Initial Public Offering Industry in Hong Kong - Case Study Example

Initial Public Offering Industry in Hong Kong Introduction In last few years, the concept of Initial Public Offering (IPO) has been coined at a greater level in the global business environment. An IPO has been defined as a stock market launch where shares of a particular company are sold to general public on security exchange for the very first time. IPOs are used by companies to raise additional money in the market through which private limited companies are converted into public limited companies. An IPO is considered as the most preferred capital raising options for a number of private limited companies but it also has a number of disadvantages in the form of high cost associated with the process and greater degree of risks in terms of the IPO failure. The current discussion is aimed at analysing the IPO industry in Hong Kong. In last few years, IPOs have been transforming the financial structure of a number of private limited companies in the country. Hong Kong is considered as the world’s leading financial centers having a capitalist economy driven by low taxation and free trade. Hong Kong is considered as the most important international financial center and in the 2009-10 year, it raised 22% of the worldwide IPO capital making it the largest IPOs in the world and thus signifying the importance of IPOs. Hong Kong is considered as the international financial center mainly because of the passive government’s policies with no control over the imports and exports (Browning, 2014). Hong Kong has suffered a dip in the IPO volumes in last two years mainly because of the financial breakdown in the Asian and European economies. However, things have been improving a lot in last few years with a number of private limited companies lining up for the IPOs. The performance of Hong Kong IPO industry has been remarkably positive and lucrative in last few years making it one of the highly preferred economic destinations for a number of investors. The major purpose of the discussion is to understand the legal framework and procedures of the industry along with focusing on the recent development and trends in a critical manner (Brown, 2014). IPO Scenario in Hong Kong As per the research conducted by KPMG (2013), it was found that funds raised via Hong Kong listing will increase to more than HKD200 billion in the year 2014. Hong Kong registered more than HKD 160 billion with more than 90 companies listed on the Hong Kong stock exchange. Furthermore, it is expected that the IPO industry of Hong Kong will witness a rise in IPOs by 78% from the previous year in the year 2014. This states the significance of IPOs in the rising economy of Hong Kong. Though, New York Stock Exchange tops the chart in terms of highest sizeable IPOs in the year 2013 but Hong Kong came second in terms of lucrative and sizeable IPOs signifying the overall preference of IPOs on the Hong Kong Stock Exchange. It was further found that the year 2013 witnessed tremendous growth and demand for IPOs in the country where 63 companies were listed and out of that; 34 companies were listed during the fourth quarter. The industry experts suggested that the trend will continue in the following years with a number of local companies willing to be listed (Barreto and Lau, 2014). KPMG (2013) further forecasted that the more than 100 companies will be listed in Hong Kong in the year 2014 with large numbers of small and medium sized organisations growing at a rapid pace. In this regard, the most important stimulus has been the policies of the China Securities Regulatory Commission in the form of introducing relaxed and simple criteria, easy and simplified checking, and hassle free approval procedures (Chan, 2014). All these factors have been the driving force behind the emergence of IPOs in Hong Kong. There is no doubt that the government’s policies have played an important and crucial role in creating a sustainable environment for IPOs and with expected growth volumes; Hong Kong is all set to become as one of the highly preferred IPO destination for the local as well as international companies. The listing of foreign companies has been tapered off in the year 2012 but the government is taking adequate steps to attract foreign companies (KPMG, 2013). Regulatory Overview This part of the discussion defines the regulatory overview of IPO industry in Hong Kong in an illustrative manner. The principle statuary and non-statuary rules governing the new issues in Hong Kong have been discussed in a detailed manner as follow. Companies Ordinance- the company ordinance sets out the prospectus regime regulating the offerings of shares and debentures. Shares and debentures cannot be issued by companies to the public for subscription or purchase until and unless the prospectus complies with the requirements in the company ordinance. It has to be registered with the Registrar of the Companies under Section 38D or 342C of the company ordinance. The Company Ordinance prospectus also includes information for companies established in Hong Kong in Part II and for companies outside Hong Kong in XII. It is important to disclose certain information like material contracts, valuation report, financial statmenets, accountant’s reports, and complete detail over the profitability of the company. Upon approval of the listing application, it is important to authorize a copy of prospectus by the exchange for registration and register with the Registrar of the Company (Morrison Foerster (2013). Securities and Future Ordinance- one of the key objectives of the securities and future ordinance is to offer protection to the investors. Section 103 of the SFO makes it an offence if any advertisement or invitation document contains an invitation to Hong Kong public to enter into an agreement. The SFO prohibits the falsification and manipulation of data and information. Any false or misleading content cannot be published in the prospectus or in agreement to