The Hong Kong Stock Exchange recently published a consultation paper seeking market feedback on its proposed rule amendments relating to share schemes of Hong Kong–listed issuers and their subsidiaries. The consultation paper, published on 29 October 2021, is now open for public comments until 31 December 2021, and the proposed changes are significant.
Share schemes are widely used as equity-based awards to incentivise employees and service providers for contributing to the issuers’ long-term growth and help align their interests with those of the issuer and its shareholders. Currently, Chapter 17 of the Main Board Listing Rule (Listing Rules) governs only share option schemes and this regime has remained unchanged for over two decades. Share award schemes are governed by Chapter 13 of the Listing Rules, which sets out the conditions for issuing securities in general. The issuer granting the share award shall seek the shareholders’ approval for each grant of new shares at a general meeting or issue new shares under a general mandate.
Given the issuer’s increasing adoption of the share award schemes, the Hong Kong Stock Exchange (HKEx) is proposing to apply a consistent regulatory framework to all share schemes funded by the issuance of new shares to align with international practice. As proposed, both the share option schemes and share award schemes acquiring new shares of the issuers would be governed by Chapter 17 of the Listing Rules under the new proposal.
To strike a balance between protecting the shareholders from the dilutive impact of the share grants and providing flexibility for the issuer to structure their remuneration policies, HKEx proposed the below key changes to the existing provisions of Chapter 17.
At present, there is no restriction on the eligibility of participants of the share option schemes. HKEx now proposes to define “eligible participants” to include (1) employee participants (i.e., directors and employees of the issuer or any of its subsidiaries); (2) related entity participants (i.e., directors and employees of related entities); and (3) service providers as determined by the remuneration committee (i.e., other persons who provide services to the issuer group on a continuing and recurring basis in its ordinary and usual course of business who are material to the long-term growth of the issuer group), which is similar to the eligibility restrictions in the United States that allow employees of the parent or associated companies and service providers as participants. The issuer shall obtain approval from the remuneration committee for share grants to related entity participants and service providers and disclose the reasons for making such grants in the announcement.
The proposal extends the existing scheme mandate limit of not exceeding 10% of an issuer’s issued shares to all share schemes involving the issuance of new shares. The mandate may be refreshed by shareholders once every three years. This is different from the US approach, whereby no mandate limit is set, and shareholders can approve the number of shares issuable under the scheme.
Having considered the dilutive effect on shareholders from repeated refreshments, HKEx proposes granting independent shareholders a veto right for additional refreshments within a three-year period. Furthermore, as an additional safeguard against dilution from share grants to service providers, the proposal requires the issuer to set a sublimit on the grants to service providers. The sublimit must be separately voted on by shareholders. The issuer shall also explain in the circular the basis for determining the sublimit.
At the same time, HKEx proposes removing the existing limit that the number of outstanding options should not exceed 30% of the issued shares. HKEx views that such limit is of limited practical effect, as the issuer is subject to a more stringent 10% scheme mandate limit.
Chapter 17 does not impose any specific requirements on the vesting period of the grants. HKEx now proposes to include a minimum vesting period of 12 months to align with the market practices unless the remuneration committee approves a shorter period regarding share grants made to employee participants that the issuer specifically identifies.
The proposal also modifies the shareholders’ approval requirement for changes to the grant terms. Any changes shall be approved by the remuneration committee and/or shareholders of the issuer if the initial grant requires such approval (as the case may be).
Share Grants to Individual Participants and Connected Persons
Currently, option grants to an individual exceeding 1% of shares in issue over any 12-month period would require shareholder approval. The proposal extends the approval restrictions to grants of share award, including grants to a connected person (i.e., director, chief executive or substantial shareholder of the issuer or an associate of any of them).
