Reformations within China have amped up its capital market offerings, not to mention the Star Market’s stellar introduction. With US-based mainland companies looking homeward, is Hong Kong still the pearl of the oriental bourses? Sophia Luo reports

Reform is a consistent theme across capital markets in mainland China and Hong Kong. With the launch of a new sci-tech innovation board known as the Star Market in Shanghai last year, the implementation of the newly amended Securities Law this year, and much-awaited registration-based initial public offering (IPO) reforms on Shenzhen’s start-up board, ChiNext, China has been forging ahead with a sweeping capital market overhaul.

“As the newly revised Securities Law takes effect, and registration-based reforms get off the ground in the Star Market and ChiNext, the registration system, with information disclosure at its core, truly becomes the cornerstone of the capital market in the Chinese mainland and brings about a chain of changes on relevant systems,” notes Zhang Liguo, chief partner at Grandway Law Offices in Beijing.

“We are embracing a highly predictable, ultra-inclusive capital market. Such a market opens the door of direct financing for all sorts of innovative companies, and small- and medium-sized private enterprises, in a more convenient, cost-effective manner,” he says.

Zhang Xiaoman, a Beijing-based partner at Commerce & Finance Law Offices, says registration-based reforms will bring the capital market back on track for serving the real economy. “Especially as the coronavirus pandemic rampages across the globe, rebuilding the supply chain and developing a circulation of domestic industries should be an essential part of our efforts to resume production and restart the economy,” he says.

“Companies at the upstream of the supply chain are in need of business rearrangement, which means a pressing and growing demand for fundraising. This is a particularly well-timed overhaul for smaller leading enterprises in certain segments of industry based in the Yangtze and Pearl River deltas. A more predictable timetable has now been set out for the once time-consuming, lengthy IPO process.”

Unlike the Star Market, which since its inception has set its sights on companies known for “hard” technologies and strategic emerging industries, the reformed ChiNext will mainly serve growth-oriented innovative companies and promote the in-depth integration of traditional industries with the innovation of technology, service, format and mode.

Pan Xiuping, a senior partner at Long An Law Firm in Beijing, says the reformed ChiNext, an older venue for tech stocks, will spell unprecedented opportunities for Chinese startups. “A good many promising startups can raise funds for future development through capital operations,” says Pan. “With the accumulation of small steps, we can reach a faraway destination with a whole new breed of world-class, high-tech corporations like Microsoft and Tesla coming into being.”

Pan says the big-bang reforms are lowering the listing and financing hurdles for China’s capital market – once the most stringent in the world – allowing domestic investors to share the huge development dividends of a wealth of high-tech firms that might have previously gone public elsewhere.

Hong kong“Shanghai in the north, and Shenzhen in the south are now deemed as a pair of mainland Chinese financial centre,” adds Zhang Xiaoman. “Despite the listing regimes of the two bourses being established with a high tendency of co-operation, competition is unavoidable in practice. There is also an inevitable overlap between investors in the two stock markets.

“As the revised Securities Law has set the legal basis for a registration-based IPO system, relying on information disclosure is far from enough,” he says. “Post-listing corporate governance and investor safeguards are equally important.

“When making inroads into capital markets, companies should not only focus on positive changes, like a higher degree of predictability and inclusiveness, and lower financing costs, but also take into account possible administrative punishment and corresponding criminal and civil liabilities as a result of non-compliance with market rules and disregard of relevant legislation and regulation.”

HK RIDES THE TIDE

Just a river away from Shenzhen, Hong Kong is one more step ahead. With the introduction of its biggest listing reform for 25 years in April 2018, local bourse operator Hong Kong Exchanges & Clearing (HKEx) opens the gateway to: (1) companies from emerging and innovative sectors with weighted voting rights (WVR) structures; (2) pre-revenue biotechnology companies; and (3) providing a concessionary secondary listing route for Greater China and international innovative companies listed on qualifying exchanges overseas.

Riding high on the tide of reforms, internet titan Alibaba managed to have the opening bell rung at the HKEx late last year. The behemoth beat a path to US listing years ago, due to Hong Kong’s long-entrenched one-share, one-vote principle. Following in the footsteps of Alibaba, NetEase and JD.com made stellar debuts in Hong Kong in June, paving the way for more US-traded mainland firms embarking on the journey home.

