Hong Kong has seen a boom in initial public offerings in recent years, and now the country's Securities and Futures Commission is aiming to crack down on lax due diligence and introduce a stricter code of conduct for sponsoring banks.

What is it?

Hong Kong’s Securities and Futures Commission (SFC) has proposed tougher rules for sponsors of initial public offerings (IPOs), which would make them civilly and criminally liable for the contents of IPO prospectuses. The IPO sponsor, a role distinct to the Hong Kong market, is a licensed corporate finance advisor that works to prepare a company for listing, with responsibilities including the preparation of all relevant documentation and the overseeing of other professional advisors to the offering.

The main proposals are that sponsors should complete the majority of the due diligence before the prospectus is submitted to the stock exchange; sponsors are made responsible for the due diligence regardless of whether they have done it themselves or relied on a third party; and sponsors cannot rely on the submissions of experts, such as accountants, in the prospectus. 

The issue of liability highlights the differences between Hong Kong and other jurisdictions such as the US. Steven Winegar, partner at law firm Paul Hastings, says that in the US there are other enforcement options available, such as civil litigation. Unlike the US, class action lawsuits are not possible in Hong Kong, and Mr Winegar says that civil litigation is rarely chosen as an option in Hong Kong because it is prohibitively expensive, and the costs of suing a sponsor can outweigh any loss on investment. 

Why is this happening?

Hong Kong’s IPO market witnessed a boom in 2010 and 2011 when a flurry of listings made it the world's IPO centre, ahead of London and New York. The regulator argues that there was overtrading during this period, with too many listings and not enough resources. Chinese textiles company Hontex is one example of a high-profile case where the SFC took action because it believed the company had false and misleading statements in its prospectus. In April 2012, the SFC took action against the sponsor, Mega Capital Asia, and fined it HK$42m ($5.42bn) over the prospectus. The SFC also took action against Hontex and in June the company agreed in court to repay its investors HK$1.03bn.

Hong Kong toughens up IPO rules

What do the banks say?

The response to the proposals has focused on criminal liability because, as one observer puts it, “nobody wants to go to jail”. There have been objections that sponsor banks should carry the burden of liability when there are other parties that can be responsible for false information in the prospectus. Others have been concerned about the powers of the SFC and whether it will in effect be acting as investigator, judge and jury and that the clampdown on sponsor banks will have repercussions for the IPO market in Hong Kong. Some observers have commented that the proposals, if implemented, will mean that banks will withdraw from sponsoring IPOs and will opt to underwrite them instead. 

What do regulators say?

The regulator is aiming to change behaviour in the market so that there is no need for any enforcement action. Ashley Alder, CEO of the SFC, says that there has been a culture where not enough attention has been paid to “kicking the tyres” of the companies listing, and there was a culture whereby sponsors submitted “half-baked” prospectuses that were amended later based on the SFC’s comments. Now the regulator wants to ensure that the full process is completed before the prospectus is submitted and the sponsors do more to ensure that they know about the companies that are listing. 

Mr Alder has said that criminal prosecution would only be pursued in the most serious cases where there are untrue statements in the prospectus about something significant, and has said “we are not on a mission to put bankers in jail”. Any criminal case would still have to be tried before independent judges, and it is unlikely that individuals would be prosecuted as the proposals focus on the liability of sponsor firms. 

What happens next?

The banking industry has worked on a collective response to the proposals, and had to submit its comments before the deadline in early July 2012. While no one is denying the value of improving the quality of listings in Hong Kong, there are a number of elements to the proposals that banks object to, especially those regarding criminal liability. The proposals would still have to go through the legislative process before they are implemented. 


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