is expected to be over HK$1.5 billion at listing. The independence criteria for assessing the investor will be the same as those for determining the independence of an independent financial adviser. As a result of the third party investment, at least one asset management firm or fund (with assets under management/fund size of at least HK$1 billion) must beneficially own at least 5% of the issued shares of the successor company when it becomes listed.

Shareholder approval required for the de-SPAC – The de-SPAC transaction will need to be approved by the SPAC’s shareholders in general meeting (written approval will not be accepted). A shareholder with a material interest in the transaction (as well as any close associates) must abstain from voting. This means that SPAC promoter(s) and their close associates will not be able to vote. In addition, if the de-SPAC transaction results in a change of control, any outgoing controlling shareholders of the SPAC and their close associates will also be unable to vote in favour of the de-SPAC transaction. Where the de-SPAC involves a connected target, for instance because the SPAC promoter or a director of the SPAC has an interest in the target, this would be subject to the connected transaction regime in the Listing Rules (requiring among other things, the advice of an independent board committee and the appointment of an independent financial adviser). The SPAC will also need to comply with additional requirements, including to show that minimal conflicts of interest exist in relation to the proposed acquisition, the transaction is on an arm’s length basis and that no cash consideration is being paid to connected persons (with any consideration shares being subject to a 12 month lock-up).

Redemption of SPAC shares only possible if vote against transaction – SPAC shareholders will only be able to redeem SPAC shares voted against the de-SPAC transaction. In this respect, the Stock Exchange is taking a more stringent approach than is adopted in other jurisdictions where SPAC shareholders are permitted to redeem their shares even where they vote in favour of the de-SPAC transaction. The Stock Exchange sees its proposal as an additional safeguard against potential abusive practices in the de-SPAC transaction process which may lead to over-valuations. SPAC shareholders will also have the right to redeem their shares if there is a material change in the SPAC promoter or if there is a proposal to extend the deadlines for announcing or completing the de-SPAC transaction.

Forward looking information – The existing Listing Rule requirements in respect of forward looking statements will apply to the listing document for the de-SPAC transaction. As a result, references to future profits or dividend forecasts in the de-SPAC transaction listing document will only be permitted if they are supported by a formal profit forecast which is reported on by the reporting accountants and IPO sponsors.

Open market in successor company shares – Reflecting that until the de-SPAC, the SPAC shareholder base will be restricted to professional investors only, the successor company will not need to meet the usual 300 minimum shareholder requirement for a traditional IPO. However, to mitigate the risk of substantial volatility in post listing trading following the de-SPAC (when retail investors will be able to trade in the shares), the successor company must meet a lesser threshold of at least 100 shareholders. The other existing open market requirements of at least a 25% public float and not more than 50% of the shares in public hands being held by the three largest public shareholders will also apply.

Lock ups for SPAC promoters and controlling shareholders – SPAC promoters will be subject to a 12 month lock up from the date of completion of the de-SPAC transaction. Promoter SPAC warrants must be subject to terms that they are not exercisable during this period. As is currently the case for controlling shareholders of listing applicants, a controlling shareholder of a successor company will also be subject to lock up restrictions, namely a six month restriction from any disposal and a further six month restriction preventing the shareholder ceasing to hold a controlling stake.

Application of Takeovers Code to de-SPAC transactions – Where a de-SPAC transaction would result in the de-SPAC target’s owner holding 30% or more of the successor company, the Takeovers Executive has indicated that it would normally waive the mandatory takeover obligations under the Takeovers Code. However, no waiver would typically be granted if a third party (not being the owner of the target company) acquires 30% or more of the successor company’s shares.

Liquidation and de-listing

If the de-SPAC transaction does not complete successfully, the Stock Exchange proposes the following:

De-SPAC deadline – A SPAC must announce the finalisation of the terms of a de-SPAC transaction within 24 months from the date of listing and must complete the de-SPAC transaction within 36 months. A SPAC will be able to request an extension (up to a maximum of six months) to either deadline where, in the opinion of the Stock Exchange, it is for a valid reason and it is approved by shareholders (excluding the SPAC promoters and their close associates). A shareholders’ vote to extend the deadline must be accompanied by an option for shareholders to redeem their shares for the IPO price, together with accrued interest.

Liquidation – If the SPAC fails to meet the deadline to either announce or complete a de-SPAC transaction, or to obtain shareholders’ approval for a material change in SPAC promoters, its shares will be suspended. Within one month of the suspension, the SPAC will be required to return 100% of the funds raised (plus accrued interest) to its shareholders, following which the SPAC will be required to liquidate.

The consultation is open until 31 October 2021. In the consultation paper, the Stock Exchange has set out very detailed comparisons of its proposals with the SPAC regimes in other key jurisdictions such as the US, UK and Singapore. It is attempting to introduce a regime for Hong Kong that is competitive whilst still including sufficient shareholder protections to uphold the quality and integrity of the Hong Kong market.

The SPAC frenzy in the US seems to be slowing, with some commentators suggesting that the SPAC bubble may have already burst. Nonetheless, even if Hong Kong may have missed the peak of this wave of SPAC activity, the Stock Exchange is likely to want to proceed with introducing a SPAC regime so that its market offering is well placed for future opportunities and to meet the needs of listing applicants and investors in the region.