Introduction

The Stock Exchange of Hong Kong (the “Stock Exchange”) issued a guidance letter on IPO vetting and suitability for listing (HKEx-GL68-13A) (the “Guidance Letter”) on 3 June 2016.

The Stock Exchange noted some listed issuers whose controlling shareholders either changed or have gradually sold down their interests shortly after the lock-up period.  One possible reason for this is the perceived premium attached to the listing status of such issuers may be more attractive than the development of the underlying business assets. The Stock Exchange believes that these companies will give rise to speculative trading which is not in the interest of the investing public. It is also concerned that activities by these companies may be structured so that they are not subject to regulatory scrutiny under the rules on reverse takeovers and on cash companies.

As a result, the Stock Exchange conducted a review of new listings between 2012 and 2015 to identify characteristics of these companies (“Target Companies”) and issued the Guidance Letter focusing on its review on the suitability of the Target Companies.

Relevant Listing Rules

The relevant Listing Rules are:

• Main Board Rule 8.04 and GEM Rule 11.06, where both the applicant and its business must, in the opinion of the Stock Exchange, be suitable for listing.
•  Main Board Rule 2.06 and GEM Rule 2.09, where suitability for listing depends on many factors. Applicants for listing should appreciate that compliance with the Listing Rules may not itself ensure an applicant’s suitability for listing.
•  Guidance letter on suitability for listing (HKEX-GL68-13) issued by the Stock Exchange in December 2013 and updated in June 2015, which provides guidance on the factors which may be taken into account of by the Stock Exchange when assessing whether an applicant and its business are suitable for listing under Main Board Rule 8.04 and GEM Rule 11.06.

Guidance

Characteristics of Target Companies

The Stock Exchange summarized the following characteristics possessed by the Target Companies based on the empirical data that it gathered:-

• small market capitalisation (i.e. the market value of the entire size of the applicant, being the product of total number of issued shares and share price);
•  only marginally meeting the listing eligibility requirements;
•  involve fund raising disproportionate to listing expenses (i.e. a high proportion of the listing proceeds were used to pay listing expenses);
•  involve a pure trading business with a high concentration of customers;
•  are asset-light businesses where a majority of the assets are liquid and/or current assets;
•  involve a superficial delineation of business from the parent whereby the applicant’s business is artificially delineated from the parent by geographical area, product mix or different stages of development; and/or
•  have little or no external funding at the pre-listing stage.

The Stock Exchange emphasized that there is no prescribed bright-line test in identifying the characteristics of the Target Companies.  Facts and circumstances will be considered on a case by case basis.  The list of characteristics stated above is not exhaustive.  The Stock Exchange retains the discretion to weigh the characteristics differently from applicant to applicant and from industry to industry. The characteristics to be considered may also change over time.

Additional Analysis or Disclosures

If a potential listing applicant exhibits some of the above characteristics, the applicant and its sponsor(s) should provide a robust analysis in the following aspects to substantiate that the applicant is suitable for listing:-

•  Use of Proceeds

Specific uses for proceeds commensurate with the applicant’s past and future business strategy and observed industry trends should be disclosed.  Commercial rationale for listing should be explained. Generic descriptions would not be accepted such as:-

• using listing proceeds to increase reputation and brand awareness;
• for potential acquisitions without identified target and specific selection criteria; and/or
• for expansion through increase in headcount.

• Future Objectives and Strategies

A comprehensive analysis should be provided to demonstrate the detailed strategic plan of the applicant for its business operations and growth.

• Profit and Revenue Growth

In the case of actual and/or expected decreasing or low profit and revenue growth after listing, a comprehensive analysis is required to substantiate the sustainability of the applicant’s business.

• Potential Sunset Industries

Where an applicant is in a potential sunset industry or in an industry that has declining market prospects, the applicant should demonstrate the feasibility, and its ability and resources to modify its business to respond to the changing demands of the market. The applicant should also demonstrate the justification of returns from the business against the cost of listing.

Based on the results of its review of the analysis, the Stock Exchange will consider the applicant’s suitability for listing. It may impose additional requirements or conditions on applicants with the characteristics stated above or even reject the applicant’s listing on the grounds of suitability.

Implications

The characteristics of the Target Companies stated in the Guidance Letter may raise concerns and uncertainty over an applicant’s suitability for listing. While it is stated in the Guidance Letter that an applicant can consult the Listing Department on a confidential basis on specific issues raised in the Guidance Letter, the Stock Exchange may not give specific guidance on the suitability of the applicant as a whole for the purpose of the Guidance Letter. It would only make a suitability assessment when a substantially complete application proof is provided.

Therefore, for prudence sake, it is advisable for prospective listing applicants to consult the Stock Exchange at the earliest possible opportunity to seek guidance on whether they fall within the characteristics of the Target Companies and are expected to provide further analysis in any aspects to substantiate their suitability for listing.

For enquiries, please contact our Corporate & Commercial Department:

E: cc@onc.hk

T: (852) 2810 1212

W: www.onc.hk

F: (852) 2804 6311

19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.