In a recent Court of First Instance (“CFI“) decision, China Ping An Insurance Overseas (Holdings) Limited v Luck Gain Limited and ors [2023] HKCFI 3315, the CFI has demonstrated how investors with beneficial interest in global notes might be able to proceed against the issuer, notwithstanding the obstacle that such investors do not normally have standing to present a winding-up petition against issuers directly. Such an obstacle is commonly known as the “no look through” principle.

The “No look through” Principle

By way of background, bonds nowadays are rarely issued to investors as a definite note. Instead, a global note representing an entire issuance will be issued, which will then be deposited in a common depositary for the relevant clearing systems. Trading of bonds would then occur through the book-entry system maintained by the clearing systems. What the ultimate investor actually acquires is a portion of the indirect beneficial interest in the global note via their intermediaries, such as banks and brokers holding accounts with the clearing systems. In other words, the ultimate investor derives its interest in the securities through a chain of intermediaries between itself and the issuer.

In relation to the rights of an ultimate investor against the issuer in a typical global bond structure, the courts of Hong Kong have currently aligned themselves with the position of the United Kingdom, the Cayman Islands and Bermuda by adopting the “no look through” principle in Leading Holdings Group Limited [2023] HKCFI 1770.

Under the “no look through” principle, the ultimate investor would only have rights against their immediate counterparty in the chain of intermediaries, which is usually the banks or brokers who have accounts with the clearing systems. Should the ultimate investor decide to petition for a winding-up against the issuer, the investor would have no standing to do so. The rationale behind is to ensure that all the bondholders would act through the trustees, in order to prevent duplicity of actions (For a detail analysis of Leading Holdings Group Limited, see our previous article).

China Ping An Insurance Overseas (Holdings) Limited

Facts

In China Ping An Insurance Overseas (Holdings) Limited, a principal amount of US$200,000,000 of guaranteed bonds (“Bonds“) was issued by the 1^st Defendant (“Issuer“). The Bonds were constituted by a Deed of Covenant, a Fiscal Agency Agreement and a Global Certificate (collectively, “Bond Documents“), and were being cleared and settled through Euroclear Bank S.A./N.V (“Euroclear“). In this regard, the Bonds were structured in the typical way as mentioned above, where a single Global Certificate was issued and held by a custodian (who is the sole registered holder of the Global Certificate), who in turn, held the Global Certificate on behalf of Euroclear.

The Plaintiff holds beneficial interests of the Bonds through Bank of China (Hong Kong) Limited , which is an account holder in Euroclear. In particular, the Plaintiff has subscribed for an aggregate amount of US$190,000,000 of Bonds, constituting (i) an amount of US$50,000,000 of Bonds acquired under a Subscription Agreement entered between the Plaintiff, the issuer and the guarantor (“Subscription Agreement“); and (ii) US$140,000,000 of Bonds further acquired through the market.

Under Clause 4.2 of the Subscription Agreement, the Issuer and the Guarantor were obliged to make satisfactory arrangement to the subscriber (i.e. the Plaintiff) to ensure that Certificates are delivered to the registrar for authentication in accordance with the Fiscal Agency Agreement. The Fiscal Agency Agreement and the Global Certificate in turn provide for the exchange of the Global Certificate for Definitive Certificates if any of the events of default occurs.

Subsequently, the Issuer failed to pay the principal amount of the Bonds, and the demands to exchange the Global Certificate for Definitive Certificates were unanswered. This constituted one of the events of default.

Following an unsuccessful winding up petition against the Issuer due to a lack of standing, the Plaintiff attempted to overcome the obstacle by commenced proceedings for specific performance under Clause 4.2 of the Subscription Agreement to compel the Issuer to issue Definitive Certificates, which would then enable the Plaintiff to enforce the debts directly against it.

Ruling

In a decision in favour of the Plaintiff, the CFI explained that the ordinary and plain meaning of Clause 4.2 of the Subscription Agreement clearly confers the Plaintiff a right to compel the Issuer and the Guarantor to exchange the Global Certificate for Definitive Certificates.

In rejecting the defendant’s argument that Clause 4.2 should be interpreted in light of the Global Note structure in place (and hence finding the Plaintiff successful would be an encroachment to the “no look through” principle), the CFI did not see any inconsistencies between Clause 4.2 of the Subscription, and the underlying Global Note structure as provided by the Bond Documents, which is the natural consequence of the Issuer entering into separate agreements with the Plaintiff. This is the case even if it would mean the risk of duplicity of actions.

