Application of Hong Kong Codes on Takeovers and Mergers and Share Buy-backs
- Application to the SPAC prior to a De-SPAC transaction: The Hong Kong Codes on Takeovers and Mergers and Share Buy-backs (“Takeovers Code”) will apply to a SPAC. Where a person acquires SPAC shares such that it and its concert parties hold 30% or more of the voting rights of a SPAC, then it will have the obligation to make a general offer to holders of the other SPAC securities.
- Waiver of application to a De-SPAC transaction: The SFC may waive the application of mandatory general offer obligation under the Takeovers Code in relation to a De-SPAC transaction, i.e. even if an owner of the De-SPAC target obtains 30% or more of the voting rights in the Successor Company after completion of the De-SPAC transaction, its obligation to make a general offer will be waived. When considering the waiver application, the SFC may consider factors such as (a) the De-SPAC target owner’s shareholding in the SPAC and its dealings in SPAC securities and (b) any relationship between the owner of the target and the SPAC promoters, and parties acting in concert with any of them.
SPAC investors rely on the SPAC promoters’ ability to identify suitable De-SPAC targets and negotiate terms for the De-SPAC transactions that will provide them with attractive returns on their investments. In order to avoid SPAC promoters signing up for De-SPAC transactions with sub-standard targets, the Stock Exchange will consider only experienced and reputable promoters to be suitable. The SPAC Guidance sets out expectations on a promoter’s track record in SPACs, fund raising and investment management, as well as relevant criteria such as details of its licenses, potential competition with the SPAC, and history of compliance with applicable laws and regulations. Although such high entry point will help safeguard the investors’ interests, it limits the pool of institutions and persons to be eligible as SPAC promoters.
Redemption rights vs additional third party investments
Another protection afforded to SPAC shareholders is their rights to redeem shares in the SPAC. However, the Joint Study referred to by the Stock Exchange found that the average and median redemption rates among its 2019-20 study cohort were as high as 58% and 73%, respectively. A quarter of the cohort saw redemption rates of over 95%. An average of 92% of institutional investors in SPACs divested their SPAC shareholdings prior to the closure of De-SPAC transactions, either through redemption or selling their SPAC shares in the secondary market.
Where redemptions reduce the cash amount for completing De-SPAC transactions, many SPACs mitigate this concern by seeking third party investments that are contingent upon the closing of the De-SPAC transactions. The Joint Study found, for a third of the SPACs in its study cohort, the majority of overall funds raised by a SPAC were not from the SPAC IPO proceeds, but from additional third party investments.
While the redemption right provides an exit to the SPAC shareholders, it also creates uncertainty to the SPAC resources for closing De-SPAC transactions which ironically is the primary objective of the SPAC.
Vetting of the listing application of the Successor Company
During the public discussions on SPACs before the Stock Exchange issued its consultation paper in September 2021, one controversy was, apart from the SPAC shareholders’ approval of the De-SPAC transaction, whether the Successor Company’s listing application should be subject to the current new listing requirements, and if not, whether SPACs might open a leeway for listing of De-SPAC targets which would not otherwise satisfy the new listing requirements.
The Stock Exchange proposed to consider a De-SPAC transaction in the same way as a reverse takeover (i.e. a deemed new listing) and require the Successor Company to meet all new listing requirements. Although such proposal received opposition from 33% of the respondents, the Stock Exchange stressed that the intention of introducing the SPAC regime is not to replace the traditional IPO route.
Therefore, the Stock Exchange adopted its proposal. All new listing requirements apply to the listing application of a Successor Company which include IPO sponsors who are to ensure the quality of assets and businesses listed via De-SPAC transactions by ensuring due diligence on the targets. In respect of the management continuity and ownership continuity requirements, the Stock Exchange may grant waivers on a case-by-case basis.
On top of the new listing requirements, the completion of a De-SPAC transaction also depends on the negotiation with the target owner, the availability of independent third party investments and the Stock Exchange’s vetting of the listing application including the valuation of the target (which is unlikely to be faster than the vetting of a traditional listing application).
It seems that a SPAC structure does not put the De-SPAC target in a position that makes it easier to list the target’s business in Hong Kong.
Market misconduct risks
A SPAC does not have any business operations. The market value of its securities depends very much on whether it is able to seek suitable De-SPAC targets and complete a De-SPAC transaction. This means that someone possessing inside information regarding such a transaction prior to its announcement might make a substantial gain from insider dealing in the SPAC securities before the transaction is announced. Consequently, the probability of insider dealing occurring in a listed SPAC tends to be higher than for an ordinary listed company.
A SPAC’s share and warrant prices are likely to be very sensitive to rumours on potential De-SPAC transactions. It may make SPAC securities more susceptible to market manipulation attempted by fraudsters who deliberately spread rumours (e.g. via social media platforms) of a forthcoming De-SPAC transaction to raise the prices of SPAC shares and/or warrants to levels at which it is advantageous for them to sell.
Regulators will need to step up their oversight on dealings in SPAC securities in order to address the risks of market misconduct.
Overall implications of the Hong Kong SPAC regime
The launch of the SPAC regime offers more investment alternatives and thus strengthens Hong Kong’s position as a leading international financial centre, but the stringent requirements are not likely to attract a large number of SPAC IPOs in the short run.