A Consultation Paper on Treasury Shares

CONTENTS

Section 1Introduction
Background
The issues
Consultation period
Section 2Present legislation, rules and codes
The Companies Ordinance
Taxation law
Other relevant legislation
Market manipulation
Insider dealing
Share Repurchase Code
Stock Exchange Listing Rules
Takeovers Code
Section 3Arguments regarding a change in the current law or regulations
Introduction
Arguments regarding the two regimes outlined in this Consultation Paper
Arguments in favour of treasury shares
Arguments against treasury shares
A possible framework for treasury shares
Expediting the reissue of shares
Arguments for and against the expedited reissue of shares
A possible framework for the expedited reissue of shares
Summary
Section 4Treasury shares in overseas jurisdictions
United States
United Kingdom
Other jurisdictions
Section 5Issues to be considered in relation to the proposal to introduce treasury shares
Existing legislative controls on repurchases of shares
Shareholder approval
Approval of price upon resale of treasury shares
Disclosure of shares held in treasury
Mandatory offers under Rule 26 of Takeovers Code
Announcement of intention with respect to holding and resale of treasury shares
Disclosure of other information at time of resale
Notification of resales of treasury shares
Voting rights
Payment of dividends, etc.
Maximum permitted holding of treasury shares
Pre-emption rights
Prohibition on resale of treasury shares at certain times
Reselling treasury shares when a company is subject to a takeover
Treatment of treasury shares in the accounts
Subsidiaries
Private and unlisted companies
Section 6Issues to be considered in relation to the proposed change to the Listing Rules
Matters unrelated to listing approval
The proposal in detail
Documentary disclosure
Other controls
Annex A - Company law in detail
Annex B - Methods of issue of shares for a listed company

Section 1 : Introduction

Background

1.1 It was stated in the consultation paper proposing changes to the Takeovers Code which was issued earlier this year that upon completion of that exercise the Share Repurchase Code would be reviewed. It was anticipated that as part of the review of the Share Repurchase Code, the possible benefits and feasibility of introducing treasury shares would also be studied. In the Report on Financial Market Review issued by the Financial Services Bureau in April 1998, it was specifically recommended that the SFC should review the concept of treasury shares in the context of its review of that Code. "Treasury shares" refer to issued shares in a company which are repurchased and held by or on behalf of the company without being cancelled.

1.2 The review of the Share Repurchase Code is currently underway and amendments will be proposed to ensure consistency among the Share Repurchase Code, the Companies Ordinance and the Listing Rules. The SFC has now considered the concept of treasury shares in the context of the experience gained of share repurchases since the Share Repurchase Code was introduced in April 1992. Notice has also been taken of the Consultative Document issued in London by the Department of Trade and Industry in May 1998 which addressed the possible introduction of treasury shares in the UK.

1.3 This review has been carried out by the Corporate Finance Division of the SFC in conjunction with the Special Consultant to the SFC, Mr. Christopher de Boer, former Chairman of the Takeovers and Mergers Panel in Hong Kong. This Consultation Paper has been endorsed by the Takeovers Panel and the SFC.

The issues

1.4 The SFC recognises that the concept of treasury shares could apply to both public and private companies. However, as demand for their introduction has in practice arisen in relation to companies listed on the Hong Kong Stock Exchange, the focus of this paper is on treasury shares as they relate to public listed companies.

1.5 In this Consultation Paper, views are invited on whether there should be any change to the law, and to provisions of the Listing Rules and the Share Repurchase Code, under which a company purchasing its own shares is required to cancel them, or to the law and other regulations which affect the process and speed of reissue of repurchased shares by listed companies.

1.6 The Companies Ordinance currently requires a Hong Kong incorporated company to cancel repurchased shares, thereby effectively preventing repurchased shares from being held "in treasury" for "resale" at a later date. However, after the shares have been cancelled in such circumstances they may, under the present regime, be "reissued" because the authorised capital of the company remains unaffected. It has been suggested by a number of listed companies that repurchased shares should not automatically be cancelled, and that they should instead be capable of being held by the company and resold when market conditions allow. This change, it is said, would give the company greater flexibility to adjust its share capital more quickly and might lead to a reduction in the company's overall cost of capital, and therefore may stimulate investment by the company. Clearly any change to the law and other relevant regulations to allow shares to be held in treasury and later resold, or to allow the reissue of repurchased shares more quickly, may need to be accompanied by other changes, such as specific disclosure requirements, in order to ensure a fair market in a company's shares and to protect the interests of public shareholders, creditors and others who do business with a company.

1.7 The majority of companies listed on the Hong Kong Stock Exchange are not incorporated in Hong Kong and are not bound by the share repurchase provisions of the Companies Ordinance (which apply only to companies incorporated in Hong Kong). These overseas companies are, instead, bound by the share repurchase legislation in the jurisdictions in which they are incorporated. Like Hong Kong, most of those jurisdictions do not allow treasury shares at present. If Hong Kong were to change its legislative framework to allow treasury shares, Hong Kong incorporated companies would have the additional flexibility perceived to result from holding and reselling treasury shares, which companies in such other jurisdictions would lack. Unless and until legislation in such other jurisdictions is also changed to allow treasury shares, Hong Kong incorporated companies may appear in that respect to be different from those incorporated elsewhere. Having regard to such a disparity, this paper also consults the public on whether making changes to the reissue provisions of the Listing Rules should be considered, in order to introduce a mechanism to enable all companies listed on the Hong Kong Stock Exchange to reissue and obtain listing for repurchased shares more quickly. It is intended that such amendments would provide such companies with benefits that are, by and large, similar to those advocated for treasury shares, regardless of where they are incorporated.

1.8 This paper therefore consults the public on the following principal issues:

(a) should listed companies incorporated in Hong Kong be allowed to hold shares in treasury for subsequent resale?

(b) if so, what regulatory framework should be put in place to allow treasury shares to be held and resold in the Hong Kong market?

(c) with regard to the disparity which may result if Hong Kong incorporated companies were allowed to hold treasury shares, should the Listing Rules be amended to enable listed companies to expedite the listing of new shares that are reissued following a repurchase and cancellation?

(d) if so, would it be necessary or desirable to introduce additional safeguards in the Listing Rules to protect shareholders and the securities market generally in cases where companies wished to take advantage of such a change?

Consultation Period

1.9 Any person wishing to comment on any issue raised by this Consultation Paper is asked to do so in writing. Comments should be received by the SFC prior to the close of business on 31st December 1998 and should be addressed to:

Securities and Futures Commission
12th Floor
Edinburgh Tower
15 Queens' Road Central
The Landmark
Hong Kong
Attn: Secretary to the Securities and Futures Commission

Interested persons may provide comments by E-mail to enquiry@sfc.hk. This Paper is also available on the SFC website at http://www.sfc.hk.

Note :

Whilst this Paper briefly summarises provisions of some of Hong Kong's Ordinances and other sources of regulation, these summaries are not an exhaustive examination of the relevant provisions and they cannot be relied upon as an authoritative legal opinion as to their content or effect. Accordingly, this Paper should not be relied upon as a substitute for seeking detailed legal advice in any specific case.

Section 2: Present legislation, rules and codes

2.1 This section of the paper briefly summarises the current legislative framework governing repurchases and reissues of shares by companies incorporated in Hong Kong. It also describes the more material provisions of the Stock Exchange Listing Rules, the Share Repurchase Code and other regulations which apply in such circumstances to all companies which have a listing on the Hong Kong Stock Exchange.

The Companies Ordinance

2.2 Under the present law, companies incorporated in Hong Kong may purchase their own shares but only in the circumstances, and subject to the conditions, laid down in the Companies Ordinance. One of the conditions is that, upon repurchase, the shares are automatically cancelled. A brief description of the relevant sections of the Companies Ordinance can be found at Annex A. A summary highlighting the relevant requirements applicable to Hong Kong incorporated listed companies is set out in the following paragraphs below. Companies incorporated in other jurisdictions are subject to the laws of the relevant jurisdiction (see paragraph 2.8 and section 4 below).

2.3 For listed companies incorporated in Hong Kong, purchase of own shares is permitted out of distributable profits or the proceeds of a fresh share issue. Only in very limited circumstances is a repurchase allowed out of existing capital. The repurchase can only take place if it is authorised by a company's articles of association, and by ordinary resolution of the shareholders in a general meeting in the case of an "on-market" repurchase or a general offer, or by special resolution in the case of an "off-market" repurchase. An "on-market" repurchase is one made on the Hong Kong Stock Exchange or a recognised Stock Exchange. The shares to be repurchased must be fully paid up and, after the repurchase, must be cancelled.

2.4 In addition to repurchasing its own shares, a company may undertake a formal reduction of share capital. This can be done if a company's articles permit a reduction of capital and it passes a special resolution of shareholders, obtains the consent of the court and cancels (or reduces the nominal value of) the shares.

2.5 Each time a company repurchases its own shares it is required to notify the Companies Registrar on a prescribed form within 14 days of delivery to it of the shares repurchased. The return must specify the class, number and nominal value of the shares and the date the shares were delivered to the company. A listed company must also specify the aggregate amount paid and the maximum and minimum prices paid in respect of shares of each class repurchased.

2.6 It should be noted that the "reissue" of repurchased shares (as opposed to the "resale" of shares out of treasury) is already permissible under the Companies Ordinance, since shares which are repurchased and cancelled pursuant to those provisions remain part of the company's authorised (but unissued) share capital, and may accordingly be "reissued".

2.7 The same provisions as those described in paragraph 2.3 above generally apply to private companies. However, the condition that shares may only be repurchased out of distributable profits or the proceeds of a share issue is relaxed. Accordingly, where distributable profits are insufficient, the shortfall may be made up out of capital. However, a special resolution is required before payment out of capital can be made and the directors must make a statutory declaration that in their opinion the company is expected to remain solvent for a year after the transaction. This declaration must be supported by a report of the company's auditor. Where a payment is to be made out of capital, members or creditors who object can apply to the court to prevent the payment.

2.8 At present, fewer than one-third of the companies listed on the Hong Kong Stock Exchange are incorporated in Hong Kong. Of the companies not incorporated in Hong Kong, three-quarters are incorporated in Bermuda, while those incorporated in the Cayman Islands form the next largest group. Both the Bermuda Companies Act (section 42A(b)) and the Cayman Islands Companies Law (section 36(3)(g)) require repurchased shares to be cancelled in similar terms to the Companies Ordinance. If Hong Kong were to change its legislative framework to allow treasury shares, Hong Kong incorporated companies would have the additional flexibility perceived to result from holding and reselling treasury shares, which companies in such other jurisdictions would lack. Accordingly, unless and until legislation in such other jurisdictions is also changed to allow treasury shares, Hong Kong incorporated companies may appear in that respect to be different from those incorporated elsewhere. In those circumstances, a playing field favouring listed companies incorporated in Hong Kong may be created.

2.9 Having regard to such concerns, the question arises whether, instead of amending the provisions of the Companies Ordinance to allow treasury shares (which would only apply to Hong Kong incorporated companies), the Listing Rules should be amended to enable all companies listed on the Hong Kong Stock Exchange to enjoy some of the benefits advocated for treasury shares. The SFC is mindful of the desirability of providing benefits similar to some of those advocated for treasury shares to companies not incorporated in Hong Kong, and is therefore also seeking views as to a non-statutory solution which is directed at increasing the speed of reissuing, and obtaining a listing for, shares that have previously been repurchased. Of course, if there is support for both approaches, there would not seem to be any reason why one approach should prevail to the exclusion of the other - i.e. both approaches could be implemented and could exist side-by-side.