As Hong Kong rises to be the world’s second-largest biotech fundraising hub, an impressive number of mainland healthcare and biotech firms, including InnoCare Pharma, Akeso and Peija Medical, have had a moment in the spotlight in the city’s IPO market in the first half of this year. A new wave of mainland companies is jumping on the bandwagon for a planned Hong Kong listing.

Hong KongAmidst the hustle and bustle of the fundraising spree, Christopher Betts, a partner in the Hong Kong office of Skadden, says the market itself has seen an increasing regulatory bias towards facilitating listings for larger, more mature companies – and a raising of listing thresholds to deter smaller companies.

“The backdoor listing rules have also been significantly tightened, making it far more difficult for smaller listed companies to grow through substantial acquisitions, or change of control transactions,” says Betts. “The corporate WVR proposals, allowing corporate entities to benefit from WVR structures, are another step in the direction of tilting the balance even more in favour of the very largest companies.”

John Baptist Chan, a partner at the Hong Kong office of King & Wood Mallesons, says mainland companies should bear in mind that the Hong Kong Stock Exchange and the Securities and Futures Commission (SFC) of Hong Kong have stepped up their levels of scrutiny against listing applicants and listed companies, both during the IPO vetting process and at the post-listing reporting vetting process.

“Instead of solely focusing on the legality and compliance of Hong Kong listing rules, and the validity of business and financials of the company, there is an increasing trend for the regulator to consider more factors that could be relevant in triggering their concerns on the suitability of the listing applicant, such as sustainability of business model,” says Chan.

Hong KongHe says the HKEx has explicitly shown its stance on this through issuing listing decisions and guidance letters that have demonstrated an increasing level of scrutiny and a higher tendency to exercise discretion and raise questions when they can reasonably infer that the listing applicant might have the characteristics that invite speculative trading.

For instance, Chan says, the HKEx is becoming more stringent on the proposed use of listing proceeds, and has questioned whether the listing applicant has genuine funding needs or commercial rationale to apply for listing. The valuation of the company might also raise questions from the HKEx. A higher P/E ratio, especially, compared with market peers, will need more reasonable justification to allow the HKEx to assess the listing applicant’s suitability.

Amid the waves of capital market reforms, the Star Market and ChiNext have also lost no time in welcoming companies adopting WVR structures, and unprofitable firms, with opened arms. Undoubtedly, the Shanghai and Shenzhen stock markets are shaping up as viable rivals to Hong Kong in the race for the IPO crown.

Zhang Liguo says most listing requirements of the Star Market and ChiNext absolutely can be benchmarked against those of Hong Kong’s main board and GEM. There is benign competition between the mainland capital market under the registration system and the Hong Kong market.

Chan says that while the Hong Kong regime only makes exemptions for biotech and mineral companies in satisfying the financial eligibility tests, the relaxed financial tests under the Star Market regime apply to a wider range of industries in the field of scientific innovation.

Although both Star and Hong Kong stock markets allow the listing of companies that cannot satisfy profit requirements, the former allows the use of factors such as research and development expenses, and demonstration of business/product that have fulfilled certain developmental milestones, to satisfy listing requirements if certain projected market capitalization thresholds are met. In contrast, Hong Kong generally still requires an assessment of the overall financial performance in the form of indicators such as revenue and/or cashflow (excluding biotech and mineral companies).

For profit-making innovation and technology-related companies (excluding biotech companies), the minimum profit threshold for listing on the ChiNext will be the lowest, compared with Hong Kong and the Star Market, as the former does not stipulate an additional requirement on actual/projected market capitalization. In terms of the size of financing, Chan says the two mainland boards also appear to be more likely to generate higher listing proceeds.

In the first quarter of 2020, 75% of the newly listed companies on the Star Market had generated listing proceeds of more than RMB500 million (US$70.5 million), while average amount of listing proceeds of new listings in Hong Kong was just HK$381 million (US$49.1 million).

