Webinar on SFC Consultation Conclusion on Bookbuilding and Placing Activities and Sponsor Coupling
This webinar covers an overview of the SFC Consultation Conclusion regarding the new bookbuilding conduct requirements, HKEx sponsor coupling, the standards of conducts expected of intermediaries as well as the SFC’s concerns on current market practices in relation to bookbuilding and placing activities in Hong Kong equity and debt capital markets.
Julia Charlton: Hello, everybody! I’m delighted to be with you today to discuss the SFC’s Consultation Conclusions published on the 29th of October 2021, on the proposed Code of Conduct on Hong Kong bookbuilding and placing activities in equity capital market and debt capital market transactions in Hong Kong, as well as the proposed sponsor coupling requirement.
I begin today by looking at the SFC’s concerns relating to Hong Kong bookbuilding and placing activities, and the market practices which led to the SFC’s proposal for the new requirements. We’ll then look at the key features of the new conduct requirements and highlight the key discussions during the consultation. I’ll close the webinar with a discussion of the new sponsor coupling requirement and the SFC’s rationale for sponsor coupling.
On the 8th of February 2021, the SFC published a Consultation Paper with two main proposals. The first was a new Code of Conduct with requirements for intermediaries conducting bookbuilding and placing activities in equity capital market and debt capital market transactions in Hong Kong.
These proposed requirements were designed to clarify the roles played by intermediaries in these transactions and set out the standards of conduct expected of them in Hong Kong bookbuilding, pricing, allocation and placing activities. The second is the sponsor coupling proposal, which would require at least one head of the underwriting syndicate, or a company within the same group, to also act as an independent sponsor.
Sponsor coupling is only required for Main Board IPOs. So today, together I’ll refer to these as the Bookbuilding Conduct Requirements. The proposals follow the thematic review of selected SFC licensed intermediaries engaged in equity capital market and debt capital market bookbuilding and placing activities, as well as discussions with market participants. That review found that in some offerings, the price discovery process had been hampered by various factors such as inflated or opaque demand.
The SFC also identified cases of what the SFC considered to be undesirable intermediary conduct, such as brokers without a mandate swarming order books at the last minute with orders of what the SFC referred to as unknown quality. The SFC’s thematic review also identified some good practices in the market which they will codify in new Bookbuilding Conduct Requirements.
Separately, the SFC found that sponsors’ fees are often misaligned with sponsors’ costs and liabilities, particularly in larger IPOs. According to the SFC, this raises concerns that IPO sponsors may compromise their due diligence work to become the head of the underwriting syndicate and so earn higher fees in order to compensate for sponsor costs, responsibilities and potential liability. Price discovery in Hong Kong is conducted by way of bookbuilding, which when conducted transparently and fairly, the SFC considers to serve the interests of both issuers and investors. The SFC stated in its Consultation Paper that, quote, "_competitive pressures have led intermediaries to engage in conduct, which often tips the scale in favor of issuers_", unquote. This, the SFC says, can distort the price discovery process and the allocation of equity and debt offerings.
Through the thematic review, the SFC identified a number of concerns with the bookbuilding and allocation process in Hong Kong. The SFC noted that there were unclear roles and functions of the various intermediaries. Fee arrangements and syndicate memberships were often being determined at a late stage and sometimes only shortly before the publication of the IPO prospectus or shortly before book close for debt offerings. There were cases of intermediaries knowingly placing inflated orders in the order book and overstating IPO demand which undermined the price discovery process and may have misled investors.
There was a lack of transparency of the order book, which prevented syndicate heads from assessing real demand or identifying unusual or irregular orders. Some syndicate members were not giving priority to orders placed by their investor clients over their proprietary orders. There were cases of preferential treatment or rebates being paid to investors.
Heads of syndicate were not maintaining adequate records of incoming client orders, important discussions with the issuers and syndicate members for the basis of making allocation recommendations.
To address the SFC’s concerns and to align incentives with the responsibilities of intermediaries, the SFC developed the new Bookbuilding Conduct Requirements, which will impose various obligations and expected standards of conduct on intermediaries involved in Hong Kong bookbuilding and placing activities through a new paragraph 21 of the SFC’s Code of Conduct.
These intermediaries will be defined as capital market intermediaries or "CMIs". The obligations and expected standards of conduct for CMIs will cover, amongst other things, ensuring transparency in the bookbuilding process and implementing an allocation policy to ensure a fair allocation of securities to investor clients, a prohibition on offering rebates to investor clients, or enabling any investor clients to pay at a price lower than that disclosed in the listing documents, and maintaining policies and procedures to identify, manage and disclose conflicts of interest and giving priority to satisfy investor client orders over the CMIs own proprietary orders.
Prior to conducting any bookbuilding or placing activities, intermediaries will be required to be formally appointed under written agreements setting out their roles, responsibilities, fee arrangements, and fee payments schedules.
For Main Board IPOs a "sponsor coupling" requirement will be introduced. "Sponsor coupling" means that at least one overall coordinator or "OC" must also be appointed as a sponsor or be a member of the sponsor’s group of companies and this sponsor must be independent of the issuer. OCs are the heads of syndicates and are a type of CMI (capital market intermediary).
They must also provide advice to the issuer client on marketing strategy, pricing and allocation and ensure transparency in the price discovery process. The SFC will introduce requirements for fee arrangements to be determined at an early stage and OCs to be appointed also at an early stage.
The SFC will also update its guidelines to sponsors, underwriters, and placing arrangements involved in the listing and placing of GEM stock, which was issued in January 2017.
The revised guidelines, "Guidelines to capital market intermediaries involved in placing activities for GEM stocks" will provide general guidance for OCs and guidance for CMIs when placing shares to their investor clients. The new Bookbuilding Conduct Requirements will come into effect on the 5th of August, 2022.
