Hong Kong: Hong Kong SPACs: Five Things You Need To Know

Requirements:

• A SPAC promoter must meet suitability and eligibility requirements at the listing of a SPAC and until completion of a de-SPAC transaction.
• The Stock Exchange will consider the SPAC promoter's relevant experience, investment management experience, and other relevant experience in assessing a SPAC promoter's character, experience, and integrity.
• A SPAC promoter will be viewed favorably if they have:
  • Experience managing assets with an average collective value of at least HK$8 billion for at least three consecutive financial years; or
  • Held a senior executive position (for example, CEO/COO) at an issuer that is or has been a constituent of the Hang Seng Index (or equivalent).
• Importantly, at least one SPAC promoter must hold: (a) at least 10% of the promoter shares; and (b) be a firm that holds a Type 6 (advising on corporate finance) and/or a Type 9 (asset management) license issued by the Securities and Futures Commission (SFC). 
• Type 6 and Type 9 licenses can be described as:
  • A Type 6 (advising on corporate finance) license is held by a corporation acting as an IPO sponsor, or advising on the Takeovers Code and the Hong Kong Listing Rules. Examples of these corporations include initial public offering (IPO) sponsors and financial advisers.
  • A Type 9 (asset management) license is held by a corporation carrying on asset management business in Hong Kong. Examples of these corporations include asset management and private equity firms.
• No limit on the number of SPAC promoters for a SPAC.
• Any material change in SPAC promoters would require a special resolution of independent SPAC investors and would trigger a redemption right for those investors voting against the change.

MoFo Commentary:

• While certain markets require a qualitative assessment of the suitability of SPAC promoters, the proposed requirements in Hong Kong are stricter than what is required in other markets and is driven by the Stock Exchange's emphasis on having a high quality regime with high quality promoters and high quality targets.
• The Stock Exchange's assessment of a SPAC promoter's suitability is qualitative . There is guidance from the Stock Exchange on information that the Stock Exchange will take into account in considering whether a SPAC promoter is suitable, including whether it has promoted other SPACs, the terms of any de-SPAC transaction, and the performance metrics of the successor company.
• We think the Stock Exchange has proposed these requirements because there is a concern that sub-standard SPAC promoters will lack the experience and expertise to find a de-SPAC target in time and to strike a good deal for the SPAC investors. Further, having at least one SFC licensed corporation involved in the SPAC listing and through to completion of the de-SPAC Transaction will we think enable the SFC to take enforcement action if it becomes necessary.

Requirements:

• The subscription and trading of a SPAC's securities are restricted to "Institutional Professional Investors" and "Individual Professional Investors" only (i.e., retail investors are excluded).
• Institutional Professional Investors are persons falling under paragraphs (a) to (i) of the definition of "professional investor" in section 1 of part 1 of schedule 1 to the Securities and Futures Ordinance (Cap. 571) (the SFO), including:
  • A recognized exchange company or clearing house.
  • A SFC-licensed corporation or SFC-registered institution.
  • An authorized financial institution.
  • An authorized insurance company.
  • An authorized collective investment scheme.
  • A registered mandatory provident fund scheme.
  • Government and central banks.
• Individual Professional Investors are persons falling under paragraph (j) of the definition of "professional investor" in section 1 of part 1 of schedule 1 to the SFO, including:
  • An individual having a portfolio of not less than HK$8 million.
  • A trust corporation with total assets of not less than HK$40 million.
  • Corporation or partnership having a portfolio of not less than HK$8 million or total assets of not less than HK$40 million.
• The Stock Exchange has proposed these restrictions because they believe that "Professional Investors" are better placed to assess, monitor, and mitigate the risks associated with SPACs.
• The above restrictions do not apply to the successor company though, whose securities will be freely tradeable amongst all investor types, including retail investors.

