Hong Kong’s stock market experienced a roller coaster ride in the year 2011 triggered by a set of unsettling events that dampened market sentiment: The drying up of corporate liquidity in China’s entrepreneurial hub Wenzhou followed by the bankruptcy filing of MF Global, and the worsening of the euro zone crisis.
“The Hong Kong market experienced its best performance in 10 years during the first half of 2011. But the IPO market took a U-turn in the second half of the year mainly because of the exacerbation of the Greek debt crisis, and the downgrading of the U.S. credit rating,” says Edward Au, national co-leader of the Public Offering Group at Deloitte China, which represented issuers who raised about half of the total funds in 2011.
In the first six months of 2011, Hong Kong saw 38 new listings and raised HK$187.2 billion ($24.15 billion), a stellar record compared to 27 new listings and HK$50.3 billion ($6.49 billion) that was raised in the same period in 2010.
Nonetheless, taking the year 2011 as a whole, Hong Kong recorded 90 new listings, a dip of 12 percent from the previous year. Total fund raised amounted to HK$271.4 billion ($35.02 billion), a drop of 40 percent from 2010.
IPOs take two; M&As to surge
With this bleak prospect, smaller deals will be tabled due to lower valuation and the deal flow will resume once the market stabilises, probably in the second half of 2012, says Au.
Against such a backdrop, reworking clients’ IPO plans has become a common theme for many law firms. “While many clients have delayed their IPO plans till 2012, some may consider other options such as private equity sponsorships to raise funds,” says Wang Yi, Shanghai-based partner at Jun He Law Offices, whose firm is advising on 30 to 40 IPOs, all of which are in the pipeline.
For those candidates determined to go ahead, Wang says their shareholders may demand them to reduce the size of their financing.
Market caution was apparent since 75 percent of the IPOs that were pushed forward in 2011 were priced below the midpoint of the indicative range. Many of the listings that were relaunched last year were often substantially slashed; the heaviest reduction being from the China Hongqiao Group which was down 63 percent from its original $2.2 billion offering.
Under heightened compliance demands, legal advisors can serve the increasingly important role of gatekeepers. “IPO candidates can benefit from the pre IPO preparatory work provided by legal counsels to identify any legal and compliance issues. This will give them ample time to fix all these defects to ensure a smooth and swift listing process in the future. It will also help them get hold of the best IPO window,” says Deloitte’s Au.
Looking ahead, Deloitte China estimates that about 100 companies are expected to list at the Hong Kong bourse in 2012 to raise proceeds totalling about HK$230 billion ($29.68 billion). Among them, about 40 were IPOs planned in 2011 that were shelved because of market uncertainties.
Since stocks are traded at a discount in the down cycle, many public companies could become attractive targets, says Edmond Chan, a capital markets partner at PwC’s Hong Kong office.
Experts foresee more mergers and acquisitions in the coming year, particularly in China’s competitive solar sector, which has seen many players rushing for listings in recent years. “We are going to see market consolidation, and smaller companies will seek mergers in order to survive,” says Jun He’s Wang.
Besides, tapping the debt market is also a viable option. “We believe some companies will go for debt issuance at this volatile time to bridge their financing needs, so that shareholders’ interest does not get diluted significantly,” says Deloitte’s Au.
Key trends and challenges in 2012
Experts cite the following key trends to watch out for in 2012: The launch of RMB-denominated IPOs, more international listings in Hong Kong by way of secondary listings or introduction, more mainland enterprises tapping Hong Kong’s market to go global, and the Hong Kong bourse vying to become an international capital market for mining and natural resources enterprises.
The state of Hong Kong’s equity market will also hinge on the unfolding of the euro zone crisis, the quantum of China’s monetary easing policy, the elections and administrative changes in key countries, and aggressive competition from other bourses.
Hot sectors to watch out for
Mainland companies will continue to form the core of new listings as many Chinese enterprises are seeking funds to fuel expansions, and strive for better market share.
In particular, many firms reported having candidates from retail and consumers sectors in their pipeline who are eager to gain access to China, the world’s second largest luxury consumer market.