Moving on, I’ll now discuss the scope of the new Bookbuilding Conduct Requirements. The requirements will apply to intermediaries that engage in providing services to issuers and/or investors and involve certain capital market activities conducted in Hong Kong. Bookbuilding activities, placing activities, and advising, guiding and assisting the issuer client in Hong Kong on bookbuilding and placing activities.
Bookbuilding activities are defined as collating investor’s orders, including indications of interest in an offering in order to facilitate the price determination and the allocation of shares or debt securities to investors, or the process of assessing demand and making allocations.
Placing activities are defined as marketing or distributing shares or debt securities to investors pursuant to those bookbuilding activities.
Intermediaries engaged in any of these capital market activities will be referred to as capital market intermediaries or "CMIs". CMIs will not include financial advisors or other professionals who only provide advice to the issuer but do not participate in any bookbuilding or placing activities.
The proposed definition of "placing activities" in the Consultation Paper doesn’t include marketing. However, the SFC decided to include marketing in the final definition as this would prevent firms without mandates from quote, "_swarming_" unquote, the order book at the last minute with orders of unknown quality. The new Bookbuilding Conduct Requirements will only cover certain types of share and debt offerings that involve Hong Kong bookbuilding activities.
For share offerings, the new requirements will cover offerings of shares listed or to be listed on the Hong Kong Stock Exchange. Offerings of shares that are already listed on the Hong Kong Stock Exchange will cover the placing of listed shares to third party investors by an existing shareholder if it is accompanied by a top-up subscription by the existing shareholder for new shares in the issuer.
With regard to shares to be listed on the Hong Kong Exchange, this includes IPOs which include share offerings in connection with a secondary listing and offer of existing shares by way of IPO. Offerings of a class new to listing and offerings of new shares of a class already listed under a general or specific mandate.
All references to "shares" in the new paragraph 21 of the SFC Code of Conduct also include depository receipts and units of interests in SFC authorized real estate investment trusts (REITs) listed or to be listed in Hong Kong. For debt offerings, the new Bookbuilding Conduct Requirements will cover offerings of debt securities listed or unlisted and offered in Hong Kong or otherwise.
Offerings which do not involve bookbuilding activities are not within the scope of the new Bookbuilding Conduct Requirements and are thus not covered. Examples of these offerings are bilateral agreements or arrangements between the issuer and the investors (sometimes referred to as club deals), transactions involving only one or several investors where the terms of the offering are negotiated and agreed directly between the issuer and the investors (sometimes referred to as private placements) and transactions where shares or debt securities are allocated to investors on a predetermined basis at a predetermined price.
A CMI will be classified as either a syndicate CMI or a non-syndicate CMI, depending on whether it has a mandate and a direct relationship with the issuer. A CMI, which is engaged by the issuer of a share or debt offering will be referred to as a syndicate CMI. Examples of titles or roles currently associated with syndicate CMIs include, in the case of senior syndicate CMIs, book runners or lead managers, and in the case of less senior syndicate CMIs co-managers and placing agents.
A CMI which is not engaged by the issuer of a share or debt offering is referred to as a non-syndicate CMI. Examples of titles or roles currently associated with non-syndicate CMIs include sub-placing agents engaged by syndicate CMIs or other non-syndicate CMIs for the placing of shares of debt securities or brokers which only collate orders received from their investor clients place them with the syndicate CMIs and distribute the securities to their clients if they receive allocations from the syndicate CMIs.
A non-syndicate CMI, which was not appointed by syndicate CMI, and therefore does not receive remuneration directly or indirectly from the issuer client and is only responsible for relaying investor clients’ orders to the CMI for placing into the order book, will not be subject to the full set of obligations applicable to CMIs under new paragraph 21 of the SFC Code of Conduct.
In particular, these execution only non-syndicate CMIs will only be required to comply with certain obligations related to the assessment of investor clients, transparency of the order book, disclosure of any rebates offer to CMIs and any other preferential treatment of CMIs or targeted investors and prohibition on offering rebates to investor clients. These obligations, I’ll talk about a bit later in the webinar.
As set out in the new paragraph 21, there are many types of share and debt offerings, which vary in nature and complexity and a CMI may play different roles in different offerings. The CMI senior management will be responsible for establishing and implementing adequate and effective policies, procedures and controls to ensure compliance with the regulations and rules which apply to the rules they play in an offering. Heads of syndicates for offerings will be referred to as overall coordinators or "OCs" and they will be identified solely by reference to the activities they carry out rather than by their titles.
For a share offering, an OC is a syndicate CMI which solely or jointly conducts any of certain activities. Firstly, an activity is the overall management of the offering, coordinating the bookbuilding or placing activities conducted by other CMIs, exercising control over Bookbuilding Activities and making allocation recommendations to the issuer client. The second activity is advising the issuer client of the offer price and being a party to the price determination agreement with the issuer client.
And the third activity is exercising the discretion to reallocate shares between the placing tranche and the public subscription tranche, reduce the number of offer shares or exercise, an upsize option or over allotment option. In the case of a debt offering, an OC is a syndicate CMI which solely or jointly conducts other types of activities.
Firstly, conducting the overall management of the offering, coordinating the bookbuilding or placing activities conducted by other CMIs, exercising control of a bookbuilding activities and making pricing or allocation recommendations to the issuer client. The proposed definition of OC in relation to share offerings in the Consultation Paper also included the activity "acting as a stabilization manager" which a few respondents argued should be removed.
The SFC agreed to remove "acting as a stabilization manager" as one of the activities, as it considers that a stabilizing manager’s role is not central to the functions of an OC.
Turning now to the obligations and standards of conduct expected of CMIs. These obligations and standards are set out in the new paragraph 21.3 of the SFC Code of Conduct and are the baseline requirements with which all CMIs have to comply.
