Hong Kong-listed issuers are currently holding EGMs to vote on amendments to their articles of association that will result in A shares and H shares no longer being deemed different classes of shares, and the consequential removal of class-specific meetings and votes.

Our article explains the context of this change, what it means for shareholders, and why Glass Lewis’ benchmark policy will typically recommend voting against the amendments.

Background

On February 17, 2023, The State Council of the People’s Republic of China (“PRC”) and The China Securities Regulatory Commission announced the implementation of a new regulatory framework for the overseas listing of PRC issuers.

The new PRC regulations repealed the Special Regulations on the Overseas Offering and Listing of Shares by Joint Stock Limited Companies and the Mandatory Provisions for Companies Listing Overseas. Under those provisions, holders of a PRC issuer’s domestically listed shares (“A shares”) and holders of its Hong Kong listed shares (“H shares”), were treated as different classes of shareholders, notwithstanding the fact that both A and H shares are ordinary shares. As a result of this distinction, any proposal to vary the rights of a particular class required the approval of at least two-thirds of each class of shareholders in separate class meetings, in addition to approval of at least two-thirds of all shareholders in a general meeting.

Under the new regulations, A shares and H shares are no longer deemed to be different classes of shares. Consequentially, PRC issuers proposing to vary the rights of one class of shareholders are no longer required by PRC law to hold separate class meetings for holders of A shares and H shares. Instead, such proposals can now be approved by way of an ordinary resolution in a general meeting of all shareholders.

Following the regulatory updates in the PRC, the Hong Kong Stock Exchange (“HKEX”, or “the Exchange”) issued a Consultation Paper on February 24, 2023, proposing amendments to the Listing Rules (“Rules”) intended to reflect these changes in the PRC regulatory framework.

These changes include consequential rule amendments aimed at removing specific requirements aligned with the repealed PRC regulations, most notably the: (i) class meeting and related requirements for the issuance and repurchase of shares by PRC issuers; and (ii) requirements for disputes involving H shareholders to be resolved through arbitration; as well as other ancillary provisions. In addition, the documentary requirements for new listing applications will be amended to reflect the PRC’s new filing requirements for overseas listings of mainland-based companies. Notably, although most class meeting requirements will be removed, the existing requirement for separate class meetings to approve de-listings and going-private transactions will remain.

What the Changes Mean for Shareholders

Class Voting

The removal of the requirement to hold separate class shareholder meetings means that H and A shareholders will lose the ability to vote as a class, separate from their counterparts, on the issuance or repurchase of shares, granting of special voting rights, or any other move to vary or abolish shareholder rights. Further, these resolutions will now only need to be passed at a general meeting, instead of three separate meetings (a general meeting, an A share class meeting, and an H share class meeting). This, coupled with the lower approval threshold of an ordinary resolution instead of a special resolution, will make it easier for such resolutions to be passed.

Despite the material impact of abolishing the class meeting requirement, this amendment was not subject to the market consultation. The Exchange took the view that because the Rule amendments were consequential of regulatory updates already enacted in the PRC, a market consultation was not required.

Calculating Dilution Limits

Since A shares and H shares will now be treated as the same class of shares, the Exchange also proposed to calculate the general mandate limit for issuances of new shares as 20% of the total issued shares of a PRC issuer, instead of 20% of each of A shares and H shares; and to calculate the limit for share repurchase schemes as 10% of the total issued shares, instead of 10% of each of A shares and H shares. As a result, decisions related to share issuance or repurchase, which directly impact share value and ownership percentages, could be made more easily.

One ‘Class’, But Differences Remain

While the PRC’s new regulatory framework is intended to remove class distinctions between PRC-listed A shares and HKEX-listed H shares, in practice, several crucial differences between the shares remain. For example, A and H shares are traded on different exchanges, subject to different regulatory requirements, and priced differently (with A shares normally being priced significantly higher than their H share counterparts).

These differences were cited by the Securities and Futures Commission (“SFC”) of Hong Kong, which clarified in a Guidance Note issued in March that “although H shares and domestic shares are one single class of shares under PRC law, the fact that H shares and domestic shares are not directly fungible with each other warrants a different approach when applying certain provisions of the Codes to PRC H Share Issuers.” The Guidance went on to confirm that, because of those differences, the SFC will still require a separate vote where an H share is to be de-listed or taken private under takeover rules.

