Across The Border
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‘IPO Connect’ seen as beneficial to Hong Kong, despite the likely complexities

Mutual connections between the mainland and Hong Kong expected to become a growing trend

PUBLISHED : Wednesday, 07 December, 2016, 5:17pm
UPDATED : Wednesday, 07 December, 2016, 10:04pm

The “primary equity connect” concept, an extended model of Shanghai- and Shenzhen-Hong Kong Stock Connect programmes being researched by the Hong Kong Exchanges and Clearing (HKEX), is a workable idea that could make the city a more competitive spot for initial public offerings, experts say.

There are huge differences between the Hong Kong and mainland IPO markets, ranging from listing rules to the mechanisms of shares pricing.

But the extended tie-up is a promising and feasible plan, according to Benson Wong, entrepreneur group leader at PwC Hong Kong.

“Nine years ago people also doubted the feasibility of what they originally called the “through train” programme for trading Hong Kong and mainland stocks.

Although such schemes require many technical issues to be solved, mutual connections between the mainland and Hong Kong are going to become a growing trend,” Wong said, adding that the two

Stock Connects now in place will certainly help to open up the mainland’s capital market.

The “through train” idea first surfaced in 2007, but was suspended due to global financial crisis, eventually morphing into the Shanghai-Hong Kong Stock Connect started in 2014, and the Shenzhen-Hong Kong equivalent, which went live on Monday.

HKEX officials are now actively promoting their ideas to expand the connect schemes to exchange traded funds, bonds and new share offerings, but no concrete details have emerged.

The primary equity connect will effectively extend the existing Stock Connect model into the primary market from the secondary one, to allow investors in Hong Kong and mainland China to subscribe to IPOs and additional issuance of new shares, issued in the two markets in the future.

According to earlier comments from HKEX officials, there are two types being considered: “inland investment in HK” (allowing inland investors to subscribe new H-shares) and “foreign investment in HK” (allowing international investors to subscribe to new shares listed in the inland market through HK).

Eddie Wong, partner of capital markets services at PwC, said industry players are excited about the “primary equity connect” idea.

“It would allow Hong Kong IPOs to receive investment from outside of the city, therefore offering more liquidity and pricing power for fund raisers,” he said.

Benson Wong also agrees it could lead to a far wider investor base, and offer what he called “more investable IPOs”, which will be a great catalyst for Hong Kong, already the world’s largest IPO market so far this year.

“Such a scheme would have a much larger impact on Hong Kong’s IPO market compared with the current two Stock Connect schemes,” he added.

Mainland China’s IPO market has been under strict regulatory controls, after fears emerged that a surge of new issuances could drain the market of funds and drag down the benchmarks.

A pipeline of more than 800 companies is backed up for listing in Shanghai or Shenzhen, while a proposed transition towards a registration-based IPO system to increase stock trading liquidity and ease listing has also been suspended since the stock rout of June last year.

It would allow Hong Kong IPOs to receive investment from outside of the city, therefore offering more liquidity and pricing power for fund raisers
Eddie Wong, partner of capital markets services, PwC

For those who are given the green light to list, offer prices are generally being set much lower compared with the average valuations of industry peers, encouraging retail investors to subscribe to new shares, before selling them off quickly after their trading debut, to make a quick profit.

In Hong Kong, however, offer prices are dictated by the market, and there is no traffic jam of IPOs.

Eddie Wong adds that an IPO Connect would require strong cooperation between regulators on both sides, but it could be launched step by step, starting with an investment quota and a short list of eligible applicants.

Melody He-Chen Junhua, a partner at law firm DLA Piper Hong Kong, thinks the key issue from a legal perspective is whether the IPO Connect would be open to retail investors or professional investors, or both.

“The biggest difference between an IPO Connect and the Stock Connects is that it would extend the link from the secondary to the primary market, and that would involve more legal issues, including prospectus registration and regulator approval,” she said.

From a Hong Kong applicant’s point of view, if the IPO Connect was available to retail investors in the mainland, it would be likely to constitute a mainland public offering, under current Chinese securities law.

As a result, she adds, any Hong Kong IPO applicant would need to have its prospectus cleared and registered with regulators from mainland, in addition to going through the Hong Kong application and approval process, which would make the process much longer and more costly.

But if the IPO Connect was restricted to mainland professional investors – institutions and high-net-worth individuals – applicants could be exempt from public offering and prospectus requirements under China’s securities law, and the shares could be issued direct to all investors in Hong Kong and professional investors in the mainland, once they were given approval from the Hong Kong regulators.

“The IPO Connect would certainly be beneficial to Hong Kong, because a wider range of investors can help push up the valuation of Hong Kong IPOs,” she added.

“But to a large extent, it depends on how it would be implemented by the regulators and the scope of investors it could be open to.”

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