Paragraph 21.4 sets out additional requirements applicable to OCs only. OCs will be required to comply with both paragraphs 21.3 and 21.4 of the SFC Code of Conduct. Let’s look first at the new Bookbuilding Conduct Requirement to conduct an assessment of the issuer and the offering.
The SFC said in its Consultation Paper, that it considers that a proper understanding of the issuer and the offering is necessary for CMIs to market the shares or debt securities to their investor clients, and for the OC to provide appropriate advice to the issuer. The new Bookbuilding Conduct Requirements will require CMIs to conduct an adequate assessment of an issuer before engaging in an offering for that issuer client. This will include taking reasonable steps to obtain an accurate understanding of the issuer client’s history, background, business performance, financial conditions and prospects, operations and structure.
Where the CMI for debt offering had been the CMI for a previous debt offering made by the same issuer, the CMI will instead be required to ascertain whether there have been any material changes in the issuer client’s circumstances of relevance to its role as CMI. The new Bookbuilding Conduct Requirements will also require CMIs to establish a formal governance process for the review and assessment of the offering including any actual or potential conflict of interest between the CMI and the issuer client and the associated risks.
The SFC considers that establishing clearly defined roles and responsibilities of CMIs from the outset will allow for better management of the offering and less confusion for buy-side participants and will address potential concerns regarding reliability of information provided by an intermediary.
The new Bookbuilding Conduct Requirements contain provisions on the timing of appointments of CMIs and OCs and stipulates that appointments must be made under written agreements setting out the fee arrangements. The SFC noted in its Consultation Paper that the current practice is for underwriting agreements for share offerings and subscription agreements for debt offerings to be typically entered into very late in the offering process, usually when the price has been fixed and allocations to investors have been finalized
These agreements do not generally define the roles and responsibilities of the CMIs. The underwriting agreements for share offerings typically specify intermediaries’ underwriting commitments which do not necessarily correspond to their fee entitlement.
In debt offerings, it’s also the norm to appoint syndicate heads verbally without written agreements. To address these issues, the new Bookbuilding Conduct Requirements will require that before a CMI starts carrying out any bookbuilding or Placing Activities, it will be required to ensure that it has been formally appointed by the issuer client or another CMI in the case of a non syndicate CMI under a written agreement to conduct such activities. The written agreement should clearly specify the roles and responsibilities of the CMI, the fee arrangements and the fee payment schedule. The fee arrangements in the agreement should include fixed fees as a percentage of the total fees to be paid to all syndicate CMIs participating in the offering including fees for providing advice to the issuer, marketing, bookbuilding, making pricing and allocation recommendations and placing these securities with investor clients often referred to as underwriting fees by the industry.
For OCs before they conduct any activities as set out in paragraph 21.2.3 of the SFC Code of Conduct, that is, any of the activities to be classified as an OC and a share offering or participate in any bookbuilding or placing activities for a debt offering, the OC will be required to ensure that it has been formally appointed by an issuer under a written agreement to conduct these activities. The written agreement should include the same information as required for all CMIs.
For Main Board IPOs, if an OC is or one of its group companies is also an independent sponsor, the OC should ensure that it is appointed as an OC at the same time as the sponsor appointment. And at least two months before the listing application submission. I’ll talk about "sponsor coupling" later in the webinar.
If an OC is not also an independent sponsor, the appointment should be made no later than two weeks after the listing application submission. For GEM IPOs, an OC should ensure that it is appointed as an OC no later than two weeks after the listing application submission.
For an IPO, an OC will be required to provide certain information to the SFC at least four clear business days prior to the listing committee hearing including the name of each OC participating in the offering.
Consultation respondents raised concerns that issuers may need to appoint additional syndicate CMIs at a later stage. To provide flexibility, the SFC therefore removed the requirement proposed in the Consultation Paper, for the appointment of non-OC syndicate CMIs and the determination of their fees to be reported to the SFC.
However, the SFC noted that all CMIs will still be required to be appointed before carrying out any bookbuilding or placing activities. The SFC considered that this will enable CMIs to assess whether they wish to accept the appointment based on their fixed fee entitlement and determine the resources they should utilise.
Under the new Bookbuilding Conduct Requirements, an OC will be required to provide advice to the issuer client on marketing strategy, pricing and allocation. In particular, new paragraph 21 will require OCs to act with due skill, care and diligence when providing advice, recommendation, and guidance to the issuer client, and should ensure that their advice and recommendations are balanced and based on thorough analysis and are compliant with all legal and regulatory requirements.
Engage the issuer client to understand their preferences and objectives on price and the desired shareholder or investor base so that the OC is in a position to advise, develop, or revise, a marketing and investor targeting strategy with a view to attaining these objectives in the light of prevailing market conditions and sentiment.
Explain the basis of its advice and recommendations to the issuer client including any advantages and disadvantages, provide advice to the issuer client in a timely fashion of key factors for consideration and how these factors could influence the pricing outcome, allocation and future shareholder or investor base. Advise the issuer client on the information that should be provided to syndicate CMIs to enable them to satisfy their obligations and responsibilities under the SFC Code of Conduct.
OCs which participate in share offerings will be required to provide guidance to the issuer client on the market practice on the ratio of fixed and discretionary fees to be paid to syndicate CMIs participating in an IPO. That’s the fee split ratio. Discretionary fees are the portion of the total fees to be paid to all syndicate CMIs at the absolute discretion of the issuer client.
There is also a requirement for the ratio between the fixed and discretionary fees to be reported to the SFC no later than four clear business days before the listing committee hearing.
OCs which participate in share offerings will also be required to advise and guide the issuer client and its directors as to their responsibilities under the Hong Kong Exchange’s requirements which apply to placing activities and take reasonable steps to ensure that they understand and meet these responsibilities.
An OC will be required to report on a timely basis various information to the SFC including any instances of material non-compliance with the Hong Kong Exchange’s requirements related to, for example, the Placing activities conducted by it or the issuer client and any material changes to the information it previously provided to the SFC and the Hong Kong Stock Exchange.
