Investment bankers fear fallout of rule change on small players
Higher costs could keep small firms out of the market, writes Enoch Yiu
Investment bankers have responded with alarm to signals from regulators that sweeping rule changes may be in the offing to govern the way sponsors bring new listing candidates to the market.
With regulators pushing for rule changes, costs for listing candidates could double, according to Stephen Clark, managing director of investment bank Anglo Chinese.
'That may result in smaller companies finding it too expensive to seek a listing in Hong Kong. It is not satisfactory if the stock exchange serves only the needs of large mainland enterprises,' he said.
Hong Kong Institute of Directors chairman Herbert Hui Ho-ming echoed the concerns.
'The government should always check and not create a bias against entities just because they are small,' Mr Hui said. 'Raising capital in the local stock market should never be the exclusive franchise of the large investment banks and enterprises.'
An investor survey conducted this year by the Securities and Futures Commission found that 94 per cent of respondents believed the watchdog should have more control over sponsors.
But Mr Clark was critical of investors not being simultaneously asked to express their opinions on the rising regulatory cost.
'It is just like asking if they would like better quality food or a better quality car. Of course they would say yes if you do not mention the cost and infer that it will be the same,' he said.
An SFC spokesman retorted, however, that the new rules aimed to enhance investor protection.
'Experience has underscored how investors and the market have suffered from sponsor failures. It is not acceptable that sponsors should be allowed to compromise their standards on the ground of cost saving,' the spokesman said.
'In the end investors pay dearly for sponsor failures. We believe a proper balance has been struck in investor protection and facilitation of market development.'
Financial regulators have this year been pushing for tighter rules covering investment bank sponsors.
The move follows a series of corporate scandals involving new listings, including the collapse of Shenyang-based orchid grower Euro-Asia Agricultural (Holdings), which allegedly inflated its revenue by 20 times in the four years leading up to its listing in Hong Kong in July 2001. The company went into liquidation a year later, and its shares were delisted in May last year. Its sponsor, ICEA Capital, earlier this year reached a $30 million settlement with the SFC without admitting any wrongdoing.
After regulatory consultations in May 2003, the Hong Kong stock exchange in January this year introduced 'Practice Note 21' as a guideline for sponsors' due diligence requirements.
Richard Williams, head of listing at Hong Kong Exchanges and Clearing, said the new guideline had led some sponsors to step up their due diligence efforts.
'We are aware from our discussions with the market that the revised guidance has resulted in many sponsor firms undertaking a thorough evaluation of their practices and approach to discharging their responsibilities. In addition, certain firms have taken steps, not always voluntarily, to address staff competence issues,' he said.
Such increasing efforts come with a cost. A head of a local investment bank said since the introduction of exchange guideline, many sponsors were hiring lawyers to go through the listing process to ensure they were following all the requirements under Practice Note 21.
'I have come across some cases where the legal fees are higher than the fee collected by the listing sponsors. The cost is going to be passed on to listed companies seeking a listing,' the banker said.
Dennis Cassidy, director and head of corporate finance of Anglo Chinese, said Practice Note 21 required sponsors to cross check information provided by the companies, auditors and property valuers as well as check the title of a client's land, which would be expensive.
He also said it was impossible to comply with as investment banks did not have the skills sets on auditing and property valuation to ensure the other professionals were doing their jobs.
Mr Williams, however, said the exchange requirements were in line with international practices.
'We believe the due diligence requirements have generally assisted in improving compliance by providing clear standards for sponsors to refer to when preparing new listing applications,' he said.
'All reputable listing venues in the world expect sponsors or equivalent parties to conduct due diligence in connection with new listings of equity securities. When the new rules were being considered, we were careful to benchmark the due diligence standards to similar requirements in other jurisdictions and we do not believe our expectations are unfairly high.'
Mr Williams does not believe the rising cost would discourage new listings. 'Companies choose to list their securities based on a number of factors, only one of which is expense. We believe the overall effect of the new rules has been to enhance the quality of the market in Hong Kong,' he said.
But even more measures were proposed in June, when the SFC issued a consultation paper outlining all licensing requirements for investment banks which wanted to be sponsors. Proposed measures included a capital requirement of $10 million and at least two principal officers with a minimum of five years' corporate finance experience. It was also suggested that investment banks buy professional indemnity insurance to cover litigation by investors.
In another consultation paper issued last week, the SFC called for a law change to allow investors to sue sponsors, in addition to company directors, for monetary compensation to cover their investment losses due to misleading statements in listing prospectuses.
Faced with this range of measures proposed by the regulators, investment banks have hit back, saying the SFC should not load all responsibility for ensuring the quality of new listings on sponsors.
A consortium of 12 international investment banks, have made a joint submission to the SFC through law firm Linklaters.
'A sponsor's role is to advise the issuer and to assist it in its listing application and IPO. The role does not and should not extend to taking primary responsibility for inadequate disclosures,' the Linklaters submission said.
The 12 banks have also rejected the proposal that they purchase indemnity insurance.
'We do not support this proposal. Members of the group have previously investigated the availability of such insurance - such insurance is not generally available in the insurance market, and, according to estimates provided by the very few companies that would be prepared to offer such insurance, the cost would be commercially prohibitive,' the submission said.
'As this cost would ultimately be borne by issuers, the group believes that it would make Hong Kong increasingly unattractive for capital raising and uncompetitive when compared with other regional financial centres.'
Anglo Chinese's Mr Cassidy shares the same views.
'It may give rise to false expectations that the tightening regulation of sponsors will give rise to a better quality IPO market. Due diligence does not eliminate risk,' he said.
'Furthermore, directors of the companies, accountants, lawyers and property valuers all have important roles in a listing process and they have their respective responsibilities in relation to the accuracy of the prospectus. Such obligation should not be shifted to the sponsors.
'As the SFC has no control over accountants, lawyers and property valuers, it appears to want to place all responsibilities on sponsors over whom the SFC has control through the licensing system.'
The SFC spokesman, however, said the sponsors had a crucial role to bring only suitable candidates to the market. 'We will not tolerate sub-standard work by sponsors and we plan to carry out theme inspections shortly. We have reminded sponsors that the new listing rules make clear their due diligence standards,' he said.
He said the SFC was still reviewing responses to its consultation and it would therefore be premature to comment on proposals including the issue of professional indemnity insurance.