Hong Kong’s stock exchange is stepping up its game to attract more listings away from the US and China, writes Luo Weiting
For years, Hong Kong has put itself on the global map as a go-to destination for companies making their entrances in the initial public offering (IPO) market.
As Asia’s financial centre ups the stakes in its battle for the so-called new economy and biotechnology listings against New York – which stole the SAR’s coveted crown as the world’s leading venue for IPOs last year – the city is betting on a much-awaited listing rule reform to fuel a resurgence of IPO activity.
With the introduction of its biggest listing reform for 25 years in April this year, local bourse operator Hong Kong Exchanges & Clearing Ltd (HKEx) sends a strong message to promising companies the world over: our doors are wide open for you.
The listing reform opens the gateway to companies from emerging and innovative sectors, with weighted voting right (WVR) structures and biotechnology companies without any prior record of revenue or profit to be listed on the local bourse. It also provides a concessionary secondary listing route for Greater China and international innovative companies listed on qualifying exchanges overseas, says Ronny Chow, a partner at Deacons in Hong Kong.
“Alongside this major listing reform, the HKEx also allows Chinese companies currently listed on the National Equities Exchange & Quotation [NEEQ, or New Third Board] to list in Hong Kong without being first delisting from NEEQ,” says Chow.
The operator of Asia’s third-largest stock exchange by market capitalization spent years of effort to eventually overturn a ban on companies that have shares with different voting rights from going public in Hong Kong, an issue that caused the city to lose out on Alibaba’s US$25 billion deal, the world’s largest IPO that listed on Wall Street back in 2014.
WVR, also known as dual-class shares, are allowed in many jurisdictions, including the US, Canada, Brazil, France, Italy and Switzerland.
“The shareholding structures are particularly attractive to fast-growing, entrepreneur-led companies, as they give the founders good prospects of continuing control, leaving them free to focus on developing the business for the long term, without the distraction that battles with hostile bidders or activist shareholders may bring,” says Greg Knowles, Asia head of corporate at Maples and Calder.
He says typically investors are investing on the basis of the founders continuing to inspire the business, and so these structures match their expectations. “Clearly the reforms open up the Hong Kong Stock Exchange to attracting a whole new breed of entrepreneur-led company, which might previously have sought a listing in the US, where dual-class structures have always been permitted,” he adds.
In the past couple of months, an impressive number of Chinese tech firms have lost no time in taking advantage of the rule change – a change meant to be the path to tech glory for an exchange once dominated by energy, financials and utilities.
Chow believes such a trend is likely to continue. Chinese smartphone maker Xiaomi became the first company to list in Hong Kong with weighted voting rights in a US$4.7 billion deal in July. Meituan Dianping, China’s largest online food review and delivery company, followed suit with its US$4.2 billion Hong Kong listing in September. Beijing-based Bitmain Technologies, the world’s biggest producer of cryptocurrency mining chips estimated to control as much as 80% of the market for cryptocurrency mining gear, has also filed to list its shares in Hong Kong with weighted voting rights in September, which could be the world’s largest cryptocurrency float.
Allowing weighted voting rights marks a big departure for Hong Kong’s strict one-share, one-vote principle. Amid years of debate and rounds of consultation, the push to adopt dual-class structures had been stalled by resistance from the securities regulator.
Having recognized that “a broad range of investors, including buy-side fund managers and other international investors, are now keen to access a far more diverse range of larger listed companies in Hong Kong, particularly tech companies”, Hong Kong’s Securities and Futures Commission (SFC) ultimately backed off from its long-entrenched one-share, one-vote principle and gave the go-ahead to alternative governance structures that grant different weights to various shareholders.
The lingering concern for the city’s regulators is how to strike a balance between safeguarding the interests of small investors and upholding the principle of treating all shareholders alike, while ensuring that Hong Kong remains attractive to companies that favour the WVR structure, says John Baptist Chan, a partner in the Hong Kong office of King & Wood Mallesons.
“On the other hand, dual-class share listing would be able to attract companies with differentiated voting rights underpinned with different corporate governance structures, and companies that fall into the definition of an innovative company in terms of innovation or business model in their operating industry,” says Chan.
The weighted voting rights structures of Xiaomi, Meituan Dianping and Bitmain Technologies are quite similar, notes Chow. “This can be explained partly by the fact that the WVR regulations set out in the new chapter of our listing rules are, like other parts of the rules, largely prescriptive in nature,” he says.
Hong Kong is the first major jurisdiction to have its own regulations for WVR, which provides for a range of ring-fencing measures to make sure that WVR does not become the norm in the market, says Chow. Such measures include detailed suitability requirements – such as requiring that the issuer must be innovative in nature, imposing limits on the role and powers of WVR holders – a higher market capitalization threshold, enhanced disclosure and corporate governance requirements. Most of them are bright-line requirements, he says.
