Industry Analysis-IPO Sponsors and Regulations

Highlights of Speech by Ms. Julia Leung, Deputy Chief Executive Officer and Executive Director, Intermediaries of Hong Kong Securities & Futures Commission at Hong Kong Conference 2019: IPO Sponsors and Regulations In a speech at Hong Kong Conference 2019: IPO Sponsors and Regulations held on October 21, 2019, Ms. Julia Leung, Deputy Chief Executive Officer and Executive Director, Intermediaries of Hong Kong Securities & Futures Commission (SFC) addressed on the topic of supervising sponsors in a changing IPO landscape, salient issues of which include the following: Changes in the IPO market landscape  Over the past decade, the landscape of the IPO market has changed. Hong Kong has clinched top positions in IPO fundraising and market capitalization, but it lags other major markets in liquidity. At the end of 2018, the Stock Exchange was ranked fifth globally in terms of market capitalization and eighth in terms of average daily turnover value. However, the Stock Exchange of Hong Kong Limited (the Exchange) only ranked 13th amongst major exchanges in terms of the ratio of its annualized turnover to market capitalization. This shows that, compared to other major exchanges, there is room to raise the turnover in Hong Kong. The SFC, together with the Exchange, is studying the possible causes behind the relatively lower trading volumes with a view to enhancing overall liquidity in Hong Kong markets. The SFC is most concerned about the implications of these findings for the quality of the market and the conduct of intermediaries. The SFC formed a multi-disciplinary team to identify patterns of misconduct that aim to manipulate stock prices, rig shareholders’ votes or scam minority shareholders. These activities may affect investor confidence and harm Hong Kong market's reputation. Supervisory regime for sponsors Primarily, the SFC conducts onsite supervision. The SFC identifies intermediaries (such as sponsors) as targets for inspection by looking at information such as licensed firms’ compliance histories, the volume of complaints and its internal impact assessment. The SFC also collects information directly from sponsors. Information submitted via the Business and Risk Management Questionnaire includes the number of sponsor engagements, how sponsor work is managed and how long due diligence would normally take. Reasonable Due Diligence The main focus of the SFC's inspections is to establish whether the sponsor has performed reasonable due diligence and has sufficient internal controls. A key requirement is for a sponsor to take reasonable due diligence steps in respect of a listing application. Another requirement is for sponsors to complete the due diligence work prior to the submission of a listing application, except matters which can only be dealt with at a later stage. Five big failings of sponsors have been identified: (1) adopting a box-ticking approach; (2) ignoring red flags; (3) deficient interview practices; (4) over-reliance on experts and third parties; and (5) improper supervision and inadequate resources. Regulatory action To tackle misbehavior, the SFC has looked at ways to intervene at an early stage. In cases where its concerns were sufficiently serious and the same sponsors were repeating the same type of conduct, the SFC requested voluntary undertakings to enhance the sponsors’ governance structure as well as their systems and controls. The undertakings could include appointing independent directors to the board to exercise effective oversight or appointing a sponsor principal independent of the transaction team to conduct a peer review of listing applications. If they refuse to provide voluntary undertakings, the SFC will impose licensing conditions. The difference is that licensing conditions will be disclosed to the public. The regulation of a quality IPO market includes establishing appropriate thresholds for the entry of listed companies, supervising corporate finance activities and upholding the high standards of conduct for intermediaries. Ultimately, the SFC hopes this leads to an environment with reduced risks for investors and all those involved in IPOs including sponsors and other professionals.