Hong Kong Stock Exchange adopts new regime for share schemes

Background

On 29 July 2022, The Stock Exchange of Hong Kong Limited (Exchange) published its conclusions on the consultation paper on the proposed changes to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (Listing Rules) relating to the grant of share awards and options to acquire new shares of listed issuers (Share Schemes). These changes would be the first of its kind since more than two decades on the Hong Kong bourse, when share option schemes first became commonly used for incentive purposes.

To reward and incentivise officers, employees and service providers contributing to the success of listed issuers on a longer term basis, Share Schemes can effectively align their interests with those of the issuers and their shareholders. Unlike other forms of remuneration like salary and cash bonuses, Share Schemes exert dilutive impact on public shareholders, of which exchanges globally are recognisant.

Currently, there is no unified framework governing issuers’ share-based incentive schemes. Chapter 17 of the Listing Rules currently governs only share option schemes involving grants of options over new shares of listed issuers and their subsidiaries. Share award schemes¹ are separately regulated under Chapter 13 of the Listing Rules.

With almost 80% of listed issuers having adopted share option schemes and up to 14% having adopted share award schemes, the Exchange recognised the need to strike a balance between shareholder protection from excessive dilution on one hand and the need for flexibility on the other, so as to allow issuers to structure remuneration packages with reference to their corporate goals and objectives, having regard to norms in specific industries and sectors. In line with the theme of robust investor protection, the upcoming changes would align Hong Kong with international practice and take reference from overseas experience, including the UK, the US, Australia, Canada and the PRC.

Key changes to the regime

Extended scope: The amended Chapter 17 will govern all Share Schemes involving grants of share awards and grants of options over new shares of (i) listed issuers and (ii) any subsidiary of a listed issuer whose revenue, profit, or total assets accounted for 75% or more of that issuer under the percentage ratios in any of the latest financial years (a Principal Subsidiary).

Definition of Eligible Participants: Eligible Participants are now defined to include:

• employee participants: directors and employees of an issuer or any of its subsidiaries;
• related entity participants: directors and employees of an issuer’s related entities (ie holding companies, fellow subsidiaries or associated companies); and
• service providers: persons who provide services to an issuer group on a continuing and recurring basis in its ordinary and usual course of business which are in the interest of the long term growth of the issuer group (but should exclude placing agents, financial advisers advising on fundraising, merger or acquisitions, and also professional service providers, such as auditors or valuers, who provide assurance or are required to be impartial and objective).²

Scheme Mandate: The existing maximum scheme mandate limit of 10% over an issuer’s issued shares will be extended to cover all share awards and share options over new shares. Such 10% limit may be refreshed (i) every three years with shareholders’ approval or (ii) within a three year period with independent shareholders’ approval (ie controlling shareholder (or where there is no controlling shareholder, the executive directors, non-executive directors and chief executive) and its associates abstaining from voting). The cap on outstanding options at 30% of issued shares will be removed.

Service Provider Sublimit: Where participants of a Share Scheme include service providers, a sublimit must be set within the scheme mandate and be approved by shareholders.

New Minimum Vesting Period: The new minimum vesting period shall be 12 months, except for employee participants, who may be subject to a shorter vesting period provided that (i) the scheme document sets out specific circumstances for the shorter vesting period, and (ii) there is an explanation by the board of directors (or the remuneration committee, where grants to directors and/or senior managers are involved) as to the appropriateness of the arrangement and alignment with purpose of the Share Scheme.

Grants to Individual Participants and Connected Persons:

• 1% Individual Limit: Shareholders’ approval requirement for option grants to an individual exceeding 1% of shares in issue over any 12-month period (1% Individual Limit) will be extended to share awards.
• Grants to an issuer’s directors (other than INEDs) and chief executives (or any of their associates):
  • INEDs’ approval is required for any share awards or share options; and
  • Independent shareholders’ approval will be required for any grants of share awards (ie not share options) in excess of 0.1% of the issued shares over any 12-month period.
• Grants to an issuer’s INEDs and substantial shareholders (or any of their associates):
  • INEDs’ approval (excluding any INED who is the grantee) is required for any share awards or share options; and
  • Independent shareholders’ approval will be required for any grants of share options and share awards in excess of 0.1% of the issued shares over any 12-month period.
• Removal of de minimis threshold: the current HK$5m de minimis threshold for grants of share options to an INED or a substantial shareholder of an issuer will be removed.

New Disclosure Requirements:

• Performance targets and clawbacks: Performance targets and clawbacks (if any) attached to the options or awards must be disclosed. If none, (i) a negative statement must be included in the scheme document and (ii) in case of grants to directors and/or senior management, an explanation from the remuneration committee on why it is not necessary and how the grants align with the purpose of the scheme must be disclosed.
• Periodic reporting: Annual and interim reports should contain specific disclosure in relation to share grants on an individual basis for certain categories of participants (eg those granted in excess of the 1% Individual Limit) and details of Share Schemes, including number of share grants available under the scheme mandate and service provider sublimit (where applicable).

Transitional Arrangements

The amendments to the Listing Rules will become effective on 1 January 2023 (Effective Date). According to the transitional arrangements stipulated by the Exchange, the new disclosure requirements will apply to all existing Share Schemes as at the Effective Date.

For share option schemes or share award schemes adopted prior to the Effective Date, issuers may continue to grant options or new shares under existing Share Schemes or advanced mandates (but only to Eligible Participants (as defined in the amended Listing Rules) from the financial year commencing on or after the Effective Date), until the refreshment or expiry of the existing scheme mandate, upon which the issuer must amend the terms of the scheme to comply with the new Listing Rules. Any new Share Scheme adopted on or after the Effective Date must also comply with the new rules.

For share award schemes adopted by way of general mandate, share grants may be made up to the sooner of: (i) the date of the second annual general meeting after the Effective Date, and (ii) the amendment of an existing scheme or adoption of a new scheme to comply with the amended Listing Rules.

¹ For example, by way of specific grant of new shares at a general meeting or general mandate approved by shareholders. The Exchange has also allowed, in certain instances, use of advanced mandate.
² Though in the case of related entity participants and service providers, the Exchange may require publication of the views of the INEDs of the issuer on whether the inclusion of these participants aligns with the purpose of the scheme and the long term interests of the issuer and its shareholders.