Specific performance is granted accordingly, allowing the ultimate investor to then have a direct right to enforce against the Issuer.

Takeaways

The case of China Ping An Insurance Overseas (Holdings) Limited importantly demonstrates that where an entitlement for the exchange of the global certificate for definitive certificates is provided contractually, an ultimate investor may still proceed against the issuer notwithstanding the “no look through” principle.  It should be noted that here, the Plaintiff was able to enforce a direct contractual right against the Issuer.  Quite often is the case, a beneficial bondholder who is not the registered holder and does not have a direct contractual relationship with the issuer (or otherwise, whose rights are expressly curtailed by the underlying document, often, the indenture), may find him/herself having no standing against the issuer.  We would, in that scenario, have to be creative and think out of the box to find a way for such a bondholder to exert pressure on the issuer and work towards a recovery, which we are seeing in a case we are working on.

See the full judgment of China Ping An Insurance here.

Background 

On 29 November 2023, The Stock Exchange of Hong Kong Limited (“Exchange“) published the Guide for New Listing Applicants (“Guide”), which (1) has consolidated and enhanced all currently effective guidance letters and listing decisions related to new listing; and (2) provides updated guidance to reflect the latest regulatory practice and expected disclosures in listing documents.

The Guide is divided into the following six main sections and an annex of streamlined listing decisions:

1. Eligibility and suitability for listing
2. Special listing regimes
3. Listing document disclosure with guidance on specific sections;
4. Specific topics relating to a new listing application
5. Other listing structures; and
6. Other matters.

Updates

The updated guidance under the Guide is summarised below:

(1) Latest Regulatory Practice

Contractual Arrangements

Generally, where there is no foreign ownership restriction, applicants must not use contractual arrangements for conducting their business. In exceptional circumstances, applicants may be allowed to use contractual arrangements if their non-restricted businesses are inseparable from the prohibited or restricted businesses, and/or are immaterial in terms of revenue, profit or otherwise during the track record period and after listing (see:  paragraph 15 of Chapter 4.1 of the Guide).

Title Certificate Requirements

In the absence of the requisite land use right certificates and/or building ownership certificates (“Title Certificates”) for land and properties involved in an applicant’s business that are significant to its operations (“Relevant Properties“), the Exchange has the discretion to consider, on a case-by-case basis, whether such defect would affect the applicant’s suitability for listing, or can otherwise be addressed by way of disclosure.

To facilitate the Exchange’s assessment, the applicant should provide at least the following:

• Risk of eviction – Whether the applicant has obtained evidence and/or confirmations from all applicable competent authorities that it has the right to use the Relevant Properties.
• Contingency plans – Details and feasibility of the contingency plans (e.g. the availability of alternative project resources in the vicinity).
• Rectification measures – Whether the applicant is in the process of applying for the Title Certificates for the Relevant Properties and any legal impediments to obtaining the same.
• Business / financial impact of the title defects – Risk of material penalties, the revenue contribution from the Relevant Properties, and where applicable, the applicant’s contractual rights to seek indemnification from the relevant parties.
• Internal control – Enhanced internal control measures adopted by the applicant to prevent recurrence of similar incidents.

(See: paragraph 2 of Chapter 4.11 of the Guide)

Over-boarded independent non-executive director (“INED”)

Where an applicant identifies an independent non-executive director who will be holding their 7^th (or more) listed company directorship, the applicant should consider appointing another INED instead (see: paragraph 7 of Chapter 3.10 of the Guide).

Special Purpose Acquisition Companies (“SPAC”)

A SPAC and a Successor Company should seek legal advice on the extent to which its listing document at initial listing and the De-SPAC transaction (as the case may be) must comply with the prospectus requirements of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.32). (see: paragraph 10 of Chapter 2.4 of the Guide, changes underlined).

Biological Assets

Since biological assets are living animals or plants that are measured at fair value less costs to sell in accordance with applicable accounting standard, they are subject to high risk, given that they are perishable and their valuation is usually subject to higher uncertainty due to the complex and not-easily-verifiable assumptions adopted. Thus, the Guide clarified that when conducting due diligence,  the sponsor should advise the details of, and steps taken to address, any limitations on due diligence (e.g. limitation in stock take). The Exchange reminds the sponsor and the applicant that serious limitations may render an applicant unsuitable for listing (see: paragraph 4 – Risks and limitations, (ii) of Chapter 4.10 of the Guide, changes underlined).

