Between 2009 and 2011, Hong Kong ranked as the leading initial public offering (IPO) center in the world, with funds raised totaling around US$120 billion. Following what was by comparison to previous years a relatively quiet 2012 for Hong Kong in terms of capital raisings, many observers predict a return toward the top of the global league table in 2013.
The obvious attractions of Hong Kong – its proximity to mainland China, a sound legal system based principally on English common law, a robust regulatory framework, a relatively low and simple tax regime, and the opportunity for issuers to broaden their investor base – were all key factors in high-profile names such as Glencore, Vale, Samsonite, Rusal, and Prada choosing to list in the jurisdiction in the past few years.
Although some market participants have decried aggressively priced offerings, claiming that these have undermined investor confidence in the region, it seems very possible that the sorts of problems that have recently beset issuers such as Bumi and ENRC in the London market will only serve to make Hong Kong seem a more appealing destination to companies looking to conduct IPOs in the years to come.
Legal and Regulatory Framework
The key piece of company law legislation in Hong Kong, the Companies Ordinance, sets out the prospectus requirements regarding the issuance of securities to the public in Hong Kong. Offering shares to the public in Hong Kong by way of a prospectus that does not meet the requirements set out in the Companies Ordinance may constitute a criminal offense. Civil and criminal liability may also attach in the event that a prospectus contains an untrue or misleading statement.
The principal securities regulator in Hong Kong is the Securities and Futures Commission (SFC). The SFC is an independent statutory body established almost 25 years ago and is responsible for administering the laws governing the securities and futures markets in Hong Kong pursuant to legislation known as the Securities and Futures Ordinance (SFO), as well as facilitating and encouraging the development of these markets.
The Stock Exchange of Hong Kong Limited (the Stock Exchange) operates and maintains the stock market in Hong Kong and is the primary regulator of companies listed on the Main Board (typically where more established entities seek a listing in Hong Kong) and the smaller Growth Enterprise Market (primarily for less well-established, growing firms). Issuers and potential entrants seeking a listing on the Main Board in Hong Kong are required to adhere to the Rules Governing the Listing of Securities on the Stock Exchange (the Listing Rules). There is a separate set of rules for securities and issuers with securities listed on the Growth Enterprise Market. Although the Listing Rules do not currently have a basis in statute, they establish the minimum requirements that an issuer and its securities must attain prior to listing.
The IPO Process
The listing methods and principal participants in the IPO process will mostly be familiar to those with experience in similar matters in the United States. An issuer may list its securities by offer for subscription, by offer for sale (i.e., the securities are already or will be in issue), by listing by way of introduction (usually when securities are already listed on another securities exchange and where there is normally no public offering in Hong Kong), and by way of a placing.
Prospective issuers are required to fulfill certain key criteria before they may list their securities in Hong Kong. The key requirements include:
- Satisfying a financial performance test (based on a market capitalization/revenue test, a profit test, or a market capitalization/revenue/cash-flow test);
- Being able to demonstrate an operating history spanning at least three financial years (as well as management and ownership continuity);
- Including audited financial statements in the prospectus that relate to a financial period ending no more than six months prior to the date of the prospectus (accounts prepared in accordance with IFRS are acceptable; U.S. GAAP is an acceptable standard under the Listing Rules for issuers seeking a secondary listing in Hong Kong and may also be considered on a case-by-case basis for primary listings);
- Satisfying the minimum public float requirement (as a general rule, 25 percent of the issuer’s total issued share capital must at all times be held by the public and not more than 50 percent of the securities in public hands can be beneficially owned by the three largest public shareholders);
- Maintaining a sufficient management presence in Hong Kong. This is usually satisfied by at least two of the executive directors of the issuer being resident in Hong Kong, although the Stock Exchange may grant an exemption from this requirement in certain circumstances; and
- The directors meeting the minimum requirements specified in the Listing Rules and there being at least three independent nonexecutive directors who must represent at least one-third of the total number of directors on the board (one of whom must have appropriate professional qualifications or accounting or related financial management expertise).
In addition to the above key requirements, the Stock Exchange does not permit certain special shareholder rights – rights that only apply to some (usually strategic investors) but not all shareholders – to subsist beyond the listing of an issuer’s securities. These include matters such as the right to nominate directors, veto rights over activities, antidilution rights, profit guarantees, put options, and guaranteed discounts to the IPO share price. There is also specific guidance regarding pre-IPO investments in shares and convertible instruments that an issuer will need to comply with in order to satisfy the Stock Exchange.