Market Feedback and Responses

The consultation conclusions were published on July 21, 2023. 41 responses from listed issuers, market practitioners, industry associations, professional parties and other entities and individuals were received, with majority support for the proposed amendments. However, several respondents expressed concerns regarding the removal of class meeting requirements, which would potentially have an adverse impact on the interests of H shareholders.

Some respondents noted the SFC’s guidance regarding takeover proposals, and suggested that other types of resolutions could also have divergent impacts on A and H shareholders. The lack of uniform pricing, with A and H shares listed on different exchanges, means that A and H shareholders may not be entitled to equivalent value, e.g. when considering the terms of a capital raising or bonus share distribution. Moreover, the lack of a uniform regulatory environment means that A and H shares may hold different rights and entitlements, such as in the case of a rights issue.

Respondents also noted that the H class is typically, but not always, the smaller of the two classes. As the smaller class would lose their veto power against certain proposals, H shares would then be a less attractive investment to investors. Consequently, this would lead to the re-evaluation of the overall value proposition associated with risk profile and liquidity of H shares, which could further influence behaviour and alter the dynamics of the relationship between issuers and investors (in cases where the A shares represent the smaller class, the dynamics would be in the opposite direction, with influence accruing to the larger H share class and away from the smaller A share class).

Additionally, respondents highlighted the importance of class votes at controlled companies, where minority class shareholders would otherwise have no ability to influence voting on ordinary resolutions. This is a common ownership structure in China — over 30% of the PRC-listed companies in Glass Lewis’ coverage are controlled — and many investors have purchased H shares in these companies on the understanding that their right to a class meeting would protect them from the influence of the controlling party.

The Exchange’s Comments and Conclusions

The Exchange states that the removal of the class meeting requirements addresses the issue of fairness for all shareholders, as all shareholders of the same class are to be treated equally, preventing either A or H shareholders from vetoing proposals, even when they are a minority class in a controlled company. HKEX considers that a better approach to ensuring fairness for all shareholders is to promote good corporate governance in general, rather than giving special veto rights to each class.

The Exchange further states that the Rule amendments would also provide a consistent framework for the protection of investors of all issuers irrespective of their place of incorporation. In addition, the Exchange expressed that they would consider imposing an ongoing H share public float requirement in review of the public float requirements to address the potential reduction in the relative size and liquidity of the H share market if PRC issuers issue new shares primarily in the form of A shares after listing.

While the Exchange rejected respondents’ arguments about preserving class meeting requirements for most proposals, it nonetheless reiterated that H shareholders’ approval will still be required for matters affecting the listing or trading of H shares on the Exchange, which includes the withdrawal of H shares from the Exchange, as it directly impacts their ability to trade these securities.

Amendments in Action

The Listing Rule amendments brought about by the PRC regulatory updates and the market consultation have been effective since August 1st. However, HKEX has clarified that PRC issuers listed on the Exchange must comply with both the Listing Rules and their articles of association. As such, the repeal of the Mandatory Provisions for Companies Listing Overseas and changes to the Listing Rules don’t invalidate the existing articles of association, including class meeting requirements, which means that the class meeting requirements in the existing articles of association remain valid and binding upon PRC issuers until and unless they amend their articles of association to remove the requirements.

PRC issuers may voluntarily remove these requirements by obtaining approvals from A and H shareholders in separate class meetings as specified in their articles of association. This means that, given the lack of market consultation, the only opportunity that H shareholders (or A shareholders for that matter) may have to express their opposition to the abolition of the class shareholder safeguards will be by voting against article amendment proposals to remove class shareholder protections. This may pose a significant obstacle for companies seeking to conform with the latest PRC regulations given that to pass such proposals, companies must obtain approval of two thirds of shareholders at both the general and respective class meetings.

To date, we have seen a handful of proposals to amend articles of association to remove references to the requirement to hold class shareholder meetings. Most, if not all, have been met with significant opposition, often most apparent, unsurprisingly, in the class meeting of H shareholders.