“Yet, the fundamental question of whether a company meets the suitability criteria of being an innovative company might not always be a straightforward one, because it involves a degree of subjectivity to some extent,” he says. “The regulators would need to be prudent to avoid arbitrary outcomes in regulation on the one hand while not undermining our local bourse’s appeal to new economy companies on the other.”
“Instead of providing an affirmative list on categorizing certain kinds of industries and companies as innovative, the stock exchange has specified a non-exhaustive list of characteristics relevant for its consideration when determining the applicability of WVR structure,” Chan points out. “The stock exchange considers that the non-exhaustive list of characteristics can be changed from time to time.”
So new and innovative business may cease or change by virtue of the market players in the particular industry. One company successfully listed under chapter 8A of the listing rules, which extends the listing platform to companies adopting a WVR structure, but does not automatically qualify another company from the same industry suitable for listing with a WVR structure if the subsequent applicant is unable to demonstrate distinctive features or characteristics, says Chan.
“In view of the uncertainty, companies are recommended to consult the stock exchange at an early stage,” he says. “Thus the application of chapter 8A is subject to a prior vetting by the stock exchange, rendering the exchange as also the gatekeeper for listing applications that adopt a WVR structure, without opening the floodgate to all potential applicants.”
As another part of a package of measures to make Hong Kong the magnet for promising companies the world over, the bourse operator also gave the green light to listings from biotech companies without track records of profitability or revenue, in a sign of its determination to test the waters in an area that could be crucial for luring big companies.
Ascletis Pharma, a Hangzhou-based maker of HIV drugs, took the lead to sell shares in Hong Kong in August, after the city relaxed rules to allow listings from unprofitable early-stage drug developers.Several biotech firms including China’s Hua Medicine and Innovent Biologics have followed with market debuts in the city. Chinese Nasdaq-listed biotech BeiGene also became the first overseas-listed biotech firm to seek a secondary flotation in Hong Kong in a US$903 million deal.
“For pre-revenue/pre-profit biotech companies, the regulators are particularly concerned that such companies have no track record to serve as a benchmark, and if they happen to fail, they could become easy targets for backdoor listing and shell activities,” says Chow. The biotech regime includes measures aiming to deal with these risks, such as expediting the delisting process, prohibiting fundamental changes in business, and requiring enhanced disclosures.
“It is too early yet to know whether the pre-revenue/pre-profit biotech companies so far listed, or to be listed in the near future, will turn out to be a success or failure,” says Chow. “And in the event of failure, how would HKEx in practice enforce its rules to delist biotech companies that have failed to meet the requirement of maintaining sufficient operations or assets.”
According to Chan, although chapter 18A allows pre-revenue biotech companies to apply for listing on the exchange, they must satisfy the suitability criteria that are additional to the requirements stipulated in chapter 18A of the listing rules, inter alia: (1) The company must have developed one core product beyond the concept stage that satisfies the definition of “regulated product”; (2) The company must be able to demonstrate that the primary reason for listing is for the purpose of raising finance for research and development (R&D) to commercialize its core product.
While a platform is opened up for biotech companies to apply for listing without fully complying with the financial eligibility test, the definition as provided under chapter 18A of the listing rules, and the relevant guidance letter, has stipulated the scope for the suitable biotech companies, says Chan.
For example, the stock exchange only recognizes three national pharmaceutical regulatory authorities, including the US Food and Drug Administration (FDA), the China Food and Drug Administration (CFDA) and the European Medicines Agency (collectively, the competent authorities).
“Thus biotech companies from other jurisdictions that have engaged, obtained authorization or approval from other national pharmaceutical regulatory authorities by definition may need to consult the stock exchange for further guidance to understand whether such authority falls within the definition of national or supranational authority,” says Chan.
Furthermore, the stock exchange has stipulated that a biotech company’s applicant must also have a commercialization plan. Once the product has passed the concept stage and the competent authority has no objection to commercializing the product, it must have a plan for manufacturing and marketing its core product at the expense of the biotech company’s applicant, he adds.
“Thus the biotech company’s applicant that has the intention to license its core product to other pharmaceutical manufacturers, which mainly focus on the production of products, may not be able to satisfy the conditions for listing under chapter 18A of the listing rules.”
All in all, the new listing reform – which opens the gateway to a new parade of companies raising funds in Hong Kong while having detailed and transparent rules to manage the associated risks to safeguard investors’ interests and confidence – is evidence of the city’s long-cherished advantages, says Chow.
Such advantages, laying the foundation for Hong Kong’s long history of being a major international financial centre and a key listing and fundraising venue, are known as “the robust financial and legal systems, as well as the local bourse’s and its regulators’ commitment to maintain or enhance competitiveness of our market, while acknowledging the need to stay prudent in developing and implementing listing reforms in order not to sacrifice investor protection”, he notes.
