On 20 May 2021, the Securities and Futures Commission (SFC) and the Stock Exchange of Hong Kong Limited (HKEX) issued their joint statement on IPO-related misconduct1 setting out issues detected in recent new listings and the regulators’ proposed approach to dealing with them. These issues mainly involve arrangements to artificially satisfy the initial listing requirements under the HKEX’s Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong (HKEX Listing Rules) or facilitate market manipulation of the shares after the initial public offerings (IPOs).
Simultaneously with the joint statement, the HKEX published its Consultation Conclusions on the Main Board Profit Requirement2 setting out its decision to increase the amount of profit required of new listing applicants by 60% to HK$80 million over three financial years (with profit of HK$35 million in the most recent year and an aggregate of HK$45 million for the two preceding years) from 1 January 2022. The increase in the profit requirement is aimed at combatting misconduct observed by the regulators following the 2018 increase in the market capitalisation requirement for profit test listing applicants to HK$500 million. For listing applicants which only just met the minimum thresholds, the 2018 increase effectively increased their implied historical price-to-earnings (P/E) ratio from 10 to 25. According to the HKEX, this led to a surge in the number of listing applicants which only just met the profit threshold and only satisfied the market capitalisation requirement with very high historical P/E ratios. These listing applicants typically justified their high valuations by reference to potential growth which they supported with profit forecasts, but many of them failed to meet their profit forecasts and/or experienced falls in their share prices and market capitalisation post-listing. This gave rise to concerns on the part of the regulators that listing applicants’ valuations were artificially inflated to meet the market capitalisation requirement. Please see Charltons’ newsletter “HKEX to Raise Main Board Profit Requirement from 1 January 2022”3 for further details.