This reporting requirement would include, in the case of a share offering, any decisions made by the issuer client that amount to any material non-compliance with the Hong Kong Exchange’s requirements. An OC should also explain the potential concerns and advise the issuer client against making decisions where the issuer client decides not to adopt an OCs advice or recommendations in respect of pricing or allocation of shares or debt securities, or for a share offering, its decisions may lead to a lack of open market and inadequate spread of investors or may negatively affect the orderly and fair marketing of these shares in the secondary market.
The OC should document any final decisions of the issuer client which deviate materially from the advice or recommendations provided by the OC, including the OCs explanation to the issuer client of any concerns associated with the decisions and advice provided. It was proposed in the Consultation Paper that an OC should provide advice and guidance to the issuer client on syndicate membership and fee arrangements.
Many respondents, including representatives from both the buy side and the sell side had reservations about this proposed requirement expressing concerns about potential conflicts of interest and that this proposal could go against issuers’ interests. In the light of these concerns, the SFC removed this requirement.
The requirement to provide guidance on the market’s practice on the fee split ratio was not included in the initial proposals as set out in the Consultation Paper. Some consultation respondents suggested that OCs should be required to provide transparent market information and comparable transactions as references for the issuer clients consideration. The SFC said that, although the OC is no longer required to advise on fee arrangements, it agrees that the issuer client should at least be informed of the market’s fee split practice.
Under the new Bookbuilding Conduct Requirements, a CMI would be required to only market the shares or debt securities to its investor clients which are targeted investors.
For a share offering, where the shares are only marketed to selected investor clients, the CMI should be satisfied that the shares have been marketed to a sufficient number of clients and the likelihood of undue concentration of holdings is reasonably low.
A CMI should also allow all of its investor clients, which are targeted investors and have indicated an interest in an offering, to participate in that offering. "Targeted investors" are defined in the new Bookbuilding Conduct Requirements as investors that fall within the types of investors targeted in the marketing and investor targeting strategy.
OCs will be required to, in consultation with the issuer client, formulate a marketing and investor targeting strategy for order generation, taking into consideration the issuer client’s objectives and preferences. The strategy may specify the types of investors targeted and the proportion of an offering to be allocated to each type of investor to enable the desired shareholder or investor base to be established.
In the case of IPOs, the strategy should also include the types of investors who may be appropriate to be cornerstone investors and should seek to achieve an open market, an adequate spread of shareholders and promote the orderly and fair trading of shares.
OCs will also be required to advise the issuer to adjust the strategy as appropriate in response to changing market conditions and sentiment. In addition, they should inform other syndicate CMIs of the marketing and investor targeting strategy.
The new Bookbuilding Conduct Requirements include provisions prohibiting CMIs from offering any rebates to investor clients or from enabling any investor clients to pay at a price lower than that offered to other investors.
For IPOs, CMIs should not enable investor clients to pay for each of the shares allocated less than the total consideration as disclosed in the listing document including the 1% brokerage fee.
For debt offering, CMIs should not enter into any arrangements which may result in investor clients paying different prices than the debt securities allocated.
CMIs will also be required to disclose to the issuer client, the OC, all of its targeted investors and the non-syndicate CMIs it appoints, any rebates offered to CMIs and any other preferential treatment of any CMIs or targeted investors.
For a share offering, CMIs should make this disclosure upon becoming aware of any rebate or preferential treatment.
For a debt offering, disclosure should be made no later than at the dissemination of the deal launch message to target investors.
OCs will be required to advise the issuer client against providing any arrangements whereby, in the case of an IPO, the investor clients would pay less than the total consideration as disclosed in the listing documents, and for a debt offering, the investor clients would pay different prices for the debt securities allocated.
In addition, OCs will be required to advise the issuer of the disclosure of any rebates and preferential treatment and, in accordance with the general requirement to disseminate material information related to the offering to all syndicates CMIs, will be required to disseminate information on rebates and preferential treatment to all syndicate CMIs.
Some consultation respondents submitted that rebates in whatever form, including rebates to private banks and investor clients, should be banned entirely so as to maintain a level playing field. The SFC disagreed and explained that they consider that rebates offered by issuers to intermediaries as incentives for their selling efforts should remain provided that they’re not passed on to investor clients and are properly disclosed in accordance with the new Bookbuilding Conduct Requirements.
A CMI will be required to take reasonable steps to assess whether its invested clients based on their profiles are targeted investors. That is, whether the investor clients are investors that fall within the categories of investors targeted in the marketing and investor targeting strategy.
For share offerings, CMIs will be required to take all reasonable steps to identify the investor clients to whom the allocation of shares will be subject to restrictions or require the prior consent of the Hong Kong Exchange under the Hong Kong Exchange’s requirements, also known as "Restricted Investors", and inform the OC prior to placing an order on behalf of such clients.
In relation to debt offerings, CMIs will be required to take all reasonable steps to identify whether their investor clients may have any associations with the issuer client, the CMI or a company in the same group of companies as the CMI, as well as provide sufficient information to an OC to enable it to assess whether any orders may negatively impact the price discovery process.
CMIs must also comply with the existing KYC requirements under the SFC Code of Conduct.
For IPOs, OCs will be required to advise the issuer client to provide, to all syndicate CMIs, a list of its directors, existing shareholders and their respective close associates and any of their respective nominees appointed for the subscription or purchase of IPO shares. They will also be required to take all reasonable steps to identify investors on such list and ensure that they will only be allocated shares in accordance with the Hong Kong Exchange’s requirements.
In the case of debt offerings, OCs will be required to advise the issuer client to provide adequate information to all syndicate CMIs to allow them to reasonably identify whether investor clients have any associations with the issuer client.
