Member Article

The Securities and Futures Commission ("SFC") have just released their consultation paper ("Paper") on the review of the disclosure of interests regime under Part XV of the Securities and Futures Ordinance (Cap. 571) ("Part XV"). The Paper contains the SFC's proposals for changes to the law on disclosure of interests in shares. Most of the provisions of the Securities and Futures Ordinance was gazetted on 28 March 2002 and came into effect (including Part XV) on 1 April 2003. Part XV re-enacted (with some changes) the old Securities (Disclosure of Interests) Ordinance and, amongst other things, these changes impacted on the taking of collateral over listed shares for future loan transactions. The Paper addresses the main issues and concerns raised by market participants on the disclosure regime since the enactment of the legislation. In particular, the Paper provides some insight into the SFC's position on the disclosure requirements that force substantial shareholders to make disclosures about using securities as collateral. The SFC proposes in the Paper (See Paragraph 2.1 of the Paper) that disclosure obligations should be imposed such that information about impending forced sales will be made public as soon as possible, to the intent that the market would come to know about impending forced sales immediately, instead of three business days later, as is currently the case. The obligation would be imposed on qualified lenders (generally, authorised banks and licensed brokers), non-qualified lenders and substantial shareholders, who have an interest of 5% or more, as follows: A lender will come under a duty of disclosure when: (i) it becomes entitled to exercise voting rights in respect of a security interest as a result of a default, and has evidenced an intention to exercise the voting rights or control their exercise or taken any step to do so; or (ii) where a power of sale has become exercisable and it offers the shares or any part of the shares for sale. The lender must forthwith (as compared with three business days under the current regime) inform the Stock Exchange and the listed issuer of the circumstances described in (i) and (ii) above and the number of shares involved, also expressed as a percentage figure of the relevant share capital. The listed issuer must immediately announce these details. The lender would still be required to disclose the details of the change in interest or change in nature of interest within three business days of such change in accordance with requirements of Part XV. It is proposed that where a substantial shareholder receives indications, whether verbal or written, from the lender of any of the circumstances described in (i) or (ii) above, the substantial shareholder must inform the listed issuer and the Stock Exchange forthwith of this fact and the number of shares involved (again expressed as a percentage figure of the relevant share capital). The listed issuer must immediately announce these details. This builds on the existing approach in the Listing Rules that currently applies only to controlling shareholders during the moratorium period (See Rule 10.07 of the Main Board Listing Rules and Rule 13.19 of the GEM Listing Rules). The SFC seeks further comments from investors regarding the uncertainty over the meaning of “forthwith”, which may in practice be too vague, and also whether the obligation to disclose impending sales should be set at a threshold higher than 5%. The Paper further sets out other proposed changes to the definition of "exempt security interest" (See Paragraph 3.1 of the Paper). Currently, where a qualified lender holds collateral against an amount due to him, he is exempted from the duty of disclosure under Part XV if the interest is held "by way of security only for the purpose of a transaction entered into in the ordinary course of his business as a qualified lender". Previously there was uncertainty over the scope of the words "by way of security only". The SFC clarifies in the Paper that the exemption also applies to (i) brokers providing margin financing and such interests are "re-pledged" to another financial institution, (ii) securities that are transferred into the name of a nominee, and (iii) collateral taken by way of absolute transfer of title. Furthermore, in relation to syndicated loans, the SFC proposes to extend the exemption to security agents where: (i) all members in the syndicate are qualified lenders; and (ii) such security agents are regulated entities in recognised jurisdictions. The definition of "security agent" would include a corporation whose business includes holding securities in safekeeping for qualified lenders. However, a corporation will not be regarded as a security agent for particular interests in shares that it holds for a qualified lender if it has authority: (i) to exercise discretion in dealing in the interests; or (ii) to exercise rights attached to the interests, except where such authority is limited to: (a) taking, maintaining or releasing the security over the interest in shares; (b) collecting dividends payable, taking up rights or other entitlements in respect of the interests in shares or preserving the value of the security in the interests of the qualified lender; and (c) dealing in the interests in shares, or exercising rights attaching to. The SFC also makes it clear that they will take a purposive interpretation of the word "transaction" in the exempt security interest provision, so that security interests taken by brokers over clients' accounts to cover the debts that the clients owe from time to time on the accounts can benefit from this exemption (See Paragraph 5.8 of the Paper). Overall, the Paper not only sets out the SFC's proposals for reform in this difficult area, but also provides some guidance on SFC's interpretation of the existing provisions, which may be helpful in relation to taking security over listed shares for future loan transactions. However, under the current proposals, Part XV will still fall short of requiring substantial shareholders to make disclosures at the time the shares are pledged, and investors will still bear any risks associated with such pledged shares. If anyone wishes to comment on the proposals, contact details are set out in the Paper which is available on the SFC website at http://www.sfc.hk. The deadline for submissions is 28 February 2005.