Guidelines from SEHK on the adequacy of activities | China

a The company must draw attention to its business activities during an IPO, but even after a successful IPO it must still maintain sufficient activities. The Stock Exchange of Hong Kong (SEHK) published its revised guidelines on principles in assessing business adequacy in January 2024 and provided examples of non-compliance with that requirement.

Rule 13.24 of the Main Board Listing Rules and rule 17.26 of the GEM Listing Rules require a listed company to carry on a business with a sufficient level of activity and assets of sufficient value to support its activities and thus the continued listing of its securities. This is a qualitative test, as the rule does not include a numerical standard for sales, profits, assets, or cash flow to prove “adequacy.” The SEHK makes assessments based on the specific facts per case.

Negative examples

The following paragraphs show several examples where the company has failed to meet the business adequacy requirement:

• A publicly traded company traded exclusively in coal and had annual sales of $1.4 million from a few customers. It had acquired coal mining rights but was not allowed to commence exploration due to legal restrictions. It suffered losses and had total assets of $2.6 million and net liabilities of $7.7 million. Plans to improve operations lacked details.
• A company involved in the retail sale of used motor vehicles has seen its turnover fall by 95% in the past five years. It recorded net losses and negative operating cash flows, with total assets reaching USD6.4 million. It would discontinue these activities and start wholesale distribution of new branded vehicles. However, the company’s wholesale operations had a short operating history and a limited customer base.
• A GEM-listed company closed down its metals business, which accounted for 90% of its turnover. It started a number of new companies that were unrelated and involved little activity. The company had a net loss of $7.7 million over the past six months and had net liabilities of $51 million.
• After significantly scaling back its original fashion accessories business, a company started a new business through the acquisition of a software and application development company. Goodwill arising from the acquisition represented half of the total assets of USD35.9 million. Subsequently, the entire software development team left the company, resulting in the suspension of the new company. The accountant has issued a disclaimer of opinion on the annual accounts due to concerns about the realizability of the goodwill.
• A company proposed to divest its major operations to the controlling shareholder, who would in turn sell his entire stake in the company to an investor. The company could not demonstrate that the remaining businesses were viable and sustainable.
• A company proposed to sell a 25% stake in its main operating company and granted the buyer an option to acquire the remaining 75% stake 24 months later. Because the company’s operations and assets were primarily conducted and held through the operating company, there would be no material operations or assets left once the buyer were to exercise its option.
• One company proposed to divest its construction sector, which accounted for 70% of its turnover and assets. The other companies that were acquired or established in the past year had recorded a loss or minimal profit in the last financial year.
• A company acquired a consultancy services business and then in less than six months proposed to divest the packaging sector, which is responsible for the entire turnover and net profit. The consultancy company’s turnover rose by more than 99% shortly before the takeover and most of the increase came from one customer.

Principles apply

It is more likely that the SEHK will consider the following circumstances as insufficient activities:

1. The core activities of the listed company are stopped, substantially reduced or deteriorated. The remaining operations do not generate enough revenue to offset operating expenses, resulting in net losses and negative operating cash flow on a structural, rather than temporary, basis.
2. The company proposes to acquire or start a new business with only a short operating history to demonstrate its viability and sustainability.
3. Some listed companies conduct their main business activities solely to maintain their listed status, rather than actually developing such activities. Common signs include a low barrier to entry/exit and a limited number of transactions or customers. These may relate to money lending businesses with only a few employees and a high concentration of customers, or to trading activities that add little or no value to the business.
4. Companies that are in financial difficulties, become insolvent or lose their main subsidiaries may no longer have sufficient operations, especially if there are no concrete recovery plans.

SEHK assessment process

The SEHK assesses whether a listed company has sufficient activities
will take into account factors such as the business model, the nature of the business, the scale of operations, the history of existing and new businesses, the composition of assets and whether a transfer of a majority stake is proposed.

Nevertheless, a decision of the listing department of the SEHK may be annulled by the listing committee or the listing committee.

Zhong Ji Longevity Science Group announced on July 25, 2022 that the listing review committee had overturned the decision of the listing committee, which had affirmed the listing division’s assessment that the company failed to maintain a sufficient operating level. The listing review committee concluded that the company’s cash lending business was sustainable and met operational adequacy requirements.

Rossana Chu is a partner at YYC Legal