An issuer need not have been incorporated in Hong Kong in order to be able to conduct an IPO of its securities on the Stock Exchange. Popular jurisdictions of incorporation for issuers aiming to list in Hong Kong include Bermuda and the Cayman Islands. The Stock Exchange has also accepted the states of California, Delaware, and Maryland as suitable jurisdictions of incorporation for companies or corporations seeking a listing in Hong Kong. Aside from the prospective issuer itself, the key participant in the IPO process in terms of overall coordination is the sponsor. Every prospective IPO candidate is required by the Listing Rules to appoint a sponsor. The sponsor’s (or joint sponsors’, if more than one is appointed) role will typically include liaising with the Stock Exchange, involvement in preparation of the prospectus, overall management of the IPO, and performance of due diligence on the issuer to confirm its suitability. Other parties normally involved in the IPO process include underwriters, separate legal counsel for the issuer and the sponsor, overseas counsel (where necessary), accountants/auditors, valuers/experts involved in compiling reports mandated by the Listing Rules, and the share registrar.
While there is no standard timetable to which the IPO process in Hong Kong must adhere, timing will often be dictated by the complexity and scale of the due diligence process to be carried out on the IPO applicant and the timing and availability of audited financial information on the prospective issuer. From a due diligence perspective, prospective issuers and underwriters in the context of an offering that may also target institutional investors in the United States will, as a general rule, conduct due diligence to a level that would enable them to establish defenses against potential liability under Rule 10b-5 of the U.S. Securities Exchange Act.
While the content of the prospectus will necessarily have to comply with the statutory and regulatory requirements in Hong Kong, the general format and layout often follows a relatively standard order, including a summary section, risk factors, summary of Listing Rule waivers granted by the Stock Exchange, industry and regulatory overview sections, history and development of the issuer, directors and senior management biographies, relationship of the issuer with controlling members and directors, summary of any connected transactions (e.g., contracts between the issuer or its subsidiaries and controlling shareholder(s), directors, and their affiliates), financial information, and a summary of underwriting arrangements. There may also be certain additional requirements for issuers involved in specific industries, such as mineral production and property development.
The prospectus approval process begins with the applicant submitting a listing application and what should be an advanced draft of the prospectus to the Listing Division at the Stock Exchange. The Stock Exchange will also pass on documents submitted by the prospective issuer to the SFC. The Stock Exchange's principal role is to review the draft prospectus in detail and to assist in ensuring adequate disclosure is made. In almost all cases the Stock Exchange will provide the prospective issuer (via the sponsor) with a list of comments to address after its initial review of the draft prospectus. There may be a number of rounds of comments and resubmission of the draft prospectus before the Listing Division is satisfied and a formal listing hearing with the Listing Committee of the Stock Exchange can be set. The Listing Committee has the final say as to whether an application for listing is successful or not.
The Stock Exchange has adopted a firmer stance in recent times by refusing to review drafts of prospectuses that it views as being substantially incomplete. In addition, and what would mark a move toward the system used in the United States, proposals have been made to publish advanced drafts of prospectuses submitted with listing applications on the Stock Exchange’s website. The SFC also wishes to clarify existing legislation to make it clear that sponsors do have civil and criminal liability for defective prospectuses.
The Listing Rules require public offers of securities in Hong Kong to be fully underwritten. Offers are also typically divided into a Hong Kong public offer tranche and an international placing tranche. As such, the prospective issuer will ordinarily enter into two underwriting agreements. A Hong Kong underwriting agreement will cover the Hong Kong public offer, while the international underwriting agreement will govern placements to institutional investors outside Hong Kong (including pursuant to Rule 144A under the U.S. Securities Act).
One feature of Hong Kong IPOs that may at first seem peculiar, and that is reflected in both the Hong Kong and international underwriting agreements, is a clawback mechanism whereby if the Hong Kong public offer tranche of the offering is oversubscribed (the initial minimum allocation of shares to this tranche is often fixed at 10 percent of the overall offer size) by a certain factor, then a proportion of the shares initially allocated to the international placing tranche will be transferred to the Hong Kong public offer tranche and the international placing tranche reduced in size as a consequence. Assuming an initial allocation of 10 percent of the total offer size to the Hong Kong public offer tranche, if that tranche is oversubscribed by 15 or more but less than 50 times, then the total allocation of the Hong Kong public offer tranche (as a proportion of the total offer size) would rise to 30 percent. In extreme cases where the public offer tranche in Hong Kong is oversubscribed by more than 100 times, this proportion rises to 50 percent.
Future Developments and Trends
There are indications that the main regulators in Hong Kong (namely the SFC and the Stock Exchange) are taking a more robust approach to ensuring that investors are sufficiently protected and that Hong Kong’s reputation as a leading financial center is safeguarded. To date, this has manifested itself in the form of a greater onus on sponsors through the proposals to clarify that they may be found civilly and/or criminally liable for defective prospectuses. The SFC has also placed an emphasis on there being early, comprehensive due diligence and a properly drafted prospectus to accompany listing applications. Our view is that the focus on improving the quality of disclosure and introducing other measures to strengthen investor protections will continue into the future.