Stocks held in inventory by a listed company that were repurchased and made non-tradable. Under previous rules, repurchased shares were required to be canceled. However, under the new rules, companies listed on the Hong Kong Stock Exchange are not required to cancel repurchased shares, making them available for future sale.

The Hong Kong Stock Exchange stated that one of the reasons for amending the stock inventory mechanism in the Listing Rules is to keep pace with the international market. In general, company law in most jurisdictions does not restrict the use of stock inventory, providing companies with greater flexibility in managing capital. Second, the scenarios in which listed companies use the stock inventory mechanism are diverse. After the amendment, the company's enthusiasm to repurchase shares will be fully utilized to boost market confidence.

Hong Kong Stock Exchange's new stock inventory rules take effect today.

In April of this year, the Hong Kong Stock Exchange revised and released the "Listing Rules" and introduced a new mechanism for stock inventory (referred to as the "stock inventory new rules"). The new rules for stock inventory came into effect on June 11.

In general, compared with shares that are publicly traded on the open market, stock inventory refers to non-tradable shares that a listed company has repurchased and held in inventory. The associated shareholder rights (including stock dividends, distributions and voting rights) will be temporarily invalidated until the stock inventory is sold from the inventory or transferred into shares traded on the market. The number of shares in stock inventory is not calculated in the total number of shares issued when calculating earnings per share.

Before the amendment, the Listing Rules of the Hong Kong Stock Exchange stipulated that repurchased shares of a listed company must be canceled. The main purpose was to prevent companies from manipulating stock prices with frequent repurchases and sales of stock inventory or engaging in insider trading. However, with the passage of time, the Hong Kong Stock Exchange believes that this provision no longer meets the needs of the market. Many jurisdictions allow the existence of stock inventory. Currently, most issuers listed in Hong Kong are not registered and established in Hong Kong, and about 92% of issuers are registered and established in jurisdictions that allow the existence of stock inventory, such as the United Kingdom, the United States, Italy, Japan, and the Cayman Islands.

The company law in these jurisdictions generally does not restrict the use of stock inventory, providing companies with greater flexibility in managing capital. In order to keep pace with the international market and enhance the international competitiveness of the Hong Kong market, it is necessary to amend the Listing Rules of the Hong Kong Stock Exchange.

Interestingly, there are also market participants who oppose the Hong Kong Stock Exchange's move. During the public consultation period, foreign companies like BlackRock and Fidelity clearly expressed their concerns and believed that if the repurchased shares of Hong Kong stocks can remain outstanding, investors will usually anticipate that these stock inventory will eventually return to the market for sale, thereby causing institutions to include stock inventory when calculating earnings per share and weakening the positive effects of share buybacks on investors.

For example, last year's Ludashi announced a repurchase proposal, which boosted its share price. Afterward, it announced the cancellation of the proposal, but the Hong Kong Stock Exchange did not take any action. In the eyes of investors, it amounted to tacit approval of the company's infringement of small shareholder interests.

In order to prevent listed companies from manipulating the market or engaging in insider trading through frequent repurchases and sales of stock inventory and maintain market fairness and order, the Hong Kong Stock Exchange has added the following provisions to the new revised rules: 1. Within 30 days after the issuer repurchasing, it shall not sell any stock inventory on or off the exchange; 2. Within 30 days after the issuer selling stock inventory, it shall not repurchase any shares; 3. Prior to the disclosure of insider information, within 30 days before any performance announcement, a person who knows that the trading object is a core related party shall not resell any stock inventory.

However, both BlackRock and Fidelity believe that the suspension period of 30 days is too short to prevent issuers from repeatedly repurchasing and reselling stock inventory on the Hong Kong Stock Exchange to profit from trading, and it is also insufficient to solve the problem that reselling stock inventory on the Hong Kong Stock Exchange may cause or increase insider trading risks.

Facilitate Hong Kong-listed companies to flexibly finance.

According to the Hong Kong Stock Exchange, listed companies have many scenarios for using the stock inventory mechanism, such as:

Stabilizing stock prices: When the stock price is low, the issuer can repurchase company stock and turn it into stock inventory to send a signal to the market that its shares are undervalued and boost market confidence.

Flexible financing: The issuer can sell stock inventory in the market at market price to raise funds. This method of financing is usually better than allotting new shares because the allotted share price is usually lower than the market price.

Employee stock incentives: After repurchasing and turning the stock into stock inventory, the issuer can transfer the stock inventory to employees to incentivize them.

Mergers and acquisition payment tool: Transfer stock inventory to pay for acquired assets.

In simple terms, there are two primary scenarios in which stock inventory returns to the market: First, if the company has financing needs in the future, it can use stock inventory for low-cost financing. Second, after repurchasing stock inventory, companies can distribute it to employees as equity incentives.

In the US stock market, due to the modification of company law in the 1970s, the cost of dividend tax is higher than that of repurchasing shares, so repurchase has become the main form of shareholder return. As a result, most US stocks prefer to cancel repurchased shares, which is also one of the important driving forces for the long bull market in US stocks for decades.

According to journalist statistics, there have been a total of 173 listed companies that have engaged in share buybacks this year, with a total buyback amount of HKD 97 billion, among which the top 20 companies that bought back the most amount of shares accounted for about 95% of the total buyback amount, reaching HKD 92.1 billion. The proportion of the number of listed companies that engaged in buybacks is only 7%, indicating that there is still great room for improvement in buyback activities.

Under the new regulations for treasury stock, Hong Kong-listed companies can apply to the Hong Kong Stock Exchange for exemption during the silent period of their financial results for share buybacks. According to incomplete statistics, this year, companies such as Swire Pacific, Yum China, Kuaishou-W, and AIA Insurance have applied for exemptions to buy back their shares during the silent period.

Protecting the rights of small and medium-sized shareholders.

The Hong Kong Stock Exchange has also established corresponding safeguards under the new regulations for treasury stock, to ensure that listed companies comply with the regulations and prevent them from manipulating the market by frequently repurchasing and reselling treasury stock, protecting the rights of small and medium-sized shareholders.

Firstly, the new regulations have added disclosure requirements related to the disposal and changes of repurchased shares and treasury stock. Issuers must obtain shareholder approval for both on-exchange and off-exchange buybacks and disclose the reasons for the buyback in letters to shareholders. In addition, listed companies must disclose the details of any reselling of their treasury stock in accordance with the new regulations in their announcements, next-day reports, monthly reports and annual reports.

Secondly, under the new regulations, the resale of treasury stock is subject to the constraint of the preemptive purchase rights of shareholders, similar to the issuance of new shares. When reselling treasury stock, the issuer must offer shares to all shareholders proportional to their shareholdings, unless specific authorization has been obtained from the shareholders.

Thirdly, according to the new regulations, the treasury stock held by listed companies does not have voting rights, which helps prevent controlling shareholders or major shareholders from using such stock as a means to consolidate their control over listed companies, and it is also a way to protect small shareholders.

Fourthly, although the new regulations do not set any upper limit on the amount of treasury stock that listed companies may hold, they require that any reselling of treasury stock must be conducted according to shareholder authorization or be offered to shareholders for purchase proportionally. This helps fully protect the interests of the issuer's shareholders.

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