Since the Stock Exchange of Hong Kong (HKEx) issued its interim guidance on Pre-IPO Investments in October 2010, the market has come to accept that early-day investors in a company preparing for an initial public offering (IPO) cannot expect to see each and every corporate governance and protection rights, however fairly or harshly negotiated, to survive a listing.

The reason for HKEx's guidance is simple: every public shareholder is the same and therefore should expect equal treatment and protection in the company after its IPO. Listing decisions and subsequent guidance letters (mainly GL43-12 and GL44-12) have also consolidated the various requirements and expectations about timing of pre-IPO investments, what count as pre-IPO "special rights" that will not be allowed to continue after IPO, how would HKEx react during an IPO application if it considers a particular pre-IPO shareholder has been conferred "special rights". (See our last update: Pre-IPO Investments: The Dos and Don'ts).

In the latest update to the guidance letter GL43-12, these requirements and expectations are further refined:

  • The "28/120" rule: Pre-IPO investment funding (i.e., the cash) must be irrecoverably settled with the IPO company at least 28 clear days before the listing application (i.e., A1 submission), or the listing (i.e., the IPO) will be postponed to 120 days after settlement of all pre-IPO investments. This is but a slight adjustment to the formerly so-called "28/180" rule, which expects the funding either arrives 28 clear days before A1 submission or 180 days before listing. It is now the "28/120" rule.
  • Divestment Rights must be terminated before A1: It is now clarified that whatever one calls it (put, call, redemption right, repurchase option etc.) so long as an pre-IPO investor is conferred a right to exit or divest his or her investment back to the IPO company or another shareholder (i.e., Divestment Rights), such rights must be terminated (or exercised) before A1 submission. HKEx will simply delay the IPO for another 120 days until these rights are terminated or exercised.

    However, HKEx may not insist on termination of such rights (and delaying the IPO) if the Divestment Rights are defined to be exercisable only if an IPO is not taking place. Presumably, redressing pre-IPO investors for IPO execution risk is considered acceptable. Obviously, in such circumstances, HKEx would expect to see very clear defining languages in the relevant agreement to the effect that the Divestment Rights in question will be terminated upon IPO. To avoid any unnecessary delay of the IPO process, pre-A1 consultation with HKEx would be useful if rights of these nature cannot be terminated before A1 submission.

  • "Negative pledges", "reserved matters" no longer acceptable even if they are fair: The previous guidance was that so long as the terms granted by the IPO company are not egregious and are fair, they may be allowed to survive IPO. We have commented earlier that what constitute non-egregious rights remain to be seen. Now, HKEx has clarified this by removing guidance to these effects altogether. That means, "negative pledges", "reserved matters" are no longer acceptable "special rights" even if they are fair. Yet, arrangements between shareholders (as opposed arrangements made with the IPO company as a party) are private arrangements and should remain unaffected by IPO.
  • No more "unwinding": The previous guidance was that unacceptable "special rights" should be "unwound". Instead of seeking to clarify what and how to "unwind" unacceptable "special rights", HKEx’s latest guidance is this: "unwinding" creates confusion and may not be practical to implement; "unwinding" will no longer be accepted as a remedy for unacceptable "special rights", which must be amended or terminated prior to listing under HKEx's guidance.