Energy and resources issuers from abroad are also keen to leverage their listing status in Hong Kong to tap into China, the world’s largest commodities importer, where vast urbanisation is underway.
The Hong Kong bourse too has responded with a rule change. “The new Chapter 18 was a very timely piece of legislation, and coincided well with the funding cycle of a lot of major international mining and resources companies,” says Bonnie Chan, the Hong Kong-based partner of Davis Polk & Wardwell, who was formerly the senior vice-president of HKEx’s listing division.
China’s lenders and financial institutions are also eager to raise funds in Hong Kong since Basel III compliance will require banks to meet higher capital and liquidity requirements, and they can spur on growth through the relaxation of the QFII and RQFII quotas. “After China’s four big state-owned banks were listed in Hong Kong, the next wave to watch out for will be banks at the provincial and city levels,” says PwC’s Chan, adding that China’s insurers, brokerage and securities companies are next in line.
Business strategies
To weather the storm in this unstable market, some firms believe building a diverse practice is vital.
“Despite current market volatility, we do not see substantial reduction in our activity level,” says James Lin, Hong Kong-based partner of Davis Polk’s Corporate Department. “We have a very healthy pipeline, and we maintain a good balance among different products such as Hong Kong IPOs, SEC-registered IPOs, high-yield and investment grade debt offerings, M&A and private equity work,” says Lin, while noting that his firm has leveraged its global network in 10 cities for listing referrals.
“In terms of a Hong Kong IPO, we are focused on maintaining a good balance between issuer vs. underwriter representation, China v non-China issuers, and state-owned v private enterprises to improve our resilience,” says Lin.
Davis Polk’s strategy is “to grow in a client demand-driven manner,” says Lin. “We are more or less evenly split between issuer and underwriters representation. We aim to maintain a diverse portfolio in terms of industries, but we are generally considered to have extremely strong credentials in the FIG sector. For instance, we have worked on landmark IPOs for issuers including the Agricultural Bank of China, the Industrial and Commercial Bank of China, the China Construction Bank, the China Merchants Bank and New China Life.”
“We have lots of deals in the pipeline, all waiting for the right window,” adds Chan from Davis Polk, who is expecting “quite an active” first quarter if market conditions permit.
Chan’s team is currently advising many candidates from the retail, mining and resources sector with about one- third of non-Chinese, and a few EMEA issuers in the pipeline.
For other firms, emphasis on quality over quantity has become a smart way to grow their businesses.
Wayne Chen, partner at Llinks Law Offices in Shanghai, says his firm has been “very selective” when it comes to taking on new assignments. “Our partners will conduct an internal review before accepting engagements. Usually, we do not have a long deals pipeline. Instead, we had many ‘qualified’ pipeline deals totalling about 30 in 2011,” he explains.
Out of those 30, Llinks advised on a total of 13 IPOs last year, with three issuers floated at Hong Kong and Taiwan bourses, and 10 at the mainland exchanges.
“Our strategy is to continue to be an expert by providing high quality services, and be selective towards new assignments even at the risk of missing out on some opportunities which could increase our revenue at a quicker pace ,” says Chen, whose firm focuses more on fees per fee earner than on gross revenue.
Thanks to this prudent approach, Llinks’ revenue has increased by 30 percent annually in the past three years, and the firm now plans to expand its capital market team.
Llinks also bolsters its IPO client base by exploring new markets such as Taiwan, enhancing efficiency of IPO reviews, participating in more promotional activities worldwide, retaining clients, and strengthening collaborations with brokers, accounting firms, and appraisal firms.
Bringing PRC issuers to list in Hong Kong requires Hong Kong and PRC law advisory. Therefore, it comes as no surprise that Beijing-headquartered Zhonglun W&D Law Firm sealed a PRC Ministry of Justice’s approved association with Hong Kong firm P.C. Woo & Co in April 2011.
The partnership is one of the few pairings anointed by PRC authorities under China's Closer Economic Partnership Arrangement (CEPA) with Hong Kong.