Apart from the most-cited advantages of the Hong Kong market, Chan highlights the fact that the HKEx has more subjective discretion on determining when to delist a listed company, reducing the risk of compulsory delisting when issues like non-compliance occur. Without any capital control restrictions, Hong Kong also remains a more ideal location for companies that wish to finance overseas projects with listing proceeds.

“Now, it seems that shares of onshore-listed companies trade at a premium to shares of Hong Kong-listed companies of their kind,” says Zhang Liguo. “I believe this also explains why most firms opt to list domestically, and several Hong Kong-traded companies recently even chose to make their way back to the A-share market.

“As a world-renowned financial centre, Hong Kong leverages its formidable advantages including greater international exposure, sophisticated institutional investors and a well-established legal system to become a go-to IPO destination for mainland firms. But unfortunately, we also notice that Hong Kong’s political environment has more or less dented its appeal to outstanding mainland enterprises.”

Hong KongGeorge Wang, a Shanghai-based partner and executive chairman of Duan & Duan, says that generally if companies plan to expand their footprints overseas in the future, while taking care of their domestic businesses, there is no real alternative to Hong Kong. But if companies look to focus on the domestic market and make their brands more recognizable with a better reputation on the basis of standardized operation, the Star Market and the ChiNext offer a better choice.

“Thanks to more relaxed listing requirements and the recent months-long IPO frenzy, biotech stocks are becoming part and parcel of the Hong Kong IPO market,” says Zhang Xiaoman from Commerce & Finance. “Looking ahead, the pipeline of biotech IPOs from mainland firms in Hong Kong will continue to be robust.

“Under the shadow of Sino-US trade tensions, artificial intelligence companies and chipmakers will prefer to choose the A-share market as home turf, but not rule out the possibility of pursuing secondary listing in Hong Kong. A case in point includes Hong Kong-listed Semiconductor Manufacturing International Corporation, which filed a listing to the Star Market in May, after delisting from New York.”

Hong kongZhang Wen, a Beijing-based senior partner at Jia Yuan Law Offices, says: “For mainland firms planning to go public, my basic advice is that going public is definitely something that adds luster to their businesses.

“With that in mind, companies can take a proper look at going public as a particular stage in the ongoing process of companies becoming stronger, doing better, and growing bigger.”

He adds: “For listings at home or abroad, disclosure requirements will become more stringent in the future, and corresponding legal responsibilities will be assumed in a more practical manner. Therefore, companies shouldn’t focus too much on short-term financial performance. They still need to make good efforts in building core competence in a more down-to-earth way.”

The favoured industries in TOP IPO deals

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AMERICAN WIPEOUT

Amid the double whammy of escalating Sino-US trade tensions and a global economic slowdown, the homecoming of mainland enterprises listed overseas bears the imprint of a bewildering change in international circumstances.

“The US has stepped up its enforcement against US-listed mainland companies, and there have been stringent reviews under the CFIUS [Committee on Foreign Investment in the US] for foreign acquisitions, especially by Chinese buyers,” says Simon Luk, partner and chairman of Winston & Strawn’s Asia practice based in Hong Kong and Shanghai. “A recent example would be Nasdaq’s decision to delist Luckin Coffee as a result of financial irregularities disclosed by the Chinese coffee chain, which was only listed recently.”

Luk says that as the US stock exchanges look to tighten the listing and maintenance requirements for Chinese and other overseas issuers, “some US-listed mainland companies might consider privatization and relisting elsewhere, especially if stock prices in the US do not reflect value of their companies”.

Hong Kong

Ren Wei, a partner at Jingtian & Gongcheng’s Beijing office, agrees. Due to the acceleration of decoupling the world’s two largest economies, and a conflict between laws in China and the Holding Foreign Companies Accountable Act (HFCAA), which imposes stricter auditability on US-listed foreign firms, mainland companies are facing an unfriendly climate in New York, says Ren.

For years, US-listed mainland companies have been disappointed by unreasonable valuations as their businesses at home are unfamiliar to international investors. Once there is a decline in earnings, or any flaw found in information disclosure, they can easily fall prey to malicious short-selling. In the face of a trust crisis triggered by the Luckin Coffee scandal, even US-listed mainland firms with good property and excellent performance can hardly manage alone, says Ren.