OCs should also take all reasonable steps to identify whether investor clients have any associations with the issuer client, CMIs or their group companies.
It was proposed in the Consultation Paper that OCs should provide relevant information about the issuer directly to the other syndicate CMIs to facilitate their identification of Restricted Investors for IPOs or investors that have any relevant associations for debt offerings. Some consultation respondents commented that this would impose an onerous burden on OCs and had concerns relating to OCs’ liability for the accuracy and completeness of the information they would be providing. The SFC agreed and said that it would be more direct and efficient for the issuer itself to disseminate the relevant information to all syndicate CMIs.
The revised provisions require an OC to advise the issuer client to provide the information to syndicate CMIs. The SFC said in the Consultation Conclusions that it will work with the Hong Kong Stock Exchange to reflect in the listing rules or appropriate guidance letters the role of the issuer in these matters
Turning now to Bookbuilding. The Bookbuilding process comprises the collation of client orders and the determination of pricing and allocation. The SFC is particularly concerned about the market practice of "X-orders" which are orders where the identities of investors are concealed. As set out in the Consultation Paper, the SFC considers that issuers may request CMIs to use "X-orders" to conceal the identities of prospective investors with whom they’re closely associated so as to hide the fact that the orders are not market driven or for other purposes
The new Bookbuilding Conduct Requirements prohibit the use of "X-orders". CMIs will be required to ensure transparency in the bookbuilding process. They should disclose the identities of all investor clients in an order book.
There will be an exception for orders placed in an omnibus basis, and in such cases, CMIs will only be required to provide information about the underlying investors, this being the investor client’s name and unique identification number to the OC and the issuer client when placing orders. When CMIs receive information about investor clients for orders placed on an omnibus basis, they will only be permitted to use the information for placing orders in that specific offering transaction.
CMIs should also take reasonable steps to ensure that all orders, including indications of interest in the order book, represent bonafide demand on behalf of its investor clients itself and its group companies. They should make inquiries with investor clients about orders which appear unusual prior to placing the order.
It was proposed in the Consultation Paper that, in respect of orders placed on an omnibus basis, CMIs should provide information about the underlying investor clients to the OC and the issuer.
Acknowledging the concerns of many consultation respondents relating to the commercial secrecy of client information, and that disclosing it to competitors may lead to client poaching, the SFC and its Consultation Conclusions modified the requirement relating to orders placed in an omnibus basis to the requirement which I just talked about.
As to the OCs obligations, they will be required to take reasonable steps to properly manage an order book and ensure the book’s transparency, including ensuring the identities of all investor clients are disclosed in the order book apart from orders placed on an omnibus basis, properly consolidating orders in the order book by taking reasonable steps to identify and eliminate duplicated orders, inconsistencies, or errors, segregating and clearly identifying in the order book and book messages any proprietary orders of CMIs and their group companies and making inquiries with CMIs which have placed orders on behalf of their investor clients, themselves, or their group companies which appear unusual or irregular such as orders, which appeared to be related to the issuer client.
As discussed in the Consultation Paper, conflicts of interest between the issuer and the CMI or its investor clients could lead to underpricing or overpricing. In order to address these concerns, the new Bookbuilding Conduct Requirements will require CMIs to establish and implement an allocation policy to ensure a fair allocation of shares or debt securities to its investor clients.
The allocation policy should take into account the principles and requirements of the new paragraph 21 provisions on conflicts of interest and proprietary orders as well as other factors, including the marketing and investor targeting strategy, the order sizes and circumstances of the investor client, the price limits for the investor clients orders, any minimum allocation amounts indicated by client investors and any applicable legal or regulatory requirements.
CMIs should prevent any practices which may result in the unfair treatment of investor clients or knowingly distort the demand for other share or debt offerings.
OCs will be required to take all reasonable steps to ensure that the price discovery process is credible and transparent and that the allocation recommendations made to the issuer client as well as the final allocation have a proper basis. They will be required to advise the issuer client on the pricing with reference to, for example, the results of the bookbuilding activities, the issuer client’s, characteristics, prevailing market conditions and the relevant authorities sentiment and requirements.
OCs should also ensure that the proprietary orders of CMIs or their group companies and the debt offerings, the offered orders placed by investor clients which have associations with the issuer client CMIs or their group companies, will not negatively impact the price discovery.
OCs will also be required to develop and maintain an allocation policy which specifies the criteria for making allocation recommendations to the issuer client . The OC should make allocation recommendations in accordance with its allocation policy and ensure that recommendations regarding the allocation of securities to the OC’s investor clients take into account the CMI allocation policy.
For an IPO OCs will be required to ensure that allocation recommendations are made with a view to achieving an open market, an adequate spread of shareholders and the orderly and fair trading of the shares in the secondary market and should ensure that any allocations to restricted investors comply with the Hong Kong Stock Exchange’s requirements.
If the allocation recommendations materially deviate from the OC or the CMI allocation policy, the OCs should explain to the issuer client the reasons for the deviation.
OCs should also explain to the issuer client, the basis of its advice and recommendations, including any advantages and disadvantages.
A couple of consultation respondents were concerned that the proposed requirements would create disincentives for CMIs to work hard to secure adequate demand to support a higher price.
For example, CMIs may seek a lower offering plan price to favor their own investor clients which would be contrary to the issuer’s interests. The SFC explained that the risk of underpricing would be a problem if issuers were in a weak bargaining position but it considers that this is not the case in Hong Kong.
The SFC considers that these requirements are essential in order to balance the interests of different parties in an offering and promote transparent and effective price discovery. Further, the issuer has the final say on pricing allocation and the OC will only be required to explain any potential concerns and advise the issuer appropriately.
The new Bookbuilding Conduct Requirements will include provisions to address conflicts of interest and the potential of the CMIs to take advantage of non-public information in the order book when placing proprietary orders.
