The Hong Kong Stock Exchange is to increase the profit requirement for companies seeking to list on the Main Board of the Stock Exchange by 60%. This is a smaller increase than was initially proposed in the consultation paper. This will mean that a listing applicant relying on the profit test to satisfy its eligibility for listing will need to have profits in its most recent financial year of not less than HK$35 million (increased from HK$20 million currently) and in the two preceding years, in aggregate, profits of not less than HK$45 million (increased from HK$30 million currently). These changes, as set out in the consultation conclusions, will become effective on 1 January 2022.
This follows rising regulatory concern that the current profit requirement threshold (which has not been increased since it was introduced in 1994) has fallen behind economic and market developments and has created opportunities for market misconduct in IPOs. With the market capitalisation requirement having been increased in 2018, there is now a misalignment between the profit and market capitalisation requirements. In particular, the regulators have observed “ramp-and-dump” schemes associated with a number of recent IPOs, commonly involving companies with small market capitalisations. As a result, the Stock Exchange and the Securities and Futures Commission (SFC) have also issued a joint statement targeting this IPO-related misconduct and setting out their regulatory approach to investigating potentially problematic behaviours.
Revised profit requirement for Main Board listings
A company seeking a Main Board listing in Hong Kong must, subject to certain exceptions, satisfy one of the three eligibility criteria set out in the Listing Rules. The profit test requires a listing applicant to have an adequate trading record under substantially the same management and ownership. As well as a market capitalisation of HK$500 million at the time of listing, the listing applicant must meet a profit threshold requirement both in its most recent financial year and an aggregated threshold in the two preceding years. The current requirements and the new thresholds are set out below:
The new profit requirement is a 60% increase over the current thresholds, but is smaller than that originally proposed. The Stock Exchange modified the requirements in response to market feedback during the consultation phase. Key concerns raised by the market on the original proposals focused on the impact the changes would have for traditional companies and smaller companies seeking to list in Hong Kong, particularly given the perception that GEM does not provide a viable alternative listing venue for such companies if they are unable to meet the Main Board listing criteria. The revised profit thresholds, and delayed implementation date, reflect the feedback, with the Stock Exchange also indicating that it may be prepared to grant relief from the profit spread thresholds over the track record period on case specific circumstance to provide flexibility.
Whilst adopting a smaller increase to the profit requirement, the Stock Exchange has indicated that the thresholds will be kept under review and may be further modified at a later date. In addition, to address some of the regulatory concerns that led to these proposals, the Stock Exchange and SFC will work together to address misconduct in IPOs. In particular, the regulators will:
- critically review estimated valuations of listing applicants to ensure that they are able to meet the market capitalisation requirement on listing and that there will be sufficient investor interest at the IPO price;
- enhance the focus and supervision of intermediaries involved in book-building and placing activities in IPOs. In February, the SFC issued a consultation paper on a proposed code of conduct on bookbuilding and placing activities aimed at setting a clear regulatory framework for those licenced or registered persons involved in such activities;
- place increased emphasis on individual accountability in Stock Exchange disciplinary proceedings. The Listing Rules will be amended from 3 July 2021 to broaden the net of those subject to disciplinary action and to widen the scope of available sanctions; and
- scrutinise more closely listing applications which contain certain features set out in the joint statement, discussed in more detail below. Where circumstances merit, the regulators may exercise their powers to reject or object to listing applications.
The joint statement on IPO-related misconduct
Simultaneously with the release of the consultation conclusions on the revised profit requirements discussed above, the Stock Exchange and SFC issued a joint statement on IPO-related misconduct, aimed at tackling some of the regulatory concerns discussed in the consultation paper. In particular, the regulators have observed suspected stock market manipulation in the form of “ramp-and-dump” schemes associated with IPOs in recent years, particularly involving companies with smaller market capitalisations. There are regulatory concerns that such schemes have been orchestrated at the IPO stage, with placings being allocated to controlled accounts which may have been part funded by either high underwriting commission or listing-related expenses. Social media is often used to ramp up the share price once listed and the shares are then sold at an artificially high price, following which the share price collapses.
The joint statement cites concerns around a lack of a robust and transparent share placement and price discovery process, coupled with suspicious and unusually high underwriting commissions, as being features contributing to the issue. It sets out a number of non-exhaustive features of problematic IPOs that may, as a result, lead to greater regulatory scrutiny during the IPO vetting process, including by requiring the applicant to demonstrate that there will be genuine investor demand or that the price has been determined through a robust and transparent process. These features include:
- the listing applicant having a market capitalisation that only just meets the minimum requirement;
- a very high price-to-earnings ratio, factoring in comparable peer valuations and the fundamentals and profit forecast of the applicant;
- unusually high listing expenses or underwriting fees; and
- high shareholder concentration in a limited number of shareholders, in particular where the public float is small.
Where regulatory concerns exist, the joint statement sets out the powers and grounds for the Stock Exchange and SFC respectively to reject or object to a listing application. It also reiterates the regulators’ powers to take action against not only the issuer, but its directors, major shareholders and intermediaries, where there is suspected misconduct.