Higher Profit Requirement for IPOs Will Hurt Hong Kong

Consultation responses suggest that HKEX’s proposal to raise the profit requirement for Main Board listing IPOs will drastically reduce its competitiveness.

Ten small and medium-sized sponsor firms have jointly opposed the HKEX (Hong Kong Exchanges and Clearing) consultation on increasing the profitability requirements for listing on the Main Board.

The consultation, issued in November, proposed to raise the profit requirement for companies seeking to list in Hong Kong from the current HKD 20 million to either HKD 50 million or HKD 60 million, to improve the quality of companies seeking to list in the city.

The profit requirement was introduced in 1994 and has not been changed since, though the market cap requirement for listed companies was raised from HKD 200 million to HKD 500 million in February 2018.

HKEX said that the increase in the market cap requirement without a corresponding increase in the profit requirement has led to an increase in listing applications from small cap issuers that only marginally met the profit requirement but had relatively high historical P/E ratios compared with their listed peers.

These small cap issuers typically justified their higher valuations by reference to potential growth, and as a result a number of them failed to meet their profit forecasts after listing, HKEX said, highlighting concerns about investor losses, harm to investor confidence, thin trading, low liquidity, and excessive market volatility post listing.

The consultation response, submitted by law firm Charltons, says that the HKEX proposal will result in Hong Kong having the highest profit requirement for listing compared to most major markets, reducing the city’s competitiveness and preventing many local and mainland SMEs from listing.

“By the HKEX’s own reckoning, the proposals would have prevented the listings of 59% or 65% of the companies which listed under the profit test between 2016 and 2019,” the response said. “This not only adversely affects these potential issuers, but also the local financial advisers, legal practices and accounting firms who act for them, as well as other businesses such as printers and translators.”

“The proposals are based on the premise that large companies are necessarily better, or pose less risk, than smaller companies, which the Group considers to be mistaken. It should also be remembered that today’s large cap companies were once small growth companies.”

Charltons also says that the proposed suggestion that the GEM market offers an alternative for SMEs is not practical, as listing on the GEM is currently “expensive and time-consuming”. Only 8 companies listed on the GEM in the 11 months to 30 November 2020, the law firm said.

The consultation response advocates a holistic review of the HKEX’s markets and the consideration of proposals to create a “diversified and inclusive market”. This should include an overhaul of the GEM’s listing process and procedures to make it an attractive SME board.

“Further, given the ongoing impact of COVID-19, this is not the time to increase the financial requirements for listing. Any review of the HKEX listing requirements should be delayed until Hong Kong’s economy has recovered to pre-pandemic levels.”

In a separate consultation response, former HKEX director (2003-2008) and activist investor David Webb says HKEX has a moral Universal Service Obligation to list any company that meets disclosure and governance requirements and is willing to bear the costs of being listed, given its statutory monopoly on the operation of a stock market in Hong Kong.

He also says a higher profit requirement will not necessarily raise corporate governance as HKEX intends, highlighting that loss-making biotech companies, as well as infrastructure and mineral exploration companies can list without a profit. “Why impose a cashflow [GEM] or profit requirement on everyone else?”

“If public equity investors wish to invest in a small, loss-making company that may one day be a big, profitable company or may simply go bust, who are you to stop them? It’s not like you don’t list riskier derivatives that expire worthless on a regular basis.”

Webb suggests HKEX scrap both the market cap and profit requirements and to merge the GEM with the Main Board into a unified board.

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