Increased Main Board profit requirement to take effect in 2022 and heightened scrutiny on IPOs

On 20 May 2021, The Stock Exchange of Hong Kong Limited (Exchange) published conclusions to its consultations on the minimum profit requirement under Main Board Rule 8.05(1)(a) for new listing applicants (Profit Requirement).

The Profit Requirement has not been changed since its introduction in 1994. Since the increase of the minimum market capitalisation requirement under Main Board Rule 8.09(2) to HK$500 million in 2018, the Exchange has seen an increase in listing applications from issuers that marginally met the Profit Requirement, but had relatively high proposed market capitalisations. The Exchange believes this misalignment of the Profit Requirement with the increased market capitalisation requirement has raised regulatory concerns as to the quality of companies seeking Main Board listings.

In the consultation paper published last November, the Exchange proposed to increase the Profit Requirement by either: (1) 150% resulting in an aggregate profit threshold of HK$125 million; or (2) 200% resulting in an aggregate profit threshold of HK$150 million for the track record period. This proposal was opposed by 83% of the respondents (including our firm).

Smaller increase in the Profit Requirement

The Exchange decided to modify its proposal by:

  • increasing the Profit Requirement by 60% only, resulting in an aggregate profit threshold of HK$80 million; and
  • amending the profit spread from a 60% : 40% split to a 56% : 44% split, such that the minimum aggregate profit required for the first two financial years of the track record period will be HK$45 million and that for the final financial year will be HK$35 million.

Accordingly, the implied historical P/E ratio for a listing applicant that meets these minimum thresholds will be 14 times, which is in line with the average P/E ratio of the Hang Seng Index between 1994 and 2020.

See below a comparison of the current and new Profit Requirements:

 

Current Profit Requirement

New Profit Requirement

Minimum aggregate profit required:

For the 1st & 2nd financial years

HK$30 million

HK$45 million

For the final (3rd) financial year

HK$20 million

HK$35 million

Total:

HK$50 million

HK$80 million

Profit spread (1st & 2nd years : 3rd year)

60% : 40%

56% : 44%

 

Implementation date

The new Profit Requirement will become effective on 1 January 2022.

That means, any Main Board listing applications (including renewals of previously submitted applications or applications for transfer of listing from GEM to the Main Board) submitted on or after 1 January 2022 will be assessed under the new Profit Requirement.

Please note that a listing applicant will not be permitted to withdraw its listing application before it lapses and resubmit the listing application shortly thereafter before 1 January 2022 such that the listing application will be assessed in accordance with the current requirement for a longer period.

Relief from the profit spread

The Exchange will be prepared to grant relief from the profit spread on case-specific circumstances, provided that the listing applicant meets an increased aggregate profit threshold of HK$80 million.

In considering whether to grant a relief, the Exchange will ordinarily, among other things:

  • evaluate the listing applicant’s business nature and the underlying reasons for its inability to meet the profit spread (e.g. growth stage companies and companies whose businesses have been severely affected by the COVID-19 pandemic and current economic downturn);
  • critically assess the need to include a profit forecast in the listing document to enable investors to make an informed decision on the position and prospects of an issuer; and
  • impose any other conditions where appropriate.

The Exchange may also make enquiries on how the issuer’s IPO price was determined with reference to the book-building process.

Heightened scrutiny on IPOs

In addition to raising the Profit Requirement, the Exchange will also work with the Securities and Futures Commission (SFC) in combating regulatory issues associated with problematic IPOs through:

  • critical review of listing applicants’ estimated valuations at the time of listing (especially those with relatively high historical P/E ratios against those of their listed peers) to ascertain their ability to comply with the market capitalisation requirement and sufficiency of investor interests at the offer price;
  • heightened scrutiny of listing applications displaying one or more of the following features as described in the joint statement on IPO-related misconduct published by the Exchange and the SFC on the same day as the consultation conclusions on the Profit Requirement: 

 

Features of problematic IPOs which may lead to enquiries by regulators:

  • the applicant’s market capitalisation barely meets the minimum threshold under the Listing Rules;

  •  very high P/E ratio taking into account the applicant’s fundamentals (including its profit forecast) and the valuations of its peers;

Remark: In the run-up to the effective date of the new Profit Requirement, the SFC will place particular focus on new listing applications which rely on aggressive profit forecasts to justify their expected valuations.

  • unusually high underwriting or placing commissions or other listing expenses; and 

Remark: Where (i) unusually high underwriting commissions or other listing expenses or (ii) material amounts of discretionary listing expenses might be paid by the listing applicant or its connected persons, the listing applicant is expected to provide the complete details of these expenses for the regulators’ scrutiny and disclose relevant information in the listing document. The Exchange will continue to closely monitor the use of proceeds after listing.

  • shareholding is highly concentrated in a limited number of shareholders, particularly where the value of the public float is small and the spread of shareholders barely meets the minimum thresholds set out in the Listing Rules.

 

  • the Exchange’s revamped disciplinary regime as detailed in its consultation conclusions on review of Listing Rules relating to disciplinary powers and sanctions published on the same day as the consultation conclusions on the Profit Requirement, under which the Exchange has introduced changes to the disciplinary regime of the Exchange to better enable the delivery of an effective regulatory response in respect of different types of misconduct, with an increased emphasis on holding individuals accountable in relation to Listing Rule breaches and additional circumstances where disciplinary sanctions can be imposed on parties subject to the Exchange’s disciplinary regime.

Review of GEM

Many respondents to the consultation paper on the Profit Requirement did not consider GEM a viable alternative listing platform to the Main Board for smaller companies. In response to this, the Exchange will launch a review of GEM and carefully consider the matters raised by respondents, including comments relating to GEM’s positioning and the market perception of GEM. If this review concludes that changes to the GEM Listing Rules are necessary, the Exchange will publish a consultation paper to seek market feedback on appropriate reforms.