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Pre-IPO Investments: HKEx Guidance Letters HKEx-GL43-12 and HKEx-GL44-12

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31 October 2012

Two Guidance Letters (Nos 43 and 44) issued by the Hong Kong Stock Exchange on 25 October 2012 provide clarification on features of pre-IPO investments that are allowed and disallowed. Loan plus warrants (where warrants are exercisable upon IPO) continue to be prohibited, but convertible and exchangeable instruments are permitted, and may survive IPO, provided that their economics and covenants under them fall within certain parameters.

Guidance Letter 43 can be found here.

Guidance Letter 44 can be found here

The Guidance Letters

The HKEx (the Exchange) issued Guidance Letter HKEx-GL43-121 (Guidance Letter 43) and Guidance Letter HKEx-GL44-122 (Guidance Letter 44, together with Guidance Letter 43, the Guidance Letters) on 25 October 2012 in relation to pre-IPO investments. The Guidance Letters provide helpful clarification and guidance on the Exchange’s view on certain structures and terms of pre-IPO investments and its approach in handling listing approvals where the listing vehicle and/or the controlling shareholder(s) of the listing vehicle has issued convertible instruments (which include convertible or exchangeable notes, bonds, loans or preference shares) to pre-IPO investors. The Guidance Letters, together with the Interim Guidance in October 2010 (the Interim Guidance) and Listing Decision LD15-2011 in July 2011 (the LD-15-2011)3, provide a road map in assisting IPO investors to structure their investments, and in assisting IPO issuers and sponsors to determine if outstanding pre-IPO investments are compliant with the Exchange’s requirements.

In Guidance Letter 43, the Exchange confirms that pre-IPO investments may survive the IPO of the relevant listing vehicle if certain atypical special rights granted to the pre-IPO investors (and not shared by all the other shareholders of the listing vehicle) are extinguished upon listing.

In Guidance Letter 44, the Exchange provides views on how economics and return to a pre-IPO investor in respect of its pre-IPO investments that are made in the form of convertible instruments may or may not be structured.

While the Guidance Letters supersede previous listing decisions on pre-IPO investments, Listing Decision LD-12-20114 and LD-15-2011 remain effective and the Interim Guidance continues to be applicable to all pre-IPO investments in respect of shares in Hong Kong listed companies. 

Acceptable pre-IPO investment instruments

The Guidance Letters reaffirm the position that pre-IPO investments in the form of loan plus warrants would not be acceptable to the Exchange where the exercise of warrants requiring the settlement of an exercise price on IPO constitutes the settlement of a standalone pre-IPO investment at that time and would not meet the timing limitations set out in the Interim Guidance. Guidance Letter 44 provides expressly that pre-IPO investments in the form of convertible bonds, exchangeable bonds, notes or loans and convertible preference shares are acceptable to the Exchange subject to the economic terms of the pre-IPO investments (including how the return to, and rights of, the pre-IPO investors are determined) complying with the guidance set out in the Guidance Letters. While some of the older listing decisions suggest that the Exchange may be prepared to take a more liberal view towards structuring of the economics of exchangeable instruments (i.e. instruments issued by persons other than the listing vehicle) as compared with convertible instruments (i.e. instruments issued by the listing vehicle itself), Guidance Letter 44 suggests that no distinction will be drawn between convertible and exchangeable instruments.

Return and economics of pre-IPO investment

The mechanisms that determine the level of return pre-IPO investors will receive from their pre-IPO investments have been subject to the Exchange’s scrutiny for some time. The Exchange’s primary consideration is to ensure adherence to the fairness principle stipulated under the Main Board Listing Rule 2.03(2) and Rule 2.03(4) (GEM Rule 2.06(2) and Rule 2.06(4)) (the Rules) which require the issue and marketing of securities to be conducted in a fair and orderly manner and that all holders of listed securities be treated fairly and equally.

In the Guidance Letters, the Exchange clarified that the following return mechanics on pre-IPO investments would not infringe the fairness principle under the Rules.

  • Conversion or exchange at fixed dollar amount or at IPO price with no adjustments

Conversion or exchange at the IPO price or at another dollar price pre-agreed between the issuer and the pre-IPO investors at the time of the pre-IPO investment without any adjustment upon listing5 is acceptable. The Exchange emphasised that any conversion or exchange mechanics that would result in two different prices for the same securities would not be viewed favourably. Any guaranteed discount to IPO price or any determination of (or adjustment upon IPO to) the conversion or exchange price that are linked to the market capitalisation of the listing vehicle would not be allowed.

The Guidance Letters do not expressly permit conversion or exchange into a fixed percentage of the fully diluted share capital of the listing vehicle where such percentage was pre-agreed between the issuer and the pre-IPO investors at the time of the pre-IPO investment. In theory, given that this conversion or exchange formula does not link a pre-IPO investor’s return to the market capitalisation of the listing vehicle and is not a discount to the IPO price at a fixed percentage, this conversion or exchange formula should be treated no differently from a conversion or exchange based on a fixed dollar amount and therefore should be acceptable to the Exchange.

  • Compensation for non-QIPOs

Pre-IPO investors are allowed to be compensated if a qualified IPO (defined as an IPO valued at or above a pre-determined amount) does not occur within a specified period of time if the amount of such compensation is a fixed amount pre-agreed between the issuer and the pre-IPO investors and specified in the investment documents. Such compensation must be specified at the time of the pre-IPO investment or is capable of being derived from the compensation provisions in the investment agreement and, although not explicitly stated, our view is that such compensation should not be linked to market capitalisation of the listing vehicle or derived from a guaranteed discount to the IPO price.

