Why Hong Kong’s stock exchange should not raise the profit requirement for listing on its main board
- Neither the high P/E ratio of listing applicants nor the existence of ‘shell’ companies justifies a move that could shut out many small-cap firms from a fundraising platform
- Instead, to support these companies, the exchange should consider lowering or even removing the profit requirement
The exchange may be exaggerating the importance of historical P/E ratios. A historical P/E ratio derived from the historical profit figure is only one factor among many in investment decision-making. An issuer’s prospects are more important to the investment decision than historical P/E ratios. Therefore, drawing an arbitrary line on historical profit is of limited use, and raising the level of this arbitrary line is not an improvement.
Many small-cap, potential issuers would have wanted to list at a lower P/E ratio. If they had been successful, and with more of these small-cap issuers listed under a lower market capitalisation requirement, we would not have seen what HKEX notes is “an increase in listing applications from small-cap issuers that marginally met the profit requirement but had relatively high historical P/E ratios”. In some cases, companies have been forced into this position by the regulatory change of 2018.
Moreover, the line distinguishing a “shell” company from a genuine small or medium-sized company is a fine one. Raising the bar for listing to eliminate potential “shell” listings runs the risk of collateral damage. Small and medium-sized companies with solid management and earnings potential are likely to be negatively impacted. As legitimate listing candidates, they will lose a vital fundraising channel.
The HKEX consultation paper raises the issue of whether (allegedly) “inflated valuations” genuinely reflect “expected market clearing prices” and of “suspected abusive behaviours such as manufacturing of an artificial shareholder base”. Investment management professionals would expect the exchange, regulators, sponsors and other professionals to play active roles in monitoring the capital markets as its gatekeepers and promoters. In the end, of course, it is also a case of buyer beware.
To support these start-ups or small companies that are growing their businesses, the exchange should consider lowering or even removing the profit requirement. This would just put the Hong Kong stock exchange on par with some of the more developed Western markets.
Raising the profit requirement can be seen as regressive and as a form of financial repression in that one segment of the society is systemically disadvantaged. Too many preconceived barriers and subjective judgments will only result in a regulatory regime that consistently produces ad hoc rulings in response to prior or current faults or misalignments.
Perhaps, a holistic approach to the listing process should be considered, not a shreds-and-patches approach.
Richard Mak, CFA, is president of CFA Society Hong Kong. Alvin M. Ho, CFA, is vice-president and society secretary of CFA Society Hong Kong
David Dodwell is on vacation