Disclosure of Interests under the Securities and Futures Ordinance - Update

12. EXEMPTIONS

There are a number of exemptions and interests which may be disregarded. These are very detailed, hence the following is limited to a brief outline only of the principal exemptions and disregards.

12.1 Basket Derivatives

Basket derivatives over the shares of at least 5 companies listed on a 'specified' stock exchange are disregarded provided that no one share accounts for over 30% of the value of the total basket. The percentage figure is calculated at the time of issue of the derivatives.

12.2 De Minimis Change Exemption on Change in Long or Short Positions (Sections 313(7) and (9))

The exemption applies so that an increase or decrease in a person's holding or short position which results in his interest crossing over a percentage level above 5% (in the case of a holding) or 1% (in the case of a short position) will not be discloseable if:

1. the percentage level of his interest is the same as, or less than, the percentage level of his interest stated in the 'Last Notification' given by him; and



2. the difference between the percentage figure of his interest disclosed in his 'Last Notification' and the percentage figure of his interest at all times after such notification, is less than 0.5%.

'Percentage level' in (i) above means the percentage figure rounded down (if not a whole number) to the next whole number. 'Percentage figure' in (ii) above, however, means the actual (unrounded) percentage figure.

The 'Last Notification' must, in the case of a holding, be a notice given under Section 313(1)(c), that is notice of a change in the percentage level of a person's interest above 5%. Hence a notification given on commencement of the SFO, on first crossing the 5% threshold or of a change in the nature of an interest will not qualify as a 'Last Notification'. In the case of a short position, the 'Last Notification' must be a notice given under Section 313(4)(c), that is notice of a change in the percentage level of a person's short position above 1%.

This exemption will not therefore apply if the percentage level of a person's interest has increased since his Last Notification or if at any time after such notification his percentage interest differed by 0.5% or more from the percentage figure of his interest stated in that notification.

12.3 De Minimis Change Exemption on Change in the Nature of Interests (Section 313(8))

There is no duty of disclosure where:

1. the 'percentage level' (ie. the rounded down figure as explained above) of a person's unchanged interest (ie. disregarding the part in which his interest has changed) is the same as the percentage level of his interest in the last notice (this notice is not restricted to notices of change in the percentage level of an interest) given by him; or



2. the percentage level of a person's unchanged interest has crossed over a percentage level if:



1. the percentage level of his unchanged interest is the same as or less than the percentage level of his interest given in the 'Last Notification' by him (ie. a notice under Section 313(c) of a change in the level of a person's interest above 5%); and



2. the difference between the percentage figure (ie. the actual unrounded figure as noted above) of his unchanged interest and the percentage figure disclosed in the Last Notification has been less than 0.5% at all times since the giving of that notification.

The SFC's Outline of Part XV contains detailed examples illustrating the workings of the de minimis exemptions.

12.4 Exempt Security Interests (Section 323(6))

An interest in shares is not required to be disclosed if it qualifies as an 'exempt security interest' ie. if it is held by a 'qualified lender by way of security only' for a transaction entered into in the ordinary course of his business (Section 323(6)). Further, the creation of the security interest in favour of a 'qualified lender' will not result in a change in the nature of the holder's interest in those shares (Section 313(13)).

A 'qualified lender' is defined under Section 308 to include an authorised financial institution, an authorised insurance company, an exchange participant of a recognised exchange company and an intermediary licensed to deal in securities or margin financing. The term also now includes overseas institutions authorised to carry on business as a bank, insurance company or activities which, in the opinion of the SFC, are equivalent to the regulated activities of intermediaries in countries recognised by the SFC.

As to when a qualified lender is taken to hold an interest in shares 'by way of security only', a distinction is drawn between the creation of a security interest in, and a transfer of title to, shares. If a person has a right to return equivalent shares and may deal with the shares transferred to him as if they are his own in the meantime, this is a transfer of title and not the creation of a security interest.

Under Section 323(7) an interest will no longer qualify as an 'exempt security interest' if the qualified lender becomes entitled to exercise voting rights of the relevant shares due to default by the person who gave the security, and shows an intention or takes any step to exercise or control the exercise of those voting rights. Similarly, an interest will cease to be an 'exempt security interest' if the power of sale becomes exercisable and the qualified lender or its agent offers for sale all or any of the shares. In either case, the qualified lender is regarded as having acquired an interest in the shares and is obliged to disclose his interest.

12.5 Wholly Owned Group Exemption (Section 313(10))

A wholly owned subsidiary is not required to notify an interest in certain circumstances if its ultimate holding company has given notice of its interest in the relevant shares. The certain circumstances in which wholly owned subsidiaries are exempted are those where the disclosure obligation arises under Sections 313(1) or (4) (as set out in paragraph 2.1 above). Significantly, the wholly owned group exemption is not available on the making of an 'Initial Notification' under Sections 310(2) and (3) (ie. notice given when the SFO came into force, when an interest is held in shares in a company which is being listed or when a notifiable interest is acquired on a reduction of the 5% threshold or 1% theshold for short positions is reduced (see paragraph 2.2 above). Hence, if a wholly owned subsidiary holds an interest of 5% or more in the shares of another company at the time that other company becomes listed, it cannot rely on the wholly owned group exemption: instead both the wholly owned subsidiary and its holding company will be obliged to separately disclose the interest in the shares held by the subsidiary.