MoFo Commentary:

• The exclusion of retail investors in SPACs is unique to the Hong Kong market. While other markets acknowledge the risks associated, Hong Kong has taken it further by excluding participation of retail investors in SPACs altogether.
• We think the exclusion of retail investors is a step in the right direction especially when Hong Kong is in the nascent stages of establishing a SPAC regime.
• Given the exclusion of retail investors, we think there may be room for the Stock Exchange to consider relaxing some of the other requirements around a SPAC listing and a de-SPAC transaction, taking into account feedback from market participants.

Requirements:

• A SPAC investor can redeem all or part of its SPAC shares that it voted against on (a) a material change in the SPAC promoter; (b) a de-SPAC transaction; or (c) a proposal to extend the de-SPAC announcement deadline or de-SPAC transaction deadline, in the circumstances of a shareholder vote.
• However, any shares voted in favor, abstaining, or failing to vote on the above matters cannot be redeemed.
• Notwithstanding redemption of the SPAC shares, the SPAC warrants may be retained.
• No limit can be placed by the SPAC on the amount of shares a SPAC investor may redeem.
• The redemption price should be the price at which such shares were issued in the SPAC IPO plus accrued interest. This means that a SPAC promoter incurs all the expenses to establish and maintain the SPAC. This could ensure that a SPAC promoter's interests are better aligned with SPAC investors who do not wish to redeem.
• Redemption on a de-SPAC transaction is subject to completion and must be completed within five business days thereafter. Redemption on a material change in the SPAC promoter or a proposal to extend a de-SPAC announcement deadline or De-SPAC transaction deadline must be completed within one month from the date of the relevant general meeting.

MoFo Commentary:

• The Stock Exchange has proposed that only those independent SPAC investors voting against a de-SPAC transaction should be entitled to redeem their SPAC shares so that there is more alignment of interest between the SPAC promoters and the SPAC investors. In other words, SPAC promoters will have to ensure that the valuation of the de-SPAC target is fair and reasonable. Otherwise, there is a real likelihood that the de-SPAC transaction may be voted down.
• While we agree that this requirement would help ensure that the SPAC promoters will be incentivized to strike a good bargain for the SPAC, we think this requirement may be a challenge to the certainty of a de-SPAC transaction. We think other requirements proposed by the Stock Exchange, such as having a mandatory private investment in public equity (PIPE) of a reasonable size together with at least one asset management firm or fund (with asset under management of at least HK$1 billion) holding at least 5% should help ensure that the valuation of a de-SPAC target is fair.

Illustration:

We use a hypothetical de-SPAC transaction to illustrate the economics of a Hong Kong SPAC below.

Before de-SPAC Transaction:

Pro Forma Cap Table:

Pro Forma Warrant Table:

1. Assuming that size of SPAC IPO is HK$1 billion and the offering price is HK$10/per SPAC Unit (each consists of 1 SPAC share + 1/4 SPAC warrant)
2. Assuming that SPAC promoter pays HK$200,000 (~US$25,680) to subscribe for a number of promoter shares that reaches the upper limit of the Stock Exchange proposed dilution cap (i.e., 20% of all issued and outstanding shares of SPAC as of SPAC's listing)
3. Assuming that (a) the at-risk capital of the SPAC promoter is HK$25 million (2.5% of gross proceeds of SPAC IPO), which SPAC may use to pay for underwriting commission, IPO sponsor fees, other offering costs and use as working capital on a going forward basis, and that (b) SPAC promoter injects the HK$25 million at-risk capital into SPAC by purchasing a number of promoter warrants that reaches the upper limit of the Stock Exchange proposed dilution cap (i.e., 10% of all issued and outstanding shares of SPAC as of SPAC's listing for promoter warrants only) at HK$2/per promoter warrant.  
4. Assuming that the SPAC public shareholders receive a number of SPAC warrants that, together with the number of promoter warrants, reaches the upper limit of the Stock Exchange proposed dilution cap (i.e., 30% of all issued and outstanding shares of SPAC as of SPAC's listing for both SPAC warrants and promoter warrants).

