Reforms to Public Offers of Unlisted Structured Products Regime

Introduction

Following the Securities and Futures Commission (“SFC”)’s publication of the Consultation Paper and Consultation Conclusions on Possible Reforms to the Prospectus Regime in the Companies Ordinance (Cap. 32) (“ CO”) and the Offers of Investments Regime in the Securities and Futures Ordinance (Cap. 571) (“ SFO”) in October 2009 and April 2010 respectively, the Securities and Futures and Companies Legislation (Structured Products Amendment) Ordinance 2011 (“ the Amendment Ordinance ”) was passed at its Third Reading by the Legislative Council on 4 May 2011 and came into effect on 13 May 2011.

Regulation of Unlisted Structured Products under the SFO

Before the Amendment Ordinance was enacted, public offers of unlisted structured products in the form of a share or debenture are regulated under the CO regime, while public offers of unlisted structured products in a legal form other than a share or debenture are regulated under the offers of investments regime in Part IV of the SFO. After the enactment of the Amendment Ordinance, public offers of all unlisted structured products are now regulated under the SFO regardless of their legal form, while the offers of ordinary shares, preference shares and plain vanilla debentures (e.g. fixed rate bonds, zero coupon bonds, promissory notes) will continue to be regulated by the CO prospectus regime so long as they do not contain any derivative element.

New Definition of Structured Product

Under the new definition of “structured product” in the SFO, “structured product” means:
(a) an instrument under which some or all of the return or amount due or the method of settlement is determined by reference to one or more of-
(i) changes in the price, value or level of any type or combination of types of
securities, commodity, index, property, interest ra te, currency exchange rate
or futures contract;
(ii) changes in the price, value or level of any ba sket of more than one type, or
any combination of types, of securities, commodity, index, property, interest
rate, currency exchange rate or futures contract; or
(iii) the occurrence or non-occurrence of any specified event(s);

(b) a regulated investment agreement; or
(c) any interests, rights or property prescribed, or of a class or description prescribed, by notice under section 392 of the SFO as being regarded as structured products in accordance with the notice.
Examples of “structured products” under the new definition would include equity linked notes, credit linked notes, equity linked deposits and equity linked instruments.

The following are specifically excluded from the definition of “structured products”:

1. a debenture issued for capital fund raising purposes that is convertible into or
exchangeable for shares of the debenture issuer or its related corporation;
2. a subscription warrant issued for capital fund raising purposes that entitles the holder to subscribe for shares of the warrant issuer or its related corporation;
3. a collective investment scheme (i.e. funds);
4. a depositary receipt;
5. floating rate note(s);
6. employee incentive schemes; and
7. insurance contracts in relation to any class of insurance business specified in the First Schedule to the Insurance Companies Ordinance (Cap. 41). SFC’s Authorisation Required

Under the new Section 104A of the SFO (which is similar to Section 104 of the SFO for
collective investment schemes), all unlisted structured products that are to be offered to the retail public would need to obtain SFC authorisation. SFC authorisation will depend on compliance with the codes and guidelines published by the SFC, which include Section IV (Code on Unlisted Structured Investment Products) of the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes a nd Unlisted Structured Investment Products.

CO Safe Harbours No Longer Available

Following the amendments to the SFO and the CO, the two commonly relied on “minimum
denomination HK$500,000” safe harbour and the “no more than 50 persons” private
placement safe harbour contained in the CO would no longer be available to public offers of unlisted structured products. This has caused uncertainty as to what constitutes “public offers” as the SFC has refused to give guidance on this matter.

Available Exemptions After Amendment

Professional Investors Exemption

Although the CO safe harbours are no longer available, there remains the professional
investors exemption under Section 103(3)(k) of the SFO which exempts any advertisement, invitation or document made in respect of securitie s or structured products, or interests in any collective investment scheme, that are or are intended to be disposed of only to Professional Investors.

Authorised Financial Institutions Exemption

Any advertisement, invitation or document made in respect of the issue of a currency-linked instrument, an interest rate-linked instrument or a currency and interest rate-linked instrument by an authorised financial institution ( Section 103(3)(ea) of the SFO) are also exempted as they are generally regarded as banking transactions or treasury instruments of banks.