Further, transactions between wholly owned subsidiaries of the same group do not give rise to a duty of disclosure since the number of shares in which the ultimate parent is interested or has a short position and the nature of its interest remains the same. Hence transfers of shares of a listed company, the grant and taking of options over such shares and the issue of warrants between wholly owned subsidiaries of the same group do not give rise to a duty of disclosure.

A duty of disclosure will arise if any relevant subsidiary ceases to be wholly owned, even if only 1% of its shares are sold to a third party.

12.6 Bonus and Rights Issue Exemption

When there is a rights issue shareholders become interested in the unissued shares covered by the issue. In calculating their percentage interest the following formula should be used (Section 314(2)):

nominal value of shares (including unissued shares) in which the shareholder is interested x 100 nominal value of shares of the listed company of the same class in issue + nominal value of shares to be issued on completion of the bonus/rights issue *

* This is the only situation where the denominator is increased to take account of unissued shares.

Shareholders of listed companies who take up rights under qualifying bonus and rights issues (and whose percentage interest therefore remains unchanged) are not required to make any disclosure whereas shareholders who do not take up their rights (and whose percentage interest therefore changes) will have to make disclosure.

If a shareholder sells his rights, both he and the buyer must make disclosure if their interests cross a percentage level.

A rights issue is defined to include the offer by a listed company of its shares to holders of its issued shares at a certain date (other than to shareholders whose address is in a place where such an offer is not allowed under local law) in proportion to the number of shares held by them at that date. A rights issue does not however cover an offer or issue of shares in lieu of a cash dividend.

The underwriter of the rights issue will acquire an interest in all rights shares that he agrees to take up if they are not taken up by shareholders. The underwriter will then need to file notice of cessation of his interest in the number of rights shares taken up by shareholders on completion of the rights issue.

12.7 Investment Managers, Custodians and Trustees

The exemption previously available to local SFC registered investment managers and trust companies is removed. The following exemptions may however be relied on:

Bare Trustee Exemption

A narrow exemption is retained for bare trustees ie. a trustee who is only entitled to deal with the interest in accordance with the instructions of the beneficiary.

Exempt Custodian Interest (Section 323(3))

The interests of corporate custodians carrying on a business of holding securities in custody for others need not be disclosed provided that the custodian has no authority to exercise discretion in dealing in the shares or exercising the rights attached to those shares.

12.8 Disaggregated Group Interests (Section 316(5))

More importantly, the SFO removes the obligation of a holding company to aggregate the interests of controlled companies (see paragraph 9.1 above) who are investment managers, custodians or trustees whose interest in the shares arises solely from their obligation or entitlement to invest in, manage, deal in or hold interests in those shares on behalf of customers in their ordinary course of business as such. For the exemption to apply the controlled company must exercise any rights to vote in respect of the shares and any power to invest in, manage, deal in or hold the shares, independently of its controlling company and any 'related corporations' (ie. companies within the same group or under the same majority control (Section 3 of Schedule 1)).

This exemption is available for the fund management industry only. It does not entitle family members whose interests in the shares of 'family controlled' listed companies are held by trustees to disaggregate such interests. A trustee of a trust does not have 'customers' and will probably not be 'carrying on a business' as an investment manager, custodian or trustee. The terms 'investment manager' and 'trustee' are specifically defined in Section 316(7).

12.9 Securities Borrowing and Lending Exemption

The Securities and Futures (Disclosure of Interests - Securities Borrowing and Lending) Rules ('SBL Rules') simplify the regime for disclosure of securities borrowing and lending for substantial shareholders (other than substantial shareholders who are also directors), 'approved lending agents' and 'regulated persons'.

Substantial Shareholders

Substantial Shareholders are exempted from disclosing changes in the nature of their interest arising on the lending and return of shares provided that they lend shares through an 'approved lending agent' (see below) who holds the shares as their agent for the sole purpose of lending shares and the shares are lent using a specified form of agreement. In essence, this is an agreement providing for the borrower to provide collateral exceeding the value of the shares lent. The value of the collateral is marked to market and the lender can require return of the shares at any time.

Approved Lending Agents

Companies approved by the SFC as 'Approved Lending Agents' ('ALAs') holding 5% or more of the shares of a listed company will only be required to disclose changes in the percentage level of its 'lending pool' of shares in that listed company. Hence if shares are added to or removed from the lending pool, a disclosure obligation will arise. ALA's are exempted from any disclosure requirements arising when shares are lent from or returned to their lending pool.