“Against such a backdrop, the US is actually losing its shine as a listing venue,” he says. “In sharp contrast, for US-listed mainland companies that operate businesses mainly at home, Hong Kong and mainland China, since the launch of the Star Market, are reinforcing their allure as a viable choice for floats.

“This prompts some large enterprises to mull over secondary listing as a way of spreading geopolitical risks. Some smaller firms are also considering delisting from the US and looking to carve out a new path in the A-share or Hong Kong markets.”

Alibaba’s highly sought after stock sale in Hong Kong set a precedent and provides a “demonstration effect” for homesick US-listed mainland companies, adds Wang. Zhang Wen says that, “amidst a wave of US-listed mainland firms making a beeline back home expected to last two to three years, Hong Kong unquestionably has what it takes to be an alternative, transitional market.”

Companies pursuing secondary listings are usually ones known for their sheer scale and influence, says Ren. “By listing shares on different stock exchanges at the same time, companies cannot only expand the channel and scale of financing, but also make their brands more recognizable in various markets, and on the international stage,” he says. “At present, the Hong Kong market probably remains the optimal choice for US-listed mainland companies considering secondary listings or relisting.”

Hong Kong
*Ranking based on top 30 HKEx deals by value
1 June 2019 to 31 May 2020
Source:Dealogic
Hong Kong
*Ranking based on top 30 HKEx deals by value
1 June 2019 to 31 May 2020
Source:Dealogic
Hong Kong
*Ranking based on top 30 HKEx deals by value
1 June 2019 to 31 May 2020
Source:Dealogic
Hong Kong
* Ranking based on top 30 SSE deals by value
1 June 2019 to 31 May 2020
Source:Dealogic
Hong Kong
* Ranking based on top 30 ChiNext deals by value
1 June 2019 to 31 May 2020
Source:Dealogic
Hong Kong
* Ranking based on top 30 STAR Market deals by value
1 June 2019 to 31 May 2020
Source:Dealogic

PLAYING IN THE WAVE

Wang from Duan & Duan joins a chorus of voices applauding the “irreplaceable role that Hong Kong looks to play in such a wave”. He says that, more than two years after the big-bang reform, the local bourse has removed many roadblocks to Hong Kong listing and offered a greater mix of favourable policies.

“Meanwhile, Hong Kong market is known for a high degree of freedom, as well as its status as one of the renowned global financial hubs, and the biggest offshore renminbi centre,” he says. “Thanks to the local currency’s peg to the US dollar and a free flow of international capital, the Hong Kong market has become a substitute for the US market.

“Despite the A-share market forging ahead with its registration-based reform, with new policies introduced to ‘welcome’ a homecoming of US-listed mainland companies, the degree of freedom that the Hong Kong market enjoys falls somewhere on the spectrum between the US and A-share markets,” says Wang. “This makes the Hong Kong market more favoured by US-listed mainland firms in terms of its capability to satisfy companies’ need for development.”

Hong KongRen says that Hong Kong has prospered for decades as the gateway between mainland China and international capital markets, and has also served as a preferred listing destination for mainland firms to finance overseas. “On the one hand, the Stock Connect scheme allows domestic investors to trade in the Hong Kong market, while on the other hand, inclusion of returned US-traded mainland firms into the Hang Seng Index will help attract investor attention and have the value of companies truly reflected,” he says.

The 50-year-old Hang Seng Index in May announced its biggest reform in 14 years. The benchmark gauge, together with Hang Seng China Enterprises Index, will admit Greater China companies under WVR structures and those with secondary listing as constituent stocks.

In addition, Ren says that, compared with the A-share market, Hong Kong is known for the simpler structure of would-be listed firms and listing procedures. In terms of regulatory requirements and standards, such as review of information disclosure, Hong Kong bears a resemblance to its US counterpart. There is no obstacle in the transition of accounting standards between the two markets, either.

