On 8 February 2021, the Securities and Futures Commission of Hong Kong (the “SFC”) issued a consultation paper (the “Consultation Paper”) which, if enacted as proposed, would have a far-reaching impact on the way in which public offerings of equity and debt securities are made in Hong Kong. Comments to the Consultation Paper will be open through 7 May 2021. The Consultation Paper was issued exactly one week after the end of the consultation period (1 February 2021) for a consultation paper by The Stock Exchange of Hong Kong Limited (the “SEHK”) that dealt with increasing the profit requirement for the Main Board. That earlier consultation paper by the SEHK generated much debate from certain market participants and we expect that the Consultation Paper will likewise invite significant discussion in the industry.
Unless otherwise specified in this alert, the proposals in the Consultation Paper apply both to equity capital market (“ECM”) and debt capital market (“DCM”) transactions.
The Consultation Paper seeks to address specific inadequacies identified by the SFC in bookbuilding and placing activities, including, among other things:
- The lack of a transparent and robust price discovery process through bookbuilding by intermediaries, e.g., inflated or opaque demand caused, in part, by the actions of intermediaries;
- The lack of alignment between the sponsors’ incentives and liabilities, particularly in the case of large IPOs, leading, in some cases, to compromised due diligence enquiries;
- The lack of specific requirements governing the conduct of bookbuilding or placing activities, whether in ECM or DCM. The SFC recognized the need to be consistent with global standards befitting Hong Kong’s stature as one of the world’s largest capital raising centers. In that regard, the Consultation Paper was prepared in light of recently-issued reports by the International Organization of Commissions (“IOSCO”), and incorporates certain IOSCO principles.
Under the Consultation Paper, the SFC has formulated a new paragraph 21 (the “Proposed Code”) in the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”) that would apply to intermediaries conducting bookbuilding and placing activities in Hong Kong. The SFC also proposed, in the ECM context, a “coupling” of the role of the syndicate head and the sponsor of an offering (“Sponsor Coupling”).
The key proposals under the Proposed Code include the following:
- Defining intermediaries as capital market intermediaries (“CMIs”) and further defining the head of syndicate to be the overall coordinator (the “OC”). The role of the OC is determined by the activities conducted by the OC and not its specific title. For example, in the case of debt offerings, an OC is a syndicate CMI that, solely or jointly, conducts the overall management of the debt offering, coordinates the bookbuilding or placing activities conducted by other CMIs, exercises control over bookbuilding activities and makes pricing or allocation recommendations to the issuer;
- CMIs will be expected to adhere to standards of conduct covering a wide spectrum of activities, including bookbuilding, allocation and placing, to address issues including inflated or opaque demand, preferential treatment and rebates, misleading “book messages”, proprietary orders which may negatively impact on the price discovery process and orders which conceal the identities of the investors;
- The coverage of the bookbuilding process under the Proposed Code is wide. For ECM activities, it would also cover (i) units or interests listed or to be listed under the REIT Code and (ii) placing and top-up placing of shares by existing shareholder in listed issuers as the issuer and the shareholder together are responsible for appointing a CMI to assist them in the placing. For DCM activities, the Proposed Code would cover all types of debt offerings, provided that the offering involves bookbuilding or placing activities conducted by intermediaries in Hong Kong;
- The DCM practice of booking “X-orders”, where the identity of investors is concealed, will be expressly prohibited. Under the Proposed Code, the identities of all investors shall be disclosed in the order book, except for orders placed on an omnibus basis;
- Syndicate membership and fee arrangements (including the fixed fee, the discretionary fee and fee payment schedule) must be determined at an early stage, through formal written agreements, to enhance accountability among syndicate CMIs and discourage undesirable behaviour. An earlier determination of roles also diminishes the likelihood of brokers without mandates “swarming” order books at the last minute and bringing in large price-insensitive orders;
