The fact that the work of sponsors in listings have been a major regulatory focus of the Hong Kong Securities and Futures Commission (SFC) in recent times is well known. Recent proposed and actual changes to the Stock Exchange of Hong Kong (SEHK) listing regime appears to add to or confirm the extent of sponsor’s duties in the listing process. They are:
- The Consultation Paper in respect of a listing regime for companies from emerging and innovative sector (2018 Consultation Paper) which was published in February 2018; and
- The Amendments to the SEHK’s Main Board (MB) Listing Rules, which became effective on 15 February 2018.
On 16 June 2017, the SEHK published the New Board Concept Paper (Concept Paper) who sought market feedback on SEHK’s proposed establishment of a New Board, to broaden capital markets access in Hong Kong by opening up to a more diverse range of issuers.
Having obtained the responses to the Concept Paper and subsequent regulatory discussions with the SFC, the SEHK released the consultation conclusions (Conclusions) on 15 December 2017. It was concluded that, instead of setting up two New Boards, the SEHK will extend the existing listing regime by introducing two new chapters to the existing MB Listing Rules. One of the new chapters relates to the listing of innovative and high growth issuers that have weighted voting rights (WVR) structures.
In February 2018, the SEHK published the 2018 Consultation Paper setting out its proposals as to the considerations that the SEHK would take into account when assessing whether an innovative company is suitable for listing under the new chapter.
As for the amendments to the SEHK’s MB Listing Rules, following the publication of the Consultation Conclusions on the Review of the Growth Enterprise Market (GEM) and Changes to the GEM and Main Board Listing Rules in December 2017, the mandatory sponsor requirement for a transfer of listing from GEM to MB is now introduced.
The 2018 Consultation Paper
The 2018 Consultation Paper set out the SEHK’s views on (i) when a company would generally be considered suitable for listing in Hong Kong with a WVR structure, and (ii) post-listing regulatory requirements designed to protect investors and maintain market integrity when it comes to listed companies with WVR structures. Of these, (ii) has received much more media, political, financial sector and corporate lawyers’ attention. We do not seek to add to the cacophony of voices that have spoken out in this regard. Instead, this e-bulletin focuses on (i), given its potential implications for a group of financial sector participants (namely sponsors) that are now the subject of intense regulatory scrutiny.
The SEHK proposes that a company be considered suitable for listing with a WVR structure if it is able to demonstrate the following characteristics:
- Nature of the company: the applicant must be an innovative company, which is expected to possess more than one of the following features:
- Its success is attributable to the application of (i) new technologies; (ii) innovations; and/or (iii) a new business model to the company’s core business, and that this serves to differentiate the company from other current players;
- R&D is a significant contributor of its expected value and constitutes a major activity and expense;
- Its success is attributable to its unique characteristics or intellectual property; and/or
- It has an outsized market capitalisation/intangible asset value relative to its tangible asset value.
- Success of the company: the applicant must show a track record of high business growth and the expectation that it will continue.
- Role and contribution of WVR beneficiaries: Each WVR beneficiary must be a director of the applicant at the time of listing who has an active executive role within the business. He/she must also have been materially responsible for the growth of the business.
- External validation: the applicant must have been previously received meaningful third party investment from at least one sophisticated investor, which remains at IPO.
Amendments to the SEHK’s MB Listing Rules
Under the new regime, where an applicant wishes to transfer its listing from GEM to MB, it must appoint a sponsor and issue a prospectus-standard listing document for the transfer as if it is a new listing applicant to the MB. The sponsor is also expected to conduct due diligence in accordance with the relevant SFC sponsor provisions and the principles set out in Practice Note 21.
Implications for sponsors
If the proposals on WVR structure listed companies in the 2018 Consultation Paper as outlined above become reality, this will inevitably lead to even more scrutiny on sponsors’ due diligence:
- WVR structure companies are, in the present Hong Kong financial, social and political environment, inherently considered as potentially controversial. Should any such listed companies run into any business or governance difficulties, sponsors will almost unavoidably be caught in the firing line for its role during the listing process.
- More specifically, concepts of “innovation”, “new technology”, “new business model” and the like are in themselves amorphous concepts. What might appear to be new or innovative now turn out to be mundane. Further, businesses that are considered new or innovative are almost inevitably more risky business propositions. Taken together, this means that:
- sponsors risk being expected to conduct almost exhaustive market due diligence (ie. significantly more due diligence work than on non-WVR structure listing applicants) on what is so new and innovative in a WVR structure listing application, in order to be in a position to defend themselves against accusations that their due diligence did not meet a “reasonable” standard; and
- the “Risk Factors” section of prospectuses for WVR structure listing applicants will likely be expected to be even more extensive and comprehensive in coverage than that which is prevailing currently with prospectuses.
As for the above-mentioned amendments to the SEHK’s MB Listing Rules, it serves as a useful reminder to sponsors as to the scope of their work. In short, when a company transfers from GEM to MB, sponsors are expected to consider all information before it, including previously published prospectuses and financial reports, with a degree of professional scepticism required for conducting reasonable due diligence as part of preparing the company’s MB listing document.