Financial Regulatory Forum

IPOs Rising: Hong Kong’s Siren Song, Meet Regulatory Gatekeeper

May 7, 2010

Hong Kong’s stock exchange beckons with an equity market “siren song”, a song that is being heard by a growing number of foreign firms, from Asia and beyond, writes Helen H Chang of Westlaw Business Currents.

The debut this week of France’s L’Occitane, in addition to headline-grabbing Russian RUSAL and others, signal the warm embrace being given. However, this embrace is not unguarded, as ‘checkpoint first!’ is the mantra of the Hong Kong Stock Exchange (SEHK). As a result, what surprises is not only those who choose to sell securities in Hong Kong, but those, like Morgan Stanely, who don’t.
Hong Kong’s capital markets are taking on an expanding role on the world’s stage. Several non-Asian firms have selected Hong Kong not merely as a listing locale, but rather as their primary listing locale. In addition to debuting primary shares of non-Asian companies, it of course to Hong Kong grown giants such as Toys ’R Us retail conglomerate Li & Fung, and billionaire Li Ka-shing’s Hutchison Whampoa.
The SEHK’s warm welcome should not, however, be mistaken for favoritism. Unlike other jurisdictions where securities regulators shy away from dispensing business advice, SEHK applicants must go through a long established vetting process of financials and credibility. In the event that Hong Kong regulators uncover aspects not to their liking, they can reject an application unless companies effect change. As such, issuers seeking to IPO are expected to comply, and in some cases, make concessions, in order to list. Two broad themes are considered in the evaluation process: financial worthiness and sufficient disclosure to promote informed decision making by the reasonable investor.
As proof of the depths of disclosure required in Hong Kong, look to L’Occitane en Provence, the second foreign company to get a primary Hong Kong listing. Following in Russia’s RUSAL’s footsteps, the French issuer recently concluded its Hong Kong public offering of over 36 million shares and trading debuting on May 7, 2010. Its offering signals not only the attractions of Hong Kong, but the deep disclosure requirements as well.
The IPO raised US $708 million on April 26, 2010, with a public trading debut scheduled for May 7, 2010. In its prospectus, L’Occitane disclosed that in addition to filing with the Hong Kong Securities and Futures Commission (SFC) and the Hong Kong Exchanges and Clearing Limited (HKEx), certain information would be published in one major English newspaper, the South China Morning Post, one Chinese newspaper, the Hong Kong Economic Times, the website of the HKEx and the company’s own website. Furthermore, results of allocations for the Hong Kong public offer would be publicly available by May 6, 2010, just in time for the company’s public trading debut the following day.
Consistent with HKEx’s goal to arm investors with information to make informed decisions, L’Occitane’s 500 page prospectus provides detailed information on its own management structure. As opposed to prospectuses filed in some jurisdictions which list the directors and major officers as a group, L’Occitane provided the names, residential addresses and nationalities of all the directors and parties involved in the offering such as coordinators and sponsors. The prospectus also discussed the corporate structure of affiliates such as Clarins, which became a shareholder of L’Occitane in 2001. The two companies continue to share business operations such as office services and overhead expenses in Korea, Switzerland and Mexico. Additionally, Clarins is L’Occitane’s joint venture partner and 50% owner of three L’Occitane subsidiaries.
With respect to use of proceeds from the IPO, L’Occitane reported that “approximately 90%… will be used to finance the development of our Group”. This percentage was further broken down to “65% for new store openings globally… these may include high growth emerging markets”; “20% for the extension and improvement of our manufacturing plants”; “2.5% for… research and development”; “2.5% for development of e-commerce channels”. The remaining “10% [would be used] for working capital and corporate purposes.” The disclosure left 5% of net proceeds unaccounted for, but had not allotted any percentages for legal fees.
Despite efforts to tidy up prospectus affairs and put its best foot forward for the SEHK, L’Occitane’s debut may be shadowed by competition. A second Russian company, Strikeforce Mining & Resources (SMR), commenced pre-marketing for a proposed Hong Kong IPO on May 3 2010, to raise an estimated US $150 million. SMR has appointed the Bank of China International, Deutsche Bank and Renaissance Capital to handle its initial public offering.
Although non-Asian companies are increasing interested in primary listings on the Hong Kong Stock Exchange, some companies may find the HKEx and the SFC too overbearing for comfort when compared to other jurisdictions. In February 2010, U.S. bank holding company Morgan Stanley filed to register securities with the U.S. Securities and Exchange Commission. In its disclosure, Morgan Stanley explicitly stated that it would not be offering securities in Hong Kong because the securities did not meet approval standards as set out by the Securities and Futures Commission. The company declined to elaborate further in its prospectus.
Similarly, China-based MIE Holdings was clear that its securities would not e traded in Hong Kong. In its prospectus for its U.S. initial public offering, filed with the SEC on May 3 2010, MIE’s formal notice to Hong Kong investors stated that its prospectus had not been approved by the SFC. Furthermore, MIE shares would not be offered in Hong Kong and no MIE material was to be construed as directed to the city’s investing public.