misguide the investors. It can be believed that this ordinance is mainly based on keeping the transparency along with safeguarding the safety of investors. Upon violation of the stated codes and requirements; companies may face legal action leading to the cancellation of operating license in the long run along with severe penalties (Morrison Foerster (2013). Securities and Futures (Stock Market Listing) Rules- The statuary regulatory body is the SFC. Under the established rules, the exchange passes the SFC copies materials submitted by the applicants and listed issuers and these copies are treated as being submitted to SFC by the applicants. Through this agreement, the SFC is free to exercise its control over the applicants by investigating the statements and information in order to analyse and assess any manipulation or falsification in data and information (Morrison Foerster (2013). The Exchange and the Listing Division- The exchange is considered as the principle regulator of the stock market applicants and participants. The division of exchange is responsible for supervising the listing process along with ascertaining the overall obligations. The listing division comprises of six divisions with the IPO transactions processing the new transactions and answering pre-IPO queries, the monitoring and compliance department monitors the compliances associated with the listing, the listing enforcement investigates possible listing breaches, the listing policy department formulates policies and offer support and guidance, the listing operations department manages the operations supporting the public disclosure filings, and the policy framework and strategy department develops listing proposals and ideas to enhance the listing regime in a systematic manner (Morrison Foerster (2013) The Listing Committee- the listing committee acts as an independent administrative decision maker and advisory body for exchange. Its main functions are to oversee the listing process and procedures, provide policy advices to the listing division on matter related to listing along with approving amendments pertaining to listing, to approve listing matters along with taking disciplinary actions, and to act as a governing and advisory body for the listing division to review wide arrays of decisions. It can be said that the decisions of the listing committee matters the most in terms of assessing the policy framework along with approving the listing processes and procedures (Morrison Foerster (2013). Key Requirements for Listing in Hong Kong New applicants are advised to contact the Exchange for detailed information over the listing to gain confidential advice on submitting a listing application. It is very important to avail key and legal information over the listing process in order to fulfill the listing requirements. Key requirements pertaining to the listing have been discussed in a critical and informative manner in the following part of the discussion (KPMG, 2013). Financial History: Profit Test Market Cap/Flow Test Market Test/Revenue Profit Attributable to Shareholders At least HK$50 million in last three years, HK$20 million in the recent year, and HK $30 million in the last two years. - - Market Capitalization It has to be at least HK$200 million at the time of the listing At least HK $2 billion at the time of the listing At least HK $4 billion at the time of the listing Revenue - It has to be more than HK $500 million for the last audited financial year It has to be more than HK $500 million for the last audited financial year Cash Flow - The positive cash flow from operating activities of at least HK $500 million last three years. - Operating History It is very important for the potential to be listed companies to have a trading record of at least three financial years with the management ownership and continuity of more than three years in the last three preceding financial years. It is also important to have ownership control and continuity for at least the most recent audited year. The Exchange considers the management continuity under the Listing Rule 8.05 (1) (b) and practice Note 3 that states; it is important to assess the management continuity to ascertain the background of the applicants and overall validity and reliability. Individuals with more number of years with the company are offered more responsibilities compared to individuals with little experience and continuity in the company. On the other hand, the ownership continuity also plays an important and crucial role considering the fact that the Exchange assesses the ownership credentials of the individuals and their past work and contribution in the success of the company and accordingly decisions are taken based on the usefulness of the information (Toloken, 2014). Financial Accounts The financial accounts play an important and decisive role in ascertaining the financial health of companies. It is important to have financial accounts that are not more than six months old before the date of the prospectus. The financial accounts should not be falsified or manipulated. There should be no window dressing and information should be presented in a clear and transparent manner. In many cases, the prices of assets are either inflated or deflated to alter the financial statements. However, during the listing of the company; these things are against the norms and code of conducts of the Listing Committee. The authenticity of the financial statements often helps the committee to take a decision in terms of forwarding the listing application. Thus, the nature and presentation of financial accounts play an important role in the decision making process (Xiao, 2014). Minimum Public Float It is recommended that at least 25% of the issuer shared capital must be held by the public all the time. If the market capitalization is above HK $10 billion then the Exchange may accept a lower percentage in between 15%-25%. In the context of the “Public” it is assumed that public cannot be any close associate