“While the homecoming of VIE-structured [variable interest entity] internet companies to the Star Market is now feasible, it remains to be tested in real practice,” says Ren. “Yet, these firms can maintain their existing VIE structures to go public in Hong Kong. In particular, US-listed mainland enterprises may make their debuts in Hong Kong first, and then further seek listings in the Star Market, which remains a possibility.”

However, Lee Kyungwon, capital markets Asia team leader and partner at Shearman & Sterling based in Hong Kong and New York, warns that mainland companies should not assume regulatory requirements applicable for listing in the US will be the same for a listing in Hong Kong.

“For instance, a proposed issuer seeking to list in Hong Kong shall fulfil an ownership continuity requirement, which is less of a concern for US listing,” says Lee. “The eligibility requirement for an issuer adopting a WVR structure is more stringent in Hong Kong, with enhanced corporate governance and investor safeguards.”

Max Hua, a partner in the capital markets practice at Shearman & Sterling’s Hong Kong office, notes that the existing WVR regime in Hong Kong has built in a set of ring-fencing measures, which impose more comprehensive and stricter regulatory requirements than other major global financial centres, including US stock exchanges. These include high-entry requirements on market capitalization, sunset provisions, and enhanced corporate governance and disclosure requirements.

The existing WVR regime in Hong Kong does not accommodate corporate WVR beneficiaries at the moment, and in this regard, the HKEx has just ended its market consultation on whether WVR beneficiaries shall be allowed to expand from individuals to corporate entities. During the consultation, the HKEx proposed requirements and safeguards in a standard higher than the US stock exchanges, including requiring a minimum economic interest requirement for a corporate WVR beneficiary, while there is no such requirement in the US.

“It remains to be seen whether these stricter regulatory requirements will dissuade some issuers from listing in Hong Kong, and whether these investor safeguard measures will be effective to address inherent risks associated with the WVR structure,” says Hua.

Chan, from King & Wood Mallesons, points out that the costs of listing in the US, including ongoing compliance costs and fees, and potential risks from lawsuits and regulators, are all quite high. If the HFCAA comes into effect, Chinese companies are expected to incur higher audit and disclosure-related compliance costs, which makes Hong Kong an attractive alternative. However, Chinese companies also need to consider the cost of delisting, in particular the tax exposure.

Betts, at Skadden, says that companies also need to think about whether they can genuinely expect to get a high degree of post-IPO liquidity in the Hong Kong market – for smaller companies that don’t find their way into indices, that may not be the case – which means that the ongoing costs of a listing may not necessarily be justified by the upfront and ongoing burden and costs.

The epic migration of mainland listings may also trigger new problems for Hong Kong regulators. Betts notes the big issue that will ultimately need to be solved is what compliance with the primary listing requirements might look like for an NYSE or Nasdaq-listed company that conducts a secondary listing in Hong Kong under the new Chapter 19C of the listing rules, but subsequently needs to comply with the primary listing requirements, either because it is no longer listed in the US or because a majority of its trade has migrated to Hong Kong.

“Would Hong Kong’s regulators really force Alibaba to unwind its partnership structure, for example? Or would we see the regulators getting comfortable making further rule changes to make a switch to a primary listing more palatable for these companies? That’s a decision that has the potential to impact literally hundreds of billions of dollars of shareholder value,” says Betts. “Stock Connect eligibility for secondary listings also remains a key outstanding piece of the puzzle.”

NASDAQ LISTING A TOUGHER OPTION

Hong Kong
Simon Luk
Winston & Strawn
Partner and chairman of Asia practice
Hong Kong and Shanghai

The Nasdaq is tightening its grip on listings, a move that will make it harder for some Chinese companies to debut on its stock exchange.

The proposed regulations, which require approval from the Securities and Exchange Commission (SEC), seek to clarify that the Nasdaq has discretionary authority to deny listing, or delist companies, after considering any audit concerns as a factor, including whether the company’s auditor has been subject to Public Company Accounting Oversight Board (PCAOB) inspection.

The rules also require companies to raise at least the lesser of US$25 million in equity capital in an initial public offering or a sum equivalent to a quarter of the value of the group, once listed.

