As the world emerges from the global financial crisis, Asia (especially Greater China) has attracted more than its share of investor interest. This is not surprising. With a total of US$55 billion raised in 2010, Hong Kong has retained its position as the world’s largest market for initial public offerings (IPOs), followed by Shenzhen, where US$42.7 billion was raised. New York, with US$36.7 billion raised, is only third.
Among the fourteen Hong Kong and U.S. IPOs that Orrick was involved in last year, five were Chinese retailers, three were energy and natural resources companies, and others were involved in technology and industrial manufacturing. We expect these industry trends to continue into 2011.
While there have been numerous changes to the legal landscape in Asia in 2010, we have selected five topics that may be of special interest to global investors and multinational companies. The first, anti-corruption compliance, concerns Asia generally, particularly Hong Kong and Singapore, which are home to many multinational regional offices. The other issues pertain more directly to Hong Kong, such as the Hong Kong Stock Exchange’s interim guidelines on pre-IPO investments, and to China, including foreign participation in renminbi (RMB) investment funds.
There has been an increasing focus on anti-corruption in Asia particularly due to the UK’s Bribery Act (enacted in April 2010 and coming into force in April 2011) and more high-profile US Foreign Corrupt Practices Act (FCPA) investigations being conducted in 2010.
Both laws are extra-territorial in effect. Each can potentially cover foreign commercial organisations with business operations in the UK or US, even where those companies are incorporated and/or the misconduct takes place elsewhere.
The Bribery Act goes even further than the FCPA. For example, there is potential liability for private corruption, and there is no defence for small ‘
Both Acts cover bribery of ‘foreign public officials’ – a status which can be wide in scope and difficult to identify, particularly where state-owned enterprises are involved. Under the FCPA, public companies need to comply with books and records requirements. Under the Bribery Act, the failure of a commercial organisation to prevent bribery is a strict liability offence and the only available defence is that it has ‘adequate procedures’ in place to prevent bribery from occurring.
Consequently, companies should assess and understand corruption risks at all levels of their business and in all jurisdictions in which they do business. They are advised to implement the right tone from the top, comprehensive but easy to understand compliance procedures including due diligence of business partners, and appropriate training for employees. They should also monitor all the above regularly and improve them where necessary.
New mediation practice direction
Hong Kong's Practice Direction 31 on Mediation (the Practice Direction) came into force on 1 January 2010. It applies to the vast majority of civil litigation in Hong Kong.
Under the Practice Direction, parties have to consider the possibility of mediation before pursuing litigation. In proceedings where all parties are legally represented, each party should at the close of pleadings file a Mediation Certificate stating that it has been advised about the availability of mediation and indicating whether it is willing to attempt mediation and, if not, its reasons.
If the parties agree to mediate, the Court may, either on application by one of the parties or of its own motion, stay the legal proceedings pending mediation. The Court will try as far as possible to avoid disrupting ‘milestone dates’ in the legal proceedings (these include such dates as the case management conference and the pre-trial review). A stay that will cause postponement of the trial date will not be allowed, save in exceptional circumstances.
Parties to all relevant civil proceedings must explore the appropriateness of mediation. If a party refuses to engage in mediation, the Court will require it to justify its refusal.
Where the Court considers that a party has unreasonably failed to try mediation, the Court may, irrespective of the outcome of the litigation, make an appropriate adverse costs order against the party concerned. However, no adverse costs order will be made where the party has a reasonable explanation for not engaging in mediation, such as where there have been ‘without prejudice’ settlement negotiations or active engagement in some other form of alternative dispute resolution.
Hong Kong's new Arbitration Ordinance
Hong Kong's new Arbitration Ordinance (Cap. 341) (the Arbitration Ordinance) was enacted on 11 November 2010. It is expected to come into force around mid-2011 to allow all stakeholders sufficient time to prepare for the various changes.
The Arbitration Ordinance unifies the domestic and international arbitration regimes by largely applying the provisions of the United Nations Commission on International Trade Law (UNCITRAL) Model Law to all arbitrations. It seeks to make Hong Kong arbitration law more user-friendly to parties from both civil and common law backgrounds. Further, it aims to facilitate the fair and speedy resolution of disputes by arbitration in a cost effective manner.
The implementation of the Arbitration Ordinance will have a number of effects. It expands the arbitral tribunal’s powers to order interim measures. It increases party autonomy and further minimises the power of the court to intervene. With written consent of all the parties involved, an arbitrator is permitted to act as a mediator.
