The Hong Kong Securities and Futures Commission (SFC) has announced new rules on the responsibilities and standards of conduct expected of capital market intermediaries (CMIs) involved in bookbuilding and placing activities in both equity and debt capital markets. The revised Code of Conduct for Persons Licensed or Registered with the SFC (Revised Code) setting out the new CMI rules comes into effect in August 2022.
The new SFC conduct requirements for capital market transactions in Hong Kong adopt all key consultation proposals including sponsor coupling, obligations of CMIs, no rebates to investor clients, and disclosure of identities of underlying investors.
In this Legal Update, we discuss some of the major changes brought about by the adoption of the Revised Code.
Capital Market Intermediaries (CMIs) and Overall Coordinators (OCs)
Under the Revised Code, CMIs and OCs are classified by reference to activities they carry out, rather than their respective titles in an offering. CMIs are intermediaries of a share offering (i.e. offering of shares listed, or to be listed, on the HKEx) or a debt offering (i.e. offering of debt securities listed or unlisted and offered in Hong Kong) who are involved in:
- collating investors' orders to facilitate pricing and allocation of securities (bookbuilding);
- marketing or distributing securities pursuant to the bookbuilding exercise (placing); or
- assisting issuer client / listing applicant in bookbuilding and placing.
CMIs acting as head of a syndicate responsible for the overall management of an offering, coordinating the bookbuilding or placing activities conducted by other CMIs, are designated as OCs. It is the view of the SFC that OCs, being overall-in-charge, are in the best position to advise the issuer and should be held accountable for (1) advising on the offer price while being a party to the price determination agreement with the issuer; and (2) making allocation recommendations.
- Appointment Specifications
Appointment of CMIs and OCs must be in writing with the issuer, specifying their roles, responsibilities, fee arrangements and the fee payment schedules. CMIs are required to be appointed before conducting any bookbuilding or placing activities; whereas OCs, in the case of an initial public offering (IPO), would have to be appointed no later than two weeks after the A1 submission.
- Syndicate Membership & Fee
The original proposal requiring OCs to provide advice to the issuers on syndicate membership and fee arrangements – or in the case of an IPO, the basis for the allocation of fixed and discretionary fees to syndicate CMIs – is now dropped. Under the Revised Code, an OC is instead required to provide guidance to the issuer on the market's practice on the ratio of fixed and discretionary fees to be paid to syndicate CMIs participating in an IPO; and to report the fee split ratio to the SFC. Though the current market's fee split ratio of 75:25 is not specified in the Revised Code, the SFC expects that the issuer should at least be informed of this market ratio – and the SFC would make enquiries where the agreed ratio significantly deviates from 75:25.
- No Rebates to Investor Clients
A CMI should not offer any rebates to investor clients or enable any investor client to pay at a price lower than that offered to other investors. While the practice of an issuer paying rebates to intermediaries as an incentive for their selling efforts is allowed, a CMI should not pass on any such rebates to investor clients and should properly disclose the details to the OC.
- Transparency of the Order Book
Under the Revised Code, OCs should take all reasonable steps to ensure that (1) the price discovery process is credible and transparent; (2) the order book has been properly managed, so that duplicate orders could be removed and irregular or unusual orders could be identified; and (3) allocation recommendations made to the issuer client, as well as the final allocation, have a proper basis. To ensure transparency and to properly manage the order book, CMIs and OCs are required to disclose in the order books identities of the underlying investor clients – and take reasonable steps to ensure all orders placed represent bona fide demand of its investor clients. For orders placed on omnibus basis, CMIs are required to provide names and unique identification numbers of investor clients to the OCs and the issuer. "X-orders" are prohibited.
- Conflicts of Interest
A CMI should establish and implement policies and procedures to manage any conflict of interest arising during the whole bookbuilding and placing process. In particular, it should give priority to investor clients' orders over its own proprietary orders and those of its group companies – and should maintain effective Chinese walls and wall-crossing policies and procedures. It is the view of the SFC that orders from syndicate members' trading desk or treasury functions should be treated as proprietary orders; whereas orders from syndicate members' asset management arms should be treated as client orders, provided that the orders are placed on an arm's length basis and effective Chinese wall controls are in place. A note is added in the Revised Code clarifying that "proprietary orders of a group company exclude orders placed by the group company on behalf of its investor clients or funds and portfolios under its management, but include orders placed on behalf of funds and portfolios in which a CMI or its group company has a substantial interest". 'Substantial' interest means more than 50 per cent interest.
- Keeping Records
OCs and CMIs should maintain books and records sufficient to demonstrate compliance with the Revised Code requirements. In particular, all changes made to the order book throughout the bookbuilding process should be documented. It is thus advisable that proper audit trails should be kept, from receipt, placing and modification of orders to final order allocation. Additionally, an OC is required to document all key discussions with, and key advice or recommendations provided to, the issuer. These records are required to be maintained for a period of not less than seven years.
- Communication with the SFC
An OC should report to the SFC any instances of non-compliance, or any material changes to the information previously provided. In the case of an IPO, the OC should provide to the SFC, by no later than four clear business days prior to the Listing Committee Hearing, (1) name of each OC; (2) allocation of fixed portion of fees paid by the issuer to each OC; and (3) total fees paid to all syndicate CMIs and the fee split ratio.
Sponsor Coupling means at least one sponsor (or one of its group company) is also appointed as an OC for the IPO.
As the SFC revealed, sponsor coupling is prevalent for IPO transactions on the Main Board but not so on the GEM. The "sponsor coupling" requirement would apply only to IPOs on the Main Board under the Revised Code.
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