HK SFC's IPO sponsor regulation conclusions: clarifications needed

Author: Ashley Lee | Published: 14 Dec 2012
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Hong Kong's Securities and Futures Commission's (SFC) highly-anticipated conclusions to its consultation paper on sponsor regulations provided details on controversial issues such as sponsors' criminal liability and public disclosure of A1 filings.

But the reactions from the market were muted, as most had expected the conclusions to contain many of the same provisions as the consultation paper.

In an interview with SFC CEO Ashley Alder earlier this month, Alder said that initial public offering (IPO) sponsors are critical gatekeepers of listing quality. Counsel agree that Hong Kong lacks a process to protect investors analogous to the class-action system in the US, the sponsor role becomes even more integral to maintaining the integrity of the markets, as does the SFC’s enforcement mandate.

However market participants agree that key elements of the sponsor regulations require clarification. The following points have generated the most questions.

The public A1 filing

Although other aspects of the sponsor regulations, such as potential criminal liability for sponsors, have garnered more press attention, lawyers have been paying close attention to provisions for public A1 filings.

Counsel have been opposed to making the A1 listing application public because it will completely change the IPO process for all parties involved.

Moreover it could invite premature public scrutiny. A comment letter by Davis Polk & Wardwell and Clifford Chance representing the views of 23 banks said that it could prove counterproductive, especially if the A1 filing includes stub financials or is missing other information that will be updated in the final prospectus.

Another comment letter by Linklaters, representing the views of five Chinese banks, agreed. It said that public disclosure of A1 draft filings could confuse investors: “We are in an era of information overload.”

In the consultation paper, the SFC did not describe the process for a public A1 filing in detail, and that it may be worked out later between market participants and the SFC.

A lawyer commented that the SFC might just require the first A1 filing draft to be public, with nothing in between that and the final prospectus.

“That’s very different from the US process,” he added. “The importance of a public filing system is to make the IPO process very transparent, and investors should be able to see how the application progresses: what changes have been made, what questions regulations have asked and how the applicant has responded.”

Although the process hasn’t yet been set out, it is important to note that the A1 public filing dovetails from practices in Singapore and Australia. While initial public filing was previously considered the standard position in the US, the JOBS Act allows emerging growth companies to file IPO registration statements to the SEC on a confidential basis.

Criminal liability

The criminal liability provisions in the sponsor regulations have received the most press attention. However counsel stress that the rules are not yet concrete.

The counsel commented that there’s been some confusion in the press regarding criminal liability. “Some are reporting it as if it’s a done deal, but the SFC’s press release mentioned that there would be a separate legislative process. We’ll waiting to see how that will play out,” he added.

Most are waiting to see how the bill passes through Hong Kong’s Legislative Council, especially whether there will be any changes made during the lobbying process.

Sponsor appointment periods and fees But the conclusions included a few new provisions that haven’t previously been mentioned in the consultation paper. Counsel largely welcomed with the minimum sponsor appointment period, set at two months before an A1 filing. A lawyer said that the pre-IPO period has become quite frenzied with anywhere from 12 to 17 banks working on a deal. The sheer volume of banks has led to tensions in the market, as competition between sponsors is intense. As issuers lure cornerstone investors, a lot of underwriters may squeeze in before an application is made or before a deal launches.

“That obviously means more banks sharing the fee pie, and may erode quality because issuers understand they can play one sponsor against each other,” he said. “Logistically, I don’t know how this will work, but it’s a well-intended suggestion.” The new sponsor fee provisions in revised paragraph 17 require that issuers specify the terms of the sponsor fee. The "no deal; no fee" arrangement that has become the status quo will no longer be permitted.

Moreover, in the SFC's executive summary of its conclusions, it says: "We consider that sponsor fees should appropriately reflect the role and responsibilities to be discharged by a sponsor and should not be confused with other services... The sponsor fee should not be contingent on the success or final size of the offering and any staged payments should be proportional to the work done on that stage."

But an in-house counsel questioned how the SFC will enforce fair sponsor fees. Common queries are whether the regulator will intervene if it seems that a bank is undercharging for sponsor work, and how fees for multiple sponsors will be determined.

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