HK misses a chance to reform

The Hong Kong Securities and Futures Commission (SFC) published its conclusions on reforms to the regulation of sponsors of Hong Kong IPOs recently. These implement changes to the Hong Kong sponsor regime, touching nearly all aspects of the sponsor role. Most controversially, this includes the due diligence process sponsors conduct and the liability they face.

On the face of it, the conclusions overhaul the Hong Kong sponsor due diligence regime by adding extensive prescriptions with respect to the already detailed process.

Such measures may do little to address perceived lapses in adequate sponsor work to improve market confidence. Indeed, the due diligence processes will be familiar to the many investment banks already accustomed to conducting international capital markets due diligence and will likely require little change to the robust practices at those sponsor firms.

Instead, the conclusions introduce the spectre of criminal liability (and also clarify the existence of civil liability) for all sponsor firms to address limited instances of inadequate sponsor work. However, they fail to address directly the most serious concerns facing the Hong Kong equity capital markets.

More so than any other market, the fate of Hong Kong markets is linked to investor confidence in Chinese issuers, and this has been shaken by a string of accounting scandals involving listed Chinese companies in a number of jurisdictions, including Hong Kong. However, it is not clear that the Hong Kong regulatory environment is any less effective in allowing enforcement against fraudulent Chinese issuers than others.

In fact, while the US Securities and Exchange Commission grapples with the Chinese government to gain access to records that may help it prosecute accounting fraud by Chinese issuers, as recently as last April the SFC fined Mega Capital and revoked its sponsor licence for failing to discharge its duties in relation to the listing of Hontex.

By focusing on sponsors the conclusions seem to ignore the reality that liability for fraud, in any form, needs to rest with those who perpetrate it. In the context of a capital markets transaction, responsibility for the prospectus must reside with the company and its management.

Thus, the Hong Kong market would have been better served had the proposals focused on working with Chinese regulators to establish a cross-border enforcement framework that facilitates enforcement against management and shareholders that defraud investors rather than over-regulate the institutions critical to its success. Indeed, China has much to gain by helping to restore Hong Kong to its place as the world’s leading IPO market.

No doubt the competitive pressures and extraordinary boom cycles that characterise Asian capital markets have led to instances of sponsor failure and the conclusions provide some helpful remedial provisions to enable sponsors to respond to these pressures and fulfil their obligations.

As a whole, however, they are likely to do little to address the real issues facing Hong Kong.