Taxation law

2.10 This Consultation Paper deals only with proposed changes to company law and regulation. If this consultation exercise results in proposals to allow treasury shares, there may be implications under taxation law which also need to be considered. When the SFC believes there is a consensus as to the way forward on this particular issue, it will liaise with the Inland Revenue Department to determine their views as to the tax implications of any change to current company law.

Other relevant legislation

2.11 The Securities (Disclosure of Interests) Ordinance (Chapter 396 of the Laws of Hong Kong) requires directors of companies listed on the Hong Kong Stock Exchange and people whose interests in listed companies exceed 10% to disclose their interests to the company and the Stock Exchange. Any known interests of certain family members of, and certain corporations controlled by, the relevant person are treated as being interests of that person. Disclosure must be made on a prescribed form within 5 days of the transaction giving rise to an obligation to notify.

2.12 Legislation relevant to treasury shares that pertains to the prevention of securities market malpractices is contained in the Securities Ordinance (Chapter 333 of the Laws of Hong Kong) and the Securities (Insider Dealing) Ordinance (Chapter 395 of the Laws of Hong Kong). The relevant parts of the Ordinances are described below. At this time the SFC does not propose to revise either of these Ordinances, since it is not currently aware of any feature of treasury shares which would reduce the effectiveness of their provisions. However, the SFC will review the Ordinances in more detail should treasury shares be introduced, to ascertain whether a tightening of such legislation will be required.

Market manipulation

2.13 It may be said that by allowing a company to repurchase and resell its own shares, one is creating conditions in which the company may more easily influence its own share price. Activities which amount to market manipulation are restricted by legislation. Section 135 of the Securities Ordinance prohibits the creation of a false or misleading appearance of active trading in any securities on a stock exchange, or the creation of a false or misleading appearance with respect to the market or price of such securities. The section prohibits a person from engaging in two or more transactions which are likely to have the effect of raising, lowering or stabilising the price of the security, or otherwise inhibiting the free market forces, regardless of whether he or she has the intent of inducing another person to enter the market.

2.14 Under section 138 of the Securities Ordinance, the making of false or misleading statements which are likely to induce persons to enter the market or to affect the price of securities is prohibited. The section operates where the statement is made knowingly, or ought reasonably to have been known, and also applies to material omissions.

2.15 Breach of section 135 or 138 of the Securities Ordinance is an offence which attracts sanctions of fine and imprisonment. Section 141 provides for statutory redress for civil liability but does not limit or diminish any liability which any person may incur under the common law.

Insider dealing

2.16 Pursuant to the Securities (Insider Dealing) Ordinance, persons who are connected with a body corporate are prohibited from dealing with its securities where they have acquired information in connection with their positions which is not generally available, but if it were, it would materially affect the price of the securities. The definitions of "a person connected with a company" and "relevant information" are set out in sections 4 and 8 of the Ordinance respectively. By reason of this definition, a person is also regarded as an insider dealer if he or she receives, and deals, on the basis of relevant information provided by an insider who is connected to the body corporate although he or she may not by himself or herself be so connected. This prohibition has a potentially wide application. Section 9 of the Ordinance lays down various circumstances when insider dealing takes place. An insider can be an officer or employee of a body corporate or the body corporate itself. In the context of treasury shares, decisions relating to resales of shares are in almost all circumstances to be taken by directors of a listed company (i.e. "persons connected with the company"), and therefore considerable care will need to be taken to ensure that they do not deal in the company's shares when they know that a resale is pending or are otherwise are in the possession of "relevant information".

2.17 Insider dealing is not a criminal offence but heavy sanctions may be imposed on persons identified as insiders. These include a payment to the Hong Kong Government of an amount not exceeding the profit made or loss avoided, a penalty of not more than three times the profit made or loss avoided, and the suspension or revocation of registration if the insider dealer is a registered person in the securities industry or a member of the Hong Kong Stock Exchange. A prohibition may also be imposed on insider dealers from occupying the office of a director, liquidator, receiver or manager, and from taking part in the management of companies. It is a defence under section 9 if the defendant can satisfy the court that he or she did not enter into the transaction with a view to profit or avoid a loss, or that the other party to a transaction knew, or ought reasonably to have known, of the information before entering into the transaction.

Share Repurchase Code

2.18 The Share Repurchase Code sets out the requirements for all purchases of own shares by a company which are not on-market purchases, that is principally specific off-market transactions or general offers. The Share Repurchase Code is being reviewed and amendments will be proposed to ensure consistency among the Share Repurchase Code, the Companies Ordinance and the Listing Rules. As currently drafted, the Code does not specifically permit or prohibit treasury shares nor does it prescribe particular treatment for repurchased shares, such as to require their cancellation. The vast majority of share repurchases conducted in Hong Kong are carried out on-market in accordance with the provisions of the Listing Rules described below, rather than by way of off-market purchase or general offer pursuant to the Share Repurchase Code. However, there may be circumstances in which a company may wish to hold shares which have been repurchased other than on-market. When the SFC has determined whether this would be appropriate, in the light of views received from the public pursuant to this consultation, it will consider whether the Share Repurchase Code needs to be changed to accommodate any concrete proposal with respect to treasury shares.

Stock Exchange Listing Rules

2.19 All companies listed on the Hong Kong Stock Exchange, whether or not incorporated in Hong Kong, are subject to the Stock Exchange's Listing Rules and must comply with the provisions of Chapter 10, which regulate on-market share repurchases by listed companies.

2.20 Rule 10.06(1) sets out the minimum requirements for the contents of the Explanatory Statement required to be sent to shareholders seeking their authority (by ordinary resolution) for a specific repurchase or a general mandate to repurchase shares on-market. It sets out the information required to be contained in the resolution and specifies that a maximum of 10% of the issued share capital of the company on the date of the resolution may be authorised for repurchase by the company. In the case of Hong Kong incorporated companies, such a mandate is valid until the conclusion of the next annual general meeting, which corresponds with the period permitted by the Companies Ordinance for repurchase mandates of such companies. Rule 10.06(1) of the Listing Rules would allow earlier revocation or variation of the resolution in the case of a company from a jurisdiction whose company law permitted such.

2.21 Rule 10.06(2) sets out the dealing restrictions which apply to the company. In particular, unless a waiver is granted in exceptional circumstances, a company may not repurchase shares:

2.22 Rule 10.06(3) states that except in circumstances where there was a pre-existing obligation, or with the consent of the Stock Exchange, a company may not make a new issue of shares, or announce a proposed new issue, for 30 days after any purchase of shares (whether on the Stock Exchange or otherwise).

2.23 Rule 10.06(4) requires the disclosure by the company of the number, and the relevant price, of shares repurchased by 9.30 a.m. on the business day following the repurchase, and the disclosure in the annual report of repurchases made during the financial year.

2.24 Rule 10.06(5) states that the listing of all shares repurchased (whether on the Exchange or otherwise) shall be automatically cancelled and that the company must apply for listing of any further issues of that type of shares in the normal way. Documents of title for repurchased shares are to be cancelled and destroyed as soon as practicable following the repurchase. These requirements correspond with the provisions of the Companies Ordinance requiring the cancellation of repurchased shares (described in paragraph 2.2 above) and the equivalent provisions of Bermuda and Cayman Islands company law (described in paragraph 2.8 above).

2.25 Paragraph 19 (1) of Appendix 7 to the Listing Rules (Contents of the Listing Agreement) states that, except in specified circumstances, the directors of a listed company are required to obtain the consent of shareholders in general meeting before allotting, issuing or granting shares, securities convertible into shares, or options, warrants or similar rights to subscribe for shares or convertible securities. Sub-paragraph (2) specifies the conditions under which a company may obtain a general mandate from its shareholders to issue new shares without first offering such shares to its shareholders. The maximum number of shares which may be allotted under any such general mandate is 20% of the issued share capital of the company on the date of the resolution granting it, together with the number of shares repurchased by the company since that date (up to a maximum of 10% of the issued share capital existing on that date). The mandate is valid until the conclusion of the next annual general meeting, unless earlier revoked or varied by the shareholders.

Takeovers Code

2.26 Rule 32 of the Takeovers Code deals with the circumstance where as a result of a company's share repurchases, the shareholding of a shareholder (or a group of shareholders acting in concert) increases. Such increases will be treated as an acquisition of voting rights for the purposes of the Code, and any acquisition or consolidation of control of the repurchasing company may require the shareholder (or group of shareholders acting in concert) to make a general offer under Rule 26 of the Code. Rule 32 also provides that such shareholder (or group of shareholders acting in concert) may apply for a waiver from the requirement to make a mandatory offer under Rule 26 of the Code. This waiver will normally be granted if all relevant information regarding the company's share repurchases and the resulting takeover implications are disclosed in a document to the shareholders, and requisite shareholders' approval is obtained pursuant to Rule 8 of the Share Repurchase Code. This waiver, however, is only extended to off-market and general offer repurchases; it does not extend to on-market repurchases. The Takeovers Panel has recently discussed whether such a waiver ought to be extended to on-market repurchases and is strongly of the view that such an extension could be open to serious abuse. It was concerned that controlling shareholders may use this means to consolidate control and circumvent the obligation to make a general offer. The Takeovers Panel considered that if there were strong support from the market for such an extension of the waiver facility, shareholders must be asked to vote upon a waiver on a case-specific basis. The SFC is seeking the markets' views on this under paragraph 5.8 in section 5 below. A note to Rule 32 also states that a shareholder not acting in concert with the directors will not normally be required to make a mandatory offer in such circumstances. However, this exception will not normally apply when the shareholder has acquired voting rights at a time when he had reason to believe that a share repurchase would take place.

2.27 Rule 33 of the Code requires disclosure of acquisitions or disposals of voting rights in a company or rights over shares, representing 10% or more but less than 35% of the voting rights of that company. Disclosure must be made by 9:00 a.m. on the business day following the acquisition or disposal. Notes to the rule state that (1) a person is not required to make a disclosure if the change in his holding results only from the redemption or purchase of shares, and (2) a person is not required to make a separate disclosure under Rule 33 if he notifies his interest in a holding in compliance with the Securities (Disclosure of Interests) Ordinance (described briefly in paragraph 2.11 above) provided that the notification is made within the 9:00 a.m. time limit referred to above. Rule 33 applies whether or not a takeover or merger is proposed or underway.

Section 3 : Arguments regarding a change in the current law or regulations

Introduction

3.1 Companies incorporated in Hong Kong may, under the present law, purchase their own shares, upon which event the shares repurchased are cancelled. Moreover, shares which have been cancelled will normally be available to be reissued without the need to pass a shareholders' resolution to increase the company's authorised capital (since this will not be reduced by the cancellation of the shares) or to give fresh authority for the reissue of the shares (since the directors will normally already enjoy such authority pursuant to a general mandate granted by the shareholders in general meeting). The key points which need to be considered, therefore, are the potential benefits and drawbacks that would flow from providing companies incorporated in Hong Kong with the additional option of holding repurchased shares in treasury for subsequent resale and/or providing all companies listed on the Hong Kong Stock Exchange with the ability to more easily reissue shares which have been repurchased and cancelled through changes to the Listing Rules and listing procedures.

