Hong Kong: H shares and the new class struggle

by Jane Moir, ACGA

20 March 2023

In a regulatory paradox, holders of H shares will lose separate class treatment to vary or abolish rights but will keep their autonomy under delisting and takeover rules, writes ACGA Head of Research Jane Moir

By the end of this month, holders of H shares may lose the ability to vote as a separate class from their domestic or A share peers on the issuance or repurchase of stock, granting of special voting rights, or any other move to vary or abolish shareholder rights.

Yet these same investors will still be entitled to a separate say where there is a proposal to privatise or delist the H shares of a PRC issuer, or where an offer is made to dual equity shareholders under the takeovers code.

This disparity in treatment comes as Hong Kong’s stock exchange attempts to reflect rule changes across the border. In a consultation paper, the bourse contends that new regulations for PRC issuers have effectively abolished class distinctions. Domestic shares and H shares alike are ordinary shares in the same company, it argues. They are effectively homogenous.

“Since holders of domestic shares and H shares (which are both ordinary shares) are no longer deemed as different classes of shareholders, the class meeting requirement now applicable to holders of domestic shares and H shares are no longer necessary,’’ HKEX concluded.

This was presented as the current state of affairs in late February 2023 as HKEX makes consequential listing rule amendments to reflect a change in PRC regulations. A market consultation, it insists, “is not required.’’

The Exchange points to other recent developments which further blur the distinction between the PRC and Hong Kong markets, including the Stock Connect programmes which enable investors in the mainland the ability to trade certain stocks in Hong Kong, and vice-versa.

A few issues however stand in the way of this apparent fusion of domestic and H shares.

The two are not fungible, leaving shareholders no opportunity to swap one for the other. One is traded on the mainland, the other in Hong Kong. They are subject to regulatory oversight in two distinct markets. Legal title to the stocks vests with different clearing houses. They are priced differently, domestic shareholders typically paying significantly more for their stock.

In other words, they are factually distinct. A domestic share is not an H share, and technically (the shares not being uniform in nature), this renders them as different classes of stock.

Both PRC domestic shares and H shares have historically been entitled to separate meetings to vote on any proposal which would vary, or abolish, their rights. Similarly, separate meetings are currently required for any withdrawal of H shares from the Stock Exchange, and privatisations or de-listings under Hong Kong’s takeover rules.

Under planned changes to the listing rules, class meetings will however no longer be required for the first category. Holders of H shares will no longer have an autonomous voice where their shareholder rights are at stake. They can however still vote as a distinct group where an H share company exits the market.

An inconvenient truth?

Despite its interpretation of the new PRC rules and disbandment of ‘two classes, separate votes’, HKEX is retaining the ability for holders of H shares to approve or veto any withdrawal of listing of H shares. Similarly, the Securities and Futures Commission (SFC) on Friday clarified in a guidance note the effect on Hong Kong’s takeover rules in respect of H shares. It will still require a separate vote where an H share is to be de-listed or taken private under takeover rules, recognising the fact that holders of H shares would be impacted “to a much larger extent” compared to its other shareholders.

The securities regulator interpreted the PRC rule changes slightly differently from HKEX, stating that it “recognises that domestic shares (in particular A shares) and H shares are traded in separate markets with different regulatory and market environments.’’

Most notably, it said, although H shares and domestic shares are one single class of shares “under PRC law,’’ the fact that the two are not directly fungible with each other “warrants a different approach when applying certain provisions of the (takeover and share buy-back) Codes to PRC H Share issuers.’’

Any proposal to privatise or delist H shares “will significantly impact holders of H shares and their interests are considered to be materially different compared to holders of domestic shares,’’ the guidance notes, adding that “the (SFC) Executive considers that holders of H shares should continue to benefit from the protection that it had prior to the PRC rule change.’’

The SFC also clarified that for the purpose of disclosure of interest rules, “whether shares are divided into different classes is a question of fact.’’ An investors’ interests in H shares would be treated separately from their holdings of A shares in the same company. “For the avoidance of doubt we should add that interests in shares, and interests in the underlying shares of equity derivatives, should only be added together if the shares are of the same class.’’

Similarly, in determining whether a party is an associate for the purpose of the takeover rules, H shares “will be treated as a separate class of shares from domestic shares (whether unlisted or A shares).” They would look to the individual holdings in H shares rather than the entire issued share capital of the PRC H share issuer.

Relative rights

Holders of H shares could be forgiven for thinking that the ability to protect their relative size (or other distinct features) through a separate vote is being sacrificed in the name of political expedience.

Without a separate vote on an issue which directly affects their class rights, such as an issuance (or repurchase) of shares, they will be at the mercy of the majority. As holders of H shares are invariably in a minority position relative to domestic interests, they would be easily outnumbered. In a share issuance, there is a real prospect of dilution if the balance is skewed through a hefty influx of A shares.

HKEX rightly points out that this is a commercial decision for an issuer yet also recognises that such a move “may reduce the relative liquidity and investors’ interest in the H share market relative to the A share market, and consequently, affect the long term development of the H share market.’’

Indeed, one of the few questions it asks in the consultation paper is whether investors have a concern that A share fund raisings may increase the proportion of A shares over H, reducing the latter relative to its domestic peers. It even solicits views on whether there should be “other provisions to promote the long term development of the H share market.”

The HKEX consultation does not specifically broach other potential variations of class rights, such as the introduction of another class of stock, for example, and in particular ones with different voting rights. The PRC rule changes which HKEX seeks to reflect require domestic companies to align their Articles of Association with state guidelines on how constitutional documents should be drafted. These guidelines do refer to special voting rights, a nod to dual class shares listed on the STAR board. It would take a change of China’s company law to widen weighted voting rights to non-STAR companies, but the guidelines leave the door open for a seamless transition if this was to change. 

The class conundrum

HKEX anticipates that H share issuers will promptly trot off and change their Articles to align with the PRC guidelines, advising those who have yet to do so to keep the existing class meetings in place in the interim. The door is still open to some holders of H shareholders to vote against such Article changes.

And while the HKEX consultation paper does not directly ask whether it should scrap separate class votes for variations of class rights, submissions may still challenge the decision.

There is thus still an opportunity to draw attention to the paradoxical, if not perverse, situation holders of H shares find themselves in.

On the one hand, they face rule changes which take away their ability to uphold class rights on the basis that they are no longer a distinct class. On the other, rules remain in place to recognise the fact that they are still a distinct class entitled to vote as such, for fear of being inherently unfair.

The consultation ends on 24 March 2023.

About the Author(s)

Jane Moir
Head of Research, ACGA

Jane Moir
 joined ACGA as a Research Director focussed on Hong Kong. Prior to joining ACGA, she worked as a barrister and financial journalist, including 11 years at the South China Morning Post covering legal and regulatory issues. Jane has also worked as a part-time lecturer in law at HKU Space and was a contributing writer for Lexis-Nexis on securities law, corporate crime and money laundering.

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