Introduction

In our newsletter published in February 2021, we discussed that the Securities and Futures Commission (the “SFC”) issued a consultation paper on conduct requirements for bookbuilding and placing activities (“Consultation”) on 8 February 2021. After the three-month public consultation, the SFC concluded its consultation in October 2021 (the “Consultation Conclusions”) and announced the new requirements (“Proposed Requirements”) in relation to the roles and conduct standards expected of capital market intermediaries (“CMI(s)”) in both equity capital market and debt capital market, in which they may also act as the head of the syndicate and designated as overall coordinator (“OC”). These Proposed Requirements together with the requirement of sponsor coupling will take effect nine months after gazettal.

Appointment of OCs and CMIs

Although having syndicate structure and fee arrangements being determined upfront may reduce unhealthy competition amongst syndicate members, it is acknowledged in the Consultation Conclusions that it may not be practicable to do so due to the changing market conditions with the fluctuating sentiment, which may lead to adjustments to the syndicate and fees. This is especially difficult for small IPOs, in which most underwriters are less likely to commit before the Listing Committee has, in principle, granted approval.

As flexibility regarding the deal structure and composition of OCs and CMIs is imperative, in the Consultation Conclusions, the SFC says they will only require (i) the OCs to be appointed no later than two weeks after the A1 submission for IPO transactions, and (ii) the OCs to submit the identity of all the participating OCs, together with the fixed fee payable to each of them, the total fees and the fee split ratio to the SFC four clear business days before the Listing Committee hearing. The appointment of the OCs and CMIs is required before conducting any bookbuilding and placing activities, where it must be done with their roles and responsibilities, fixed fee entitlement and fee payment schedule specified in writing.

Advice on fee arrangements

Considering the potential conflict of interests caused by having OCs to advise issuers on fee arrangements, the SFC will amend the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code”) and require OCs to provide guidance to the issuers for the split between fixed and discretionary fees (fee split ratio). The fee split ratio will be 75:25 (around 75% fixed and 25% discretionary), which is in line with the prevailing market practice. The SFC will also require the OCs to report the fee split ratio to the SFC four business days before the Listing Committee hearing. The SFC is also of the view that issuers should assess whether they should deviate significantly from the 75:25 ratio.

Rebates and preferential treatment

The objective of disallowing rebates is to maintain a level playing field such that investor clients are prevented from paying different prices for the same debt securities. However, in the Consultation Conclusions, the SFC will not ban all rebate arrangement in the view that it is the incentives offered by the issuers for the intermediaries’ selling efforts, upon the conditions that the rebates will not be passed on to investor clients and details of the rebate arrangement should be properly disclosed. On the other hand, rebates to investor clients through a reduction of brokerage commission in IPO cases are not allowed.

Transparency of the order book

Managing the order book properly is a pivotal role for the OC during the bookbuilding and allocation process. OC is required to take all reasonable steps to remove duplicate orders and identify irregular or unusual orders or errors in the order book. To facilitate such a process, the identities of underlying investors need to be disclosed and any updates of the material information relating to the offering should be provided to the CMIs in a timely manner. 

The SFC acknowledged the concerns about poaching clients due to the identity disclosure of underlying investors, it will therefore amend the Proposed Requirements so that the CMIs only need to provide the client’s name and unique identification number (such as ID card number), while the information received from the investors may only be used by the CMIs (including OCs) for placing orders for the specific offering.

Further, whenever the amount of placing the order is larger than that the investor client indicated he/she anticipates to be allocated, CMIs owe the responsibility to clarify with the client of his/her actual wish and to enquire in cases where the order is not commensurate with the investor client’s financial profile. The SFC will prohibit “X-orders” in the order book to ensure transparency in the bookbuilding process.

Conflicts of interest

A CMI should establish, implement and maintain policies and procedures to identify, manage and disclose any actual and potential conflicts of interest in relation to the relevant parties in the bookbuilding and placing process. Priority should always be given to satisfying investor clients’ orders over its proprietary orders and those of its group companies and proprietary orders can only be price takers in debt offerings. CMI should also establish and maintain Chinese walls with appropriate policies and procedures.

Concerning the nature of the order, SFC is of the view that orders from syndicate members’ trading desks should be treated as proprietary orders, while orders from syndicate members’ asset management arms should be treated as client orders, provided that the orders are placed on an arm’s length basis and effective Chinese Wall controls are in place. The Proposed Requirements has provided a note clarifying that proprietary orders of a group company is taken as excluding orders placed by the group company on behalf of its investor clients or funds and portfolios under its management, but will include orders placed on behalf of funds and portfolios in which a CMI or its group company has a substantial interest.

Record keeping

OCs and CMIs are required to maintain records of all changes made to the order book which is feasible by technology means. Proper audit trails, from order generation and modification to allocation should be kept at least two years while other material information such as key communications with and information provided to relevant parties, details of rebates arrangements, information forming the basis of all submissions made to SEHK and the SFC, etc. should be maintained for a period of not less than seven years.

Sponsor coupling

In the Consultation Conclusion, proposed sponsor coupling requirement will be adopted such that at least one sponsor, who is with a good understanding of the issuer through its due diligence work and in a good position to give quality advice to the issuer throughout the transaction, shall be appointed as an OC. As the SFC acknowledged that “sponsor coupling” is not as prevalent for smaller-size IPOs, the requirement of sponsor coupling will only apply to Main Board IPOs.

Conclusion

The Code and GEM placing guidelines will be revised and the amendments will take effect nine months after the gazettal. The SFC will work also with The Stock Exchange of Hong Kong Limited (“Stock Exchange”) to introduce corresponding amendments to The Rules Governing the Listing of Securities on Stock Exchange and The Rules Governing the Listing of Securities on GEM of Stock Exchange.