Paying for a rights issue or open offer with a stock loan

Part of the Facility Structuring & Terms Guide — view the full guide

Rights issues and open offers ask existing shareholders for cash on a fixed timetable. For a controlling shareholder whose wealth sits in the shares, borrowing against the existing holding is one way to take up the entitlement without selling.

This note explains why controlling shareholders give irrevocable undertakings, how a stock loan funds the subscription, what happens to nil-paid rights on pledged shares, and where the Takeovers Code limits apply. It covers the Main Board rules; GEM has its own equivalents. It is orientation, not legal advice.

Why do controlling shareholders give irrevocable undertakings?

No rule requires one; the reasons are commercial, such as signalling support or reducing the need for underwriting. Where an issue is not fully underwritten, the listing document must state whether each substantial shareholder has undertaken to take up its entitlement, and on what conditions.

Underwriting has been optional since 3 July 2018. Main Board Rule 7.19 says rights issues "need not be underwritten", and Rule 7.24 applies the same to open offers. Where an issue is underwritten, the underwriters must normally be licensed for dealing in securities and not connected persons, or be the issuer’s controlling or substantial shareholders.

Rule 7.19(3) sets out what the listing document must disclose when an issue is not fully underwritten, including the statement about each substantial shareholder’s undertaking. The same rule warns that a shareholder taking up its full entitlement may unwittingly incur an obligation to make a general offer, and lets the issuer scale applications down to avoid one.

If a controlling shareholder underwrites the issue itself, the issuer must use a compensatory arrangement for unsubscribed shares rather than excess applications (Rules 7.21(2) and 7.26A(2)). Minority approval is needed in defined cases, such as a rights issue that would increase the issued shares or market capitalisation by more than 50%, or an open offer not made under a general mandate; controlling shareholders then abstain from voting in favour.

How does a stock loan fund the subscription?

The holder borrows against the existing shares and pays the subscription money through its CCASS participant before HKSCC's cut-off, which falls before the issuer’s own deadline. The new shares can then be added to the collateral under the facility’s terms.

HKSCC’s procedures set the practical deadlines. For a rights issue, a participant’s subscription instruction is normally due before 11:00 a.m. on the deadline day, and HKSCC may not act on it if the money is not in place by 1:00 p.m. For an open offer, participants other than investor participants normally instruct by 7:00 p.m. one business day before the last day for subscription.

So the loan has to be drawn, and the cash in the participant’s designated bank account, earlier than the issuer’s timetable suggests. Drawdown timing, the advance against the enlarged holding and whether the new shares are charged automatically are commercial terms that vary by facility. Whether the new shares add to borrowing capacity turns on the same screen as the old ones, set out in our note on which HKEX stocks can be pledged.

One Takeovers Code point applies to the lender. A financier that is not an authorised institution under the Banking Ordinance and provides finance in connection with an acquisition of voting rights is presumed to act in concert with the borrower unless the contrary is established (class 9 of the definition of acting in concert). Taking up new shares adds voting rights, so the presumption can matter near a threshold.

For a director, the Model Code applies as well. Creating a pledge to secure the loan is a dealing, as is any excess application, while taking up the entitlement is not. Our note on directors, the Model Code and pledging HKEX shares covers clearance and the black-out periods.

What happens to nil-paid rights on pledged shares?

For shares held in CCASS, the rights are credited to the stock account that holds the pledged shares, so selling, exercising or moving them needs whoever controls that account. Whether the security extends to the rights and the new shares depends on the security document.

Nil-paid rights are the renounceable entitlement to subscribe in a rights issue. They are issued on provisional allotment letters and trade on the Exchange as temporary securities before the subscription deadline, and the acceptance period must be at least 10 business days (Main Board Rule 7.20). In a rights issue, selling part of the rights to fund the rest is one option.

An open offer has no nil-paid rights: no renounceable document is issued, so the entitlement cannot be traded. Entitlements not taken up go to excess applications or to placees under a compensatory arrangement (Rules 7.21(1) and 7.26A(1)). Letting them lapse is not a Model Code dealing, but the Takeovers Code normally treats the dilution as a disposal of voting rights.

How does the timetable line up with the loan?

The issuer’s timetable fixes every date, so the loan has to fit it. Entitlements follow the holding on the record date, nil-paid rights trade for at least five business days, and acceptance and payment fall due three business days after their last trading day.

HKEX’s guide on trading arrangements for corporate actions gives the durations. A rights issue needs at least six business days’ notice of book closure and at least two trading days cum-entitlement after that notice. Its acceptance period runs at least 10 business days from the day after the provisional allotment letters are sent.

An open offer needs at least 10 business days’ notice of book closure and stays open for at least 10 business days. A general meeting lengthens the timetable: in HKEX’s sample timetables, the payment deadline moves from day 22 to day 34 for a rights issue, and from day 26 to day 34 for an open offer.

For the loan, three dates matter most: the record date, which fixes the entitlement; HKSCC’s payment cut-off, by which the cash must be in place; and the crediting of the new shares, after which they can join the collateral. Where the subscription is one step in a longer plan, our note on longer-tenor and follow-on facilities covers upsizing an existing facility.

What if taking up excess shares moves my holding past a Takeovers Code threshold?

Then a mandatory general offer may be required unless the SFC Executive grants a whitewash waiver. An offer is triggered by reaching 30%, or, for a holder between 30% and 50%, by rising more than 2% above its lowest holding in the previous 12 months.

The Listing Rules cap a controlling shareholder’s excess applications. The issuer must disregard excess applications by a controlling shareholder and its associates beyond the total number of securities offered minus the number they take up under their assured entitlements (Main Board Rule 7.21, with Rule 7.26A for open offers).

Under Note 1 on dispensations from Rule 26, a whitewash waiver is normally granted if independent shareholders approve the waiver by at least 75% and the issue by more than 50% of the votes cast (SFC: the Takeovers Code). Buying or selling voting rights between the announcement and completion can invalidate it, and the circular must say whether the new shares will be transferred, charged or pledged, and to whom.

Two further points affect the borrower. Letting rights lapse lowers the base from which the 2% creeper is measured, which limits later purchases. And whether creating or enforcing a pledge in the whitewash window counts as a disposal is not settled by the Code’s text, so confirm it with Hong Kong counsel first. An enlarged holding may also bring filings under SFO Part XV, covered in our note on Part XV disclosure for stock loans.

This article is educational and is not legal or regulatory advice. How the Listing Rules, the Model Code and the Takeovers Code apply to a particular subscription and pledge is a question for your own Hong Kong legal counsel and the issuer’s advisers. Hong Kong Stock Loans acts as an arranger and introducer in collaboration with SFC-licensed counterparties.

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