In addition, the proposal requires all grants to connected persons to be approved by the remuneration committee instead of independent non-executive directors (INEDs) in the existing Listing Rules. HKEx also introduces a new de minmis exemption for grants to connected person. The current Chapter 17 treats all grants to a connected person as a connected transaction, thus subject to the independent shareholders’ approval requirements. Under the new proposal, independent shareholders’ approval will only be required for (1) each grant of share awards over 0.1% of the issued shares of the issuer to a director (other than an INED) or the chief executive of the issuer over any 12-month period; and (2) each grant of share awards and options in excess of 0.1% of the issued shares of the issuer to an INED or a substantial shareholder of the issuer over any 12-month period. Such relaxation will provide the issuer with greater flexibility in structuring directors’ and senior management's remuneration policy.
To facilitate shareholders in assessing the impact of the grant, the issuers are to publish in an announcement the grant details, including a description of the performance targets and clawback mechanism of the grant. An issuer planning to deviate from the above disclosure requirement should in an announcement and/or circular disclose the reasoning of the issuer’s remuneration committee as to why it allows such deviation and how the proposed grants can serve the purpose of the scheme.
To provide a clear identification on people with greater influence on the company, the disclosure should be made on an individual basis for a grant that is made to (1) a connected person; (2) a participant with share grants in excess of the 1% Individual Limit; (3) a related entity participant or service provider with share grants in excess of 0.1% of the issuer’s issued shares over any 12-month period. Other grants may be disclosed in aggregate by category in the announcement.
The proposed disclosure requirements in the annual and interim report align with the existing Chapter 17 requirements. In addition, the issuer is required to disclose the fair value of the grants; and the number of options and awards grants under all share schemes during the reporting period divided by the weighted average number of issued shares for the period and the number of shares available for grant under the scheme mandate at the beginning and end of the reporting period. The disclosure requirements allow the shareholders to better assess the dilution impact of the scheme and align with the international disclosure standard.
Disclosure of the Work Performed by the Remuneration Committee
The proposals emphasise the role of the remuneration committee in overseeing the operation of share schemes. Accordingly, the issuers should disclose matters relating to share schemes reviewed and/or approved by the remuneration committee during the financial year in the Corporate Governance Report.
Transfer of Share Awards or Options
Currently, share options may not be transferred to another person. HKEx proposes offering a waiver for the transfer to a vehicle, including a trust or a private company, for the benefit of the grantees and their family, provided that such transfer would continue to meet the purpose of the scheme and other requirements of Chapter 17.
Voting Rights of Unvested Scheme Shares
As there are concerns about undue influence over the exercise of voting rights of unvested shares by the issuer’s senior management, HKEx proposes that the trustee holding unvested shares of a share scheme abstain from voting on matters that require shareholder approval. The issuer must also disclose the number of unvested shares held by the trustee of its share scheme in its monthly returns.
HKEx aligns the disclosure requirements on the share schemes funded by the existing shares with that applicable to share schemes funded by new shares. The voting right restriction and disclosure requirement for unvested scheme shares applicable to share schemes funded by new shares would also apply to those funded by existing shares.
The new proposal also extends to govern the share schemes of subsidiaries, but it has provided some relaxation on the approval requirements involving grants by an insignificant subsidiary (i.e., subsidiaries whose total assets, profits, and revenue compared to that of the issuer group are less than (1) 10% under the percentage ratios for each of the latest three financial years; or (2) 5% under the percentage ratios for the latest financial year). Adoption of share grants by an insignificant subsidiary and the subsequent refreshment of mandate may be exempt from the shareholders’ approval requirement if (1) they are approved by the issuer’s remuneration committee; (2) the scheme complies with other Chapter 17 requirements; and (3) the subsidiary is and will remain an insignificant subsidiary.
The proposal is a response from HKEx to the issuers' increasing adoption of share awards and options. The proposed changes are significant, and issuers, proposed issuers contemplating a listing on the HKEx, and their subsidiaries should pay careful attention to its development and seek appropriate guidance in structuring their incentives for employees.
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