Hong Kong’s Securities and Futures Commission has tabled sweeping changes to syndicate structures for debt and equity offerings in an effort to improve transparency around bookbuilding and stamp out bad practices.
The SFC's consultation paper on conduct in capital markets, released on Monday, formalises proposals first discussed with market participants in November.
It calls for issuers to name an overall coordinator (OC) to handle bookbuilding for all equity and bond offerings, similar to the sponsor role on an IPO, and disclose underwriting fees in advance.
The SFC said the proposals would curb the use of inflated orders from intermediaries looking to join the syndicate or inflate their fees during bookbuilding, reducing the risk of deals pricing at an unsustainable level. It also outlined clear guidelines around the use of rebates and "X orders" to limit conflicts of interests.
Bankers have mostly welcomed the proposals as a step in the right direction, although many expressed doubts about their impact in the competitive Hong Kong market.
"It’s a good development, but it will probably have a limited impact as we still have banks promising huge bids before they are appointed,” said a DCM banker.
Market observers also questioned whether the more onerous requirements would drive business away from Hong Kong – especially in the bond market, where many deals can easily be run out of Singapore.
New titles
Under the draft code, one or more bookrunners would be named as an OC and held responsible for running the book and making pricing and allocation recommendations to the issuer. In an IPO, at least one OC must also act as sponsor.
Other bookrunners may receive a joint global coordinator title even if they are not doing the work of an OC, but those bookrunners should not give an issuer pricing and allocation advice.
The SFC will require the OC to record any changes in orders made during the process – as well as to note whether issuers ignored their advice on pricing and allocations. The draft code does not state whether other members of the syndicate will be allowed to see the book too.
The new regime also calls for titles and fees to be decided well in advance. Under the proposed code of conduct, issuers would have to appoint their equity syndicate and decide their fee structure at least four days before an IPO listing hearing, while for a bond offering these matters should be decided “early in the process”.
The proposals aim to tackle problems with a fluid syndicate structure that have escalated in recent years with the influx of Chinese competitors in the Hong Kong market.
It has become common for debt and equity offerings to feature dozens of joint bookrunners and for titles to change during execution as issuers reward the arrangers that deliver the biggest orders. Despite reforms in 2013 to hold IPO sponsors more accountable, fees are still skewed towards underwriting performance, encouraging bookrunners to inflate orders or place more emphasis on quantity than quality, potentially driving up the price of an offering.
The SFC will require the split of fees between syndicate members to be decided in advance. While discretionary fees – a common incentive on Hong Kong IPOs – will be allowed, it expects this portion to be no more than 25%–30% of the total.
ECM bankers generally welcome the push to determine the roles and fees earlier in a deal, but they do not think this will help stop the issuers from pricing their deals too high.
“For us, given we are mostly sponsors on deals, it is always good to determine the roles and fees earlier," said a senior ECM banker at a US bank. "The requirement of an overall coordinator is also very similar to current IPO practice too, which is one or two main sponsors being the key contact point to the issuer and leading the overall IPO process from marketing to pricing."
An ECM banker at a Chinese bank said the new rules may result in "a slightly slimmer syndicate structure".
“Issuers are also likely to ask banks to show them potential orders earlier before they determine roles and fees for each bank. It’s still the same, but just the process has been brought forward. There would still be inflated orders with no price sensitivity, and there would still be issuers who want to price the deals high even though all banks are against it,” said the banker.
No more Xs
In a clampdown on bond underwriting, the SFC's proposals will ban "X orders" and require the identities of all investors to be disclosed to the OC and the issuer. Names may only be withheld from the order book for orders placed on an omnibus basis.
Syndicate members will also be barred from placing knowingly inflated orders.
The regulator expressed serious concerns about the transparency of order books and potential conflicts of interest among bookrunners. It said that in one recent bond offering, an investor informed an intermediary of its intention to subscribe for US$5m, but the intermediary placed an order of US$20m.
In other bonds, bookrunners have refused to share the identity of the investors with the syndicate, making it impossible to judge the quality of allocations. Sometimes SSAs like sovereign wealth funds may place X orders for privacy reasons, or bookrunners may withhold the name to prevent other arrangers from poaching their client, but bankers claim that X orders are often misleading: some are placed to receive a favourable allocation by implying it came from an important investor, while others may conceal that they are proprietary or come from a related party, such as a bank’s asset management arm.
The measures will please many DCM syndicate managers, especially those at international firms who argue they are held to higher standards elsewhere.
“X orders exist in Europe for SSAs, but it doesn’t trigger the kinds of behaviour you get here because it’s run under MIFID,” said an Asia DCM syndicate head.
“It creates an incentive in terms of allocations which is not in the interests of the market. If I am B&D [billing and delivery] bank, it’s my responsibility to judge the quality of the book, and I can’t do it if there are X orders.”
Rebates, another controversial feature of the Hong Kong market, are also to be regulated. The SFC proposes to ban bookrunners from subsidising the 1% brokerage fee on IPOs, and to prohibit private banks from passing on rebates on bond issues to their investor clients. The OC will be responsible for disclosing any preferential investor treatment, and for advising an issuer to ensure all investors participate in an offering at the same price.
Limited impact?
Despite broad support for a tighter bookbuilding regime, some market participants questioned how effective the rules would be in practice.
In DCM, many deals could be easily moved elsewhere if compliance is too onerous.
“A lot of Chinese bond issues are almost loan-like in character, so if it’s too much of a pain they will move to loans or onshore deals,” said one observer.
The SFC said the proposed code would not apply to debt offerings that were club deals arranged between an issuer and investors. That could arguably apply to many Chinese US dollar offerings in which bookrunners are also investors and pricing appears to have been decided in advance – potentially allowing some bond deals to avoid regulatory attention.
The first ECM banker also questioned why Hong Kong needed to introduce the regulations.
"Why does Hong Kong’s regulator have to interfere with a heavy hand on deals, while other markets such as the US are actually giving issuers and banks more flexibility?” the banker said.
The proposed code will cover IPOs, equity placements, and all kinds of debt offerings involving bookbuilding or placement by intermediaries in Hong Kong.
Market participants have until May 7 to give their feedback.