CMIs will be required to establish, implement and maintain policies and procedures to identify, manage, and disclose actual and potential conflicts of interest which may, for instance, arise when a CMI serves the interests of both it’s issuer client and investor clients, serves the interests of its investor clients when having a proprietary interest including a proprietary interest of its group companies in an offering or has full discretion over allocations to investor clients or a proprietary order. CMIs’ policies and procedures should also govern the process for generating proprietary orders and making allocations to such orders.
Under the new Bookbuilding Conduct Requirements, CMIs will also be required to always give priority to fulfilling investor clients orders over their own proprietary orders and proprietary orders of their group companies. They should only be the price taker in respect of proprietary orders and proprietary orders of their group companies and ensure that these orders would not negatively impact the price discovery process.
CMI should also segregate and clearly identify their own proprietary orders and proprietary orders of their group companies, whether directly or indirectly, in the order book and book messages.
As to the meaning of "proprietary orders of a group company", the new Bookbuilding Conduct Requirements say that such proprietary orders will not include orders placed on behalf of the group companies, clients or funds and portfolios under its management but will include orders placed on behalf of funds and portfolios in which the CMI or the group company has a substantial interest.
For a debt offering, CMIs will be required to take reasonable steps to disclose to the issuer client, how any risk management transactions it intends to conduct itself, the issuer client or its investor clients, will not impact the debt securities pricing.
Senior management of CMIs will be required to review and approve certain types of orders and allocations including proprietary orders of the CMI and its group companies, orders from investor clients which may appear unusual, such as orders which may appear to be related to the issuer, and allocations to restricted investors in the case of share offerings
Throughout the offering, CMIs will receive information from the issuer, OCs, other CMIs and its investor clients, which would materially affect the offering including information about the offer price and the ways in which the OCs and CMIs should discharge their responsibilities. The new Bookbuilding Conduct Requirements include provisions on communications with issuers other than CMIs and targeted investors.
CMIs will be required to disclose complete and accurate information in a timely fashion on the status of the order book and other relevant information it receives to the OC, whether directly or indirectly, and non-syndicate CMIs it appoints, so that they can perform their duties and its targeted investors so that they can make an informed decision.
An OC will be required to inform other syndicate CMIs of the issuers clients’ marketing and investor targeting strategy and disseminate material information related to the offering as included in, for example, the launch time sheet and book messages in a timely fashion to all syndicates CMIs.
OCs should ensure that the disseminated information is complete and accurate and has a proper basis. Material information related to the offering includes, for example, information which may affect the prices, orders received per investor type, proprietary orders of CMIs and their group companies and known preferential treatments and rebates.
Under the new bookbuilding conduct requirements, a CMI will be required to maintain books and records sufficient to demonstrate compliance with all applicable requirements of the new paragraph 21. And these include assessments of the issuer client, the offering and investor clients, audit trails or key communications with the issuer client, investor clients and other CMIs, where a CMIs order is placed on an omnibus basis, the intended basis of allocation for all orders, with justifications and any material deviations from the CMIs’ allocation policy. A CMI must maintain records of the documented information for at least seven years. This requirement will be reduced to only two years for audit trails.
OCs will be required to document various matters including all changes in the order book throughout the bookbuilding process and all key discussions with and key advice or recommendations provided to the issuer client. OCs have to maintain records of the documented information for at least seven years.
Although some consultation respondents commented that it would be burdensome to require OCs and CMIs to maintain records which evidence every change in the order book throughout bookbuilding process, over half of the respondents considered it to be feasible. The SFC agreed with the majority that these requirements are feasible, particularly in light of the proliferation of electronic means by which intermediaries can adopt and maintain information when conducting bookbuilding activities. The SFC also said that setting a quantifiable range of the records which would be kept would be arbitrary and therefore undesirable.
General principle three of the SFC Code of Conduct provides that an intermediary should have and effectively employ the resources and procedures which are needed for the proper performance of its business activities. The new Bookbuilding Conduct Requirements build upon this principle by containing provisions for resources, systems, and controls including Chinese walls, appointment of non-syndicate CMIs and surveillance and monitoring.
Under the new paragraph 21 of the SFC Code of Conduct, a CMI should maintain sufficient resources and effective systems and controls to ensure that it can discharge its obligations and responsibilities.
In addition, CMIs will be required to take adequate measures to prevent the flow of information which may be confidential or price sensitive amongst staff performing different activities relating to the offering.
For example, research, report preparation, sponsor work, Bookbuilding activities and placing activities and to prevent and manage any conflicts of interest. In particular, CMIs should establish and maintain effective Chinese walls and wall crossing policies and procedures.
CMIs will also be required to exercise due skill, care and diligence in the selection and appointment of any non-syndicate CMIs to assist it in distributing shares or debt securities. CMIs will also be required to regularly carry out independent surveillance and monitoring to detect any irregularities, conflicts of interest, leakage of price sensitive or confidential information and potential non-compliance with regulatory requirements or its own internal policies and procedures.
The SFC considers that fee arrangements, particularly the ratios of fixed fees to discretionary fees and allocations of fixed fees to syndicate members, should be agreed at an early stage. Under the new Bookbuilding Conduct Requirements, each written agreement to be entered into by a CMI or an OC will be required to specify the fee arrangements including the allocation of fixed fees to the particular CMI as a percentage of the total fees to be paid to all syndicate CMIs and the fee payment schedule.
OCs which participate in a share offering should provide guidance to the issuer client in relation to the market’s practice on the ratio of fixed and discretionary fees to be paid to syndicate CMIs participating in an IPO. That is, the fee split ratio.
The SFC said in its October 2021 Consultation Conclusions that the market practice for the fee split ratio is currently approximately 75% fixed fees and 25% discretionary fees, a 75:25 ratio. The SFC also provided in the Consultation Conclusions that post-IPO price performance should not be a consideration in determining the allocation of discretionary fees.