(2) Updated Guidance on Disclosures in Listing Documents

The updated guidance on disclosures is based on comments commonly raised during the Exchange’s vetting process as a result of recent market developments (e.g. new regulations and/or emergence of new business models such as tech and e-commerce platform industries). The Guide provides the general principles on listing document disclosure and drafting together with guidance on specific sections. In addition, the Exchange has introduced a new chapter on disclosure requirements of Corporate Governance & Environmental, Social and Governance (Chapter 4.3 of the Guide) to help applicants and their advisers consider the relevant issues at an early stage.

Implementation

The Guide will come into effect on 1 January 2024, upon which the corresponding guidance letters and listing decisions will be archived. For future updates, the Exchange will issue new guidance by way of updating the Guide instead of publishing separate / standalone guidance letters and listing decisions.

For the full text, please refer to the Guide.

In the recent case of Song Lihua v Lee Chee Hon [2023] HKCFI 2540, the Court of First Instance (the “CFI“) has refused to enforce an arbitral award in an arbitration by the Chengdu Arbitration Commission in Mainland China as it would be contrary to public policy to enforce the award, pursuant to section 95(3)(b) of the Arbitration Ordinance (Cap. 609).

In that case, the Respondent sought to set aside the enforcement order on the grounds that, inter alia, in the second hearing of the arbitration, one of the three arbitrators who attended the hearing by video conference did not meaningfully participate in it. It was observed that during the course of the hearing, the arbitrator was:-

(i). moving from one location to another, indoors and outdoors,

(ii). travelling in a car,

(iii). appearing offline from time to time,

(iv). talking to someone else in his room,

(v). looking into the distance instead of focusing on the screen, and

(vi). giving no response to the questions from the chairman of the tribunal.

In light of the above, the CFI held that the conduct of the arbitration lacked due process and fell short of the high standards expected by Hong Kong courts for a fair and impartial hearing. While acknowledging the pro-arbitration and pro-enforcement stance of Hong Kong courts, the CFI reiterated the fundamental principle that no person shall be judged without a fair hearing in which each party is given the opportunity to respond to the evidence against it and to be heard on its case. The CFI emphasized that not only must justice be done, but it must also be seen to be done. In the circumstances of the case, enforcement of the award would violate the most basic notions of justice in Hong Kong and thus should be refused.

The significance of this case is twofold. Firstly, although the Applicant relied heavily on the fact that the supervisory court in Mainland China had not set aside the award and had allowed its enforcement in Mainland China, Hong Kong courts are prepared to apply their own standards and law when deciding whether enforcement would be contrary to the public policy of Hong Kong. Secondly, it highlighted the importance of due process and compliance with recognized rules of natural justice, which is quite often a precondition to recognizing and enforcing an arbitral award.

It is also worth mentioning that around the same time, the English High Court handed down the judgment of The Federal Republic of Nigeria v Process & Industrial Developments Limited [2023] EWHC 2638 (Comm), setting aside the arbitral awards pursuant to section 68(2)(g) of the Arbitration Act 1996 on the ground that they were obtained by fraud and contrary to public policy. Misconduct committed during the arbitration included bribing the other side’s staff, providing to the arbitral tribunal evidence which was known to be false, and improperly retaining and misusing the other side’s documents which were subject to legal professional privilege. The English court was of the view that such conduct represented the most severe abuses of the arbitral process which could not lead to a just result.

These recent enforcement related decisions in Hong Kong and the UK  serve as a helpful reminder that in relation to misconduct on the part of the arbitrator or the opposing party, one would sometimes have a potential last recourse to court by challenging the arbitral award.

The Arrangement of Reciprocal Recognition and Enforcement of Judgments in Civil and Commercial Matters, signed by Hong Kong and the Mainland on 14 July 2006 (“2006 Arrangement“), was implemented through the Mainland Judgments (Reciprocal Enforcement) Ordinance (Cap. 597) (“Existing Regime“).

This was succeeded by the 2019 Arrangement, signed on 18 January 2019, set to be implemented through the new Mainland Judgments in Civil and Commercial Matters (Reciprocal Enforcement) Ordinance (Cap. 645) (“Ordinance“) and relevant rules (Cap. 645A) (“Rules“) on 29 January 2024. Please click here for the Gazetted Ordinance and here for the Gazetted Rules.

