Introduction

On 8 February 2021, the Securities and Futures Commission (the “SFC”) issued a consultation paper (the “Consultation Paper”) on (i) a proposed code of conduct for Hong Kong bookbuilding and placing activities in equity capital market and debt capital market transactions (the “Proposed Code”); and (ii) a proposal to introduce “sponsor coupling”, which would require at least one sponsor to act as an overall coordinator (“OC”) as the head of syndicate. The consultation will remain open until 7 May 2021.

Issues in bookbuilding and placing activities

In the Consultation Paper, the SFC identified the following issues when conducting bookbuilding and placing activities by the market intermediaries:

(1)     intermediaries are sometimes given titles which have little bearing on their seniority or responsibilities in a transaction;

(2)     some issuers wait until shortly before the publication of the prospectus or shortly before book close (for debt offerings) to decide on the fee arrangements, thus allowing intermediaries to join a syndicate at the last minute;

(3)     intermediaries make inflated orders or place orders where identities of the investors are concealed, thus hampering the price discovery process;

(4)     intermediaries have preferential treatment for or pay rebates to some investors;

(5)     there is misalignment between the sponsors’ incentives and liabilities, especially in larger IPOs, which in some cases leads to compromised due diligence enquiries; and

(6)     there is a lack of documentation and records which should be maintained by the intermediaries during the bookbuilding and placing activities.

Proposed Code

The key proposals under the Consultation Paper in relation to the introduction of the Proposed Code are as follows:

A new paragraph 21 in the Code of Conduct for Persons Licensed by or Registered with the SFC on bookbuilding and placing activities in equity capital market and debt capital market transactions would be introduced and apply to intermediaries conducting bookbuilding and placing activities in Hong Kong. The Proposed Code aims to address the issues relating to bookbuilding and placing activities, which form the integral parts of a single policy package.

Under the Proposed Code, intermediaries which are involved in bookbuilding and placing activities will be classified as capital market intermediaries (“CMI”) with specified roles and the head of syndicate will be classified as the OC with specified roles in the bookbuilding and placing process. The Proposed Code will set out the standards of conduct expected of CMIs, including bookbuilding, allocation and placing, to address issues such as inflated or opaque demand, preferential treatment and rebates, misleading “book messages”, proprietary orders which may negatively impact on the price discovery process and orders which conceal the identities of the investors. The OC will be subject to additional condition requirements, including advising the issuer on pricing, allocation and marketing strategies.

The Proposed Code will also require the CMIs to agree and determine syndicate membership and fee arrangements (including the fixed fees and fee payment schedule at an early stage by formally appointing CMIs through written agreements specifying the roles and responsibilities and fee arrangements), in order to enhance accountability amongst syndicate CMIs and discourage undesirable behaviours. An earlier determination of the roles of the CMIs also diminishes the likelihood of brokers without a mandate “swarming” order books at the last minute with pledges for shares of unknown quality.

The Proposed Code will prohibit any CMI from offering any rebates to its investor clients or passing on any rebates provided by the issuer. This prevents some investors from participating in an offering at a price that is effectively lower than that offered to other investors. It is also proposed that the OC will be required to take reasonable steps to ensure that all orders placed in the order book on behalf of its own investor clients, itself and its group companies represent bona fide demand, while other CMIs must not place knowingly inflated orders. The OC will also be vested with the responsibility of making enquiries with its investor clients about orders which appear unusual. The OC should therefore maintain adequate records of orders placed by its investor clients so as to substantiate that there are no fictitious or knowingly inflated orders placed in the order book. As such, the OC will be responsible for consolidating the order book by taking reasonable steps to identify and eliminate duplicated orders, inconsistencies and errors, and  to segregate and clearly identify in the order book any proprietary orders of CMIs and their group companies. The OCs and CMIs under the Proposed Code should establish and implement allocation policies to ensure a fair allocation of shares or debt securities to their investor clients.

Sponsor coupling

The SFC noted in the Consultation Paper that the underwriting fees are substantially higher than sponsor fees. Based on its analysis of the 99 IPOs listed during the nine months ended 30 September 2020, the average sponsor fee was HK$6.3 million and the average underwriting fixed fee was HK$43.9 million. The SFC acknowledged that there is misalignment between fees and the sponsors’ costs and responsibilities, where sponsors typically incur substantial costs for performing its role as sponsors while the potential consequences of regulatory breach can be severe. The SFC considers that if the sponsors are not appointed as OC from the outset, there are concerns that they may be incentivised to compromise due diligence to secure the appointment. The SFC is further of the view that the party acting as the sponsor of the listing applicant would have gained a thorough knowledge of the business, financial performance, its industry and future prospects of the listing applicant as a result of the due diligence work. The sponsor is also responsible for preparing market-comparable analysis, profit forecast and valuations based on financial models. As such, in the Consultation Paper, the SFC considers the sponsor would be in a better position to act as OC as it would be able to combine the responsibilities as a sponsor with those of an OC, which can then manage the overall offering in the interests of investor clients and the issuer in a more efficient and coherent manner.

In the soft consultations previously done by the SFC, the SFC noted there was resistance to proposals to require all OCs to be sponsors, as this may limit flexibility for the issuer to appoint OCs. After taking into account of the market concern, the SFC proposed that the listing applicant should appoint at least one sponsor (or the company within the same group as the sponsor) who will also be appointed as an OC (the “Sponsor OC”) for the IPO. The Sponsor OC should be appointed as OC and sponsor at the same time and at least two months before filing the listing application. The listing applicant can appoint other OCs, which may or may not be sponsors of the IPO, no later than two weeks after the submission of the listing application.

By enacting the said proposal for sponsor coupling, the SFC contemplates that at least one sponsor would be free of potential incentives to limit due diligence in order to secure the position of OC while the investors can rely on the Sponsor OC to provide comprehensive and authoritative information.

Conclusion

The consultation will be closed on 7 May 2021 and interested parties may submit their comment on the consultation to the SFC before the deadline. The SFC will announce the consultation conclusion as appropriate and it proposes that there will be a six-month transition period for the industry to comply following the implementation of the proposals.