Hong Kong is an active market for initial public offerings (IPOs)1 and debt offerings2 . Bookbuilding and placing activities by intermediaries in equity and debt capital market (ECM and DCM) transactions are substantial but, in contrast to a comprehensive regulatory regime for listing sponsors in the IPO process, were not previously subject to specific regulatory requirements.
In a previous Legal Update, we provided a high-level overview of new requirements in the Code of Conduct for Persons Licensed by or Registered with the Securities and Future Commission (Code of Conduct) that will apply to bookbuilding and placing activities in ECM and DCM transactions from 5 August 2022.
This Legal Update elaborates on the context and scope of the new requirements and provides recommended next steps for intermediaries to prepare for the new requirements in coming months.
Background of the New Requirements
The new requirements in the Code of Conduct are aimed at combating substandard practices and control deficiencies in bookbuilding and placing activities in parts of the Hong Kong markets. This includes lack of transparency in the order book, preferential treatment or rebates paid to some investors, conflicts of interest between intermediaries and its investor clients, and a lack of documentation and record keeping processes.3
In targeting these problems, the new requirements seek to improve governance and enhance market standards to achieve a more transparent price discovery process, fair and orderly capital markets, improve investor confidence and enhance market development in Hong Kong.
The new requirements are set out in new paragraphs 17.1A and 21 of the Code of Conduct. The scope and key points of the new requirements are summarised below.
Scope of the New Requirements
a. Types of offerings
The new requirements target the following offerings:
- Share offering: an offering of shares listed or to be listed on the main board of The Stock Exchange of Hong Kong Limited (Main Board); or
- Debt offering: an offering of debt securities listed or unlisted, and offered in Hong Kong or otherwise.4
b. Types of activities
The new requirements cover three types of defined activities:5
- Bookbuilding activities: collating investors’ orders (including indications of interest) in an offering in order to facilitate: (i) price determination and allocation of shares or debt securities to investors; or (ii) the process of assessing demand and making allocations;
- Placing activities: marketing or distributing shares or debt securities to investors pursuant to those bookbuilding activities; and
- Advising, guiding and assisting the issuer client in bookbuilding and placing activities.
Notably, the following types of activities are excluded from the new requirements:6
- Offerings which do not involve bookbuilding activities such as:
- bilateral agreements or arrangements between the issuer and investors (commonly known as “club deals”);
- transactions where only one or several investors are involved and the terms of the offering are negotiated and agreed directly between the issuer and the investors (commonly known as “private placements”); and
- transactions where shares or debt securities are allocated to investors on a predetermined basis at a pre-determined price.
- A share offering:
- to which an intermediary has subscribed as principal deploying its own balance sheet, for onward selling to investors (commonly known as “block transactions”); or
- selling of listed shares by existing shareholders (commonly known as “secondary offering”).
c. Who do the new requirements apply to?
The new requirements apply to capital market intermediaries (CMIs) and the overall coordinator (OC). Both terms are defined in the Code of Conduct.
Who are CMIs?
Any licensed or registered person engaged in the above mentioned activities covered by the new requirements are considered a CMI. There are two types of CMIs:7
- A CMI which is engaged by the issuer of a share or debt offering is referred to as a “syndicate CMI”.
- A CMI which is not engaged by the issuer of share or debt offering is referred to as a “non-syndicate CMI”.
Who are OCs?
An OC of a share offering is a syndicate CMI which, solely or jointly, conducts any of the following activities:
- overall management of the offering, coordinating the bookbuilding or placing activities conducted by other CMIs, exercising control over bookbuilding activities, and making allocation recommendations to the issuer client;
- advising the issuer client of the offer price and being a party to the price determination agreement with the issuer client; or
- exercising the discretion to reallocate shares between the placing tranche and public subscription tranche, reduce the number of offer shares, or exercise an upsize option or over-allotment option.
As regards a debt offering, an OC of the offering is a syndicate CMI which, solely or jointly, conducts the overall management of the 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 client.
If a CMI conducts any OC activities, it will be considered an OC – and must comply with OC obligations under the Code of Conduct, regardless of whether the CMI was formerly appointed by, or has entered into a written agreement with, the issuer.8
Financial advisers and other related professionals are excluded
The new requirements do not apply to financial advisers and other professionals who are appointed by issuers – as long as they do not participate in bookbuilding or placing activities.9
a. What are CMIs and OCs required to do?
The following diagrams illustrate the key requirements for CMIs and OCs in the life-cycle of a share or debt offering, with supplementary points following the diagrams. For the full text of the new requirements, please refer to the following link: G.N. 6932/2021.
Syndicate CMIs must comply with all the requirements set out in the updated Code of Conduct. As noted in the orange boxes in the diagram above, a non-syndicate CMI which is not appointed by a syndicate CMI is only required to comply with the requirements on (i) assessment of investors, (ii) order book, and (iii) rebates and preferential treatment offered.10
As regards conflicts of interest, proprietary orders of a group company exclude orders placed by the group company on behalf of its investor clients or funds and portfolios under its management, but include orders placed on behalf of funds and portfolios in which a CMI or its group company has substantial interest – namely, more than 50%.11
On the requirement of advice to the issuer client, an OC participating in a share offering is required to provide guidance to the issuer on the fee arrangements, including the market’s practice on the ratio of fixed and discretionary fees to be paid to syndicate CMIs.
