Hong Kong analyst disclosure regulations need clarity

Author: Ashley Lee | Published: 19 Feb 2014
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  • Analysts working at underwriting banks are permitted to write research reports on IPOs.
  • But Hong Kong’s sponsor regulations and Due Diligence Guidelines include confusing provisions on analysts receiving material information;
  • A lawyer has set out a proposal for improving uncertainty related to analyst reports in HK IPOs.

Hong Kong’s sponsor regulations have caused increased concern over pre-deal reports by underwriting banks’ analysts.

Analysts working for a bank underwriting a Hong Kong IPO can cover the company via pre-deal research reports – a practice that’s banned in the US. While there has been some scrutiny over these analyst reports, new guidelines in the sponsor regulations might need further clarification.

Although analysts at a bank underwriting an IPO cannot give recommendations or pricing targets for the client, they are seen as an important marketing tool for the offering; one of the key aspects issuers consider when choosing underwriters is the bank’s analyst capabilities.

"When the law firms review pre-deal research, they typically ask the analyst not to include any factual information that isn’t in the prospectus," said David Neuville of Cadwalader Wickersham & Taft. "But that’s not what the standard calls for, as the analyst could use information that is not material."

Analysts and their employers don’t always accept these comments, and take a more pragmatic view, he added.

Material information

The SFC implemented a regulatory framework on pre-deal research in 2011. But requirements were expanded under Chapter 30 of the Sponsor Due Diligence Guidelines, which states that a sponsor should take reasonable steps to ensure that all material information concerning a listing application disclosed or provided to analysts is contained in the relevant listing document.

This is because the SFC has been concerned about the so-called equality of information flow. It also prohibits pre-deal research reports from being used by the listing applicant as a way to distribute material information without prospectus liability.

This is redundant though, because the sponsor regulations stipulate that all material information must be in the prospectus.

"There is no need to prohibit giving material information to analysts if that information is not in the prospectus, because regardless of whether the analyst gets it, it needs to be in the prospectus," Neuville said in a client note.

Neuville added that the market might be reading the concept of materiality too narrowly. Instead, information that is not to be given to analysts if not in the prospectus actually falls somewhere between 'material’ and 'substantive.’

That substantive information is essential for the analyst to provide the scrutiny needed to market the IPO. There’s no legal basis for denying analysts factual information that is not material, and, so far there has been no action from the regulator.

"We haven’t seen any litigation related to analyst reports in Hong Kong and I’m not aware that the regulators have taken any position with respect to a particular case," Neuville said.

However, he commented, there are a great deal of opinions in the marketplace.

Time for change?

Neuville’s note included four proposals to clarify the regulatory regime in this area. One was to restore the previous regime, in which analysts could seek information on the basis that all information not included in the prospectus is not material. But that seems unlikely.

Other suggestions were to establish processes for the provision of information to analysts; to make pre-deal research publicly available in Hong Kong or follow the US model by banning pre-deal research completely.

He predicted that the second option – to focus on the provision of information – was workable for the Hong Kong market. That would involve requiring issuers to keep records of all written information provided to research analysts, and ensure that copies of that information were also given to the parties involved in preparing the prospectus.

"Nine times out of ten, it’s likely that particular information given to the analyst isn’t material, but having a record of providing that information to the working group shows that they received the information and decided not to include it in the prospectus," he added.

This proposal would be line with requirements under the Due Diligence Guidelines, which require that sponsors consider appropriate steps to exercise reasonable control over and understand the content of information from the listing applicant to research analysts. A similar suggestion within the guidelines is that all information provided to research analysts must be passed through the applicant’s lawyers.

However keeping records of information sent to analysts would add yet another process to the already-onerous Hong Kong IPO process. Under the sponsor regulations, they now require underwriting banks to track transaction teams, due diligence matters and other issues that arise in the course of a listing.

Neuville tried to account for this under the information-based regime. In formulating the proposal, he added, he tried very carefully to ensure that information provided to research analysts in writing – if not the substance of every oral conversation – needs to also go to the banks and law firms doing the diligence.

Further reading

HK SFC’s IPO sponsor regulations: clarifications needed

Why small firms suffer under SFC sponsor rules

Lawyers opposed to public A1 filings