3.2 In so far as there is strong support for relaxing the existing law or regulations to allow treasury shares and/or to expedite the reissue process under the Listing Rules, it will be necessary to consider how far to go and whether to put in place additional safeguards to protect shareholders, creditors and others dealing with the company. The SFC believes that in relation to both the treasury shares and the expedited reissue routes, there would not need to be any material changes to the shareholder approval and/or information disclosure procedures which currently apply when a company repurchases shares. On the other hand, there would be a need to consider carefully what restrictions (for example, as to numbers of shares held, timing of sales, disclosure of intention to resell, etc.) should apply to any shares held in treasury, recognising that any such restrictions may reduce the appeal of holding treasury shares. If it is thought appropriate to expedite the reissue process, there may be prudential concerns which necessitate controls being incorporated into new or revised reissue procedures. Such controls may therefore also be regarded as detracting to some extent from the potential benefits of a relaxation to the existing framework.

3.3 Although the introduction of treasury shares or an expedited procedure for reissuing shares would not of themselves appear to give rise to any need for existing companies or securities legislation to be revised (other than in order to implement any relevant new proposal itself), the continuing effectiveness of the regulatory framework as a whole, and particularly the market malpractices provisions described in paragraphs 2.13 to 2.17 in section 2 above, will be kept under close review for any weaknesses coming to light following the introduction of treasury shares or an expedited procedure for reissuing repurchased shares.

Arguments regarding the two regimes outlined in this Consultation Paper

3.4 The following paragraphs of this section refer to arguments which the SFC is aware have been put forward in relation to proposals to allow companies to hold treasury shares. In considering these arguments, it should be borne in mind that any change made in Hong Kong legislation to permit the holding of treasury shares would only apply to Hong Kong incorporated companies. Any similar change in relation to overseas incorporated companies would need to be implemented through legislation in those jurisdictions. Paragraphs 3.16 to 3.23 below address an expedited procedure for reissuing shares following a repurchase and cancellation which, subject to any applicable contrary provisions of the law of the place of incorporation, would apply generally to all companies listed on the Hong Kong Stock Exchange.

Arguments in favour of treasury shares

3.5 To better manage the balance between debt and equity : The main argument that has been put forward for allowing companies to hold repurchased shares in treasury rather than cancelling them is that it would give companies increased ability to manage the level of their capital in the same way as they manage other resources. By managing the balance between debt and equity capital, it is argued, a company would be able to reduce its average cost of capital over the business cycle. It is also argued that the speed and flexibility with which treasury shares could be resold through the market would enable listed companies to carry a higher level of debt (when this is considered to be cheaper than equity), as they would know that treasury shares could be resold relatively quickly if interest rates rose and the company's gearing was approaching a level higher than was considered appropriate.

3.6 To provide additional flexibility in fund raising : Companies would find it attractive to have the option of using their broker to resell treasury shares in small lots through the market at the full market price. The option is considered to be a useful alternative, in appropriate market conditions, to approaches such as rights issues and placings of shares which typically involve the shares being underwritten and/or offered at a discount to the market price. Whilst issuing new shares at a deep discount provides companies with one mechanism to reduce the need for underwriting, it would appear that they would welcome the additional option of avoiding underwriting costs by gradually selling treasury shares through the market as and when market conditions allow. A brief summary of the principal requirements applying to common methods of issuing shares can be found in Annex B.

3.7 To permit investment in a company's own shares : Another argument put forward in favour of companies being able to hold shares in treasury is that companies would be able to invest in their own shares if they considered that the return from doing so would be higher than that which could be achieved from pursuing other business projects. Treasury shares would increase or decrease in value like any other asset held by the company. Accordingly, it is argued, treasury shares would provide an opportunity for the company to boost the returns for long-term shareholders by acquiring their own shares when they were undervalued by the market and reselling them for a profit at some time in the future.

3.8 To dispose of shares without the restrictions applicable to issues of new shares : It has also been argued that the resale of treasury shares would be potentially more flexible than the issue (or reissue following a repurchase and cancellation) of shares in the following respects:

(a) treasury shares would not be subject to the rules which effectively prevent issues of shares at a discount to their nominal value;

(b) there would be no need to comply with certain requirements of Hong Kong company law relating to the allotment of shares (allotment being part of the process of issuing shares). These include the following:

(c) there would similarly be no need to comply with any restrictions which appeared in a company's articles of association in relation to the issue of shares.

3.9 To facilitate the management of employee share schemes : Finally, it has been argued that allowing listed companies to hold treasury shares would also lead to streamlining of procedures as far as the management of employee share schemes is concerned. At present, employee share schemes involving existing shares (as opposed to newly issued shares) would commonly be structured by the company advancing funds to a separate trust for the purchase of the shares. If the company were allowed to hold the shares directly (i.e. by repurchasing them and then holding them in treasury), those shares could be used to cover the exercise of share options, or the distribution of shares, and trust arrangements may not be necessary.

Arguments against treasury shares

3.10 Increased risk of market manipulation : A counter argument is that to allow the holding of treasury shares would give companies an opportunity to create a false market or to manipulate the price of their shares, particularly for short-term gain. Indeed, it was for this reason that, when the law was changed in 1992 to allow for the first time for shares to be acquired by a company, there was also a requirement that the shares be cancelled. However, it is also recognised that the existing framework, which allows repurchase and cancellation, is possibly open to this sort of abuse in any event.

3.11 Increased risk of directors seeking to benefit themselves personally : A specific concern might be that directors would be tempted to utilise the share repurchase and resale mechanism as a way to manage the company's share price in such a way as to benefit themselves rather than shareholders generally. This might happen for example in relation to the issue or exercise of share options, where directors may be tempted to arrange for the company to sell treasury shares after they have exercised their share options and sold their personal shares.

3.12 Directors wishing to support the value of the shares in other circumstances : There may also be a concern that share repurchases and resales might be used to support a share price artificially in other circumstances, for example, in takeover situations. The Takeovers Code contains a number of provisions dealing with this type of activity and the Takeovers Panel would need to consider whether any changes would be required if treasury shares were to be permitted. Manipulation may also be a risk where a company seeks at a particular time (such as when trying to secure further debt or equity finance) to give an impression of value which may not be justified by its performance, by influencing the company's earnings per share and other performance ratios. These concerns, however, exist to a certain extent at present since repurchases of shares by companies are already permitted, albeit that the shares repurchased may not be held in treasury under the current law.

3.13 Circumvention of pre-emption rights : Another possible concern is that the resale of treasury shares could be used as a way of circumventing pre-emption rights. However, it should be recognised that companies already have significant flexibility under the general mandate to issue shares without them being subject to pre-emption rights (see paragraph 2.25 in section 2 above).

3.14 Treasury shares are not a "panacea" : It would be unrealistic to consider that treasury shares are the panacea every listed company has long awaited. Whilst there may be considerable support for introducing treasury shares with every attractive feature desired by the securities market, in practice considerable care will need to be exercised to ensure that abuses of the facility are minimised, if not entirely avoided. Rules and controls will need to be put in place to provide necessary protections for those dealing with the company (as to which, see section 5 below) and these may be regarded by some observers as limiting considerably the attractiveness of holding treasury shares.

A possible framework for treasury shares

3.15 If the Companies Ordinance were changed to allow treasury shares, the SFC sees the following taking place:

(a) Companies will continue to carry out repurchases as before, pursuant to the existing legislative and regulatory controls. However, the company will have a choice as to whether or not repurchased shares will be cancelled. Subject to any limit which the law may impose (as to which, see paragraph 5.16 in section 5 below), any shares not cancelled will be held by the company as treasury shares.

(b) Returns and notices regarding the repurchase will be filed with the Companies Registrar and the Hong Kong Stock Exchange as usual. The notice should specify whether the shares are to be cancelled or held in treasury, the number of shares held in treasury and the total issued capital of the company (as to which, see paragraph 5.6 in section 5 below) and include a statement of intention as to what the company proposes, such as with respect to any period of time the shares may be held (as to which, see paragraph 5.9 in section 5 below) ;

(c) Accounting entries will be made by the company to recognise the repurchase of shares and the holding of treasury shares (as to which, see paragraph 5.24 of section 5 below);

(d) When treasury shares are to be sold, and depending on the size (or other specified characteristics) of the transaction, the company may be required to issue an announcement informing the public in advance of its intention (as to which, see paragraph 5.9 in section 5 below);

(e) After the sale has taken place, notices will be filed with the Companies Registrar and the Stock Exchange. The notice should state the number of treasury shares held before and after the sale and the total issued capital of the company (as to which, see paragraph 5.11 in section 5 below);

(f) Accounting entries will be made by the company to recognise the sale (as to which, see paragraph 5.26 in section 5 below);

(g) Monitoring by the Stock Exchange of proper compliance by companies with the relevant regulations applying to treasury shares, for example, with respect to :

Section 5 below addresses in more detail certain matters referred to above and generally highlights other issues arising in relation to treasury shares.

Expediting the reissue of shares

3.16 The repurchase of shares with cancellation already provides companies with the ability to increase the balance of debt to equity capital. However, it appears that companies consider that some of the applicable regulatory restrictions contained in Chapter 10 of the Listing Rules (see in particular paragraphs 2.19 to 2.24 in section 2 above), together with the time and expense currently involved in reissuing, and obtaining a listing for, new shares make the existing mechanism too cumbersome for effective management of equity capital.

3.17 Currently, the general mandate to issue shares authorises directors of listed companies to issue up to 20% of a company's existing issued share capital, together with any shares repurchased up to a maximum of a further 10% of existing issued share capital, without requiring further shareholders' approval. A listed company seeking listing of new shares is required to comply with relevant provisions of Chapter 9 of the Listing Rules. A summary of the principal requirements applying to the most common methods of issue can be found in Annex B. If the listing approval process for the reissue of repurchased shares could be expedited, it may be possible to achieve some of the advantages ascribed to treasury shares mentioned in paragraphs 3.5 to 3.9 above.

Arguments for and against the expedited reissue of shares

3.18 A level playing field and ease of implementation : Changing aspects of the procedure for reissuing shares that have been repurchased, and specifically that part of the procedure which involves the grant of listing for such shares, will benefit all companies with a listing on the Hong Kong Stock Exchange. By comparison, the alternative of changing the Companies Ordinance to allow for the holding and resale of treasury shares would only apply to Hong Kong incorporated companies. The changes which may need to be made to the current repurchase and reissue regime to implement such an expedited reissue of shares would require amendment to the Listing Rules only. As the Listing Rules could be changed with less formality and greater speed than the Companies Ordinance, the relevant regime could be put in place sooner than would be the case if treasury shares were to be introduced.

3.19 The position of Hong Kong incorporated companies : Any expedited reissue solution would not address the Companies Ordinance and common law restrictions and controls described in paragraph 3.8 above, and it is important to note that these will continue to apply to Hong Kong incorporated companies. However, it will be evident upon considering these restrictions and controls that they are not likely in practice to hinder reissues of shares in most circumstances. If the expedited reissue proposal described below in this section is implemented, the SFC will consider whether the existence of the Companies Ordinance restrictions would place Hong Kong incorporated companies at a disadvantage relative to companies from jurisdictions which did not have such restrictions. To the extent that the SFC concludes that overseas jurisdictions have less stringent provisions dealing with a company issuing shares, it will consider whether to recommend legislative changes to bring Hong Kong legislation into line with that in such overseas jurisdictions.

