On 20 January 2017, the Securities and Futures Commission ("SFC") and The Stock Exchange of Hong Kong Limited ("Exchange") issued a joint statement ("Joint Statement") expressing grave concerns over the price volatility of stocks listed on the Growth Enterprise Market ("GEM") and criticising that placing practices in a significant number of GEM listings may not enable an orderly, informed and efficient market for such securities to develop.
The SFC on the same day issued a guideline ("SFC's Guideline") to provide guidance to sponsors, underwriters and placing agents on the standards of conduct that is expected of them in the listing and placing of GEM IPO stocks.
This client alert summarises the key points in the Joint Statement and the SFC's Guideline that new applicants, sponsors, underwriters and placing agents in GEM IPOs should take note of.
Joint Statement - Key points to note
The Joint Statement supplements the regulatory principles and requirements under the GEM Listing Rules in connection with the listing and placing of GEM IPO stocks. Here are the key points:
- Adequate spread of holders - The SFC and the Exchange are of the view that where the securities in public hands are overly concentrated, the conditions for an open market may not exist even if such securities are held by 100 holders, being the minimum number of placees under the GEM Rule 11.23.
- Shares "in public hands" - In relation to the requirement that a minimum prescribed percentage of offered securities be in public hands, the SFC and/or the Exchange, where appropriate, will take appropriate actions with respect to any proposal, arrangement or agreement whereby one or more persons: (a) take(s) up securities in a placing on behalf of, (b) holds securities on behalf of, or (c) otherwise acts in accordance with the instructions of, any core connected person (who is not regarded as a member of "the public"), with a view to avoiding the application of any GEM Listing Rule.
- Preferential treatment to placees - No preferential terms or treatment (whether offered by new applicants or other persons (e.g. underwriters or placing agents)) as to price or otherwise may be afforded to any placee unless adequate disclosure of such terms or treatment is made in the listing document. The Exchange reserves the right to reject any such proposed arrangements.
- Role of new applicants - When ensuring that there is an open market in the securities for which listing is sought, new applicants are expected to: (a) take due care to decide, in consultation with the sponsor, among other things, (i) the method of listing; (ii) the target investor type and placee mix; (iii) the overall strategy and allocation basis; (iv) any preferential treatment to placees, and retain proper documentation on these matters; (b) seek assistance from underwriters/placing agents to adopt an appropriate strategy and allocation basis to achieve an open market; and (c) list all the underwriters and placing agents appointed and their contact details in the prospectus to provide additional information to investors about available distribution channels.
- Role of sponsors and underwriters/placing agents - see a separate section below.
- The SFC / Exchange may make enquires where there are concerns that the placing securities may be concentrated in too few hands, or a large number of placees may each hold too few securities or the conditions for an open market may not otherwise exist.
- The SFC / Exchange will take action against those new applicants, sponsors and underwriters/ placing agents who fail to have appropriate policies and procedures to ensure that any GEM IPO placing is conducted in a fair and orderly manner.
SFC's Guideline to sponsors, underwriters and placing agents - Key points to note
Sponsors, underwriters and placing agents, all having an important role in the listing and placing of GEM IPO stocks, are expected to use their best efforts to assist new applicants to comply with all the relevant regulatory requirements, including the relevant GEM Listing Rules (as supplemented by the Joint Statement).
The SFC's Guideline aims to provide guidance to sponsors, underwriters and placing agents on the standards of conduct that is expected of them in the listing and placing of GEM IPO stocks. Here are the key points:
- Advise the new applicants on the following:
- the relevant regulatory requirements and the potential consequences for non-compliance;
- the method of listing - By way of placing only? Or offer for subscription/sale in addition to a placing tranche?
- the target investor type and placee mix;
- the overall strategy and allocation basis with a view to achieving an open market and an adequate spread of shareholders, and to meeting the requirement that a minimum prescribed percentage of offered securities be in public hands;
- the proper disclosure of any preferential treatment afforded to any placees in the new applicant's listing document; and
- the retention of proper documentation by the new applicant as required under the Joint Statement.
- Retain proper documentation to demonstrate that the sponsor has used all reasonable efforts to discharge all of its obligations.
Placing agents/underwriters should:
- Conduct placings with sufficient senior management oversight.
- Put in place appropriate policies and procedures to avoid any undue concentration of shareholdings and to maximize the likelihood of an open, fair and orderly market in the securities at the time of listing, which should include a marketing programme directed to a wide range of clients. For example, placing agents/underwriters should:
- promptly notify their clients that they have been appointed as a placing agent for a GEM IPO with a brief description of the new applicant and a cautionary statement;
- allocate a reasonable number of account executives to each placing transaction and the placing opportunity should not be offered to certain clients to the exclusion of other clients;
- endeavour to respond to enquiries from prospective clients who are interested in participating in the placing and to open accounts for these investors in good time for the placing; and
- should not afford clients any preferential treatment unless this has already been properly disclosed in the listing document.
- Conduct "KYC" procedures properly - Confirm whether a client intending to subscribe is the beneficial owner of the client's account (i.e. not a nominee of some other person) and is independent of the new applicant, its controlling shareholders and directors. Exercise caution when relying on the client's declaration of the client's independence and make further enquiries (by way of, for example, internet search) in cases of doubt. Pay special attention to the following "red flags":
- clients subscribing for the placing are procured or introduced by the new applicant, its controlling shareholders or directors;
- clients subscribing for the placing have known business, financial or other relationships (e.g. employees, suppliers or customers) with the new applicant or any of its controlling shareholders or directors;
- clients subscribing for the placing have familial relationships or share the same address with other placees; and
- accounts of clients subscribing for the placing are operated by the same person.
- Ensure that subscriptions are commensurate with the client's financial position. Sources of funding for the subscription of placing shares should be established before any acceptance of the client's subscription using a risk-based approach.
- Reject subscriptions where there is a suspicion that the client may be a nominee of some other person whose identity the placing agent is unable to ascertain or the acceptance of subscriptions will result in an inadequate spread of shareholders.
- Keep proper records to demonstrate compliance with the SFC's Guideline throughout the entire placing process. There should be sufficient details covering, among others, (i) all notifications to clients, (ii) all orders received, (iii) the rationale for allocation of the securities as well as the reasons for rejection of orders and (iv) the list of placees submitted to the Exchange.
Consequence of failure to comply with the SFC's Guideline
A failure to comply with any of the requirements of the SFC's Guideline by a sponsor, underwriter or placing agent (and their representatives) may reflect adversely on its fitness and properness and may result in disciplinary action. When assessing compliance with the SFC's Guideline, the SFC will adopt a pragmatic approach taking into account each firm's particular circumstances.
The SFC started a review of the GEM in late 2015 to address the many problems in the GEM. The issue of the Joint Statement and the SFC's Guideline is an initial step to address some of the current concerns with GEM IPO placements while the regulators are working on a broader GEM reform.
Separately, in late 2016, the SFC's Executive Director of Enforcement, Thomas Atkinson announced that specialised teams would be set up for investigating key risk areas, one of which concerned the GEM.
Firms that act as GEM IPO sponsors, underwriters or placing agents should ensure due compliance with the requirements under the Joint Statement and the SFC's Guideline to avoid disciplinary action to be taken against them. They should also keep abreast of the development of the GEM reform and get prepared to comply with the tightened rules that may be introduced in the future.