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SFC’s plan to introduce PUSU rule among the most significant Takeovers Code amendments

  • Indicative price as floor price might see buyers losing advantage  
  • SFC has no plan to adopt Five Tests in chain principle situations 
  • Takeovers code amendments stand, no key further changes expected  

Hong Kong’s financial watchdog’s plan to give itself the power to issue a put up or shut up (PUSU) order is one of the most significant forthcoming changes to the Codes on Takeovers and Mergers and Share Buy-backs, said financial and legal advisors.  

A PUSU order requires a potential offeror to either announce a firm intention to make an offer within a certain timeframe (put up), or to reveal when it no longer proceeds with an offer (shut up).

The Securities and Futures Commission (SFC) historically relied on “the spirit” of other rules under the Codes to issue such an order, only upon the request of offerees, according to a consultation paper published in May. 

The consultation paper on proposed amendments to Takeovers Code, aside from introducing the PUSU order, also covers significant proposals such as plans to impose restrictions on binding offer prices and revisions to the chain principle. 

The formal introduction of PUSU mechanism could be particularly useful in hostile offers, said Alex Bidlake, a partner at Linklaters. It can be a “real pain” for a target company that receives such an offer, as the company is restricted in certain activities during the offer period including exploring material transactions and even increasing its Executives’ compensation, she continued. 

That said, advisors anticipate the Executive will be sparing in its use of the PUSU order.  

Tommy Tam, a partner with Clifford Chance, reckoned that the regulator would be cautious and only exercise its power to end offers that have been open for a lengthy and indefinite period.  

Bidlake also expected that the exercise of issuing a PUSU order will be limited as most of Hong Kong’s listed companies are controlled companies – which cannot in practice be the subject of a hostile takeover bid – hence the need for a PUSU order will be rare. 

The other rules which currently allow dealmakers to seek what is in effect a PUSU order are “imperfect tools for the job”, Bidlake reckoned. 

One example of this came on 12 August 2016 when, following a prompt by the SFC, Glorious Property [HKG:0845] made a PUSU order application under Rule 31.1(b) of the Code, regarding an indicative take-private bid from its controlling shareholder that had been dragging on for 16 months. 

Disclosed price as floor price 

Meanwhile, some practitioners have raised concerns about the SFC’s proposed requirement to treat an indicative offer price as a floor price for a future potential binding agreement. 

This would rule out the possibility of an offeror reaching a recommended definitive price below an indicative price, said a local investment banker who covers takeover, share buyback and general offer deals. 

However, the SFC’s intention is well justified as this price restriction will protect shareholders from potential share price manipulation, said two financial advisors. 

As Dechert’s partner Stephen Chan pointed out, the regulator has mentioned that the disclosure of an indicative offer price is not generally permitted before an announcement of a firm intention to make an offer “unless there are exceptional circumstances such as the need to clarify an incorrect market rumor”. 

An example of this came this month when L'Occitane International [HKG:0973] confirmed media reports that had said its controlling shareholder was considering a conditional voluntary offer. The luxury goods retailer clarified that the speculated HKD 35 per share price was false and a potential deal would be no less than HKD 26 per share. 

No adoption of Five Tests

The SFC’s reluctance to adopt the Five Tests approach – which is used under Hong Kong’s listing rules for notifiable transactions – in determining the substantiality test under the chain principle has also drawn concerns from some of the market participants. 

“From a practitioner's perspective, the adoption of the Five Tests should technically provide a more straightforward guidance on how to determine whether the holding in the second company is significant in relation to the first company,” Chan said. 

That said, it is understandable that the SFC is inclined to retain its discretion in assessing the need for a chain principle offer, Chan added. 

Besides, the takeovers Code “is meant to be high-level guidance to achieve conduct fairness in the context of an offer and is intentionally not written as rules like the Listing Rules,” according to Jeckle Chiu, partner of Mayer Brown. He noted that offers of the kind require assessment “on the part of the regulator about the intention of the buyer of the top-of-the-chain company, and a bright-line Five-Tests like approach can be counter-conducive to such assessment.” 

In fact, the regulator has been pragmatic when dealing with the substantiality test. 

Tam said when the test could generate “anomalous” results, the SFC had been flexible in waiving the need for a chain principle offer considering all relevant facts and circumstances.  During a previous case he worked on the need to make a chain principle offer was waived, because the company in question was nearly bankrupt which resulted an over 100% asset test result – well above the chain principle threshold. 

No further big change 

Despite an initial 23 June deadline, the consultation is still pending as of today (22 August), according to the regulator’s website. But market practitioners do not expect the regulator to significantly diverge from its initial proposals.  

Chiu said the amendments put forward are hardly “fundamental conceptual changes but fine-tunning [to] the Takeovers Code” to make it more user friendly. He is of the view that market practitioners will generally welcome these changes. 

The proposals will help create a more level playing field for deal structures in Hong Kong, and are especially useful for market players who have less experience of how the SFC interprets the rules in practice, said Bidlake.