Hong Kong regulator to toughen IPO oversight

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HONG KONG (Dow Jones Banking Intelligence) – Hong Kong’s securities watchdog, the Securities and Futures Commission (SFC), is understood to be about to issue a new consultation paper, in which it will propose tougher due diligence requirements – as well as harsher sanctions for IPO sponsors that fail to follow them. This is likely to face opposition on the part of the securities industry, although since banker-bashing remains in fashion, the new rules should ultimately see the light of day.

Ashley Alder, the new Chief Executive of the SFC and a former senior securities and M&A lawyer, will have wasted no time since his appointment last October in introducing reforms to improve governance of the IPO market in Hong Kong. This comes hot on the heels of earlier criticism by the SFC in March 2011 about deficiencies in the execution of IPOs in the Special Administrative Region of China.

Some of this will of course have been driven by the Stock Exchange of Hong Kong’s (HKEx) reliance on issuers from the Chinese mainland, despite steady – but still measured – steps to introduce international companies to listing there. According to data from the exchange, as of March 2012, Chinese companies accounted for 45.6% of the number of companies listed in Hong Kong, as well as for 58.2% of the total market capitalization on HKEx and 65.0% of the total equity turnover.

A number of Chinese companies listed in Hong Kong and abroad (chiefly in north America) have in recent months been in the spotlight of regulators, as a result of actual (or alleged) misleading or fraudulent disclosure, as illustrated by the high profile case of Sino-Forest Corp. in Canada, and its well-publicized brawl with hedge fund Muddy Waters. Auditor resignations among the Big Four have also regularly featured in recent months.

Regulators have also been quick to point the finger at IPO sponsors, brokers or banks that guide issuers throughout the listing process (and on HKEx’s GEM board for companies at an early stage of development, also once they have become listed). In May 2011, the China Securities Regulatory Commission (CSRC) already introduced new, tougher rules for IPO sponsors on the mainland.

[See my column “China’s IPO sponsors in the spotlight“, May 11 2011]

In Hong Kong (as on the mainland), a key component of the execution of IPOs is through the use of principals, a limited pool of individuals licensed by the SFC to be involved in due diligence and in the preparation of listing documentation, and who can effectively sign off on new listing applications.

[See my column “Principals key to playing HK’s IPO game“, October 14 2011]

The new rules are likely to introduce criminal liability for sponsors, which could now mean some jail time for banking and broking staff, if they are shown to have failed in properly checking IPO prospectus information. This would go far beyond the existing regime, which, unlike that in other Asian jurisdictions such as Singapore, only provides for light penalties, including fines, reprimands and, potentially, the suspension of licenses.

The SFC has already shown its teeth this morning in a rare (and significant) case, stripping broker Mega Capital (a unit of Taiwan’s Mega Financial Holdings Co.) of its right to advise on IPOs, also fining it an unprecedented US$5.4 million.

While details are yet to be released, legislators and investors have been quick to applaud the SFC’s initiative. Bankers, on the other hand, will no doubt put up a brave fight to resist what they probably see as an unnecessary, added layer of supervision in one of the most active and liquid capital markets in the world – and at a time when new equity issuance has considerably retreated, as compared to the boom years.

(Philippe Espinasse worked as an investment banker in the U.S., Europe and Asia for more than 19 years and now writes and works as an independent consultant in Hong Kong. Visit his website at Readers should be aware that Philippe may own securities related to companies he writes about, may act as a consultant to companies he mentions and may know individuals cited in his articles. To comment on this column, please email [email protected]).

[This article was originally published on Dow Jones Banking Intelligence on 23 April 2012 and is reproduced with permission.]