3.20 Financing of a repurchase of shares : As mentioned in paragraphs 2.3 and 2.8 of section 2 above, broadly speaking, listed companies, whether incorporated in Hong Kong, Bermuda or the Cayman Islands (collectively being the jurisdictions of incorporation of over 90% of the companies listed on the Hong Kong Stock Exchange) may repurchase their shares by using distributable profits or the proceeds of a fresh issue of shares. Over time (and other things being equal), a company that is active in repurchasing and reissuing shares will reduce the amount of its distributable profits because the proceeds from an issue of shares do not constitute distributable profits, and thus do not increase distributable reserves of a company. Without legislative change, this may prove an impediment to companies which wish to be active in repurchasing shares (whether they are held in treasury and resold or cancelled and reissued). However, this may not be a problem unless the only change made to the existing regime involves a change of the Listing Rules (ie. without also changing Hong Kong legislation to provide for treasury shares). This is because it is possible that if treasury shares were introduced the legislative changes may include some relaxation of the treatment of treasury shares - for example, to allow some adjustment of distributable reserves by reference to the sale proceeds. This may be regarded as a relative disadvantage of implementing a change to the Listing Rules without any change to the Companies Ordinance.

3.21 Similar advantages and disadvantages to treasury shares : Although the matters mentioned in paragraphs 3.5 and 3.6 above are described as being advantages associated with treasury shares, they can be seen to apply equally well to any proposed relaxation of the rules on the reissue of shares. Similarly, the matters mentioned in paragraphs 3.10 to 3.12 as being disadvantages of treasury shares would also apply in the case of an expedited reissue route.

A possible framework for the expedited reissue of shares

3.22 If the Listing Rules are changed to expedite the reissue of repurchased shares, the SFC contemplates that companies will continue to carry out repurchases as before, and the shares will be cancelled in accordance with the Companies Ordinance or other applicable legislation governing overseas companies. Notices of repurchases will be filed with the Companies Registrar (in the case of Hong Kong incorporated companies) and the Stock Exchange (in the case of all listed companies) as usual.

3.23 The SFC proposes that, at any time following the passing of a resolution granting a repurchase mandate, an application may be made by the company to the Stock Exchange for a block listing of shares. The block listing will comprise the maximum number of shares that the company could reissue on the assumption that it conducts share repurchases to the fullest extent during the validity period of its current repurchase mandate. The Stock Exchange could then grant a standing confirmation for listing of up to that number of new shares comprised within the block listing application, provided that listed status would attach to specific shares only at the time of their reissue and subject to the Stock Exchange receiving one day's prior notice of any proposed issue of shares pursuant to that approval. Subsequently, upon notification by the company to the Stock Exchange of the number of shares involved in any proposed reissue of repurchased shares, such number of shares could be treated as having listed status with effect from the business day following the notification. Subject to any restrictions imposed, management would be able to reissue shares at any time, in any quantity on or off market. Matters relating to this proposal are discussed in detail in section 6 below.

Summary

3.24 The SFC considers that it is the appropriate time to consult the public on whether it is desirable to introduce treasury shares in Hong Kong. Not only have the Financial Secretary of Hong Kong and the Department of Trade and Industry in the United Kingdom recommended consideration of their introduction, but the SFC believes that review of the existing framework is appropriate in light of the considerably different economic climate which now prevails in Hong Kong. The Takeovers Panel, which has also recently discussed the matter, cautions that the introduction of treasury shares should not be viewed solely as a response to market conditions, nor is it a panacea to problems being experienced by listed companies in Hong Kong. However, the Takeovers Panel does recognise that there are reasons why treasury shares may offer more flexibility to companies in managing their balance of debt to equity capital than currently exists.

3.25 The introduction of treasury shares will require changes to be made to existing company law in Hong Kong. Such changes will apply to Hong Kong incorporated companies, but not those incorporated overseas. Companies incorporated in overseas jurisdictions will only acquire any perceived benefit as and when their company law also changes to provide for treasury shares. Currently, two-thirds of the companies listed on the Hong Kong Stock Exchange are incorporated overseas. None of the relevant jurisdictions currently allow companies to hold treasury shares. A change to the law in Hong Kong may give listed companies incorporated in Hong Kong some advantage over companies incorporated elsewhere.

3.26 Any proposal to introduce treasury shares must include consideration of the restrictions and controls which may be required to ensure that the perceived benefits of the facility are not abused. In the United States (being the only major common law jurisdiction to allow treasury shares), very strict rules and regulations have been implemented to prevent the abusive use of treasury shares. The controls in Hong Kong are likely to include requiring prior approval from shareholders, disclosure of transactions and restrictions on resale. It is recognised that the attractiveness of treasury shares will decrease as the number of requirements and restrictions increases. However, the potential advantages must be weighed against the potential risks to persons dealing with companies which hold treasury shares and to the public generally, as well as the need to prevent malpractices in the securities market.

3.27 When considering the introduction of treasury shares, the Takeovers Panel also suggested that consideration should be given to achieving some of the benefits attributed to treasury shares by changing the Listing Rules rather than the Companies Ordinance. This would apply to all companies listed on the Stock Exchange, whether or not incorporated in Hong Kong, and implementation of any changes to the Listing Rules is, under normal circumstances, quicker than implementation of changes to legislation. The SFC is therefore also consulting the public on a change to the Listing Rules which will permit a company to reissue more readily shares previously repurchased and cancelled. The SFC's proposal is outlined in paragraphs 3.22 to 3.23 above. It should be noted, however, that whilst this alternative has the merits of its possible application to all listed companies and its speed of implementation, it does not benefit from all advantages attributed to treasury shares, since provisions of company legislation (particularly restrictions on the issue of shares), will continue to apply. The relevant restrictions in this respect, as they apply to Hong Kong incorporated companies, are described in paragraph 3.8 above, and in further detail in Annex A. Furthermore, the perceived benefit outlined in 3.9 above (namely, to facilitate the administration of employee share schemes) would not be achievable in the manner suggested.

Section 4 : Treasury shares in overseas jurisdictions

United States

4.1 In the United States, companies may deregister and cancel repurchased shares (which rarely happens) or keep them in treasury. While held in treasury, shares are normally not eligible for dividends and do not have voting rights. They can be used as bonus shares, for employee stock plans or in acquisitions, but may not be resold to the public unless they are registered under the U.S. Securities Act of 1933, or are resold through an exemption under that Act, such as a private placement regulated by the Act, which normally means that the placees are subject to selling restrictions. Any profit or loss on resale must be dealt with through reserves and not through the profit and loss account. They are excluded for the purposes of calculating per share ratios. There are no limits on the number of shares that can be held in treasury.

United Kingdom

4.2 In the United Kingdom, as in Hong Kong, repurchased shares must be cancelled, thus reducing the issued but not the authorised share capital of a company. In May 1998, the Department of Trade and Industry issued a Consultative Document which proposed that the law should be changed to allow companies to purchase and hold for subsequent resale up to 10% of their issued share capital. However, there is currently no proposal to modify the reissue process. It should be noted that generally speaking UK listed companies only request, and the institutional shareholder bodies only approve, that the number of shares which may be issued for cash on a non-pre-emptive basis is 7.5% of existing shares during any rolling three year period.

Other jurisdictions

4.3 In Australia, Bermuda and the Cayman Islands, the law is similar to that of the UK and Hong Kong at present. Under the law of the People's Republic of China, PRC companies cannot acquire their own shares except pursuant to a cancellation of shares due to a reduction in registered capital or a merger with another company which holds shares in the company or other purposes specified by law and in regulations. Subject to relevant regulatory approvals and provisions in its Articles, an H share company may repurchase issued shares provided that such shares are cancelled within 10 days, its registration particulars are changed and it issues a public notice. However, due to the possible need to settle debts or offer guarantees to creditors in the context of the reduction of capital and the present difficulties related to obtaining regulatory approvals, repurchases of shares by PRC companies are not in practice currently taking place.

4.4. Several countries in Europe allow treasury shares to be held and the Second Company Law Directive 77/91/EEC lays down requirements for those countries which allow treasury shares. These requirements principally provide that only fully paid shares may be purchased by a company, they must be purchased out of distributable profits, the total amount held in treasury may not exceed 10% of issued share capital, the right to vote such shares has to be suspended, and if the shares are shown as an asset, an undistributable reserve of the same amount must be created as a liability.

Section 5 : Issues to be considered in relation to the proposal to introduce treasury shares

5.1 The purpose of this section of the Consultation Paper is to highlight a number of regulatory issues which would arise if treasury shares were to be introduced into Hong Kong law.

Existing legislative controls on repurchases of shares

5.2 Although the repurchase of shares by companies for cancellation is already permitted, the introduction of treasury shares will raise new issues in relation to the holding of shares in treasury and the resale of shares.

The share repurchase element of a treasury share regime is not expected to raise many new issues over and above those raised by share repurchases for cancellation. As a result, it is expected that in general the current shareholder and creditor protection mechanisms applicable to share repurchases set out in the Companies Ordinance will be sufficient.

In the context of the treasury share proposal referred to in this Consultation Paper, and apart from the drafting changes required specifically to provide for repurchased shares to be held and resold, do you believe that change should also be made to other provisions of company law which may be relevant to a treasury share regime?

5.3 It is appropriate to consider whether a company should only be permitted to hold repurchased shares in treasury if they were acquired through an on-market repurchase and, if so, whether the current controls on on-market repurchases contained in the Listing Rules will continue to be appropriate.

Should shares proposed to be held in treasury only be repurchased on the Stock Exchange? Should there be other controls (in addition to those contained in the Listing Rules (as to which, see paragraphs 2.19 - 2.24 in section 2 above)) on the volume, pricing and timing of repurchases of shares specifically because some or all of such shares may in future be held in treasury?

Shareholder approval

5.4 Another question is whether shareholders, when asked to approve a repurchase of shares, should be asked to approve it specifically for holding in treasury for resale or for cancellation, such that if the purchase were approved for one purpose and the company subsequently decided on the other, shareholders would have to approve the change. Alternatively, shareholders could perhaps approve a repurchase leaving the decision as to holding for resale or cancellation to the directors, with a requirement that when the directors of the company thereafter announced their intention to repurchase shares, or actually effected the repurchase, the directors are required to state whether the shares are to be held in treasury for resale or cancelled.

Should shareholders, when approving a repurchase, be asked to specify whether the shares are to be held in treasury for resale or are for cancellation? If it is not specified at the time of the shareholder approval, should a company be required to announce prior to or after a repurchase whether the shares are to be held in treasury for resale or for cancellation?

Approval of price upon resale of treasury shares

5.5 One of the arguments in favour of treasury shares is that companies would have the flexibility to sell shares in the market at full market price rather than at a discount. The question therefore arises whether regulations should require shareholders to approve the price at which treasury shares are to be sold. This could be, for example, at a minimum price or at a price related to the then current market price or to an average of, say, the latest five days' trading prices. Also relevant is whether consideration other than cash could be received, such as when the company may offer treasury shares in consideration for an acquisition of assets. Closely related to this, and to the question of obtaining full value for treasury shares, is whether a company should be allowed to sell such shares off-market.

Should shareholders be asked to approve the price at which treasury shares are resold? How should such price be determined? Should other forms of consideration be permitted? Should resales off-market be permitted?