Regulated Persons

Interests in shares borrowed by 'regulated persons' (ie. companies licensed to deal in securities and overseas brokers in recognised jurisdictions), that merely act as a conduit (ie. they borrow and on-lend the shares within 5 business days) are disregarded. On the return of shares to the regulated person, it may either return them to the ultimate lender or lend them to another borrower. Provided this is done within 5 business days, the regulated person's interest is disregarded. Regulated persons can still rely on this exemption if it transfers shares to a related company provided that the related company on-lends the shares within 5 business days after they were acquired by the regulated person.

Both ALAs and regulated persons are required to keep records of their transactions in the shares.

12.10 Collective Investment Schemes (Section 323(1)(c))

The interests of holders, trustees and custodians of collective investment schemes authorised by the SFC, certain pension and provident funds schemes and qualified overseas schemes are not required to be disclosed.

A 'qualified overseas scheme' means a collective investment scheme, pension scheme or provident fund scheme established in a country recognised by the SFC. It will not include a scheme which is not run as a business, has less than 100 holders or where less than 50 persons hold 75% or more of the interests in it (Section 323(5)).

12.11 Intermediary Exemption (Section 323(1)(i))

The SFO provides an exemption for an intermediary (eg. a dealer or broker) licensed or registered for dealing in securities who acquires interests in shares as agent for his client. The exemption only applies if (i) the interest is acquired for (and from) someone who is not a related company of the intermediary and (ii) the interest is held by the intermediary for not more than 3 business days.

A similar exemption applies to intermediaries whose interests arise under exchange traded stock futures or stock options contracts.

12.12 Further Exemptions

1. Dual listings: a company may apply to the SFC for exemption from the provisions of Part XV if it is listed on an overseas exchange and certain other criteria are met.



2. Structured products: the issuer of structured products may apply to the SFC for an exemption from Part XV. The main conditions to be satisfied are that the company's shares are not listed in Hong Kong, it does not intend to raise publicly traded equity capital in Hong Kong and only the structured products will be listed in Hong Kong. It is the substantial shareholders and directors of the issuer of the structured products who are able to claim the exemption. The issuer and holders of the equity derivatives must still include interests in the underlying shares of those derivatives in determining their disclosure obligations.

13. INFORMATION TO BE DISCLOSED (SECTION 326)

The SFO removes the previous requirement for substantial shareholders to disclose particulars of registered shareholders and changes in those particulars. Instead, it introduces more structured notification forms to facilitate disclosure. Among the details to be disclosed by a substantial shareholder are the following:

1. In the case of corporate substantial shareholders, the name and address of any person in accordance with whose directions it, or its directors are accustomed or obliged to act, except where it is listed in Hong Kong or on a specified stock exchange or is the wholly owned subsidiary of any such listed company.



2. In the case of subsequent disclosures of long positions in shares disclosure is required of the highest price and average price per share paid or received in an on-exchange transaction. In off-exchange transactions the highest and average consideration per share and nature of the consideration must be disclosed. If no price or consideration has been paid or received, this should be stated. Transactions in equity derivatives do not require details of price or consideration.



3. In the case of equity derivatives, details as to whether they are listed or unlisted, cash or physically settled, and details of the underlying shares.

14. TIMING OF NOTICE

Notices should be filed with the Stock Exchange and the relevant listed company at the same time or one immediately following the other (Section 324(2)). The previous requirement for notice to be given to the Stock Exchange first has been removed.

15. FORMS TO BE USED

There are 6 separate forms to be used for notification of interests under the SFO. These are:

• Form 1 – Individual Substantial Shareholder Notice



• Form 2 – Corporate Substantial Shareholder Notice



• Form 3A – Director's/Chief Executive's Notice of Interests in Shares of a Listed Company



• Form 3B – Director's/Chief Executive's Notice of Interests in Shares of Associated Corporation



• Form 3C – Director's/Chief Executive's Notice of Interests in Debentures of Listed Company



• Form 3D – Director's/Chief Executive's Notice of Interests in Debentures of Associated Company

The forms and notes thereto can be downloaded in Chinese and English from the Hong Kong Exchange and Clearing Limited web?site or the SFC website.

The forms can be printed out and completed manually. Alternatively they are available in Microsoft Excel format and can be completed offline using the Excel programme.

Directors who are also Substantial Shareholders must use Form 3A (annexed hereto) instead of Form 1 to disclose interests in shares of a listed company of which they are directors.

If an event gives rise to separate disclosure obligations in each capacity (as director and substantial shareholder), both obligations can be fulfilled by filing Form 3A. For example, if a person has a 5.9% interest in the shares of a listed company and acquires a further 0.2%, he must file a notice as a director (who must disclose all transactions) and as a substantial shareholder because his interest has crossed a percentage level.

16. PENALTIES FOR FAILURE TO DISCLOSE (SECTION 328)

Failure to make disclosure within the time limits required by the SFO or the making of a statement which is false or misleading in any material particular constitutes a criminal offence carrying a maximum fine of $100,000 or maximum prison sentence of 2 years for each offence. Members and officers of a company can also be personally liable for the offences of a company. The Financial Secretary may further impose restrictions on the transfer of the shares of any person convicted of an offence.

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