Unless otherwise agreed, the parties are prohibited from disclosing any information relating to the arbitral proceedings. However, any party to an arbitration may apply to have related court proceedings held in open court. The Arbitration Ordinance aims to maintain the previous position in relation to enforcement of arbitral awards; Hong Kong is well known for its ‘pro-enforcement bias.’
Interim guidance on pre-IPO investments in Hong Kong
In the US, issuance of securities at a price substantially below the contemplated IPO price can create a ‘cheap stock’ issue that has accounting and tax implications. The main focus of ‘cheap stock’ appears to be whether a portion of the issuer’s compensation or other expenses may not have been accounted for because of the issuance of stock, options or other securities at below fair value.
The Hong Kong Stock Exchange (HKSE) also examines the timing, pricing and rationale of pre-IPO investments during the listing application process. Frequently, questions from the HKSE centre on whether the pre-IPO investors took ‘genuine investment risk’ that would justify the price differential.
However, some market practitioners have observed that recent decisions by the HKSE on this issue have raised questions about how the HKSE applies its principles and conducts its practice consistently.
To address concerns raised by market practitioners, on 13 October 2010, the HKSE issued an interim guidance, under which it would generally require that pre-IPO investments must be completed either (a) at least 28 clear days before the date of the first submission of the first listing application form, or (b) 180 clear days before the first day of trading of the issuer's securities.
Despite this general interim guidance, the Listing Committee of the HKSE recognises that there may be circumstances where pre-IPO investments on terms more favourable than those offered to IPO investors may be justifiable.
Interestingly, departing from past reluctance to engage in a discussion of this issue until the listing application process has commenced, the HKSE stated in its news release that ‘potential applicants are encouraged to consult the Listing Division before submission of listing applications if they have any questions.’
Dismantling a red chip structure
Traditionally, international private equity houses making growth capital investments in Chinese businesses would invest in an offshore holding company holding Chinese subsidiaries and form what is known in the market as a ‘quasi red chip’ corporate structure.
This started to change over the course of 2009 and 2010. Many PE houses are exploring the possibility of dismantling the quasi red chip structure so that their portfolio businesses can list in Shanghai or Shenzhen (including the ChiNext market). The impetus has been the level of activity in, and P/E ratios offered by, the A-share market and the anticipated continuing strength of the RMB,
Before deciding whether to dismantle a red-chip structure, companies should know the implications associated with such a move. While the A-share market may appear attractive at this time, investors should remember that the move onshore is irrevocable.
When the foreign investor becomes an equity holder of the Chinese company, the Chinese company will likely convert into an equity joint venture. It must be further converted into a joint stock company before it can list on the A-share market, which requires the company to have been profitable for the preceding three years.
Even with such profitability, there is no guarantee that the conversion will be approved and whether a company can be listed on A-share market depends largely on the China Securities Regulatory Commission’s policy. Investors must also take note that Chinese joint venture and company laws generally offer less protection to equity holders. And after an equity joint venture is converted into a joint stock company, all shareholders face a one-year promoter lock up.
Further, dismantling a quasi red chip structure involves a complex interaction of corporate and tax laws of each jurisdiction where an entity within the corporate group has been incorporated, as well as accounting and cash flow issues.
Developing an overall restructure plan that works from a multi-jurisdictional legal, accounting, cash flow and tax perspective is far from straightforward, and involves very tailored analyses. In many instances, the factual circumstances simply make it impossible for the restructuring to occur on terms acceptable to all the parties involved.
Foreign participation in RMB funds
The Chinese legal landscape continues to evolve quickly. As late as the last week of December, news reports emerged that Shanghai will start a pilot program under which a foreign invested fund manager in China may bring in foreign currency, exchange it into RMB, and contribute it into RMB funds that it sets up as long as such contribution does not exceed 5% of the size of the fund.
Reportedly, the program will also permit certain ‘qualified foreign limited partners’ to exchange foreign currency into RMB for the purpose of making partnership capital contributions into RMB funds, so long as the aggregate of such foreign contributions do not exceed 50% of the size of the fund.
This program could potentially herald a new age in the formation of international RMB funds. We shall provide updated analysis on this as soon as the relevant rules and regulations are issued.
About the Author
Orrick, Herrington & Sutcliffe LLP is a global law firm with more than 1,100 lawyers in 23 offices in Asia, Europe and North America. The firm focuses on litigation, complex and novel finance and innovative corporate transactions.