Disclosure of shares held in treasury

5.6 If companies were permitted to repurchase their shares and hold them for resale, shareholders and others would need to know the exact number of shares which were held in treasury, much as they currently need to know details of any cancellation of shares. When a company repurchases shares for cancellation, the aggregate issued share capital of the company and the voting rights attaching to them are reduced. Such reduction has the corresponding effect of increasing the percentage holding of each shareholder in the issued capital and voting rights of the company. Should the voting rights on treasury shares be suspended, as discussed in paragraph 5.12 below, the net effect will be the same. By similar reasoning, any sale of shares from treasury will, much like an issue of new shares, have the effect of increasing the total issued share capital (and the total number of voting rights attributable to the share capital) of the company, and thus reducing the percentage holding (and voting rights) of each shareholder in the company.

5.7 The need for disclosure by the company of its dealings in treasury shares would seem to follow from the disclosure obligations which directors and substantial shareholders of the company would have in relation to their own voting rights pursuant to the Securities (Disclosure of Interests) Ordinance (see paragraph 2.11 in section 2 above). In relation to this disclosure requirement alone, any announcement would need to detail: (i) the number of shares in the relevant transaction, (ii) the aggregate holding of shares in treasury following the transaction and (iii) the aggregate issued share capital of the company following the transaction. Disclosure requirements along these lines would need to take account of those changes proposed under the amendments to the Securities (Disclosure of Interests) Ordinance, and would need to evolve as necessary to accommodate any further change to those rules in future. The need for disclosure also arises because of the requirements of Rule 33 of the Takeovers Code (which is mentioned briefly in paragraph 2.27 in section 2 above), which may require a notification to be made by a person holding shares in the company upon a resale of treasury shares by the company. Unless Note 1 to Rule 33 is extended to cover the effect of a resale of treasury shares there may be a need for notification by substantial shareholders (for these purposes, any person holding 10% or more but less than 35% of the voting rights) under that provision insofar as their holding of shares increases or decreases to or beyond a whole percentage figure. If the Note is not extended as described above, the company would need to give such reasonable period of prior notice of a proposed resale of shares as would enable substantial shareholders to comply with any notification requirement they may have under that Rule. As mentioned below, disclosure in relation to other aspects of any proposed repurchase of shares for holding in treasury may also be appropriate for other reasons, which is likely to result in these announcements dealing also with other matters.

Should transactions in, and holdings of, treasury shares be disclosed to the extent necessary to enable persons having disclosure obligations under the Securities (Disclosure of Interests) Ordinance to comply with such obligations? Should Note 1 to Rule 33 of the Takeovers Code be extended to cover the effect of resales of treasury shares?

Mandatory offers under Rule 26 of Takeovers Code

5.8 Rule 32 of the Takeovers Code (which is mentioned in paragraph 2.26 in section 2 above) usually requires a shareholder or a group of shareholders acting in concert who acquire or consolidate control of a company as a result of a share repurchase to make a general offer under Rule 26 of the Code. It has been argued that the holding of repurchased shares in treasury (as distinct from the cancellation of such shares) suggests a short term change to the voting rights attributable to the remaining issued shares of the company, since such repurchased shares may be resold comparatively quickly. For this reason it is suggested that Rule 32 may be relaxed in cases where shares repurchased are held in treasury. Of course, any relaxation of the obligation to make a general offer may be open to abuse by controlling shareholders who seek to use this as a means of consolidating control without incurring the obligation to make a general offer. Minority shareholders' interests may, however, be protected in such circumstances if they are given the right to vote upon whether or not a general offer should be made. This would be similar to the waiver that is currently available for general offer and off-market repurchases which give rise to an obligation to make a general offer under Rule 26 of the Code.

Should a repurchase of shares which are held in treasury be treated differently from a repurchase of shares for cancellation in the context of Rule 32 of the Takeovers Code, such that a general offer may not necessarily be required by reason only of an acquisition or consolidation of control in such circumstances? If different treatment can be justified, should waivers to the requirement for a general offer under Rule 26 of the Code be on the same basis as those available for general offer and off-market repurchases?

Announcement of intention with respect to holding and resale of treasury shares

5.9 Another requirement which might be felt to be useful would be that companies had to announce in advance their intentions regarding treasury shares, particularly upon purchase and prior to resale. The knowledge of the company's intentions generally, and of an impending sale in particular, could add to transparency in the market. On the other hand announcements of intentions to sell subject to market conditions or certain price levels could be open to abuse. Furthermore, in very volatile markets it may be impractical to require companies to announce their intention in advance.

Should announcements of intentions with respect to holding and resale of treasury shares be required? If so, how far in advance and how detailed should they be?

What if the company changes its intention?

Disclosure of other information at time of resale

5.10 Another question which arises in this context is whether the company should be required to disclose other information, such as in relation to its latest financial position, when it sells treasury shares. In the US, resales of treasury shares to the public may need to be preceded by a registration statement if they constitute the offer and sale of securities to the public. Any prospectus used to offer or sell the securities must meet certain disclosure requirements. Chapter 11 of the Listing Rules sets out the Hong Kong Stock Exchange's requirements for the contents of listing documents, which must be approved by the Stock Exchange prior to issue. Chapter 7 of the Listing Rules provides that shares may only be listed by one of the methods described in that chapter. Unless a separate regime is established for the listing of treasury shares (which is most likely to be necessary), any resale of treasury shares would need to fall within one of the existing methods referred to in the Listing Rules. A number of the methods described require the issue of a listing document. It is useful to note in this context that a placing by an issuer of shares of a class already issued does not require a listing document under the Listing Rules unless a prospectus or listing document is otherwise required. It seems to the SFC that a resale of treasury shares is likely to be difficult to distinguish from a placing of shares and that there may therefore be little justification for requiring a listing document in this case. Whether or not a listing document is required in relation to a sale of treasury shares, the circumstances may be such as to require the filing of a prospectus. Assuming that neither is required, the question remains whether some information should nevertheless be disclosed at the time of resale in order to ensure that purchasers of such shares are in the possession of latest financial information.

Should the company be required to disclose particular information, for example in relation to its current trading position?

Notification of resales of treasury shares

5.11 There are already requirements in the Companies Ordinance and the Listing Rules for companies to notify a repurchase of shares, giving details of the date, number and price on the day next after the share repurchase took place. There would appear to be a strong case for similar notification requirements for resales of shares from treasury, both immediately after the time of sale and in the company's annual report. Such notification would include details of (i) the number of shares held in treasury prior to the resale, (ii) the number of treasury shares sold, (iii) the price at which they were sold, (iv) the difference between the sale price and purchase cost, (v) the number of shares held in treasury after such sale, and (vi) the aggregate issued share capital after such sale.

Should sales of treasury shares be reported at the time to the Companies Registrar and the Stock Exchange, and in the company's annual report?

Voting rights

5.12 Voting rights on treasury shares are suspended in the United States and in a number of countries within the EEC. The SFC does not recommend that shares held in treasury should retain voting rights. If such rights were retained, it is difficult to see any justification for allowing the company the right to exercise them in relation to affairs of the company reserved to a vote of the shareholders, since these votes are intended to solicit the views of the genuine owners of the business. Difficult questions would also arise as to who should exercise them. Not allowing for voting rights on treasury shares would affect the proportionate rights of genuine shareholders in relation to the company, and will accordingly impact on calculations of levels of shareholding for the purposes of disclosure under, among others, the Securities (Disclosure of Interests) Ordinance and the Takeovers Code. It would follow that any acquisition by a company of shares for retention in treasury would automatically increase the proportion of voting rights held by all other shareholders, and any sale of shares from treasury would decrease those voting rights. This is no different from the impact that a repurchase/cancellation, on the one hand and a new issue of shares, on the other, by a company currently has on the interests of its shareholders.

Should voting rights attaching to treasury shares be suspended whilst the shares are held in treasury?

Payment of dividends, etc.

5.13 There would appear to be a case for requiring the suspension of dividends that might otherwise be paid on any shares held in treasury on the grounds that it is pointless for companies to pay money to themselves. That is the position usually taken in this respect in the United States and the EEC. If dividends were not to be paid on treasury shares, presumably no other payment (such as any payment in a winding up of the company) should be payable in respect of those shares. If treasury shares are to be regarded as being in limbo and devoid of all rights, it would seem that they should also not be entitled to participate in rights issues or open offers, etc.

Should treasury shares be entitled to receive dividends or any other payments, such as in a winding up? Should all other rights from time to time exercisable by shareholders be suspended whilst the shares are in treasury?

5.14 In the United States, treasury shares are also excluded for the purposes of calculating per share ratios, such as earnings or dividends per share. However, it must necessarily follow from this treatment that companies could influence these and other performance data by merely increasing or decreasing their holdings of shares in treasury. This risk of manipulation does already exist under the existing repurchase/cancellation and new issue rules, but both of the new routes contemplated by this paper are in part intended to accelerate the ease with which shares could be withdrawn from and replaced into the market and may thus aggravate this risk.

Should treasury shares be included in the calculation of earnings per share and other performance data?

5.15 Questions also arise as to the extent to which treasury shares should be treated as assets of the company. Justification can be seen, for example, to the extent that they can generate sale proceeds in excess of their purchase price or can be used in settlement of rights exercised under a share option scheme. If any other value could be regarded as attaching to shares held in treasury, difficult questions arise as to whether a company should be prevented from using them in particular ways, for example, pledging those shares.

Should there be restrictions on what a company may do with treasury shares?

Maximum permitted holding of treasury shares

5.16 Currently, directors of companies may seek approval annually, by general mandate of shareholders, for on-market repurchases of shares for up to 10% of the outstanding issued share capital on the date of the meeting. Subject to other constraints, such as the requirement to maintain the minimum level of public float, shareholders could therefore annually approve purchases of 10% of a gradually decreasing share capital, with shares repurchased being cancelled. If treasury shares were allowed, there may need to be a percentage limit on the number of shares that could be held in treasury. In the United States, for example, there is no limit on the number of shares held, whereas in the EEC, a limit is imposed, such that treasury shares may not constitute more than 10% of a company's issued capital from time to time. Alternatively, and in order to prevent the build up of a large stock of treasury shares, it may be possible to provide that any treasury shares not released into the market within a specified period of the purchase, say 12 months, would be automatically cancelled, i.e. treated as authorised but unissued capital, much as if they had been cancelled upon repurchase. Furthermore, one must consider whether there needs to be any restriction on a company issuing new shares if it is holding shares in treasury.

Should there be a percentage or other limit on the number of shares held in treasury and capable of resale? Should treasury shares be cancelled automatically if not resold after a specified period? Should a company be allowed to issue new shares only if any holding of treasury shares is used first?

Pre-emption rights

5.17 The Companies Ordinance does not contain the equivalent of section 80 of the UK Companies Act, which gives existing shareholders the right to be offered the first opportunity to purchase any new shares issued by a company in proportion to their existing shareholding. A provision of similar effect may, however, be contained in the company's articles of association. Section 57B of the Ordinance, however, requires directors to obtain the approval of the shareholders in general meeting prior to any allotment of shares which is not offered pro rata to existing shareholders. This usually takes the form of a standing approval renewed every year. Under the Stock Exchange Listing Rules, the maximum number of shares that shareholders may approve for issue (i.e. without infringing the pre-emption rights incorporated into paragraph 19(2) of the Listing Agreement) is 20% of the outstanding issued share capital at the date of the resolution, together with any shares purchased by the company up to a maximum of a further 10%. The mandate lapses automatically at the next general meeting unless it is then renewed or is earlier varied or revoked by the shareholders in general meeting. Shareholders routinely approve such general mandates.

