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Revision of the TSE Listing System

On May 19 2009, the Tokyo Stock Exchange (TSE) announced that it will revise its listing system, including its rules. These revisions are scheduled to be implemented in August 2009 with some exceptions.

Before the announcement, the Advisory Group on Improvements to the TSE Listing System published a proposal entitled For Creating A Better Market Environment Where Investors Feel Secure on April 23 2009. The proposed revisions to the listing system are based mainly on this proposal.

In the proposal, the Advisory Group mainly discussed private placements to third parties and reverse stock splits, in response to requests from investors.

Under the Companies Act a listed company may, in principle, issue new shares within the limit of its authorised shares and allocate them to a specific third party (a private placement) solely by a resolution of the board of directors. This allows listed companies to realise flexible financing. However, the framework also allows listed companies to easily dilute the voting rights of existing shareholders and to arbitrarily select large shareholders to whom the shares are allocated. If such actions are permitted without restrictions, existing shareholders' interests may be substantially impaired by corporate decisions. Consequently, in such cases, not only are investment incentives reduced, but corporate governance of the listed companies is of little real value.

The Advisory Group's proposal also identified some problems with reverse stock splits. The Companies Act permits a stock company to conduct a reverse stock split on the basis of a special resolution of its general shareholders meeting. However, reverse stock splits can significantly affect minority shareholders; as a consequence of a reverse stock split, minority shareholders may find themselves holding less than one share and lose their status as shareholders.

Under the Companies Act, if any fraction less than one share is generated, a stock company must sell the number of shares equivalent to the total sum of the fractions and deliver the appropriate proportion of proceeds to the shareholders in exchange for their respective fractional shares. These shareholders may be further impacted because the Companies Act does not guarantee that the shareholders will receive proceeds based on a "fair price". Moreover, in order to avoid a drop in the stock price of the company, the sale process may be delayed.

Taking the above issues into consideration, the TSE has decided that adjustments to the listing system are necessary. The main changes to be implemented are described below.

First, regarding private placements, the TSE will be able to apply delisting measures to listed companies that carry out private placements where the ratio of (i) the number of votes attached to shares to be issued to (ii) the total number of votes attached to issued and outstanding shares before the placement (dilution ratio) exceeds three-to-one. These dilution ratios were identified by the Advisory Group in the proposal as capable of severely impairing the rights of existing shareholders. Furthermore, the TSE may apply delisting measures if a private placement results in a change in the controlling shareholders, and during the three-year period following such a change, the soundness of transactions with such shareholders is found to be significantly lacking.

Moreover, the TSE will create a new rule as one of the "items to be observed" in the Corporate Code of Conduct, which works as a guideline for listed companies of the TSE. Under this rule, if the dilution ratio of a private placement is one-to-four or more, or if a change in controlling shareholders of a listed company occurs as a result of a private placement, the company must obtain an objective opinion regarding necessity and reasonableness of that placement from an independent committee or others that maintain certain independence from the company management, or confirm that it has the support of shareholders through a resolution at a general shareholders meeting. If the listed company violates this rule, sanctions such as a public announcement may be imposed by the TSE.

Second, as for reverse stock splits, if listed companies implement reverse stock splits that deprive some shareholders of their voting rights, and such shareholders' interests are unreasonably harmed, the TSE may also subject these companies to delisting measures under the new rules.

Through the threat of delisting and the additional requirements of support and objectivity, the TSE plans to prevent private placements to third parties and reverse stock splits that impair the rights of existing investors.

The TSE has announced these revisions as part of an effort to protect shareholders and investors and as a way to increase market credibility. However, as some critics caution, stronger restrictions against private placements to third parties leads to concerns that such restrictions may prevent flexible financing and ultimately have a negative effect on the capital markets, especially in light of the current market conditions.

Eiji Takao, Akihiro Ishikawa and Akira Matsuda

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