The amendments did not specify a fee split ratio but the market norm is 75:25 between fixed fees and discretionary fees. This market norm applies to both OC and non-OC syndicate CMIs. The issuer should be informed of this market ratio – and the SFC would make enquiries where the agreed ratio significantly deviates from 75:25.
The new requirement of 'sponsor coupling' for OCs means that, before accepting an appointment by a listing applicant as a sponsor for a listing application on the Main Board, a sponsor should ensure that it is either:
- independent of the listing applicant, and ensuring that it or one of the companies within its group of companies is appointed at the same time as an OC for that listing application; or
- has obtained written confirmation from the listing applicant that at least one sponsor, which is independent of the listing applicant, or one of the companies within the group of companies of that sponsor, has been appointed as an OC for that listing application.12
Updates to GEM Guidelines
The amendments to the Code of Conduct do not affect placing activities for GEM share offerings. However, the SFC's Guidelines to Capital Market Intermediaries Involved In Placing Activities for GEM Stocks (GEM Guidelines) will also be updated to achieve similar aims as the enhanced Code of Conduct.
In summary, the GEM Guidelines will be revised with effect on 5 August 2022 to provide further guidance to CMIs and OCs engaged in placing activities conducted in Hong Kong for GEM IPOs. One point to note – the sponsor coupling requirement does not apply to GEM stocks.
Please refer to the following link for the full text of the updates to the GEM Guidelines: G.N. 6935.
Recommended Next Steps
It will take time for intermediaries to plan and prepare for the new requirements in the coming months. We suggest the following next steps:
- Conduct a gap analysis of existing policies, procedures, systems and controls to check whether updates are required to address the new requirements.
- If needed, prepare new policies and procedures.
- Keep an audit trail of changes in internal policies and procedures and management approvals obtained.
- Review systems to ensure proper record keeping, such as essential documents and communications related to advice and decisions provided to issuer.
- Set up a function/team to conduct independent surveillance and monitoring on a regular basis to detect irregularities, conflict of interests, leakages of price sensitive or confidential information about the issuer client and the offering, and potential non-compliance with applicable regulatory requirements or its own policies and procedures.
- Create a timeline and project plan for the implementation of the changes to address the new requirements.
- Conduct training for senior management and relevant staff on the new requirements and changes made to internal policies and procedures.
- Formulate assurance or audit plans to check compliance with the new requirements and internal policies and procedures.
- Watch out for updated Listing Rules and other related guidance from the regulators on bookbuilding and placing activities.
New Requirements for Intermediaries in Singapore on the Horizon?
The trend for increased regulation of intermediaries can be observed in Singapore as well. On 15 December 2021, the Monetary Authority of Singapore (MAS) released a consultation paper to seek views on the introduction of due diligence requirements for corporate finance advisers when they advise on corporate finance transactions, with additional requirements when advising on IPOs. A draft of the proposed MAS Notice is annexed to the Consultation Paper on Introduction of Due Diligence Requirements for Corporate Finance Advisers dated December 2021. The MAS consultation closed on 15 February 2022.
CMIs with a presence in Singapore should monitor this development as well.
1 According to the Stock Exchange of Hong Kong, the Hong Kong IPO market has ranked #1 in the world in 7 of the last 12 years, and in 2020 alone, HK$398 billion was raised in the Hong Kong IPO market.
2 According to the Hong Kong Monetary Authority quarterly bulletin dated March 2021, new issuance of Hong Kong dollar debt instruments increased by 16.8% compared with 2019, reaching HK$923 billion.
3 Consultation Paper on (i) the Proposed Code of Conduct on Bookbuilding and Placing Activities in Equity Capital Market and Debt Capital Market Transactions and (ii) the “Sponsor Coupling” Proposal dated February 2021 (Consultation Paper), page 11.
4 Code of Conduct, new paragraph 21.1.2
5 Code of Conduct, new paragraph 21.1.1.
6 Consultation Conclusions on (i) the Proposed Code of Conduct on Bookbuilding and Placing Activities in Equity Capital Market and Debt Capital Market Transactions and (ii) the “Sponsor Coupling” Proposal dated October 2021 (Consultation Conclusions), page 7 paragraph 13.
7 Code of Conduct, new paragraphs 21.2.1 and 21.2.2.
8 Code of Conduct, new paragraphs 21.2.3 to 21.2.5.
9 Consultation Conclusions, page 12 paragraph 38.
10 Consultation Conclusions, Annex B footnote 7.
11 Consultation Conclusions, page 22 paragraph 103
12 Code of Conduct, new paragraph 17.1A.
13 Currently known as the 'Guideline to sponsors, underwriters and placing agents involved in the listing and placing of GEM stocks'.