Hong Kong Stock Exchange Consultation: Findings on Main Board Profit Requirement
On May 20, 2021, The Stock Exchange of Hong Kong Limited (the Bourse) published findings (Conclusions of consultations) to its consultation document of November 27, 2020 (the Consultation document). The consultation paper deals with the proposal to significantly increase the profit requirement for listing on the main board of the Bourse as part of the profit test of the main board of the Bourse, one of three financial tests allowing to ” establish eligibility for listing on the main board of the Stock Exchange (Main Board). The other two financial tests, namely the market capitalization / income test and the market capitalization / income / cash flow test, remain unchanged.
The main market concerns relate mainly to the impact of the consultation paper on the ability of small and medium enterprises (SMEs) and businesses in traditional industries to register in Hong Kong. After careful consideration of all comments, the Exchange has decided to:
- adopt a 60% increase in the profit requirement of the current total profit of HK $ 50 million for the immediate previous three years to HK $ 80 million (modified profit increase) and change the profit gap to 45 million HK $ for the first two financial years of the historical period and HK $ 35 million for the last financial year (revised profit gap);
- implement the Amended Profit Increase and Revised Profit Gap as of January 1, 2022; and
- provide flexibility by granting revised profit gap relief in specific circumstances.
This alert will review the stock market’s decision to increase the profit requirement, outline current market concerns about the move, and suggest a way forward.
Consultation on increasing profit requirement
Under Rule 8.05 (1) (a) of the Main Board Registration Rules, the current minimum amount of profit attributable to shareholders of a new nominee is HK $ 20 million for the most recent financial year and total of HK $ 30 million over the previous two financial years. years (Profit Requirement).
In the consultation document, the Exchange proposed to increase the required profit by 150% or 200%, and also sought market opinion on:
- whether there is another alternative requirement which should be taken into account for the increase in the profit requirement;
- whether the stock market should consider granting temporary relief from the profit gap from the increased profit requirement due to the difficult economic environment; and
- conditions for temporary relief.
The majority of respondents to the consultation paper did not support the amount of the proposed increase in the profit requirement or the urgency to implement such a proposal in 2021. The main concerns of the respondent included:
- the impact on the ability of SMEs and businesses in traditional industries to register in Hong Kong, and the potential negative effect on the Hong Kong economy if too many of these applicants are denied access to the capital market ;
- the Growth Enterprise Market (GEM) is not seen as a viable alternative to the Main Board as a listing venue. GEM registration and compliance (including quarterly reports) is expensive. In addition, the number of GEM quotes, as well as the level of liquidity and the volume of transactions, have also been reduced;
- the appropriateness of the timing of the change in light of current economic conditions;
- jeopardize the competitiveness of the stock exchange vis-à-vis other large foreign stock exchanges which have lower and less stringent profit requirements; and
- the increase in the profit requirement not being the right approach to solve the shell-making problem and the valuation problem, given that a strict and comprehensive regulatory regime after registration was already in place. square. The valuation problem arises from the increase in the market capitalization requirement in 2018, resulting in an unexpected increase in the number of listing applicants who marginally met the profit requirement and failed to meet the requirement for listing. market capitalization only with very high historical P / E ratios (compared to those of their listed peers) during their IPOs.
After careful consideration of respondent comments, in consultation with the Securities and Futures Commission, the Exchange decided to modify the proposal as follows:
Lower increase in profit requirement
The Exchange has decided to increase the required profit by 60 percent, resulting in an overall profit threshold of HK $ 80 million. It also decided to change the profit spread to a 56/44 percent allocation so that the minimum total profit required for the first two years of the historical period will be HK $ 45 million and that for the last year will be HK $ 35. million. This translates to an implied historical P / E ratio of around 14 times, which is in line with the average P / E ratio of the Hang Seng Index between 1994 and 2020.
The amended profit increase and revised profit spread will take effect on January 1, 2022. All lead board applications (including renewals of previously submitted applications or GEM transfer applications) submitted on or after January 1, 2022 will be assessed as part of the modified profit increase. .
All main draw applications submitted before January 1, 2022 will still be assessed against the current profit requirement. However, an enrollment applicant will not be permitted to withdraw an enrollment request that they submitted within six months of its expiration and resubmit the enrollment request shortly after the effective date of the modified profit increase, so that the listing application will be assessed in accordance with the current Profit Requirement for a longer period.
Flexible relief of the revised profit distribution
The Exchange has indicated that it is prepared to grant a temporary exemption from the revised profit gap, but will only do so on a case-by-case basis, provided the listing applicant complies with the modified profit increase. It will not take a tick-box approach and will not list a fixed set of conditions precedent. Factors that the Exchange has indicated it will take into account include, among others:
- the nature of the applicant’s business and the underlying reasons for their inability to meet the revised earnings gap (for example, companies in the growth phase and companies whose operations have been severely affected by the COVID-19 pandemic and the current economic downturn); and
- can inquire about how the price of the issuer’s IPO offer was determined with reference to the book building process.
Review of GEM Registration Rules
In response to market comments on GEM, the Exchange will also initiate a review of GEM’s listing rules and carefully consider the issues raised by respondents to the consultation paper, including comments regarding GEM’s positioning and GEM’s perception on the market. If this review concludes that changes to the GEM listing rules are necessary, the Exchange will issue a consultation paper soliciting market comment on the appropriate reforms.
To take away
New or already submitted Main Board applications, as well as GEM transfer applications should take note of these newly published consultation findings, as the increased profit requirement will have a direct impact on success. of their registration requests.
If you would like to discuss anything in or related to this alert, please contact members of our Hong Kong Capital Markets team.