The Supreme People’s Court will promulgate a judicial interpretation for implementation, but it is not yet announced.

Importantly, the new Ordinance and Rules will not apply retrospectively and will only apply to judgments given after 29 January 2024. The Existing Regime will continue to apply to judgments dated before 29 January 2024 (if applicable as outlined in the table).

Please click here for a table analysing and comparing the two Arrangements.

The 2019 Arrangement, along with the forthcoming implementation of the Ordinance and Rules, substantially broadens mutual judgment recognition between the Mainland and Hong Kong, enhancing judicial support in civil and commercial areas, and bolstering the legal appeal of both regions.

On 20 October 2023, the Securities and Futures Commission (“SFC“) and the Hong Kong Monetary Authority (“HKMA“) issued a joint circular (“Joint Circular“) to provide updated guidance to intermediaries conducting virtual asset (“VA“) related activities, including (a) distribution of VA-related products[1], (b) VA dealing services, (c) VA asset management services; and (d) VA advisory services. The Joint Circular supersedes the previous joint circular issued on 28 January 2022.

Background

The SFC’s initial regulatory approach was to impose a “professional investors only” restriction on various types of VA-related activities. However, in light of the rapid growth of the VA landscape , and the new licensing regime for VA trading platforms which came into effect on 1 June 2023 which allows VA trading platforms to provide services to retail investors, retail investors now have increased exposure to VA activities. Although VAs are becoming more popular globally, the regulatory landscape in different jurisdictions remains varied, and the SFC and the HKMA are of the view that risks associated with VAs and VA-related products may be difficult for retail investors to understand. Hence, it is necessary for the SFC and the HKMA to review and update their policies to provide further guidance on intermediaries conducting VA-related activities.

A. Distribution of VA-related Products

The SFC and the HKMA will impose the following investor protection measures specifically relating to the distribution of VA-related products, in addition to the requirements under the complex product regime[2]:

Selling restrictions – Subject to certain exceptions, VA-related products which are considered to be complex products should only be offered to professional investors. Intermediaries should also observe specific selling restrictions in Hong Kong and other jurisdictions which are applicable to a particular VA-related product.

VA knowledge test – Before effecting a transaction on behalf of a client (other than institutional professional investors[3] and qualified corporate professional investors[4] (“Exempt Investors“)), intermediaries should assess whether such client has knowledge of investing in VAs or VA-related products, for instance, whether the client has undergone training or attended courses, or has had other work or trading experience in relation to VAs or VA-related products. If a client lacks such knowledge, the intermediary may only proceed after it has provided adequate training to such client on the nature and risks of the VAs and VA-related products.

Suitability obligations – Intermediaries should observe the suitability obligations as supplemented by the Suitability FAQs, including:

(a) ensuring that any recommendations or solicitations made are suitable for or are otherwise in the best interests of the client in all circumstances, taking into account, among other things, the nature and features of the VA-related product, the client’s risk tolerance and financial situation;

(b) where the VA-related product is a derivative product, ensuring that the client understands the nature and risks of the product and has sufficient net worth to be able to assume the risks and bear potential losses of trading in such product; and

(c) conducting proper due diligence on the products, including, among other things, understanding the products’ risks and features and regulatory status, and the targeted investors.

Providing financial accommodation – Before intermediaries provide any financial accommodation to the client, it should ensure that the client has the financial capacity to meet the obligations arising from leveraged or margin trading in VAs and VA-related products.

Warning statements – Apart from Exempt Investors, intermediaries should provide to clients (a) information and warning statements in relation to VA-related products, and information on the underlying VA investments, in a clear and easily comprehensible manner; and (b) risk disclosure statements specific to VAs.

B. VA Dealing Services

Intermediaries must be licensed or registered for Type 1 (dealing in securities) regulated activity to provide VA dealing services, and may only partner with SFC licensed VA trading platforms (“SFC-licensed platforms“) to provide such services, either by (i) introducing clients to the SFC-licensed platforms for direct trading; or (ii) establishing an omnibus account with the SFC-licensed platforms.

