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The Stock Exchange may question the commercial rationale for listing applications – Another measure to avoid shell companies

On 3 June 2016, The Stock Exchange of Hong Kong Limited (the “Exchange”) issued a new guidance letter GL68-13A “Guidance on IPO vetting and suitability for listing” (the “New Guidance Letter”) noting its concerns over certain listing applicants with questionable commercial rationale for listing. 

The Exchange noted that there have been a number of newly listed issuers' controlling shareholders which either sold, or gradually sold down, their interests shortly after the post-listing regulatory lock-up period, sometimes, combined with changes to management and/or the nature of the listed business.  The Exchange believes that one explanation for this phenomenon is the perceived value attached to listing status by the original controlling shareholder of the newly listing company as opposed to a genuine need for fund raising, and a listing status, to develop its business.  Such companies are prone to invite speculative trading, which is not in the interest of the investing public. In addition, the Exchange noted that activities by such companies may be structured so that they are not subject to regulatory scrutiny currently available to crack down shell companies for backdoor listings.

Against the above background, the Exchange plans to take a more focused review on applicants that exhibit characteristics of such kind of companies.  The Exchange may impose additional requirements or conditions on such applicants, or it may even exercise its discretion to reject the applicant's listing on the grounds of suitability.

Characteristics of companies identified by the Exchange that may raise questions regarding their commercial rationale for listing

In its review of the new listings in recent years, the Exchange has identified the following characteristics of companies which may raise questions regarding the reasons and justification for their listing, and which may therefore raise concerns on their suitability for listing:

  • small market capitalisation;
  • only marginally meet 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.

It should be noted that the above list is not exhaustive.  The Exchange will take into account the facts and circumstances of each applicant in weighing the characteristics, and these characteristics may also change over time.

Robust analysis to substantiate suitability for listing

For applicants which exhibit some of the above characteristics, the Exchange expects the applicant and its sponsors to provide a robust analysis to substantiate that the applicant is suitable for listing, which should cover, among other things, the following areas:

  • Use of proceeds – disclose specific uses for proceeds commensurate with the applicant’s past and future business strategy and observed industry trends and explain the commercial rationale for listing. The Exchange would not be satisfied with generic descriptions such as (a) using listing proceeds to increase reputation and brand awareness, (b) for potential acquisitions without identified target and specific selection criteria, and/or (c) for expansion through increase in headcount;
  • Future objectives and strategies – provide a comprehensive analysis to demonstrate that the applicant has a detailed strategic plan for its business operations and growth;
  • Profit and revenue growth – where an applicant (a) has experienced decreasing or low profit and revenue growth; and/or (b) is expected to record decreasing or low profit and revenue growth after listing, provide a comprehensive analysis to substantiate that the applicant’s business is sustainable; and
  • Potential sunset industries – where an applicant is in a potential sunset industry or in an industry that has declining market prospects, demonstrate that (a) it is feasible and the applicant has both the ability and resources to modify its business to respond to the changing demands of the market; and (b) the returns from the business justify the cost of listing.

Reminder to sponsors

Sponsors are reminded that before submitting listing applications on behalf of applicants, they should ensure that they have carefully examined all the material issues which are necessary for assessing whether the applicant is suitable for listing, and that for applicants that exhibit any of the characteristics mentioned above, a robust analysis as mentioned above should be included in the application proof.   Issues relevant to the suitability assessment include not only those discussed in the New Guidance Letter, but also all other relevant factors, including those referred to in the Exchange’s earlier guidance letter GL68-13 “Guidance on suitability for listing”. 

The New Guidance Letter pointed out that while consultation with the Listing Department on a confidential basis on specific issues raised in the New Guidance Letter is possible, the Exchange may not give specific guidance on the suitability of applicant as a whole for the purpose of the New Guidance Letter as it would only make suitability assessment when a substantially complete application proof is provided.

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