Benita Yu, a partner at Slaughter and May in Hong Kong, joins a chorus of voices applauding the advantages for seeking a Hong Kong listing.
Depending on what is important to the issuer, she believes they include “certainty of the listing regime, liquidity, flexibility for new economy issuers in terms of weighted voting rights, biotech companies and secondary listings of innovative companies, broad range of overseas jurisdictions accepted for floats in Hong Kong, and active secondary market and flexible legal regime for further fund raising for growth post-listing”.
Hailing the listing reform as “a breakthrough in the previous regulatory perspective and an important step towards keeping abreast of market development”, Charles Chau, a partner at Jones Day in Hong Kong, says, “it is anticipated that the new listing regime will enhance Hong Kong’s attractiveness as a leading fundraising market in the world, and its position as a leading international financial centre. This is undoubtedly a significant milestone in the capital market of Hong Kong.”
With a critical mass of new economy and biotech companies starting to form, Hong Kong stands as a credible choice for companies weighing up the choice between listing in the US and Hong Kong, says Christopher Betts, a partner at Skadden Arps Slate Meagher & Flom in Hong Kong.
Unlike in the US, there are no class actions in Hong Kong, where the litigation and compliance risk is lower, notes Chau.
Chinese citizens can buy listed securities in Hong Kong through the Hong Kong-Shanghai and Hong Kong-Shenzhen Stock Connects. Such an advantage is not available for companies listed in the US, he says. The city is known for having no quota for the number of companies to be listed. And the Hong Kong Stock Exchange applies consistent standards in vetting lasting applications.
“With the additional disclosure requirements under the new Hong Kong listing regime, there is a more balanced relationship between management and the shareholders, which will appeal to both new listed companies and investors,” says Jo Lit, a counsel in the corporate and investment funds groups of Walkers’ Hong Kong office.
Due to the high market capitalization requirement for companies with a WVR structure to be listed in Hong Kong, Lit says there will be more companies opting for the A/B share structure – typical WVR structure similar to that of Hong Kong – to be listed in the US rather than Hong Kong.“Having said that, the lower post listing compliance costs and the Chinese advantage that Hong Kong offers will continue to allure major Chinese innovative companies to opt for listing in Hong Kong,” she says.
Lin Xiaochun, a partner at Shu Jin Law Firm in Shenzhen, deems Hong Kong to be a viable listing platform “for companies who have global vision, global brand or global market”.
She notes that companies who are more familiar with the Hong Kong IPO market than with its counterpart in the US may relish the idea of going public in Hong Kong, especially given many political issues in the capital market they may otherwise face in China this year.
Chan, at King & Wood Mallesons, believes the stock market in Hong Kong has been identified as “one of the most transparent markets, which stipulates the listing conditions and requirements with suitable guidance for a potential applicant to research and prepare its potential listing application”.
The stock market in the US adopts the disclosure basis methodology. While the application process is streamlined and relatively straightforward, the derived disadvantage is the relatively high post-IPO compliance cost for the listed issuer by virtue of the litigation system in the US, which allows class actions and contingency fees, Chan notes. He adds that it is argued that investors are more likely to sue in class for any omission of material information not disclosed in the prospectus.
The China market, on the other hand, adopts a merit basis for vetting. As a result, it would take a more substantial amount of time to vet the listing application, which would render it almost impossible for the listing applicant to realize its listing plan on time.
“The power and responsibility of vetting the listing application remains to be conferred to the [Hong Kong] stock exchange subject to the statutory oversight of the SFC – the statutory regulator that administers and implements the Securities and Futures Ordinance – after the completion of the consultation on the decision making and governance structure for listing regulation,” says Chan.
He says that in Hong Kong, the overall performance in vetting the listing application will continue to adopt a disclosure basis approach subject to the analysis of eligibility, suitability, sustainability, compliance of rules and sufficiency of disclosure. So, the hybrid approach in Hong Kong is a middle ground of that in the US and China.
“With active market trading and minimal government intervention, the stock market in Hong Kong would continue to allow the potential applicant to prepare its application with sufficient guidance and published listing decisions,” he says.
Despite all the strengths, Betts believes the city’s listing process is “lengthy, burdensome and comes with numerous technical, procedural and disclosure requirements, some of which companies may not be prepared for”.
For example, on the technical side, he says the HKEx has strict rules around the terms of pre-IPO investments and the use of contractual arrangements – or variable interest entity structures – that are adopted by many new technology companies. And on the disclosure side, there are detailed requirements around the disclosure of employee equity grants.
“The Hong Kong listing process is a substantive review process that requires the listing applicant to justify that its business model is sustainable, as opposed to a disclosure-based regime, so one challenge often faced by new economy companies is explaining the merits of their business model to the persons vetting their listing application, who may not themselves have any industry background,” says Betts, adding, “there is definitely scope to simplify the whole process.”
