Hong Kong’s regulators are making concerted efforts on multiple fronts to reduce the use of shell companies for questionable activities.
In June, the Stock Exchange of Hong Kong released a consultation paper to tighten the reverse takeover rules and listing criteria on the back of increased creation and trading of shell companies used to help beneficiaries with backdoor listings.
Backdoor listings are a means for a company to go public by acquiring an already listed company, thus bypassing the initial public offering process. It can be used when the acquiring company does not meet the requirements for listing on an exchange.
Shell companies in this context are entities with a stock market listing but with limited assets or operations, noted Colum Bancroft, managing director at consulting firm AlixPartners.
‘These shells can be targeted by companies seeking a stock market listing as they can acquire the shell’s listing without having to comply with the stringent and costly IPO listing process,’ he told Citywire Asia.
The new rules require acquisition targets to be suitable for listings and meet trading record requirements. The enlarged group must also meet all the new listing requirements.
Moreover, when a reverse takeover or extreme transaction involves a series of transactions and arrangements, issuers are required to include it in the listing document or circulate the pro forma income statement of all its acquisition targets and any new businesses developed as part of the series.
A Hong Kong Exchanges and Clearing Limited (HKEx) spokesperson clarified that while these activities are limited to a small segment of the market, they can lead to speculative trading, market manipulation, insider trading and unnecessary volatility in the market.
The spokesperson said that the exchange had noted ‘evolving’ backdoor listing structures and corporate actions to strip out operations in recent years, and has issued various guidance letters and listing decisions as a result.
Along with the consultation on backdoor listings, the exchange has also identified criteria for a listed issuer’s suitability for continued listing.
The latest set of proposals target both the demand and supply side of backdoor listings, with increased scrutiny of transactions designed to gain a backdoor listing on one side and enhancing the ability of the exchange to remove the listing status of shell companies on the other side, Bancroft explained.
‘It is clear that the exchange will closely scrutinise any changes in ownership, management team and principal businesses for signs of shell characteristics,’ said Bancroft.
‘In addition, the letter also highlights business risks such as trade or economic sanctions, accounting fraud, internal control failures and excessive reliance on a key customer as factors which may in extreme examples lead to an issuer being considered no longer suitable for listing.’
While the proposed changes apply to backdoor listings, shell companies have traditionally earned a bad name as conduits of money laundering, with reputational damages aggravated by the recent Paradise Papers and Panama Papers revelations.
While the structures can be set up by the super-rich for legitimate reasons, such as tax planning or to facilitate asset transfers, they can also be used to launder money by creating a complex web of transactions.
Hong Kong is also ramping up its supervision on that front. The Securities and Futures Commission (SFC) has launched a consultation to amend the jurisdiction’s guidelines on anti-money laundering and terrorist financing targeted at bank customers, ahead of an on-site visit by the Financial Action Task Force (FATF) later this year.
It now wants to expand the types of politically exposed persons (PEPs) to include prominent persons at international organisations, and extend the special requirements for foreign PEPs to high risk business relationships with domestic PEPs and international organisation PEPs.
Financial institutions will also be allowed to stop pursuing the customer due diligence process if they feel that the process will tip-off the client, instead requiring the firm to file a suspicious transaction report with the Joint Financial Intelligence Unit.
Banks will have to keep all records obtained through the due diligence and monitoring process, including the results of any analysis.