Hong Kong ramps up scrutiny on IPOs
Hong Kong's securities regulator is clamping down on poor quality listing documents after identifying some "serious deficiencies" in filings, warning that some bookrunners are failing to meet standards as they grapple with a surge in initial public offerings.
The city last year regained its place as the world’s top listing venue with more than US$37bn of proceeds, and applications are showing no sign of slowing down.
According to bourse operator Hong Kong Exchanges and Clearing, more than 100 companies filed listing applications in January alone, taking the total number of current listing applicants to more than 400, including 11 foreign companies.
The deluge of applications has been a welcome change for investment banks, which saw their revenues take a hit from slow business in the years after the pandemic. However, cracks are beginning to appear and the Securities and Futures Commission is concerned that sponsors – the banks that take a lead role in preparing listing applications – are taking on too many mandates.
“The gatekeeping role of sponsors in the listing process is critical to maintaining the quality of Hong Kong’s capital market and sustaining investor confidence in new listings that will hold up through all market cycles. That role may have been eroded in their eager pursuit of deal volume,” said Julia Leung, chief executive officer of the SFC, in a statement.
Most banks let go of dealmakers during the slowdown to cut costs and are struggling to hire the right talent at the pace needed to cater to the boom.
"The surge in listing applications coupled with downsizing in 2023 and 2024 has had a big impact on market participants, including investment banks, audit firms and law firms as to their production capacity," said Billy Au, a Hong Kong-based lawyer at Johnson Stokes and Master.
The SFC on January 30 issued a circular reminding banks to maintain standards after the Stock Exchange of Hong Kong and the SFC had sent a joint letter to some sponsors about their concerns in December. The SFC circular revealed that the regulator and the stock exchange had asked 13 sponsors to complete comprehensive reviews within three months on concerns raised for sponsor work. They also suspended the vetting of 16 listing applications as of December 31.
The regulator did not identify the 13 banks.
The SFC in its circular warned that it may suspend other applications if sponsors provide materially incomplete or unsatisfactory responses to regulators or if listing documents are "unreasonably lengthy".
It said that besides deficiencies in document preparation, sponsors had also failed to follow key regulatory processes, indicating they may not have a "thorough understanding of the listing applicants", or may have failed to perform reasonable due diligence before submitting applications.
“Some sponsors haven’t done their jobs properly and IPOs are coming to us which are of poor quality. With more than 400 IPOs coming, it’s just not manageable. Hopefully investment banks will prioritise their resources and focus on the good quality ones,” said HKEx chairman Carlson Tong Ka-shing at a media lunch.
Insufficient capacity
The SFC said it is concerned that sponsors have insufficient staff with appropriate knowledge, skills and experience. It also flagged that “principals,” who are responsible officers qualified to supervise transaction teams for IPOs, do not have sufficient capacity, and said that some sponsors have attempted to appoint principals that are not suitably qualified.
The regulator is capping the number of active listing engagements each principal can oversee at six and asking sponsors to submit the names, the number of appointed principals and the number of active listing engagements each is engaged in within two weeks.
CICC and Citic Securities are sponsors on 101 and 99 active deals in Hong Kong, according to IFR's analysis of public filings. They respectively employ 34 and 42 responsible officers currently, according to public data collated by Webb-site.com, a database created by the late Hong Kong-based activist investor and corporate governance evangelist David Webb. Huatai International, which is acting as a sponsor for 54 deals, has 26 responsible officers.
The data do not include confidential filings or work on listings that have not been filed yet, meaning the true number of deals is likely to be even higher.
According to IFR calculations, about 370 companies have publicly filed for IPOs.
Not all responsible officers are qualified to be principals for IPOs as they need to pass certain examinations. As such, it is impossible to know from public data exactly how many deals on average each principal is working on, but experts agree that these numbers indicate a resource crunch.
The SFC said all sponsors are required to report the ratio of active listing engagements undertaken to the number of appointed sponsor principals, and any staff engaged in IPO sponsor work who have not passed the required examination within a prescribed period.
Recruiters say there has been a rush to hire responsible officers and sponsor representatives in recent months, especially at second and third-tier banks, as investment banks compete for business.
“We have been poaching responsible officers from other firms to cope with the increasing IPO mandates. We have also asked our ROs who haven’t taken the sponsor-related exams yet to do so as soon as possible,” said an ECM banker.
The SFC said it will now require all individuals engaging in IPO sponsor work to pass certain examinations within three years of first working on IPOs.
The regulator also noted that some sponsors are relying too much on third parties including legal advisers, accountants and valuers to conduct certain tasks, without adequately assessing their competency.
Johnson Stokes and Master's Au noted that while the other market participants like audit firms and law firms are not under the supervision of the SFC, they need to comply with professional codes of conduct, duty of care, assist the sponsor in maintaining the quality of due diligence and ensure their team members are not over-stretched.
However “the listing sponsor needs to take overall responsibility of the due diligence of the listing applicant – whether from the legal side, the financial side or the business operational side”, he said.
China directive?
The increased scrutiny may be part of a broader effort to improve the quality of Chinese companies looking to raise funds through H-share listings.
China is considering introducing a minimum market capitalisation requirement for domestic issuers that are planning to list in Hong Kong, after a growing number of small Shanghai and Shenzhen-listed companies announced such plans, according to people with knowledge of the matter.
Some speculated that Beijing may also have given some direction to the Hong Kong securities regulator to keep a close eye on the quality of listing applications, noting that Chinese regulators often throttle the pace of IPO filings if they think the industry is at overcapacity.