Also, in order to assist with the identification of arrangements that substantially differ from market norms, OCs will be required to provide certain information to the SFC by no later than four clear business days prior to the listing committee hearing for an IPO. This information includes the name of each OC participating in the IPO, the allocation of the fixed portion of the fees paid by the issuer to each OC, the total fees as a percentage of the gross amount of funds raised of both the public offer and the international tranche to be paid to all syndicate CMIs and the fee split ratio, the ratio between the fixed and discretionary portions of the total fees to be paid to all syndicates CMIs in percentage terms.
The OC should notify the SFC as soon as practicable of any material changes to any of this information.
As the SFC will not require OCs to advise issuers on fee arrangements as proposed in the Consultation Paper, it will also not require OCs to confirm to the SFC that the issuer has determined the allocation of discretionary fees to each syndicate CMI and the fee payments schedule no later than listing as also proposed in the Consultation Paper.
However, the SFC said in its Consultation Conclusions that it will explore with the Hong Kong Exchange, the possibility of introducing a requirement for issuers to confirm directly that they have determined the allocation of discretionary fees to each syndicate CMI and the fee payment schedule no later than listing.
As is the existing practice, the composition of the syndicate will be disclosed at the time of the publication of the prospectus. The SFC said in its Consultation Conclusions that it will work with the Hong Kong Exchange to introduce a requirement under the listing rules or appropriate guidance letters for the public disclosure of OCs at an early stage of the offering.
Currently, underwriting fees for the Hong Kong public offer tranche are disclosed in the prospectus whilst underwriting fees for the international placing tranche are disclosed infrequently. Consultation respondents in general supported requiring disclosure of the total fees to be paid to all syndicates CMIs participating in the international placing tranche.
The SFC in its consultation conclusion said that it considers that the total fees payable to all syndicate CMIs covering both trances should be disclosed in the prospectus and if the issuer also appoints an overseas firm to conduct underwriting Bookbuilding, or placing shares in an IPO, the prospectus should disclose the fees payable to the overseas firm covering both tranches.
Turning now to "sponsor coupling", under the new Bookbuilding conduct requirements, listing applicants will be required to adopt "sponsor coupling" for IPOs on the Main Board of the Hong Kong Stock Exchange. This is the requirement that for an IPO, at least one sponsor, which is independent of the listing applicant is, or one of the sponsors group companies is, also appointed as an OC for the IPO. "Sponsor coupling" will not be required for GEM IPOs.
As set out in the Consultation Paper, the SFC found from its pre-consultation discussions with market participants, that where an IPO transaction is led by a large group of syndicate CMIs with a variety of titles. And the heads of syndicate are not clearly identified, buy-side participants may be faced with a confusing situation.
The SFC noted that many market participants indicated that preferably, IPO transactions should be led by one or a small group of clearly identified senior syndicate members from the outset in order to ensure consistency in advice and allow participants to know who can provide accurate and reliable information and who is primarily accountable for the transaction. The SFC also noted that it appears that there is an increasing interest by CMIs to be appointed as heads of syndicate for IPOs. They observe that when heads of syndicate also act as sponsors for an IPO, advantages can accrue for the overall offering.
However, an increasing proportion of the heads of syndicate did not act as sponsors during the nine months ending 30 September 2020 as compared to in 2018. Based on the SFC’s analysis of the IPOs conducted in the first nine months of 2020, underwriting fees are substantially higher than sponsor fees
The SFC suggested that this indicates a misalignment between fees and sponsor costs and responsibilities, particularly in larger IPOs where sponsors normally incur substantial costs and any regulatory breaches could potentially result in severe consequences. The SFC further noted that where sponsors also act as the head of syndicate, the total fees may properly compensate the additional sponsor resource commitments and responsibilities.
If sponsors are not appointed as head of syndicate from the outset, the SFC is concerned that they may be incentivized to compromise due diligence to secure the appointment. In addition, the SFC also noted that market participants were resistant to proposals requiring all OCs to be sponsors based on concerns that it would limit the issuer’s flexibility in appointing OCs with strong marketing abilities and may prejudice standalone boutique sponsor firms with no marketing capabilities.
The concept of "sponsor coupling" was developed to address the SFC’s consents that sponsors may compromise their standard of due diligence to secure an OC appointment. The SFC took the view that by acting as both OC and sponsor, the intermediary should be in a better position to provide quality advice to the issuer.
The SFC considers that "sponsor coupling" will ensure that at least one sponsor will be free of potential incentives to carry out limited due diligence in order to secure an OC role. The early appointment of the sponsor OC will discourage sponsors from compromising their due diligence obligations. Through "sponsor coupling" the sponsor OC will be in a position to give comprehensive advice to the listing applicant throughout the transaction and buy-side participants will be able to look to the sponsor OC to provide well-informed and authoritative answers to their questions.
Let me look now at the specific provisions for "sponsor coupling" in the new Bookbuilding Conduct Requirements. Under new paragraph, 21.4.1B in relation to IPOs on the Main Board, prior to accepting an appointment, an OC will be required to ensure that it or one of its group companies is also appointed as a sponsor, which is independent of the issuer client. This is known as the "Sponsor OC" and that both appointments are made at the same time. And at least two months prior to the issuer client’s listing application submission, the A1 filing, or provide a written confirmation from the issuer client that at least one sponsor, which is independent of the issuer client has been appointed as an OC for that IPO. In which case, appointment as an OC should be made no later than two weeks after the issuer client’s listing application has been submitted.
The new paragraph 21.4.1B is mirrored in a new paragraph 17.1A of the SFC Code of Conduct. Paragraph 17 sets out the standards and requirements for sponsors. Under new paragraph 17.1A before accepting an appointment by a listing applicant to act as a sponsor for a Main Board IPO, the sponsor will be required to either be independent of the listing applicant and ensure that it is also appointed at the same time as an OC in connection with that listing application or obtain written confirmation from the listing applicant that at least one sponsor, which is independent of the listing applicant, has been appointed as an OC in connection with that listing application.