Lin Wei, managing partner of Zhonglun W&D’s Shanghai office, says the strategic move aims to provide PRC clients a “one-stop service” for listings in Hong Kong.
“We have streamlined our operations and become more efficient. We can now reduce the fees by as much as 20 percent, and this makes us more competitive,” explains Lin, whose firm is letting P.C. Woo share the resources of its existing offices in China and abroad. The two firms are also actively promoting cross training and client referrals.
Underwriters of the Hong Kong IPOs tend to dictate the choice of PRC firms. So having a designated Hong Kong firm on its side gives Zhonglun W&D more autonomy, and allows it to proactively seek PRC issuers interested in listings across the border, Lin points out.
Besides, partnering with a leading Hong Kong firm in the capital market offers quality assurance to the transactions: P.C. Woo’s senior partner Moses Cheng currently serves as a director on the board of HKEx and has extensive experience in IPO matters.
More foreign issuers to come
With relatively high liquidity and backed by China’s strong growth, HKEx has continued to attract headline-grabbing listings of foreign issuers of the likes of AIA, L’Occitane and Samsonite since 2010.
In the past year, seven international companies were floated at HKEx, including Glencore International’s mega dual listings in Hong Kong and London to raise HK$77.7 billion ($10.3 billion). The bourse has also welcomed the first listings of companies from Japan, Italy and the U.S. The companies are SBI Holdings, Prada, and Coach Inc. respectively.
Many of these foreign issuers have listed at HKEx via Hong Kong depositary receipts (HDRs) in “listings by introduction” in which no capital is raised. The issuer remains poised for future fund raisings and the listing can also be a valuable marketing tool to raise their brand awareness among Asian investors.
Having acted on three HDRs issued by companies such as Brazilian mining giant Vale SA, SBI and Coach last year, Neil Torpey, Paul Hastings’ Hong Kong-based chair and partner, says his firm is fielding many inquiries from overseas clients who are interested in following suit.
Another developing trend, Torpey says, is Asia-based U.S.-listed companies looking to return their listing and trading activity to Hong Kong without undertaking a costly, potentially controversial “take private” transaction in the U.S. “The managements of these companies often consider getting a secondary listing in Hong Kong, and then gradually migrating the trading of their shares (from their primary listing exchange) to Hong Kong,” he explains.
One of the much talked about offerings is the debut of Coach’s HDRs in December 2011. It paved the way for other U.S. companies who are keen on tapping into China’s vast consumer market via Hong Kong. The landmark rollout of the American handbag retailer’s HDRs cleared many regulatory hurdles as it went ahead without the need to register the securities with the SEC.
Coach was advised by Fried Frank, and Paul Hastings served as the counsel for its sponsor J.P. Morgan in this transaction.
Valerie Ford Jacob, chairperson and capital markets group head of Fried Frank, says her team has to meet complicated compliance and listing rules at HKEx, the New York Stock Exchange, and the SEC. In particular, the firm has to reconcile to conflicting rules such as differences in takeover codes and timing of filings which it follows up by matching all issue statements at various bourses.
With a test case in view, the market anticipates more international companies to list at the Hong Kong exchange by introduction since the stock market is likely to be choppy in 2012.
The eastward bound ambition of U.S. companies plays to the strength of Fried Frank, one of the earliest firms in Hong Kong with an integrated U.S. and Hong Kong law practice. The firm’s positive outlook for deal flow in 2012 is evident in its recent additions of three M&A partners Douglas Freeman, Victor Chen and Carolyn Sng at its Hong Kong office.
As more foreign issuers poise themselves to list in Hong Kong, industry players are calling for the bourse to standardise and simplify its listing rules pertaining to dual primary listings, or secondary listing of non-PRC overseas companies in Hong Kong.
“Currently, the secondary listing process in Hong Kong and requirements are as comprehensive as those in primary listing, although waiver for strict compliance of certain rules may be granted by HKEx on a case-by-case basis,” says Au.
RMB equity in Hong Kong?