Hong Kong Listing Regulators
These closely guarded gates are maintained by the SFC and HKEx, the two main gatekeepers of the SEHK. While the HKEx occupies a front-line position in regulation of listed issues and administration of listings, the SFC is the statutory body responsible for market regulation in Hong Kong.
The HKEx is responsible for administering the Stock Exchange Listing Rules and can make additional rules for proper market regulation, but the SFC must give written consent before these rules take effect. With respect to listing applicants, the HKEx is responsible for evaluating suitability of applicants, in part, and to ensure that sufficient disclosure is provided to investors for them to make an informed decision. Accountants’ reports and listing documents are among the items required to be filed with the HKEx for evaluation.
The SFC has an expanded mandate, beyond gatekeeper to the public markets. In addition to enforcing securities and futures legislation, the SFC patrols takeover and other market related activity such as investor or director conduct. Under the Securities and Futures Ordinance (SFO), the legislation that gives the SFC its legal might, the watchdog can make rules prescribing requirements to be met before an issuer’s securities may be listed and determine the procedure for dealing with approvals for listings. The SFC maintains weight over issuers even after their IPO. The SFO gives the watchdog broad investigation powers and the ability to de-list unruly companies guilty of contravening Hong Kong securities law.

Listing in Hong Kong
The SFC maintains that all applicants, regardless of their country of origin, must go through the same application process in order to list in Hong Kong. A uniform standard for evaluation is applied to all issuers to-be, although occasionally, individual circumstances can be considered. Under the statutory dual listing regime, applicants are required to file listing documents with both the HKEx and the SFC. Financial vetting, closely followed by public interest considerations seem to be the focus of the HKEx and the SFC.
To start, new applicants must satisfy one of the 3 tests concerning profit, cash flow or revenue. For example, under the profit test, the profit attributable to shareholders of an application must be over HKD20 million or US$2.6 million. Consistent management and ownership for at least three years prior to listing are also requirements for each of the tests. Furthermore, new applications must have sufficient working capital for at least 1 year from the date the prospectus is published.
Other conditions aimed at facilitating an open market may also determine whether an applicant is approved. For example, at least 25% of an issuer’s total issued share capital must be held by the public at all times, although a lower percentage between 15-25% may be accepted at regulator discretion.
These rules may sound stricter than their application in practice and the IPO story of one hopeful proves that not all hope is lost even to those that don’t clearly make the cut. Russia’s UC RUSAL became the first ever non-Asian company to launch a primary offering in Hong Kong in January 2010, raising approximately US $2.2billion. The aluminum producer was previously rejected in October 2009 and bluntly told by Hong Kong regulators to reduce its debt if it wanted a second shot. And reduce it tried. In the end, disclosure and a plan of action, to be monitored by the SFC, helped RUSAL make the grade.
The company’s 1141 page prospectus, filed with the HKEx on December 31 2009, starts in red with ‘the Company does not meet the profit test.’ RUSAL goes on to explain that it has been given the green light to IPO based on its large market capitalization, revenue of more than HKD 500 million and positive cash flow. Despite satisfying certain portions of the revenue and cash flow tests, RUSAL was still obligated to disclose why, in two pages of red, it failed the profit test and to provide details of its proposed restructuring and debt payment plans to creditors.
Of note, in the U.S. individual exchanges, monitored by the Securities and Exchange Commission (SEC), maintain their own listing standards. The NYSE has gone after recent listing particularly aggressively.  In late 2008, the SEC approved an NYSE proposed rule change to amend Section 102.01C of its Listed Company Manual, to allow for revised initial listing standard under which companies may qualify to list. The rule is styled by the NYSE as the “Assets and Equity Test.” Under the rule, a company, in addition to other requirements must have “(i) $75 million in total assets, (ii) $50 million in stockholders’ equity and (iii) $150 million of total market capitalization.”  For additional information on U.S. IPOs and exchange regulation, please see the previous Westlaw Business Currents article IPOs Rising: Rules are Weapons in NYSE-NASDAQ Battle.

Conclusion
Hong Kong’s main securities regulators appear to run a tight ship when it comes to guarding the gates to the Hong Kong Stock Exchange. Although the SFC and the HKEx may take a more hands-on approach to vetting listing applications than other jurisdictions, their good intentions should not deter companies from the SEHK. Laying down uniform listing requirements such as financial worthiness and demanding detailed disclosure in simple language, Hong Kong regulators promote investor confidence that is essential to keep investment capital flowing into the SEHK. Thus far, the fruitful offerings of RUSAL and L’Occitane are likely to attract other non-Asian companies to IPO in Hong Kong, where they will undoubtedly be met with diligent border control.

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