5.18 The resale of shares held in treasury is not an issue of new shares and would not, therefore, fall within the current wording of paragraph 19(2) of the Listing Agreement. This raises a number of issues. First, the resale of treasury shares would not be subject to the pre-emption rights described above, and such shares could be sold directly to whomsoever the directors chose. Indeed, it would be illogical (as well as defeating a main feature of treasury shares) to impose pre-emption rights on shares repurchased and held in treasury, when such rights are effectively waived by shareholders under paragraph 19(2) in relation to any reissue of the equivalent number of new shares following a cancellation of the same repurchased shares. Secondly, it would follow that any shares held in treasury could be added to any new shares which could lawfully be issued by the company, including pursuant to the directors' general mandate.

5.19 If it were possible to hold treasury shares for a lengthy period of time, the directors could have at their disposal the maximum permitted number of treasury shares. Any repurchase resolution thereafter granted by shareholders and used in full would then require all additional repurchased shares to be cancelled. Subject to any restrictions which may be imposed by the shareholders or by regulations with a view to limiting the use of treasury shares or to limit the total number of shares at the disposal of directors at any one time, the directors would theoretically be able to issue in one tranche shares amounting to considerably more than 30% of the company's issued capital as at the date of the general meeting granting the paragraph 19(2) mandate.

Bearing in mind certain of the stated advantages of treasury shares outlined in section 3 above, should the method of resale or other disposal of treasury shares be controlled or regulated, such as pursuant to a shareholders mandate? Should there be restrictions on any category of person (such as connected persons) to whom treasury shares may be sold? Should any treasury shares held by a company be capable of being added to other shares at the disposal of the directors?

Prohibition on resale of treasury shares at certain times

5.20 Under the Stock Exchange Listing Rules there is a requirement prohibiting purchases by a listed company of its own shares after a price sensitive development has occurred or has been the subject of a decision until that information has been made public. In particular, a company may not purchase shares during the month before the preliminary announcement of the company's annual results or the publication of the interim report. In order to reduce the scope for market manipulation there is a strong case for similar restrictions to apply to any resale of treasury shares.

Should companies be prohibited from reselling treasury shares at price sensitive times?

5.21 The restriction in paragraph 10.06(3) of the Listing Rules, which prevents a company from making or announcing a new issue of shares for a period of 30 days after any repurchase of shares, would not currently apply to resales of treasury shares, because of the technical distinction between issues of new shares and resales of existing shares. However, it could be made to apply in order to restrict manipulation of the share price.

Should the prohibition on making or announcing a new issue of shares for a period of 30 days after any repurchase of shares apply also to resales of treasury shares?

Reselling treasury shares when a company is subject to a takeover

5.22 The issue of authorised but unissued shares by an offeree company subject to a takeover offer is currently restricted on the grounds that it may constitute unacceptable frustrating action contrary to Rule 4 of the Takeovers Code. The Takeovers Panel considers that the resale of treasury shares is analogous to an issue of new shares and would propose to amend the Code accordingly if treasury shares were allowed. This issue also lends weight to the proposition that resales of treasury shares should only be conducted on-market, which was touched upon in paragraph 5.5 above.

Should companies be restricted from reselling treasury shares when subject to a takeover, delisting proposal or privatisation?

Treatment of treasury shares in the accounts

5.23 Paragraph 3.20 in section 3 above touches upon the legal aspects of the financing of repurchases of shares and the effects on distributable profits of the company. It is possible that if changes are made to the Companies Ordinance to accommodate treasury shares, some change may also be made to the way in which repurchases of shares currently impact on distributable profits of a company and how resales of treasury shares should then be treated. The SFC's recommendation in this respect adopts that of the IASC referred to in paragraph 5.26 below.

Would you consider that changes to the financing aspects of the repurchase of shares regime should be considered if treasury shares are introduced? If so, do you have particular recommendations?

5.24 In June 1998, the International Accounting Standards Committee ("IASC") issued for public comment a draft interpretation regarding the accounting treatment of treasury shares. The issues addressed in the interpretation were:

(a) how treasury shares should be presented in the issuing enterprise's consolidated balance sheet; and

(b) how the difference between the purchase cost and the resale price should be presented when treasury shares are subsequently resold.

5.25 The IASC concluded that treasury shares should be presented in the consolidated balance sheet of the issuing enterprise as a deduction from equity. This may be disclosed as a one-line adjustment of equity or by adjusting individual parts of equity such as share capital, share premium and retained profits. The SFC suggests that a one-line adjustment is the appropriate treatment as it reflects the short term nature of the adjustment to equity.

Should treasury shares be presented in a consolidated balance sheet as a one-line adjustment of equity?

5.26 Where treasury shares are subsequently resold, the difference between purchase cost and the resale price should be presented in the financial statements of the issuing enterprise as a change in equity. It should not be shown as part of net profit or loss for the period. The SFC considers that, where there are a number of purchases and sales of treasury shares, the purchase cost of shares sold should be determined using the first-in-first-out method. Any deficit on resale of treasury shares should be charged to distributable reserves, any gain should be treated as a non-distributable reserve only available to cover deficits on subsequent sales of treasury shares.

Do you agree with this proposed treatment?

Subsidiaries

5.27 At present company law (section 28A of the Companies Ordinance) generally prohibits subsidiaries from being shareholders in their holding company. If treasury shares were to be permitted, there appears to be a case for relaxing this provision so that a subsidiary could purchase, hold and resell its parent company's shares, such shares becoming in practice treasury shares of the parent company. In such a case, the general requirements outlined above, such as restrictions on voting rights, dividends and percentage limits, would have to apply equally to the case where shares were held by a subsidiary. However, complications may arise if treasury shares were held by a subsidiary, particularly in the event of a change of control or liquidation of that company. These complications may deter companies from holding shares in a parent company either for their own account or on behalf of the parent company.

Should subsidiaries be able to purchase, hold and resell shares in their parent companies?

Private and unlisted companies

5.28 It may be argued that on the grounds of equal treatment any change to the law to allow companies to repurchase and hold shares in treasury should apply to both public and private companies. However, the case for allowing companies to repurchase shares for treasury has so far been made in the context of listed public companies, and it is not clear to what extent unlisted public or private companies would find this additional option useful. It should be noted that most of the arguments in favour of allowing treasury shares mentioned in paragraphs 3.5 to 3.9 in section 3 above do not apply in the private or unlisted company context and the laws against market manipulation and insider dealing which serve as safeguards in the public company context would not be available to provide the same safeguards. Any change to the Listing Rules would by definition have no relevance to private or unlisted companies.

As the focus of this Consultation Paper is on listed public companies, the SFC has not considered the position of unlisted or private companies. However, comments are also invited on whether the law should be changed to give unlisted or private companies the ability to hold treasury shares for resale. Would unlisted or private companies be disadvantaged if changes were made to allow treasury shares to be held by listed public companies only?

Section 6 : Issues to be considered in relation to the proposed change to the Listing Rules

6.1 It is the SFC's view that some of the advantages and disadvantages commonly attributed to treasury shares could be reasonably well replicated without the need to introduce treasury shares. This section of the Consultation Paper discusses the SFC's proposal for a new mechanism to facilitate the reissue of repurchased shares and invites comments on whether this could achieve the desired end without changes to company law.

Do you believe that a proposal along the lines described in paragraph 3.23 of section 3 above would be a workable alternative to treasury shares?

Matters unrelated to listing approval

6.2 The SFC's proposal in this respect addresses that part of the process by which new shares are introduced into the market which is within the control of the Stock Exchange, namely the granting of listing approval. Specifically, it aims to facilitate a rapid issue of new shares with listed status on the Stock Exchange. Clearly, the granting of listing approval is only one of a number of steps which have to be taken to get new shares issued and ready to be traded on the Exchange, and further consideration of the other steps in the process remains to be done. The SFC welcomes any comments, not only on the block listing proposal itself, but also on any potential difficulties which may hinder other aspects of the issue and delivery of shares in such circumstances.

Do you believe there are matters unrelated to the granting of listing which may make this proposal unattractive or unworkable?

6.3 One such restriction which immediately arises is that contained in rule 10.06(3), which is described in paragraph 2.22 in section 2 above and referred to in paragraph 5.21 of section 5 above in the context of treasury shares. This provision is likely to reduce the opportunities for a company to manipulate its share price by repurchasing and reissuing shares in rapid succession. The SFC's view is that this provision should remain in place, but would welcome the public's view on whether this provision should be relaxed, and if so, the nature of any alternative control which may be regarded as being appropriate?

Do you believe that the restriction contained in Rule 10.06(3) should be modified, and if so, to what extent?

The proposal in detail

6.4 The SFC proposes that a company should be entitled to apply to the Stock Exchange in advance for listing permission for such number of authorised but unissued shares as is equal to the number of shares that the company may in due course repurchase pursuant to its repurchase mandate. The exact number of shares to which the repurchase mandate applies (being up to 10% of the issued capital on the date of the general meeting which grants the mandate) will be known and would usually be specified in the relevant resolution. By definition, the shares capable of being repurchased will already be in issue and listed at the date of the general meeting granting the repurchase mandate. The block listing will relate to the issue of new shares in connection with (but only following, and to the extent of) a prior repurchase and cancellation of existing shares having taken place. The application for block listing could be made by the company at any time after the passing of the resolution granting the repurchase mandate.

Do you believe that such arrangements are appropriate and/or adequate?

6.5 The block listing approval will confirm that listed status will attach automatically to any new shares issued by the company in an amount not exceeding the number of shares actually repurchased pursuant to the repurchase resolution. The listed status of such shares will only attach with effect from the date after notification of a proposed reissue of shares is given to the Stock Exchange. In its return to the Stock Exchange the company would have to demonstrate how the reissue of shares could be reconciled with the numbers of shares previously repurchased.

6.6 Assuming that a company had repurchased (and therefore cancelled) shares up to the limit of its repurchase mandate, this prior approval would enable the company to issue in a readily marketable form shares equal in number to 10% of its issued capital as at the date of the relevant authorising resolution of shareholders. The general mandate given to directors to issue shares (see paragraph 2.25 in section 2 above) will normally include authorisation to issue shares equal in number to any shares repurchased by the company. Such shares can be reissued without first offering them to shareholders in accordance with the pre-emption rights contained in paragraph 19(1) of the Listing Agreement.

The SFC does not see any need for any additional authority from shareholders before the directors issue shares within the block listing approval, but would welcome the public's views in this respect.

6.7 Upon the company issuing new shares the company would be required to notify the public that new shares have been issued pursuant to the company's block listing approval, giving details of the number of new shares issued, the price per share and aggregate consideration received. Unless Note 1 to Rule 33 of the Takeovers Code (described briefing in paragraph 2.27 in section 2 above) is extended to cover the effect of an issue of shares there may be a need for notification by substantial holders (for these purposes, any person holding 10% or more but less than 35% of the voting rights) pursuant to that provision. This arises because the issue of shares by the company will have the effect of reducing the holding of other shareholders in the company. Insofar as any such holding is decreased to or beyond any whole percentage figure between 10% and 35% or falls below 10%, notification must be made by 9:00 a.m. on the dealing day following the transaction. If Note 1 to Rule 33 is not extended as described above the company would need to give such reasonable period of prior notice of the proposed issue of shares as would enable substantial shareholders to comply with any notification requirement they may have under that Rule.

