The Securities and Futures Commission is proposing to introduce a package of measures to codify industry good practice for intermediaries engaged in equity and debt capital market transactions and rectify problematic behaviours in the market. The proposals would introduce a new paragraph into the Code of Conduct which will apply to intermediaries carrying out bookbuilding and placing activities in both ECM and DCM transactions. The new paragraph defines the different intermediaries based on the role played in the transaction and sets out the standards of conduct expected across the spectrum of activities (including in assessing the issuer and the offering, advising the issuer, marketing, bookbuilding, allocation and placing and record keeping) imposing additional conduct requirements on those in an overall coordinator role. Syndicate membership and fee arrangements will be required to be determined and documented at an early stage in formal written appointments of intermediaries. In addition, for IPOs, it is proposed to require at least one overall coordinator to also be appointed as a sponsor.

These proposals are in response to a thematic review by the Securities and Futures Commission of licenced intermediaries engaged in ECM and DCM transactions and follow recent reports by the International Organization of Securities Commissions which addressed conflict of interest issues and conduct risks in this area.

The consultation paper highlights a number of current issues impacting the market such as behaviours leading to inflated demand for offerings, a lack of transparency in orders placed, conflicts of interest where syndicate members invest on behalf of clients and on a proprietary basis, and preferential treatment or rebates paid to investors. The proposals seek to address these conduct issues and to tackle the competitive pressures in the market. They also seek to align the incentives paid to intermediaries with their responsibilities in the transaction.

In this bulletin we highlight the key proposals. The consultation is open until 7 May 2021 and if the proposals go ahead, there would be a six-month transitional period to enable the industry to adjust to the changes.

New paragraph 21 of the Code of Conduct

Scope

The consultation paper sets out a new paragraph 21 to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission entitled “Bookbuilding and placing activities in equity capital market and debt capital market transactions”. It will apply to intermediaries (referred to as capital market intermediaries, CMIs) involved in any of the following in Hong Kong:

  • bookbuilding activities, namely collating investors’ orders in a share or debt offering to facilitate price determination and allocation or the process of assessing demand and making allocations;

  • placing activities, namely distributing shares or debt securities pursuant to the bookbuilding activities; or

  • advising, guiding or assisting the issuer in relation to the above activities.

The new paragraph only applies to transactions involving bookbuilding (so excludes, for example, transactions where the issuer negotiates the terms of the offering directly with a small number of investors). It applies to both equity IPOs and secondary offerings (including where shares are issued under a general or specific mandate) and extends to placings by shareholders.

It also covers all types of debt offerings involving bookbuilding or placing activities.

CMIs and OCs

The new paragraph sets out the role of an Overall Coordinator (OC). The OC is defined as being a syndicate CMI which conducts certain specified activities, such as overall management of the offering, coordinating the bookbuilding or placing activities of other CMIs, advising the issuer on the offer price, or (in the case of a share offering) exercising discretion on reallocations between tranches or acting as the stabilising manager. A distinction is also made between syndicate CMIs (being those appointed by the issuer) and non-syndicate CMIs (which are not engaged by the issuer and include, for example, sub-placing agents engaged by syndicate CMIs).

Standards of conduct for CMIs and OCs

The new regime sets out the baseline obligations and standards of conduct for CMIs. These include:

  • a requirement to conduct an adequate assessment of the issuer before engaging in a share or debt offering for that client;

  • before conducting any bookbuilding or placing activities, ensuring that a formal written agreement has been entered into, clearly specifying the roles and responsibilities and fee arrangements;

  • taking reasonable steps to assess its investor clients to determine if they should be included in the targeted investor strategy or whether any are restricted;

  • marketing to targeted investors, in a sufficient number to limit the risk of an undue concentration of holdings;

  • ensuring the bona fides of all orders placed in an order book and transparency in the bookbuilding process;

  • establishing and implementing an allocation policy to ensure a fair allocation to investor clients;

  • not offering or passing on rebates to investors and disclosing rebates offered to CMIs and any other preferential treatment of any CMIs or targeted investors;

  • disclosing complete and accurate information in a timely manner on the order book and other information to the OC and non-syndicate CMIs;

  • maintaining sufficient books and records to demonstrate compliance with the new regime;

  • establishing, implementing and maintaining policies and procedures to identify, manage and disclose conflicts of interest;

  • maintaining sufficient resources and effective systems and controls to ensure that it can discharge its obligations and responsibilities; and

  • dealing with the regulators in an open and cooperative manner.

Additional obligations are imposed on OCs reflecting their role in the transaction. These include the following:

  • Before conducting any of the activities prescribed within the definition of the role of OC, the OC should ensure it is formally appointed in writing by the issuer to conduct such activities, with the agreement clearly setting out the roles, responsibilities and fee arrangements.

  • In the case of an IPO, before accepting the role, the OC must ensure that it (or a member of its group) is appointed as an independent sponsor (with both appointments made at least two months before submission of the listing application). Alternatively, the OC must obtain the issuer’s written confirmation that at least one independent sponsor has also been appointed by it as an OC. In the latter case, the OC’s appointment should be made no later than two weeks after submission of the listing application.

  • The new paragraph sets out obligations when advising the issuer on the offering, including to act with due skill, care and diligence.

  • The OC should advise the issuer on the composition of the syndicate and the fee arrangements.

  • The OC should devise a marketing and investor targeting strategy with the issuer and advise the issuer on adjustments as a result of market conditions.

  • The OC should take all reasonable steps to ensure that the price discovery process is credible and transparent, the order book is properly managed and allocations are made on a proper basis. An OC should use best endeavours when advising the issuer or making pricing or allocation decisions, to balance the issuer’s interests and those of investor clients and the best interests of the integrity of the market.

  • For an IPO, the OC should ensure that sufficient information is available to reasonably identify restricted investors. In debt offerings, the OC should take reasonable steps to ensure that sufficient information is available to reasonably identify whether any investor clients have any associations with the issuer, CMIs or their group companies.

  • An OC should share, or take reasonable steps to ensure that the issuer provides, information about the issuer to other syndicate CMIs involved in the offering to enable the CMIs to fulfil their obligations to assess the issuer and identify any restricted investors. The OC is also required to inform other syndicate CMIs of the marketing and investor targeting strategy and disseminate material information related to the offering in a timely manner.

  • The OC is required to document changes to the order book during the bookbuilding process, as well as other record keeping requirements including to document key advice and discussions with the issuer on key aspects such as the syndicate composition, pricing and allocation policy.

  • The OC is required to report certain information to the Securities and Futures Commission, and in particular where the OC is also a sponsor, information about the syndicate and allocations with the prescribed timeframe.

These baseline obligations and standards of conduct have been designed, in part to rectify problematic behaviours identified by the Securities and Futures Commission during the thematic review mentioned above. In addition, they are intended to codify good market practices to enhance the quality of intermediary conduct and ensure a level playing field.

Sponsor coupling

The consultation paper is also proposing “sponsor coupling” on IPOs. This essentially requires that at least one OC must also act as a sponsor for the IPO. The sponsor must be independent of the issuer and either the same entity as the OC or an entity within the same group. The OC that is also a sponsor must be appointed at least two months prior to the filing of the listing application. The issuer may also appoint other OCs (who need not be sponsors) and these appointments must be finalised not later than two weeks after the filing of the listing application.

This proposal is designed to ensure that the OC that is also in a sponsor role will have a better understanding of the issuer and can better advise it. It will also help alleviate regulatory concerns that due diligence by sponsors may be being compromised in order to win the OC role (in particular when competing with non-sponsors).