- Specifically, in respect of IPOs, composition of the syndicate members (CMIs), total fee arrangement on the public offer tranche and the international tranche, the ratio between fixed fee and discretionary bonus, allocation of any fixed fee by the listing applicant to the CMIs shall be submitted four clear business days before listing committee hearing and any material changes shall notify the SFC as soon as they have been agreed;
- In DCM transactions, some issuers offer rebates to private banks to incentivise them to sell debt securities to their clients and, in some cases, the private banks pass on these rebates to clients. Under the Proposed Code, a CMI shall not offer any rebates to its investor clients or pass on any rebates provided by the issuer. Moreover, a CMI shall not enter into any arrangement that may result in investor clients paying different prices for the debt securities allocated;
- Proprietary orders may present conflicts of interest for CMIs. Under the Proposed Code, a CMI should (i) establish and implement policies to identify, manage and disclose potential conflicts of interest; (ii) establish and implement policies to govern the process of generating and making allocations for proprietary orders; (iii) give priority to investor clients’ orders over the CMI’s proprietary orders; and (iv) only be a “price taker” in relation to proprietary orders;
- Proper record keeping system and new policies and procedures including allocation policy shall be in place to document the bookbuilding process for not less than seven years on (i) assessments of the issuer client, share or debt offering and investor clients; (ii) audit trails from the receipt of orders through to the final order allocation; (iii) all key communications between, and among, the OCs, other CMIs or investor clients, including order book status; (iv) the intended basis of allocation for all orders with justifications and any material deviations from its allocation policy; (v) all key communications with the issuer client; (vi) rebates offered; (vii) any other preferential treatment offered; and (viii) information forming the basis of all submissions made to SEHK and the SFC.
The Sponsor Coupling proposals are designed to mitigate the incentive on the part of sponsors to compromise their due diligence enquiries to win the OC role, particularly when sponsors face fierce competition from non-sponsors who also covet the OC role. A key element in the Sponsor Coupling rules is that, in IPOs, at least one OC must also act as a sponsor. This sponsor must be independent of the issuer. In addition, other OCs must not be appointed later than two weeks after submission of the listing application.
In light of the introduction of the Proposed Code and to avoid duplicating requirements, the SFC proposes to make corresponding changes to the GEM Placing Guidelines. Furthermore, to facilitate implementation of the Proposed Code, subject to the responses to the Consultation Paper, the SFC and SEHK will work together to implement changes to the Main Board Listing Rules and GEM Listing Rules.
Views Being Sought
The SFC is seeking views on the Consultation Paper, including whether the proposed measures are appropriate and proper to address the concerns identified by the SFC, and we intend to prepare a formal written response to the SFC accordingly. We understand that many of the suggestions under the Proposed Code will be a major departure from current practices. In that regard, please feel free to contact any member of our ECM team or DCM team for further discussion, whether on the Consultation Paper itself or on the consequential changes to be made to your internal rules and procedures or policies should any of these proposals be adopted.
King & Wood Mallesons’ capital markets practice is one of the largest and most active practices in the region with a team experienced in providing one-stop-shop advice in respect of the laws of Hong Kong SAR, the PRC, England and the US across a range of equity and debt security products. The team has been consistently recognized by FinanceAsia Awards, a financial and capital markets focused publication that recognizes the best law firms, banks and brokers in Asia’s key markets, and was awarded “Hong Kong Firm of the Year” for the last two consecutive years.
Jason Kuo and Tony Jacobsen contributed to the preparation of this alert.
*Any reference to “Hong Kong” or “Hong Kong SAR” shall be construed as reference to the “Hong Kong Special Administrative Region of the People’s Republic of China”.
 IOSCO issued a report in September 2018 on conflicts of interest and associated conduct risk in the the equity capital raising process, and issued a further report in September 2020 on the debt capital market.
 Please note that the proposals summarized in this alert are by no means exhaustive. You are advised to read the Consultation Paper in its entirety for a comprehensive understanding of the Proposed Code.