Should Note 1 to Rule 33 apply so as to remove any need for disclosure of any disposal of voting rights resulting from an issue of shares by the company? Do you consider that the disclosure arrangements described in this paragraph are suitable? Assuming that the connected transaction provisions of the Listing Rules will continue to apply as at present, should there nevertheless be any restriction on the persons to whom shares are issued?

Documentary disclosure

6.8 A number of the existing methods of issuing shares require that a listing document, complying with the requirements of Chapter 11 of the Listing Rules, be issued in order to convey certain information to potential investors. Placings of shares within the directors' general mandate are usually an exception, and it is often possible to issue such shares without falling within the prospectus requirements of the company's governing law. The SFC sees some justification in treating reissues of shares pursuant to the block listing on a par with placings, such that the company's proposed reissue of shares would not usually require a prospectus or a listing document.

Should a listing document be required when shares are issued pursuant to the block listing approval? If so, what minimum information should it contain? How and when should any such information be disseminated to the potential allottees of new shares and to the public?

Other controls

6.9 The SFC believes that a number of the areas in which controls may be appropriate within the treasury share regime will also warrant similar controls in the expedited reissue regime. In particular, the matters discussed in paragraphs 5.20 and 5.21 would appear to require to be addressed in relation to reissues of shares.

Do you agree that the matters discussed in paragraphs 5.20 and 5.21 are relevant also in the context of the expedited reissue of shares? Do you believe any other areas (whether or not discussed in relation to treasury shares) may be of concern?

ANNEX A - COMPANY LAW IN DETAIL

This Annex describes in more detail some of the provisions of the Companies Ordinance (Chapter 32 of the Laws of Hong Kong) which are concerned with matters discussed in this Consultation Paper. The relevant provisions only apply to companies incorporated in Hong Kong. The word "company" should therefore be construed as referring to a company incorporated in Hong Kong, and "listed company" should be construed as referring to a company incorporated in Hong Kong the shares of which are listed on the Hong Kong Stock Exchange. The description of the provisions referred to in this Annex is not exhaustive.

Issue of shares

1. Although the expressions "allotment of shares" and "issue of shares" are sometimes used inter-changeably, in practice there is a distinction. Allotment is commonly regarded as being the appropriation of a given number of shares to an allottee (or applicant for shares). The allotment creates an enforceable contract for the issue of the shares. The term "issue" in relation to shares imports that some subsequent act has been done whereby the title of the allottee has been completed. The shares are issued when an application to the company has been followed by allotment and notification to the purchaser and completed by entry on the register of members.

2. The policy of the Companies Ordinance is to ensure that the issued capital of a company is a meaningful indicator of the funds available to creditors of the company. It is common for companies to issue shares for a consideration other than cash, but if a company issues shares to the public, section 42 of the Ordinance requires that the minimum subscription must be paid in cash. Furthermore, the amount payable on each share on application must not be less than 5 per cent. of the nominal amount of the share. Consideration other than cash must be consideration recognised by the law of contract. Hence the issue of shares in consideration of past services is not permitted. The courts will not normally question the sufficiency of the consideration if the company considers that it has received valuable consideration in money or money's worth. To prevent abuses, section 45 requires a company to deliver to the Companies Registrar a return of allotment within eight weeks, which includes details of any contract allotting shares for a consideration other than cash.

3. The amount of any premium is commonly regarded as issued capital as much as the amount representing the par value of the shares. Section 48B of the Companies Ordinance requires a company which has issued shares at a premium to transfer the premiums to a share premium account. As share premiums are regarded almost as paid up capital, their return to shareholders is very strictly controlled. The share premium account may be applied only:

(a) in paying up unissued shares to be issued to shareholders as fully paid bonus shares;

(b) in writing-off preliminary expenses of the company or the expenses of, or the commission paid or discount allowed on, any issue of shares of the company; or

(c) in providing for the premium payable on redemption of redeemable preference shares.

4. Allotment and issue of shares at a discount means an issue of shares for a value less than the par value of the shares. Where the consideration is in cash, common law prohibits the issue of shares at a discount. This is primarily in order to protect creditors of the company. Section 50 of the Companies Ordinance permits issues of shares at a discount but only in restricted circumstances. The issue must be authorised by resolution of shareholders in general meeting and confirmed by order of the court. The resolution must specify the maximum discount and the shares must be issued within one month of the court order. Furthermore, at the date of the issue, the company must have been carrying on business for not less than one year.

5. Section 57B of the Ordinance provides that notwithstanding anything in a company's memorandum or articles of association, the directors of a company shall not, without the prior approval of the company in general meeting, exercise any power of the company to allot shares. However, no prior approval is required in the case of an allotment pursuant to an offer made pro rata to the members of the company. The approval of members may be confined to a particular exercise of the power or may apply to the exercise of that power generally, and may be unconditional or subject to conditions. Any such approval will continue in force until the earlier of the conclusion of the first annual general meeting following the date on which the approval was given or the expiration of the period within which that annual general meeting is required to be held. However, any approval may be previously revoked or varied by the company in general meeting.

Redeemable shares

6. Section 49 of the Ordinance provides that a company limited by shares or limited by guarantee and having a share capital may, if authorised by its articles, issue shares which are to be redeemed (or liable to be redeemed) at the option of either the company or the shareholder. Redeemable shares may not be issued unless the company has also issued shares which are not redeemable. Redeemable shares may not be redeemed unless they are fully paid.

7. Section 49A provides that subject to an exemption for private companies (for which see paragraph 14 below) redeemable shares may only be redeemed out of the distributable profits of the company or out of the proceeds of a fresh share issue. Any premium payable on redemption must be paid out of distributable profits. Redeemed shares are to be treated as cancelled on redemption and the amount of the company's issued share capital shall be diminished by the nominal value of those shares. However, the redemption shall not be taken as reducing the amount of the company's authorised share capital.

Purchase of own shares by all companies

8. Section 49B provides that a listed company (being a company which has any of its shares listed on the Hong Kong Stock Exchange), and an unlisted company limited by shares or limited by guarantee and having a share capital, may purchase its own shares if authorised to do so by its articles. The shares include any redeemable shares, whether or not they have reached their redemption date. However, a company may not purchase its own shares if this would result in there no longer being any member of the company holding shares other than redeemable shares. Section 49B also provides that, in general, the requirements of sections 49 and 49A (set out in paragraphs 6 and 7 above) apply to the purchase by a company of its own shares as they apply to the redemption of redeemable shares.

Requirements for listed companies repurchasing shares

9. Section 49BA deals with the purchase of own shares by a listed company. A listed company may purchase its own shares (a) under a general offer; (b) on the Exchange or on a recognised stock exchange (i.e. a market purchase); or (c) neither under a general offer nor a market purchase.

(a) General Offer

A general offer is an offer to all members of a company or to all members holding shares of a particular class on terms which are the same for all those shareholders. It must be authorised by the company in general meeting and a copy of the document containing the offer and a statement signed by the directors containing particulars sufficient to enable a reasonable person to form a valid and justifiable opinion as to the merits of the offer must be sent to members with the notice of general meeting. An ordinary resolution (over 50 per cent. of votes in favour) is generally sufficient authorisation for these purposes, but if the general offer may result in a member being compelled to dispose of his or her shares under section 168B and Schedule 13 of the Companies Ordinance (because 90 per cent. of the members have accepted the offer), then the offer must be authorised by a special resolution (75 per cent. or more of votes in favour) of the company on which no relevant shareholder has voted and an independent investment adviser must be appointed to advise on the merits of the proposed offer. A "relevant shareholder" for these purposes is one who has given notice to all other shareholders before the meeting at which the resolution is passed, that he will not offer any of his shares for purchase.

(b) Market purchases

A market purchase must also be sanctioned by the company in general meeting and a memorandum of the terms of the proposed purchase must be included together with the notice of general meeting. The authorisation will be valid until the company's next annual general meeting, when it may be extended until the date of the following annual general meeting.

(c) Purchases made other than by general offer or in the market

A purchase made other than by general offer or in the market must also be authorised by a special resolution of the company in general meeting. Notice of the meeting must include a copy of the proposed purchase agreement, or if it is not in writing, a memorandum of its terms and a statement signed by the directors containing particulars that would enable a reasonable person to form a valid and justifiable opinion as to the merits of the proposal. The directors are also required to have made due and diligent enquiry of the members who will be affected by the proposal. The special resolution will not, however, be effective if any member holding shares to which the resolution relates votes on the resolution and the resolution would not have been passed if he had not voted.

(d) Exemption from section 49BA

The SFC may exempt a listed company from any of the requirements of section 49BA subject to whatever conditions it thinks fit. It may also vary, suspend or withdraw an exemption if any conditions imposed are not complied with or on such other ground as it thinks fit.

(e) Contingent purchase contracts

Section 49E sets down provisions relating to a "contingent purchase contract", i.e. a contract which is not a binding commitment to purchase shares but one under which the company may become entitled or obliged to purchase shares. The section provides that a listed company may only purchase its own shares in pursuance of such a contract if it is approved in advance by a special resolution of the company before the contract is entered into. The notice and information requirements and voting restrictions described in sub-paragraph (c) above apply.

(f) Assignment and release

Section 49F provides that the rights of a listed company under a contract to purchase its own shares authorised under section 49BA or section 49E are not capable of being assigned. The section also provides that an agreement by a listed company to release its rights under a contract authorising a repurchase under a general offer or a repurchase which is neither a general offer nor a market purchase is void unless the release agreement is approved in advance by a special resolution before the agreement is entered into. Again the notice and information requirements and voting restrictions described in sub-paragraph (c) above will apply to any such resolution.

Requirements for unlisted companies repurchasing shares

10. An unlisted company may only purchase its own shares under a contract approved in advance under section 49D or section 49E. Section 49D provides that the terms of the proposed contract must be authorised by special resolution of the company before it is entered into and the authority may be varied, revoked or renewed by special resolution of the company. The voting restrictions referred to in paragraph 9(c) above will apply to any such resolution. A copy of the contract or a memorandum of its terms (if it is not in writing) or of any variation, must be available for inspection by members both at the company's registered office for at least 15 days prior to the meeting and at the meeting itself.

(a) Contingent purchase contracts

Section 49E provides that an unlisted company may only purchase its own shares pursuant to a contingent purchase contract if the contract is approved in advance by a special resolution of the company before the contract is entered into. The notice and information requirements and voting restrictions referred to above in this paragraph 10 apply.

(b) A ssignment and release

The rights of an unlisted company under a contract approved under section 49D or section 49E are not capable of being assigned. An agreement by an unlisted company to release its rights under a contract so approved is void unless the terms of the release agreement are approved in advance by a special resolution of the company before the agreement is entered into. Again the notice and information requirements and voting restrictions referred to above in this paragraph 10 apply.

Disclosure and inspection requirements upon a repurchase of shares by any company

11. Section 49G requires that a company which has purchased its own shares delivers to the Companies Registrar within 14 days details of the number and nominal value of the shares and the date on which they were delivered to the company. In the case of a listed company, the aggregate amount paid for the shares together with the maximum and minimum price paid for each class of shares also has to be notified. A company is required to keep a copy of any approved contingent purchase contracts and contracts authorised by listed companies which are neither general offer nor market purchase (or memoranda of their terms) at its registered office for ten years. These must be open to inspection by members of the company and, in the case of listed companies, any other person.