The paperwork intensive and time consuming listing process means that a deal can take as long as six to eight months from start to finish, compared with four to five months for a US IPO, during which time market conditions may fluctuate significantly, he notes.
The concern over market fluctuations rings true as protracted and escalating trade tensions between the world’s two largest economies cast a shadow over Asia’s financial hub.
“The recent Sino-US trade skirmish has highlighted that the macroeconomic environment could change dynamically and dramatically within a short period of time,” says Chan. “Given that the latest financial period reported on by the reporting accountant must not have ended more than six months before the date of the listing document, as required by the new listing rules, an unexpectedly lengthy vetting process would affect the applicant’s listing timetable.”
Since the listing timetable is highly dependent on the turnaround time of comments from the stock exchange’s vetting team, market sentiment cannot be easily anticipated and is subject to the change of the macroeconomic conditions, he says.Therefore, a prolonged period of time spent waiting on the comments and responses from the stock exchange would also become a huge hurdle for a listing applicant to adhere to its listing plan.
Betts believes that fast growing companies with highly innovative business models that are still, and expect to continue to be, loss making may find it more appropriate to list in the US, while companies that have achieved, or are close to achieving, profitability may be more appropriate for Hong Kong.
This belief is tied to the fact that historically the overwhelming majority of listings in Hong Kong have been by companies that were already profitable and were more easily understood by Hong Kong investors, who typically value them based on traditional price-earnings multiples.
The belief can also be attributed to the city’s significant regulatory focus on the protection of retail investors,who, under Hong Kong’s listing rules, are mandated to receive a material portion of the shares in every IPO (up to 50% of the deal, depending on the level of over-subscription).
Hong Kong also requires no less than 25% of shares to be in “public hands”, meaning that most companies are selling 25% of their share capital at the time of the IPO. In the US, on the other hand, the deal can be entirely allocated to institutional investors, and there is no prescribed minimum percentage to be placed, notes Betts. “The offer process, however, is a product of the 1990s and ripe for a rethink,” he says.
Its focus on ensuring Hong Kong retail investors are able to subscribe for a material portion of every deal leaves little flexibility in the offer process, Betts points out. Among other things, the price range must be determined prior to the bulk print of the prospectus, which can be two or more weeks before the IPO completes.
“The new listing regime has only been launched for less than one year,” says Yu from Slaughter and May. “The markets and intermediaries should be allowed time to continue to work together on calibrating the right approach to pre-IPO preparation, including the appropriate level of due diligence and disclosures, valuation, post-listing research support and investor education.”
Chinese IPOs in Hong Kong by deal value
|1||King & Wood Mallesons||12,367.39|
|2||Han Kun Law Offices||6,326.63|
|4||Grandall Law Firm||3,985.12|
|5||Jingtian & Gongcheng||2,629.32|
|6||Commerce & Finance Law Offices||1,564.92|
|7||Tian Yuan Law Firm||1,310.79|
|8||Zhong Lun Law Firm (Beijing)||1,245.09|
|9||Haiwen & Partners||1,137.16|
|1 October 2017 to 30 September 2018|
|1||Skadden Arps Slate Meagher & Flom||14,933.03|
|3||Freshfields Bruckhaus Deringer||7,491.14|
|3||Davis Polk & Wardwell||2,577.62|
|10||Latham & Watkins||1,492.17|
|10||Simpson Thacher & Bartlett||1,121.36|
|10||Drew & Napier||963.09|
|1 October 2017 to 30 September 2018|
|1||Maples and Calder||16,551.01|
|3||Conyers Dill & Pearman||2,515.23|
|1 October 2017 to 30 September 2018|
Chinese IPOs in Hong Kong by deal number
|1||Jingtian & Gongcheng||24|
|2||King & Wood Mallesons||12|
|3||Commerce & Finance Law Offices||11|
|4||Tian Yuan Law Firm||9|
|5||Grandall Law Firm||8|
|7||Shu Jin Law Firm||5|
|8||Han Kun Law Offices||4|
|=10||Zhong Lun Law Firm||2|
|=10||Haiwen & Partners||2|
|=10||AllBright Law Offices||2|
|=10||Jia Yuan Law Offices||2|
|=10||GFE Law Office||2|
|1 October 2017 to 30 September 2018|
|1||Skadden Arps Slate Meagher & Flom||10|
|=4||Chiu & Partners (Hong Kong)||5|
|=4||Davis Polk & Wardwell||5|
|=4||Luk & Partners (Hong Kong)||5|
|=8||Latham & Watkins||3|
|=8||Simpson Thacher & Bartlett||3|
|=8||Wilson Sonsini Goodrich & Rosati||3|
|=8||Shearman & Sterling||3|
|=8||Loong & Yeung (Hong Kong)||3|
|1 October 2017 to 30 September 2018|