The circumstances under which a sponsor is considered not to be independent of the listing applicant are specified in chapter 3A of the listing rules.
These include the circumstances where the sponsor is a connected person of the listing applicant or where the sponsor group and any director or closely associate of the director of the sponsor collectively holds or will hold more than 5% of the issued shares of the listing applicant.
In order to be considered a group company of the sponsor, the definition of group of companies in section one of Part 1 of Schedule 1 to the SFO is applied. "Sponsor coupling" will only be required for IPOs on the Main Board of the exchange, as I’ve said.
During the consultation, the majority of respondents supported the introduction of "sponsor coupling" as they considered that it will help and share the transparency of offerings which they think is in the best interest of investors and ease concerns that sponsors which are not appointed as OCs at an early stage may compromise their due diligence standards to acquire an OC mandate.
On the other hand, some sponsors commented that "sponsor coupling" might give too much bargaining power to the sponsor OCs. The SFC disagreed with this view explaining that fees are currently not aligned with sponsor costs and responsibilities which is putting sponsors under pressure to compromise their due diligence, to secure their appointments of an OC.
Therefore, the SFC considers that it appears that sponsors currently have too little bargaining power. It was proposed in the Consultation Paper that the "sponsor coupling" requirement apply to all IPOs, both Main Board and GEM. A few respondents were concerned that small boutique sponsors without underwriting or distribution capacity would be driven out of the market as issuers generally do not wish to appoint multiple sponsors, particularly in GEM IPOs.
If "sponsor coupling" were introduced, many small but highly professional sponsors would no longer be able to act as sponsors. In response, the SFC said that the impact on small boutique sponsors should be limited and referred to data that in the year ended 30 September 2020, 72% of the 127 sponsors were engaged as a syndicate member which indicates that they have the necessary capabilities.
However, the SFC acknowledged that "sponsor coupling" is not as prevalent in GEM IPOs where small boutique sponsors with limited underwriting or distribution capability tend to be more active. The SFC is of the view that sponsors compromising the standard of due diligence is of less concern in GEM IPOs as the SFC considers that their sponsor fees are generally commensurate with their work. And for these reasons, the "sponsor coupling" requirement will only apply to IPOs on the Main Board and not GEM.
In terms of the impact of "sponsor coupling", there are different perpsectives. The issues that concern bulge bracket banks which offer the full range of services including acting as IPO sponsor and underwriting are different from the concerns of smaller sponsor firms which don’t necessarily have underwriting capabilities.
The issues that concern mega-hot IPOs, which are many times oversubscribed, are also very different to those, for listing smaller companies particularly on GEM. There are a couple of potential issues that may arise due to "sponsor coupling". The first is the potential conflict of interest between the OC as the lead underwriter and the issuer.
As the Consultation Paper noted, the IOSCO report on conflicts of interest in the equity capital raising process highlighted the risk of IPO underpricing due to the inherent conflict between the interest of the underwriters and the issuer.
While it’s in the issuers’ interest for the share price to be as high as possible, it may be in the underwriters’ interest to under-price the offering to increase the chances that all the shares are subscribed by investors and minimize the chance that they will have to purchase unsubscribed shares. Given that inherent conflict, there is an argument against the OC advising the issuer on price.
The SFC responded to this in the Consultation Conclusions saying that they’re of the view that "sponsor coupling" would not exacerbate conflicts of interest given that "sponsor coupling" is already prevalent for Main Board IPO transactions.
As mentioned, applying the "sponsor coupling" requirements to all IPOs would disadvantage smaller sponsor funds which don’t all have underwriting capabilities.
In theory, these firms could be appointed as joint sponsors and practice issuers maybe unwilling to pay more than one set of sponsor fees. The "sponsor coupling" requirements would therefore effectively preclude these boutique sponsor firms from acting as IPO sponsors. Nevertheless, they will still have the opportunity to participate in GEM IPOs where "sponsor coupling" doesn’t apply. But given that GEM IPO activity has fallen so much recently, there’s in fact only been one GEM IPO so far in 2021, the "sponsor coupling" requirement may in reality have a significant effect on some smaller sponsor firms.
The SFC sees the "sponsor coupling" requirements as a means to address its concern that sponsors may compromise their due diligence inquiries to win the profitable role of syndicate head for which they generally face fierce competition from non-sponsors.
Part of the answer to that concern would be to ensure that sponsors are properly compensated for their work responsibilities and potential liability as sponsors. Although the SFC commented in its 2012 Consultation Conclusions on the sponsor regime that sponsor fees should appropriately reflect the sponsor’s role and responsibilities, no provision to that effect was in fact included in the Code of Conduct and the concern that sponsors may potentially skimp on their due diligence could perhaps have been addressed by making it a requirement that sponsor fees properly reflect the work and potential liability of the sponsor under paragraph 17 of the Code of Conduct.
The SFC has many means at its disposal for dealing with sponsors which conduct inadequate due diligence. And there are many examples of the SFC bringing disciplinary proceedings against sponsors on this basis. The new Bookbuilding Conduct Requirements were gazetted on the 5th of November, and as I said previously, they will come into effect on the 5th of August 2022.
So there’s a nine month transition period to give a reasonable time for CMIs to implement the requisite operational and system changes to comply with the new requirements. The SFC will work with the Exchange to introduce appropriate amendments to the listing rules which will dovetail with the new Bookbuilding Conduct Requirements.
So that brings me to the conclusion of the formal part of this presentation. Thank you again all of you very much for attending today. I wish you all a great weekend and a very happy Christmas season. Bye!
CH-019430 (Webpage Portal) | 2021-12-17 (Published) | 2022-01-10 (Updated)