After de-SPAC Transaction (Earn-Out Exception Exercised):

Pro Forma Cap Table:

Pro Forma Cap Table Post-Warrant Exercise:

1. Assuming that SPAC issues a number of additional promoter shares to the SPAC promoters after completion of the de-SPAC transaction that reaches the upper limit of the Stock Exchange proposed dilution cap for such "Earn-out exception" (i.e., 10% of all issued and outstanding shares of SPAC as of SPAC's listing). The Earn-out exception is linked to objective performance targets and should not be determined by changes in the price or trading volume of the successor company's shares. The Earn-out exception is also subject to SPAC public shareholders' approval.
2. Assuming that the size of PIPE investment meets the Stock Exchange proposed minimum requirement for a de-SPAC successor company with a post-closing expected HK$1.5 billion + market capitalization (i.e., 15% of HK$13.38 billion ~ HK$2.007 billion).
3. Assuming that the SPAC public shareholders and SPAC promoter exercise all SPAC warrants and promoter warrants.

MoFo Commentary:

• The Stock Exchange suggests capping promoter shares at 20% of the total number of shares the SPAC has in issue as at the initial offering date, with further issuance of up to 10% subject to earn-outs permitted as part of a de-SPAC transaction. Although there is no specific dilution cap on promoter shares required in the United States, in practice, the U.S. SPAC promoters customarily pay a nominal amount (US$25,000) to subscribe for approximately 20% of the total number of shares the SPAC has in issue as at the initial offering date. Accordingly, we think the cap suggested by the Stock Exchange is in line with the market practice.
• The 10% earn-out exception is unique to the Hong Kong market and may aid Hong Kong SPAC promoters in de-SPAC negotiations by working as a benchmark for the promoters to negotiate for the issuance of additional promoter shares, whereas it is rare for the U.S. SPAC promoters to receive such earn-out and it is becoming more common for the U.S. SPAC sponsors to face forfeiture of sponsor shares.
• Unlike the United States where there is no specific requirement on dilution cap on warrants, the Stock Exchange prohibits the Hong Kong SPAC from issuing warrants that (a) entitle the holder to purchase more than 1/3 of a share upon exercise; or (b) if exercised, would result in more than 30% of the number of the SPAC's shares in issue at the time such warrants are issued. The Stock Exchange also prohibits the Hong Kong SPAC from issuing promotor warrants, which if exercised would result in more than 10% of the number of the SPAC's shares in issue at the time such warrants are issued. The 10% dilution cap imposed on the promoter warrants is part of the 30% dilution cap imposed on all warrants issued by a Hong Kong SPAC.

• We think that a de-SPAC transaction may offer higher valuation certainty to the de-SPAC target. The valuation of a de-SPAC target is determined through negotiation among the SPAC promoters, the target shareholders and the PIPE (private investment in public equity) investors, which offers higher certainty than price discovery through a book building process in a traditional IPO and allows the use of customizable M&A tools (e.g., earn-out for target shareholders) to structure the delivery of a negotiated valuation in a more creative fashion. This feature would be particularly attractive to companies with no or few market comparables.
• With regard to PIPE investment, the Stock Exchange requires a mandatory outside independent PIPE investment to complete a de-SPAC transaction, which is to provide the market with additional comfort on the valuation.
• The mandatory outside independent PIPE investment should (a) constitute at least 25% of the expected market capitalization of the successor company (or 15% if the successor company's market capitalization is over HK$1.5 billion); and (b) result in at least one independent asset management firm or fund (with asset under management/fund size of at least HK$1 billion) owning at least 5% of the issued shares of the successor company as at the date of the successor company's listing. The requirement of having a mandatory PIPE to help ensure that the valuation of a de-SPAC target is fair and consistent with the Stock Exchange's emphasis on having a high quality regime with high quality targets.

The consultation period will end on October 31, 2021. Morrison & Foerster is talking to potential SPAC promoters and IPO sponsors who are interested in Hong Kong SPACs to seek their professional views and comments, and we will be providing our feedback and views to the Stock Exchange in due course.