For intermediaries providing VA dealing services under an omnibus account, as a licensing or registration condition, such intermediaries must comply with the terms and conditions prescribed by the SFC, which include, among other things, that:

(a) before providing VA dealing services to retail investors, intermediaries should: (i) assess each retail investor’s knowledge of VAs and risk tolerance level; (ii) set a reasonable exposure limit for each retail investor, with reference to such retail investor’s financial situation (including net worth) and personal circumstances; (iii) ensure that the VA dealing services are conducted through an omnibus account established and maintained with an SFC-licensed platform that is not subject to the licensing condition that it can only serve professional investors; and (iv) implement adequate controls to ensure that retail investors can only trade in VAs that are made available for trading by retail investors by the SFC-licensed platforms; and

(b) any deposit of VAs by a client, or any withdrawal of VAs by a client, must be dealt with through the intermediary’s segregated account(s) established and maintained with (i) the intermediary’s partnered SFC-licensed platforms; or (ii) authorised financial institutions (or their local subsidiaries) which meet the expected standards of VA custody issued by the HKMA. Intermediaries should also comply with the relevant anti-money laundering and counter-terrorist financing requirements with respect to VAs when handling these VA deposits and withdrawals.

There are also additional requirements and licensing or registration conditions for intermediaries who provide VA dealing services when acting as introducing agents of a SFC-licensed platform.

C. VA Asset Management Services

Intermediaries must be licensed or registered for Type 9 (asset management) regulated activity to provide asset management activities relating to VAs which meet the de minimis threshold (that is, a stated investment objective of a portfolio to invest in VAs or an intention to invest 10% or more of the gross asset value of a portfolio in VAs). As a licensing or registration condition, such intermediaries must comply with additional requirements under the terms and conditions prescribed by the SFC relating to the management of such asset portfolios.

If a Type 1 (dealing in securities) intermediary is authorised by its clients to provide ancillary VA dealing services on a discretionary basis, the intermediary should only invest less than 10% of the gross asset value of the client’s portfolio in VAs (that is, below the “de minimis threshold”).

D. VA Advisory Services

Intermediaries must be licensed or registered for Type 1 (dealing in securities) or Type 4 (advising on securities) regulated activity to provide VA advisory services, and are expected to comply with all the regulatory requirements (including to observe the suitability obligations) imposed by the SFC and the HKMA when providing advisory services, irrespective of the nature of the VAs.

When recommending any VAs to retail investors, intermediaries should take all reasonable steps to ensure that (a) the VA is of high liquidity and is an eligible large-cap VA (that is, it is included in a minimum of two acceptable indices issued by at least two different index providers), and (b) the VA is made available for trading by retail investors by the SFC-licensed platforms.

Implementation

There will be a 3-month transition period before the full implementation of the updated requirements under the Joint Circular. Hence, intermediaries may continue to provide VA-related services to their existing clients who have been assessed to possess knowledge of VAs based on the results of the VA knowledge tests conducted before 20 October 2023.

If intermediaries intend to further expand their VA-related services, particularly to retail investors, or make any changes to their existing activities, they should notify the SFC and the HKMA (where applicable) in advance.

Takeaway

The Joint Circular has introduced additional investor protection measures and other updates to the policies in light of the latest market developments, and has clarified the standard of conduct expected from intermediaries’ conducting VA-related activities, which demonstrates the Hong Kong Government and the regulators’ joint commitment to enhance the level of responsibility and accountability of key players in the VA industry in Hong Kong. We look forward to the SFC and the HKMA issuing further regulatory guidelines and updates as the VA industry continues to expand and develop in the future.

For the full text, please refer to the Joint Circular and Appendices.

[1] “VA-related products” refer to investment products which (a) have a principal investment objective or strategy to invest in virtual assets; (b) derive their value principally from the value and characteristics of virtual assets; or (c) track or replicate the investment results or returns which closely match or correspond to virtual assets.

[2] The complex product regime refers to the requirements in paragraph 5.5 of the Code of Conduct for Persons Licensed by or Registered with the SFC (“Code of Conduct“) and Chapter 6 of the Guidelines on Online Distribution and Advisory Platforms.

[3] “Institutional professional investors” is defined under paragraph 15.2 of the Code of Conduct as persons falling under paragraphs (a) to (i) of the definition of “professional investor” in section 1 of Part 1 of Schedule 1 to the SFO.

[4] “Qualified corporate professional investors” refers to corporate professional investors which have passed the assessment requirements under paragraph 15.3A and gone through the procedures under paragraph 15.3B of the Code of Conduct.