or relative of the issuer. At the same time, any person whose acquisition of securities is financed by the connected person cannot be considered as the issuer. Spread of Shareholders It is stated that at least 300 shareholders are required and at the time of the listing not more than 50% of the securities can be under the custody of three largest public shareholders. All these initiatives are taken to safeguard the applicant and public in the long run. Competing Business It is important for the company to disclose all the relevant information to the public and falsification and manipulation of data and information cannot be done. There should be no conflicts in between the issuer and applicant and the public as this can impact and affect the overall listing process. Sufficient Management Presence It is required that two of the directors of the company should reside in Hong Kong until and unless waived by the Exchange. These two directors should not be involved in any activity that can affect the name and image of the company in a negative manner. Directors’ Qualification and Listing Rule It is important that the directors of the company have the character, experience, skills, and integrity to enhance the standard of competence. It is also important to have desired set of skills required to manage the company and shareholders along with being honest and transparent in the business approach. Accounting Standards It is important for the listing applicant to prepare account in accordance to one of the following mentioned standards (rule 4.11). These standards act as a guideline for being transparent and honest in terms of highlighting the information and set of data. The Hong Kong Financial Reporting Standard is highly preferred followed by the International Financial Reporting Standard and China Accounting Standards for Business Enterprises. The Exchange clearly states that, it is important for the listing companies to follow only one accounting standards and two standards cannot be followed at the same time. For secondary listing, the Hong Kong Exchange states that the US GAAP, UK GAAP, Canadian GAAP, or Japanese GAAP can be followed (Morrison Foerster (2013). IPO Procedure and Preparation Prior to IPO, companies tend to review their legal, financial, business processes, and corporate structure to ascertain and meet the public market expectations. Corporate restructuring is the process of reorganizing the legal, ownership, and operational structure of the company to make it more profitable. Assets and liabilities are structured in a systematic manner to reduce the financial losses. At the same time, it is important to identify a sponsor as every new listing company needs a sponsor. A Sponsor should not hold more than 5% of the total share of the company. The Listing rule 7.03 further states that an offer for subscription must be fully underwritten. For this purpose, the listing applicant is required to sign an agreement with the underwriters. This helps the listing company in terms of getting the desired exposure along with understanding the marketing dynamics by being safe. Once the applications are suitable for listing; offer for subscription is made that is often followed by offer for sale, and placing. However, prior to listing; a detailed investigation of the legal and financial obligations of the companies is conducted by the Listing Division to assess the authenticity (Brown, 2014). Conclusion Based on the critical analysis of the discussion, it was found that the IPO industry in Hong Kong has been thriving at a rapid pace making it as one of the highly preferred IPO destinations on the global financial map. It was also found that the governing and regulatory bodies are driven by specific set of rules and regulations that have to be followed by all the companies willing to be listed (Timmons, 2014). The rules and procedures are made to safeguard the interest of the companies and shareholders and thus making it an ideal process. The coming years may witness sharp increase in the IPOs with a number of potential companies being allured by the concept of IPO in the recent run. References Browning, J (2014) Hong Kong Lures New York IPOs After China Auditors Ban. Retrieved from http://www.bloomberg.com/news/2014-01-26/ban-means-hong-kong-luring-new-york-ipos-china-overnight.html Brown, A (2014) Hong Kong IPO Market Predicted to Boom in 2014. Retrieved from http://www.business2community.com/finance/hong-kong-ipo-market-predicted-boom-2014-0727785#!wAyso Barreto, E and Lau, F (2014) Daimler-backed BAIC Motor revs up $2 billion Hong Kong IPO. Retrieved from http://www.euronews.com/business-newswires/2299660-daimler-backed-baic-motor-revs-up-2-billion-hong-kong-ipo/ Chan, R (2014) Hong Kong to remain top market for mega IPOs from Chinese firms. Retrieved from http://www.scmp.com/business/money/markets-investing/article/1428122/hong-kong-remain-top-market-mega-ipos-chinese-firms Daily Mirror (2014) Quirky IPOs make a splash in Hong Kong. Retrieved from http://www.dailymirror.lk/business/features/43266-quirky-ipos-make-a-splash-in-hong-kong.html KPMG (2013) KPMG forecasts Hong Kong IPOs to raise over HKD200 billion in 2014. Retrieved from http://www.kpmg.com/cn/en/pressroom/pressreleases/pages/press-20131216-kpmg-forecasts-hong-kong-ipos-in-2014.aspx Morrison Foerster (2013) A Guide to Hong Kong's IPO. Retrieved from http://www.mofo.com/files/Uploads/Images/121119-The-MoFo-Guide-to-Hong-Kong-IPOs.pdf Timmons. H (2014) Why the Year of the Horse could be a winner for the Hong Kong stock exchange. Retrieved from http://qz.com/173169/why-the-year-of-the-horse-could-be-a-winner-for-the-hong-kong-stock-exchange/ Toloken, S (2014) Hong Kong molder and toolmaker files for IPO. Retrieved from http://www.plasticsnews.com/article/20131213/NEWS/131219959/hong-kong-molder-and-toolmaker-files-for-ipo Xiao. C (2014) IPOs ‘set for record year’ in 2014. Retrieved from http://www.chinadailyasia.com/business/2013-12/17/content_15106475.html Read More