  • Redemption at a fixed IRR

Redemption at the option of the pre-IPO investors (whether prior to maturity or at maturity) of convertible or exchangeable instruments at a fixed internal rate of return on the principal amount of such instrument is acceptable if the internal rate of return is derived by discounting future cash flows to their net present value. In theory, the same principle should apply to any redemption exercisable by a pre-IPO investor upon the occurrence of an IPO prior to maturity where such pre-IPO investor does not opt for a conversion or exchange at the time of an IPO.

Survival of pre-IPO investments after listing

The Guidance Letters also confirm the Exchange’s position that pre-IPO investments may survive the IPO of the shares of the listing vehicle into which a pre-IPO investment is made subject to the termination of atypical special rights that are granted to the pre-IPO investors. While the Exchange considers that most of the atypical special rights should not survive the IPO of the shares of the listing vehicle, some rights may continue to exist on certain conditions.

Rights that must be terminated upon listing ◦ Put options – put options that entitle pre-IPO investors to put their investments back to the issuer at any time at a pre-determined price (whether fixed or determined by a pre-agreed formula) is not permitted to survive listing. Although not explicitly distinguished, we believe that such put right should be distinguished from the redemption rights that are exercisable by pre-IPO investors under convertible or exchangeable instruments prior to or at maturity at a fixed Internal rate of return and the permission for investors to be compensated at a pre-determined amount if a qualified IPO does not occur within a specified period of time which, as discussed above, are allowed. Following the principle of equality of treatment between shareholders of a listing vehicle, we expect that prohibited put options are limited to a put of the converted or exchanged ordinary shares that a pre-IPO investor has obtained from its pre-IPO investment, and should not apply to the putting of the investment instrument itself pre-conversion or exchange.

  • Additional information rights – any right to additional information that is not made available to the general public is not permitted to survive listing.
  • Board representation and other veto rights – any pre-IPO investors’ right to veto the listing vehicle’s major corporate actions6, or if certain action cannot proceed without pre-IPO investors’ consent7, is not permitted to survive listing.
  • Adjustments to compensation – any right that would result in an adjustment of the return to which a pre-IPO investor is entitled upon listing is not permitted, in particular where such adjustment results in a profit guarantee that is linked to the market price of the shares, or market capitalisation, of the listing vehicle.

Rights that may be permitted to survive IPO ◦ Anti-dilution rights – any pre-existing contractual right granted to pre-IPO investors under their pre-IPO investments to be allotted additional shares in the listing vehicle may be exercised before listing subject to full disclosure of such pre-existing contractual entitlement and the number of shares to be subscribed for by, or allotted to, such pre-IPO investors in the prospectus and the allotment results announcement, and such allotment or subscription being made at the IPO price. Such anti-dilution rights must be extinguished after listing to ensure compliance with various restrictions on further allotment of shares by directors of the listing vehicle under the Listing Rules.

  • Negative pledges – while it is usual for the Exchange to require security created by or any guarantee provided by the listing vehicle and its group companies to support a shareholder’s indebtedness under a pre-IPO investment, or security created by or any guarantee provided by a shareholder to support the listing vehicle’s or its group companies' indebtedness, to be released upon listing, the Exchange considers that negative pledge provisions included in pre-IPO investment documents in a form commonly seen in debt documents (for example, market standard loan agreements or bond documents relating to bonds issued by listed corporations) may continue to apply after listing. The Exchange will review the negative pledge provisions on a case by case basis and may require Sponsor confirmation that the negative pledge provisions are in line with normal terms of debt issues (see also “Sponsor awareness points” below).
  • Profit guarantee – any right to additional compensation to a pre-IPO investor if the listing vehicle’s profit does not meet a certain level in the future that is settled by a shareholder (and not settled by the listing vehicle) may survive listing if the amount of compensation is not linked to the market price of the shares, or the market capitalisation, of the listing vehicle.
  • Right of first refusal and tag-along rights – such rights granted to a pre-IPO investor by controlling shareholder(s) may survive listing as these are private contractual agreements between shareholders of a listed corporation with which the Exchange would not interfere.

Sponsor awareness points

The Guidance Letters also provide valuable guidance to sponsors advising listing applicants on their listing preparation and application. As it is clear from the Guidance Letters that some provisions which contravene the underlying principles of the Guidance Letters will not be permitted by the Exchange, sponsors should be aware of the Guidance Letters when advising listing applicants on pre-IPO investments or when advising listing applicants on whether pre-existing pre-IPO investment structures have to be amended to comply with the Guidance Letters (the latter may have an impact on the overall timetable of the listing application). Furthermore, sponsor confirmation may be required in certain instances (confirmation with respect to negative pledges which remain post-listing was cited as an example in the Guidance Letters) although we are aware of the Exchange having asked for more extensive Sponsor confirmations in other cases. Generally speaking, the Exchange will also expect enhanced disclosure with respect to the cash flow and cash position of the listing applicant in the prospectus.


Since the issuance of the Interim Guidance and LD-15-2011, there has been a degree of uncertainty for some time for market players as to how pre-IPO investments should be structured in a way that is acceptable to the Exchange. The Guidance Letters have provided some welcomed pointers on the Exchange’s approach to features of pre-IPO investments that have been seen in the market. Pre-IPO investors should take into account the guidelines given by the Exchange in the Guidance Letters when structuring future pre-IPO investments and consider revisiting the terms of any existing pre-IPO investments. As mentioned above, potential issuers and IPO sponsors should take into account the Guidance Letters in determining if existing pre-IPO investments are compliant or if they need to be renegotiated so as not to cause delays to the listing timetable.