Zhejiang Expressway was one of the first companies that attempted to amend their articles to reflect the regulatory changes in the PRC and to remove the requirement to hold class shareholder meetings. The proposal was scheduled to be put to shareholders at the company’s AGM on May 4th, but was later withdrawn from the meeting agenda. The company cited shareholder opposition and stated that they would await the publication of the consultation conclusions by the Exchange.

At Jiangsu Expressway’s AGM on June 20th, although the article amendment proposal made it to a shareholder vote and received support from almost 82% of ordinary shareholder at the AGM, it failed to receive the requisite support at the H shareholder class meeting, with an overwhelming 98% of H shareholders voting against the amendments. Despite the fact that H shareholders in attendance represented just over 14% of the voting rights in attendance at the meeting, and the fact that the proposal receive majority support in the general meeting, the resolution could not be passed due to the opposition received by H shareholders. As a result, Jiangsu Expressway will be bound by its existing articles and their requirement to hold class shareholder meetings, illustrating the veto-power instilled in H shareholders by the class meeting requirement that they are understandably eager to protect.

Glass Lewis Perspective

Glass Lewis’ benchmark policy is aligned with the concept of “1 share, 1 vote”, and generally opposes dual- or multi-class share structures, which can give small groups of shareholders disproportionate voting power via weighted voting rights or class voting requirements. However, we recognise that class meetings provide an important mechanism to protect shareholders when the rights and interests of different shares diverge.

Class meetings are most directly relevant for controlled companies, which represent a significant proportion of PRC-listed issuers. In this case, because of the differences between H and A shares that will remain despite the new regulatory framework, the protections afforded by class meetings are significant even in the absence of a controlling party.

With the removal of class meetings, the following outcomes can be anticipated:

  • Removal of Class Shareholder Veto: Class meetings allow shareholders in the smaller or minority class to collectively influence and block resolutions that could potentially infringe upon their rights or undermine their interests. The absence of class meetings could lead to a diminished level of protection for these shareholders. On the other hand, the removal of the class meetings may benefit the larger shareholder class and the issuer as a whole, who are no longer constrained by the need for approval from multiple classes.
  • Greater Risk of Dilution: Without the ability to collectively exercise veto rights through class meetings, the smaller class of shareholders may face a higher risk of dilution. Decisions related to share issuance or repurchase, which directly impact share value and ownership percentages, could be made more easily.
  • Change in Corporate Governance: The absence of class meetings might lead to a more concentrated decision-making power among major shareholders or corporate management in the larger shareholder class, potentially marginalizing the input and concerns of the smaller class of shareholders.
  • Potential for Litigation: Shareholders in the smaller class might resort to legal action to protect their rights and interests, potentially leading to an increase in shareholder litigation if they feel their voices are not adequately heard under the new rules.

We also find the concurrent removal of class distinctions when calculating issuance limits to be concerning. In our opinion, the current issuance limit of 20% of each of A shares and H shares is already excessive. Should class vetoes be removed, we strongly advocate for a reduction in both the issuance limit and the issue price discount to 10%. Such an approach would foster a more equitable balance and ensure that shareholders in the smaller class are not subjected to disproportionate adverse effects.

Overall, we believe the removal of class meetings is to the disadvantage of the smaller shareholder class but to the advantage of the larger class, while the removal of class distinctions when calculating issuance limits poses risks to shareholders of both classes.

Voting Recommendations

Glass Lewis is typically limited to writing one Proxy Paper, with one set of voting recommendations, which can apply to both classes of shareholders. With this in mind, we will typically recommend voting against these amendments to articles of association on the basis that the divergence of interests between H and A shareholders warrants maintaining the existing system of class meetings and vetoes.

However, we will also highlight that this recommendation was not made in consideration of any one individual shareholder’s position, which is a significant limitation that may change any individual shareholder’s interests in the vote. As institutional investors can and do hold either, or both, A share and H share classes, their best interests are served by a consideration of their own position within the dual-class voting structure.

If shareholders are to vote in their own best interests:

  • Shareholders in the smaller class, who currently hold a veto, should vote against the amendments, aligning themselves with the retention of the class meetings and therefore veto rights; whereas
  • Shareholders in the larger class should vote for the amendments, aligning themselves with the abolishment of the class meetings.

Given that smaller-class shareholders have a veto over any vote that impacts their class meeting rights, significant opposition will be enough to keep class meetings intact.

 

Laura McDonald is also an author of this report.