With mainland issuers constituting more than half of HKEx’s market cap, the Hong Kong bourse has kicked off initiatives to facilitate trading in yuan, and foster closer ties with mainland exchanges.
One of the new measures will be the creation of a Hong Kong stocks exchange trade fund (ETF) to be listed on the mainland bourse.
“If they are allowed to trade overseas stocks through an organized scheme, listed companies in Hong Kong are likely to be the biggest beneficiaries. With the increase in liquidity and turnover, market rerating is likely to happen in Hong Kong,” says Deloitte’s Au.
Besides, HKEx has been testing the exchange participants’ readiness to trade, and clear RMB products since March 2011. The floatation of the first RMB real estate investment trust (REIT), Hui Xian REIT, in April 2011 was a case in point.
The bourse has also introduced the “Single Tranche, Single Model” and “Dual Tranche, Dual Model” of RMB equity issuance in June 2011. The latter allows the same issuer to offer, and initially list a tranche of yuan-traded shares and a tranche of Hong Kong dollar-traded shares.
Subsequently, HKEx rolled out the RMB Equity Trading Support Facility to enable secondary trading of RMB-denominated equities in October 2011.
Although Hong Kong is yet to see a yuan-denominated stock, the market anticipates the first one will be available soon.
“We believe HKEx is ready on the trading and issuance of RMB equity. It’s the weak market sentiment that is slowing all equity issuance, including the potential first RMB equity, substantially,” says Au, noting that Hong Kong needs to maintain a sufficient pool of yuan.
Industry experts also welcome recent new rules and clarifications on RMB foreign direct investment which have alleviated the repatriation of yuan raised offshore back to China for business expansion.
The RMB Qualified Foreign Institutional Investors (RQFII) rules, announced in December, has green lighted Hong Kong’s offshore yuan to invest in mainland equity market at a cap of RMB $20 billion ($3.17 billion).
“We expect to see more companies issue RMB-denominated bonds or shares in Hong Kong to avoid the risk of exchange rate fluctuations, and save exchange costs for their investment on the mainland,” says Au, considering that the cost of borrowing in RMB bonds is cheaper than in U.S. dollar bonds.
To realize RMB IPOs in Hong Kong, Davis Polk’s Chan believes the challenges and opportunities lie in matching available RMB funds with RMB investment opportunities. “We have already seen the RMB bond market growing at a very impressive pace, whereas RMB equity products still remain scant.”
In the backdrop of these developments, PRC firms are gearing up for yuan equity advisory work. Llinks’ founding partner David Yu says: “This is going to be advantageous for both PRC companies and PRC legal counsels like us. We have done some research to ensure that we will be able to instantly provide legal support to clients in need.”
Many more are upbeat about closer ties between Hong Kong and China’s equity markets.
“We believe the continued internationalisation of RMB will help boost the status of Hong Kong’s capital market. Hong Kong should continue to develop its RMB market capability as well as measures to facilitate the mainland market connectivity. This will help create a larger market,” says Deloitte’s Au.
Key HKEx rules changes
By Edward Au, national co-leader of Public Offering Group at Deloitte China
One of the key listing decisions issued in October 2011 effectively requires additional information to be disclosed in prospectus, if the offering only occurs subsequent to the year-end of the company.
For instance, if the offering only occurs in March 2012, the company’s financial information for FY 2011 and related commentary on results needs to be included. So the requirement has put another layer of uncertainty on when the additional full-year financial information of the candidate will be ready for re-vetting, given there are always the Chinese New Year holidays in between.
HKEx has updated its listing rules effective Jan. 1, 2012 to simplify the property valuation disclosure requirements. As such, inter alia, no further valuation report is required if the property interest of the issuer’s non-property activities is less than 15 percent of its total assets. This will reduce the cumbersome valuation and disclosure process for certain non-properties issuers, and it is well received by the market.
Besides, HKEx has approved 18 jurisdictions for listing applications with recent additions including Guernsey, Canada’s Alberta, France and Italy. The list is likely to be expanded with countries mainly from Europe, and possibly, the Middle East. ALB