Starting from May 1, 2023, convertible preferred shares and redeemable convertible preferred shares issued by listed companies also became subject to the same call option and refixing regulations applicable to convertible bonds (“CBs”).
For the purpose of preventing the misuse of convertible bonds and bonds with warrants (collectively referred to as “CB/BWs”) in connection with unfair trade practices such as increasing the largest shareholders’ shareholding through circumvention of legal requirements and dilution of the value of existing shareholders’ shareholding, the Financial Services Commission (the “FSC”) previously amended the Regulations on the Issuance and Disclosure of Securities (the “Securities Issuance and Disclosure Regulations”), which became effective on December 1, 2021.
Accordingly, in cases where listed companies issue CB/BWs, the amended Securities Issuance and Disclosure Regulations (i) impose a public disclosure obligation on the issuers in relation to a third party’s exercise of a call option to purchase the CB/BWs (strengthened call option disclosure obligations), (ii) place a limit on call options that may be granted to the issuer’s largest shareholders and specially related parties, and (iii) require the issuers to make an upward adjustment of the conversion price of CB/BWs issued through private placement, which grants the issuers discretion to make a downward adjustment of the conversion price (“refixing”).
Following the amendments to the Securities Issuance and Disclosure Regulations, on September 7, 2022, the FSC announced “Convertible Bond Market Inspection and Additional Supplementary Measures,” which strive to similarly implement call option and refixing regulations in regards to convertible preferred shares and redeemable convertible preferred shares (collectively referred to as “Preferred Shares”). In light of the above, the FSC announced on December 27, 2022 a plan to amend the Securities Issuance and Disclosure Regulations to apply the regulations on call options and refixing regarding Preferred Shares issued by listed companies. This was followed by the FSC’s resolution to approve such amendment on March 29, 2023 (Link).
Although Preferred Shares are similar in economic substance to CBs in that they are both mezzanine securities with combined characteristics of equity stocks and debt securities, the FSC excluded Preferred Shares from the scope of products to undergo systemic improvement in 2021 on the basis that, unlike CBs, Preferred Shares are mostly issued by unlisted companies.
However, in its Convertible Bonds Market Inspection and Additional Supplementary Measures announced in September 2022, the FSC introduced a plan to implement supplementary measures to prevent the misuse of the Preferred Shares in unfair trade practices, in consideration of listed companies’ continued issuance of the Preferred Shares with call option and refixing features. The key objectives of such supplementary measures are to (i) prevent the misuse of Preferred Shares as means to increase the largest shareholders’ shareholding through circumvention of legal requirements and (ii) maintain consistency in regulations across different types of securities. The FSC appears to have introduced the latest regulatory change as part of such supplementary measures.
The key details of the amended Securities Issuance and Disclosure Regulation are as follows:
Disclosure of Preferred Share Purchase Option Granted to Third Party
A disclosure obligation will be imposed on a listed company that issues Preferred Shares if (i) a third party exercises a call option to purchase the Preferred Shares or (ii) the issuer decides to acquire the Preferred Shares it has issued and subsequently sells said Preferred Shares to a third party (e.g., by the issuer’s exercise of a call option or the shareholder’s exercise of a put option).
Imposition of Limit on the Exercise of Call Options by Largest Shareholder
If a listed company issues Preferred Shares that grant a call option to its largest shareholders or to specially related parties, the exercise of the call option will be limited to the shareholding proportion of the largest shareholders or specially related parties at the time of issuance of the relevant Preferred Shares.
Improvement of Conversion Price Adjustment System
When a listed company issues Preferred Shares through private placement, if the company has the discretion to make a downward adjustment of the conversion price in the event the market price of the underlying stock falls, it must also make an upward adjustment in the event the market price of the underlying stock bounces back.
In addition, the amendment stipulates that (i) when a listed company issues Preferred Shares through public or private placement, the conversion price shall be equal to or greater than the threshold price determined in accordance therewith (as in the case of the issuance of Preferred Shares); (ii) the exercise of conversion rights for Preferred Shares issued through public placement shall be prohibited during a one-month period starting from the issuance date; and (iii) the exercise of conversion rights for Preferred Shares issued through private placement shall be prohibited during a one-year period beginning from the issuance date.
The recent amendment to the Securities Issuance and Disclosure Regulations is significant in that the regulatory requirements applicable to CB/BWs now apply to Preferred Shares as well. Please note that the regulatory requirements on Call Options and Refixing features apply to Preferred Shares approved to be issued by a resolution of the issuing company’s board of directors on or after May 1, 2023, the effective date of the amendment.