Capital redemption reserve

12. Section 49H provides that, where shares are redeemed or purchased wholly out of profits, the amount by which the company's issued share capital is reduced, following cancellation of the shares, must be transferred to a reserve called "the capital redemption reserve". If the shares are redeemed or purchased wholly or partly out of the proceeds of a fresh issue and the total amount of those proceeds is less than the nominal value of the shares purchased, the amount of the difference has to be transferred to the capital redemption reserve.

Redemption and repurchases financed out of capital by any company

13. Section 49B(4) provides that if authorised by its articles any company may repurchase its shares out of capital in order to (a) settle or compromise a debt or claim; (b) eliminate fractional shares, or in the case of listed companies, an odd lot of shares; (c) fulfill an agreement in which the company has an option or is obliged to purchase shares under an employee scheme approved previously by the company in general meeting; and (d) comply with a court ordering a purchase in respect of either an application to the court by minority shareholders upon an alteration in the company's objects, or an unlisted company providing financial assistance for the acquisition of its shares, or unfairly prejudicial conduct.

Redemption and repurchases financed out of capital (private companies only)

14. Section 49I permits a private company to make a payment in respect of a redemption or purchase of its own shares under section 49A (or as the case may be 49B) otherwise than out of distributable profits or the proceeds of a fresh issue of shares. However, certain conditions must be met. In particular, section 49I provides that the company must be authorised to make payments of that kind by its articles. The amount of any payment of capital in respect of such a purchase is limited to the amount which, taken together with any available profits of the company and the proceeds of any fresh issue of shares made for the purposes of the purchase, is equal to the price of the purchase. This amount is referred to as the "permissible capital payment". If the permissible capital payment is less than the nominal value of the shares purchased, the amount of the difference must be transferred to the capital redemption reserve. However, if the permissible capital payment is greater than the nominal value, the amount of the fully paid share capital and undistributable reserves may be reduced by a sum not exceeding the amount by which the permissible capital payment exceeds the nominal amount of the shares.

15. Section 49J defines the circumstances in which profits can be regarded as "available profits" for the purposes of section 49I. Sections 49K - 49N set out further requirements which are designed to protect members and creditors. The principal requirements include the following :

(a) any payment out of capital under section 49I has to be approved by a special resolution;

(b) the directors must first make a statutory declaration concerning the amount of the permissible capital payment and its effect on the company's ability to pay its debts and carry on its business over the following year;

(c) the directors' declaration must have annexed to it a report by the company's auditors regarding the matters mentioned in the declaration;

(d) the resolution approving the payment will be ineffective if a member whose shares are to be purchased exercises the voting rights of those shares and the resolution would not have been passed had he not done so;

(e) within a week of the passing of the resolution the company must arrange to have published in the Government Gazette a notice stating that the company has approved a payment out of capital for the purpose of acquiring its own shares along with other details including a statement that any creditor of the company may apply to the court for an order prohibiting the payment. Unless the company notifies each of its creditors in writing a notice also has to be published in an appropriate national newspaper;

(f) any member of the company who has not voted in favour of the resolution and any creditor may, within five weeks of the resolution being passed, apply to the court for its cancellation;

(g) in that case, the court may confirm or cancel the resolution or amend its provisions. The court's order may also provide for the company to take a number of other actions, such as the purchase of the shares of any of its members and the consequent reduction of the company's capital.

Maintenance of capital

16. Section 58(1A) of the Ordinance lays down the general rule that, except as is provided in the Ordinance, no company limited by shares or limited by guarantee and having a share capital shall purchase or subscribe for its own shares or reduce its share capital in any other way. Section 58(1B) provides that if a company purports to act in contravention of subsection (1A), the company is liable to a fine, and every officer of the company who is in default and any relevant shareholder (within the meaning given in paragraph 9(a) above) who knowingly permits the contravention of section (1A) is liable to a fine and imprisonment.

17. Section 58(1C) provides that subject to section 168A (alternative remedy to winding up in case of unfair prejudice), if a company purchases any shares in itself under sections 49 to 49S, no such purchase shall be void by reason only of a failure to comply with any of those provisions. Subsection (1D), however, qualifies this by stating that notwithstanding subsection (1C), a purchase is void if, as a result of the purchase, there would no longer be any member of the company holding shares other than redeemable shares.

18. Section 28A prohibits a subsidiary owning shares in its parent or holding company and further provides that any allotment or transfer of shares in a company to its subsidiary shall be void. The section only operates when there is a holding company and subsidiary relationship, both of which expressions are defined in section 2(4) for the purposes of the Ordinance.

Reduction of capital

19. Section 58(1) provides that, subject to confirmation by the court, a company limited by shares or limited by guarantee and having a share capital may, if authorised to do so by its articles, by special resolution reduce its share capital in any way. Section 59 provides that where a company has passed a resolution for reducing share capital, it may apply to the court for an order confirming the reduction. Section 59 also provides that creditors may object to the reduction of capital. The court must prepare a list of creditors entitled to object to the reduction of capital in order that they may be consulted. If a creditor does not agree to the reduction of capital the court may dispense with the agreement of the creditor if the company secures payment of his debt.

20. Section 61 provides for the registration of the order by the Companies Registrar as well as the registration of a minute approved by the court showing the reduction of the company's share capital. The resolution for reducing share capital, as confirmed by the order, only takes effect on registration.

ANNEX B - METHODS OF ISSUE OF SHARES FOR A LISTED COMPANY

This Annex describes briefly the more common methods by which a company listed on the Hong Kong Stock Exchange may issue new shares. The description of the provisions contained in this summary is not exhaustive.

1. An application for listing by a company already listed is a simpler process than for a completely new applicant. This is because the Stock Exchange will already have decided that the company itself is suitable for listing and, therefore, will simply want to ensure that the documentation surrounding the proposal is adequate and the proposal itself is proper.

Rights Issues

2. This consists of an offer by way of rights to existing holders of securities which enables those holders to subscribe for further securities in proportion to their existing holdings. The allotment of shares on renounceable provisional letters of allotment enables allottees to renounce their right to subscribe in favour of third parties in the market. The issuer may make arrangements to dispose of securities not subscribed for by allottees or by their renouncees, either by means of excess application forms enabling shareholders to subscribe for more than their initial entitlement, or disposing of such securities in the market.

3. The Listing Rules generally require that all new issues of equity securities by a listed issuer must first be offered to the existing shareholders by way of rights unless the shareholders have agreed otherwise. Under paragraph 19 of the Listing Agreement, the consent of shareholders in general meeting is required for an issue of shares or other convertible securities, or for granting rights to subscribe for shares or such convertible securities. The exception is when they are issued to existing shareholders (excluding certain overseas shareholders) pro rata to their existing holdings, or a general mandate has been given by the shareholders to the directors to issue such shares or securities.

4. A Listing Document is required which must comply with the requirements of Chapter 11 of the Listing Rules. The issue must, in normal circumstances, be fully underwritten. Subject to additional disclosure requirements for the Listing Document, and the permission of the Stock Exchange, it may be appropriate for an issuer to proceed without underwriting.

5. In any case where the proposed rights issue would increase either the issued share capital or the market capitalisation of the issuer by more than 50% (on its own or when aggregated with any other rights issue or open offer made in the previous 12 months), the issue must be conditional on approval by shareholders in general meeting at which any controlling shareholder shall abstain from voting. In such circumstances the Stock Exchange may require :

(a) an issuer to make full disclosure in the Listing Document of the purpose, and proposed use of the proceeds, of a rights issue; and/or

(b) that a rights issue is fully underwritten.

6. In addition, no rights issues should be made within 12 months of the commencement of dealings in the securities of a new applicant on the Stock Exchange unless the issue is approved by shareholders in general meeting at which any controlling shareholder does not vote. This applies whether or not the issued share capital or market capitalisation would be increased by more than 50%.

7. Offers of securities by way of rights normally have to be conveyed by renounceable provisional letters of allotment or other similar negotiable instruments, which must state the time (being not less than 14 days) within which the offer may be accepted. In cases where the issuers have a large number of overseas members, a longer offer period may be appropriate, but the Stock Exchange must be consulted if a period exceeding 21 days is proposed.

Open Offers

8. This consists of an offer to existing holders of securities to subscribe for securities, whether or not in proportion to their existing holdings, which are not allotted to them on renounceable documents. Because the securities are not evidenced by a renounceable document, existing holders of securities are not given a right that they can sell on in the market; they merely have the right to subscribe if they wish to. An open offer may be combined with a placing to become an open offer with a clawback mechanism. In that case, a placement is made subject to the rights of existing holders of securities to subscribe for part or all of the placed securities in proportion to their existing holdings.

9. A Listing Document is required which must comply with the relevant requirements of Chapter 11 of the Listing Rules. An open offer must, in normal circumstances, be fully underwritten.

10. If the proposed open offer would increase either the issued share capital or the market capitalisation of the issuer by more than 50% (on its own or when aggregated with any other open offers or rights issues made in the previous 12 months), provisions very similar to those described in paragraph 5 above in relation to rights issues will apply. Similarly, provisions equivalent to those set out in paragraph 6 and 7 (except in relation to the reference to renounceable letters of allotment) above also apply to open offers.

11. If the securities are not offered to existing holders in proportion to their existing holdings then, unless the securities will be issued by the directors under the authority of a general mandate granted to them by shareholders in accordance with the Listing Agreement, an open offer requires the prior approval of the shareholders in general meeting.

Placings

12. A placing involves obtaining subscriptions for the sale of securities by an issuer or intermediary primarily from or to persons selected or approved by the issuer or intermediary. A placing or on behalf of a listed issuer of securities of a class already listed does not have to be supported by a listing document unless a prospectus or listing document is otherwise required or issued. Placings of securities by listed issuers will be allowed :

(a) where the placing falls within any general mandate given to the directors of the applicant by the shareholders; or

(b) where the placing is specifically authorised by the shareholders of the applicant in general meeting.

Capitalisation and Consideration Issues

13. A capitalisation issue consists of an allotment of further securities to existing shareholders, in proportion to their existing holdings. The allotment is credited as fully paid-up out of the issuer's reserves or profits, or otherwise not involving any monetary payment. A capitalisation issue includes a scrip dividend scheme under which profits are capitalised. A Listing Document is required which must comply with the relevant requirements of Chapter 11 of the Listing Rules.

14. A consideration issue consists of the issue of securities as consideration in a transaction or in connection with a takeover or merger, or the division of an issuer. A consideration issue will be a "Share Transaction" for the purposes of Chapter 14 of the Listing Rules, unless it also constitutes a discloseable transaction and will be subject to the requirements of disclosure by means of a press notice.

Exchange, substitution, conversion etc.

15. Securities may be brought to listing by an exchange, substitution, or a conversion of securities into other classes of securities. A Listing Document in the form of a circular to shareholders is required, which must comply with the relevant requirements of Chapter 11 of the Listing Rules.

16. Securities may also be brought to listing by :

(a) the exercise of options, warrants or similar rights to subscribe or purchase securities;

(b) an issue of securities on the exercise of options granted to or for the benefit of executives and/or employees; or

(c) such other methods as the Stock Exchange may from time to time approve.

 



Page last updated : 1 Aug 2012