The Hong Kong Stock Exchange (HKEX) has recently published a consultation paper seeking market feedback on proposals to create a listing regime for special purpose acquisition companies (SPACs) in Hong Kong. The move shortly follows the introduction of the new rules by the Singapore Stock Exchange earlier in the month that enable SPACs to be listed on its Main Board.
What are SPACs?
Although the concept of SPACs is not new, the recent momentum and exponential growth has been extraordinary. According to publicly available information, around US$80 billion of proceeds was raised in the United States last year. A similar amount has been raised in 2021 in the first quarter alone.
A SPAC is essentially an entity which is formed for the purpose of listing on a stock exchange to raise funds which will be used to make an acquisition at a later stage (a de-SPAC transaction). Until it identifies a target business to acquire (via a business combination) within a pre-determined timeframe post-listing, it has no commercial operations with no assets, thus it has also been described as a blank check company. The shareholders in a SPAC are fundamentally putting trust in the sponsor team to find and acquire a privately held business, which would benefit from the sponsor’s expertise and the SPAC’s public listing status, to create a combined business which drives returns for shareholders in both entities. The SPAC will set out in its listing document the type of investment it is looking to make in terms of size and industry sector.
Prior to the consummation of a de-SPAC transaction, the proceeds from the listing are placed in a trust account. Such proceeds may not be used other than for the acquisition and operation of the target business, as well as for redemption of shares in connection with the de-SPAC transaction or liquidation. If a SPAC fails to acquire any target business within the pre-determined timeframe, it must be liquidated and delisted after it makes full refund (plus accrued interest) to its shareholders.
There are elements of the SPAC structure which are common to a traditional private equity model, and many private equity sponsors have been behind recent listings. There are, however, very substantial differences. By definition, a SPAC is a public company. There is no diversification, and a SPAC will almost always look to acquire a single vehicle. There is also a tighter investment window, most SPACs aim to make an acquisition within two to three years (subject to local regulations). Finally, rather than hold, grow and improve the portfolio company until exiting through a sale or initial public offering for a period of time, the target business will be listed immediately on completion of the acquisition.
Proposal for Hong Kong SPACs
The HKEX has proposed a prudent approach with multiple safeguards and restrictions that would result in a SPAC listing regime being more stringent than that of the United States and Singapore.
Some key points of the proposal are as follows:
- Investor suitability: the subscription for and trading of a SPAC’s securities would be restricted to professional investors only. Such restriction would not apply to the trading of shares of any listed issuer following the completion of a de-SPAC transaction.
- SPAC promoters: SPAC promoters must meet suitability and eligibility requirements, and each SPAC must have at least one SPAC promoter licensed by the Securities and Futures Commission and hold at least 10 per cent of the promoter shares.
- Dilution cap: promoter shares are proposed to be capped at 20 per cent of the total number of shares of the SPAC in issue as at the initial public offering date, with further issuances of additional promoter shares of up to 10 per cent of the total number of shares depending on satisfaction of performance targets. A similar cap of 30 per cent would also be imposed on the dilution resulting from the exercise of warrants.
- Fund raising size: the funds expected to be raised by a SPAC from its initial public offering must be at least HK$1 billion (approximately US$128.2 million).
- Application of new listing requirements: a successor company must meet all new listing requirements, including minimum market capitalisation requirements and financial eligibility tests. At least one independent sponsor must be appointed for the de-SPAC transaction.
- Independent third party investment: this would be mandatory and must constitute at least 15 per cent to 25 per cent of the expected market capitalisation of the successor company, validating the valuation of the successor company.
- Shareholder vote: a de-SPAC transaction must be approved by SPAC shareholders at a general meeting. The SPAC promoter and other shareholders with a material interest in the de-SPAC transaction would need to abstain from voting on such resolutions.
- Redemption option: SPAC shareholders must be given the option to redeem their shares prior to (i) a de-SPAC transaction, (ii) a change in SPAC promoter and (iii) any extension to the deadline for finding a suitable target business for the de-SPAC transaction. Shareholders who opt to redeem would receive a pro rata amount of 100 per cent of the funds raised by the SPAC in its initial public offering (plus accrued interests).
- Return of funds to shareholders: if a SPAC is unable to announce a de-SPAC transaction within 24 months after the initial public offering, or complete one within 36 months after the initial public offering, the SPAC must liquidate and return 100 per cent of the funds it raised (plus accrued interest) to its shareholders. The SPAC will be delisted by the HKEX.
Using offshore companies for SPACs
Nearly 60 per cent of the companies listed on the HKEX are incorporated in the Cayman Islands. We expect such practice to continue as and when the regulations governing the listing regime for SPACs are promulgated in Hong Kong.
Using offshore companies (such as British Virgin Islands and Cayman Islands companies) has all of the usual advantages that have made such entities popular in a variety of contexts. They are tax neutral, flexible corporate jurisdictions with strong rule of law, and appeal ultimately to the Privy Council (which consists of the same judges who sit in the Supreme Court of the United Kingdom). Both the BVI and the Cayman Islands have light but effective merger codes, and the legal procedures for effecting a redemption of shares are streamlined and flexible. Service providers of all stripes in both jurisdictions are sophisticated and capable of handling complex, high value transactions such as listings and public company mergers.
Introducing a SPAC listing regime to the Hong Kong capital market is appealing, as it provides an alternative listing option for issuers and encourages potential sellers to dispose of target businesses given the higher level of deal certainty with SPACs (eg the availability of cash of SPACs is a matter of public record).
The HKEX has offered a short window to consult the market, which will end on 31 October 2021. We will monitor this closely and would be keen to discuss.