Lee Kyungwon, capital markets Asia team leader and a partner at Shearman & Sterling based in Hong Kong and New York, says stricter requirements for auditors appear to be a more targeted attempt to weed out Chinese companies, such as Luckin Coffee, which have raised audit concerns.

Similarly, Lee says that minimum fundraising thresholds are a targeted attempt to eliminate smaller-sized transactions involving Chinese companies that may present higher risks to investors.

“Proposed rules will not affect companies with the size of business to do a benchmark deal, quality management and appropriate audit processes. If anything, it would improve the quality of Chinese companies listed on Nasdaq,” says Lee.

“But a general concern would be that this reflects the current US regulatory trend on increased scrutiny of Chinese companies seeking to list in the US. It would be interesting to see if the New York Stock Exchange would also roll out similar rules.”

David Cheng, a partner at Winston & Strawn’s Hong Kong office, says that implementation of the proposed rules “will increase the difficulty for Chinese companies to list, or continue to list, on the Nasdaq. As a result, some Chinese companies looking to list overseas may have to rethink whether the Nasdaq is a suitable venue for their listing.”

“Some of these companies may choose to list in other more friendly stock exchanges, such as Hong Kong,” says Cheng.

Likewise, he says for existing Nasdaq-listed Chinese companies that may face delisting as a result of non-compliance with the proposed rules, Hong Kong stands as a viable option for secondary listing, or relisting, in view of its proximity to mainland China.

Given the current fragile Sino-US relationship, Simon Luk, a partner and chairman of Winston & Strawn’s Asia practice based in Hong Kong and Shanghai, expects that “the US may continue to introduce new hurdles for Chinese companies seeking listing in the US”.

“Chinese companies considering listing in the US are advised to pay close attention to the updates of the applicable listing rules from time to time,” says Luk. “Further, they need to be flexible, as there is a risk that the current listing regime for Chinese companies in the US may change drastically, with short notice, in the near future.”

THE LAST WORD

Hong Kong
Xue Lian
Partner
V&T Law Firm, Beijing

Competition between the ChiNext and the Star Market is a good thing for companies, offering a wider range of options to go public. Stock exchanges are different from securities regulators in nature. Stock exchanges have long directly dealt with listed companies. Therefore, they ought to be more market-oriented, with a better understanding of trades.

In terms of attracting high-quality would-be listed firms, I believe competition between the twin boards will also bring more transparency to the market and give a boost to the fairness, justice and openness of the market as a whole.

 

Hong Kong
Xiang Zhenhua
Partner
Jingtian & Gongcheng
Beijing

When seeking a listing on the ChiNext or the Star Market, companies should pay more attention to improving quality of information disclosure and ensuring that the information disclosed is true, accurate, complete, readable and understandable.

The practice of piling up impractical, useless and misleading information should be avoided, in order to provide strong support for regulators and investors getting a good understanding of companies’ business and operations.

Hong Kong
Liu Yan
Managing Partner and Head of Capital Markets/Securities Department
Tian Yuan Law Firm

Generally speaking, companies capable of going public are the best among industry counterparts. No matter whether for listing on the ChiNext or the Star Market, a company’s ability to continue as a going concern and as a normative organization stand as the most fundamental requirements.

Therefore, would-be listed companies should first and foremost do well in business. With good business at the core, and with the help of brokers, lawyers and accountants to fulfil the normative requirements, going public is an act of following the natural course. Once they have become listed entities, companies are required to disclose all sorts of information and assume responsibilities accordingly. This is also the price that must be paid for listing. Companies should be mentally prepared for that.

Hong Kong
Kingsley Ong
Partner
Eversheds Sutherland
Hong Kong

One example of rising tensions between China and the US can be seen from the Nasdaq tightening its listing rules earlier in May. Most industry players expect to see Hong Kong playing a bigger role as a neutral ground for fundraising.

However, the new proposed national security law obviously creates uncertainties for investors, and the further escalation of geopolitical tensions will make investors even more nervous. It also comes at a sensitive time, when Hong Kong’s economy has already suffered several waves of major setbacks following from the US-China trade war, social unrest, and the covid-19 pandemic. I expect Hong Kong stock markets will remain very volatile in the immediate future. This will delay many potential Hong Kong listings.