HKEX raises the bar on profit requirements

The regulatory body also plans to keep a watchful eye on IPO-related malpractices.

The Hong Kong Stock Exchange (HKEX) has pushed through with an increase in profit requirements for listing eligibility, which will impact small companies applying to be part of Hong Kong’s stock market.

Taking effect from 1 January 2022, the profit requirement for listing eligibility will be $80m, a 60% increase from the previous $50m. Initially, the HKEX had proposed a 100% increase to the profit requirement, but strong opposition from interest groups push back and settled eventually with the $80m minimum.

Additionally, the minimum amount of profit attributable to shareholders will be increased to $35m in the most recent financial year, from the previous $20m and $45m in aggregate over the two preceding financial years.

Any Main Board listing applications (including renewals of previously submitted applications or GEM transfer applications) submitted on or after 1 January 2022 will be assessed under the Revised Profit Requirement and the Revised Profit Spread. 

According to a paper by international law firm Linklaters, this has been the first increase to the profit requirement since it was introduced in 1994.

Since the increase in minimum market capitalisation requirement to $500m in 2018, HKEX noticed a surge in listing applications from small market capitalisation issuers that only managed to fulfil the Market Cap requirements with high historical price-to-earning ratios.

According to Linklaters, raising the profit requirements seeks to balance the interests of corporate stakeholders whilst also safeguarding investor’s interests.

The HKEX says it is prepared to grant relief based on the individual circumstances of each listing applicant, such as companies in early growth stages or those who have been severely affected by the pandemic. 

“It will be interesting to see whether the market will witness a big surge of small market cap IPO applicants rushing to file their applications before the implementation of the new profit requirement on 1 January 2022. We anticipate the regulators will monitor market developments and revisit the profit requirement as necessary,” Linklaters said

Targeting malpractices and investor fraud

The HKEX, together with the Securities and Futures Commission, also released a joint statement, sharing their conclusions to the Main Board Profit Requirement consultation paper. 

Both regulatory bodies said they had become aware of initial public offering malpractices from "ramp-and-dump" schemes, in which stock prices are artificially inflated through false and misleading statements. 

There have also been issues with the share placement and price discovery processes. A lack of transparency here had enabled allocations of IPO shares to controlled places that artificially satisfied the initial listing requirements. Further, the two regulators cited instances of unusually high underwriting commissions and listing expenses.

Concerns for malpractices will be addressed by Hong Kong regulators through a more stringent review of each IPO applicant’s estimated valuation to ascertain their actual ability to comply with the Market Cap requirements.

HKEX will also heighten scrutiny of a listing application where the regulators have reason to believe that the listing applicant has artificially inflated the offer price to meet the market capitalisation requirements. In such a case, the HKEX will exercise its discretion to reject a listing application if the regulators’ concerns are not satisfactorily addressed.

To address perceived allocations to controlled places, the SFC has proposed introducing a regulatory regime to apply greater scrutiny to book-building and placing activities.

The HKEX said that it will enhance its disciplinary power and range of sanctions to impose appropriate consequences when malpractice has been identified, with an emphasis on holding individuals accountable.