On 17 December 2020, Julia Charlton presented a webinar on The HKEX profit requirement proposals – consultation on the Main Board profit requirement, providing a detailed overview of the HKEX’s consultation paper on the Main Board profit requirement issued on 27 November 2020 with analysis of the proposals and consideration of the impact of increasing the HKEX’s Main Board profit requirement to be one of the most stringent eligibility tests among the world’s major international stock exchanges.
THE HKEX PROFIT REQUIREMENT PROPOSALS – HKEX CONSULTATION ON THE MAIN BOARD PROFIT REQUIREMENT
LISTING RULES
Ch. 8 – qualification for listing
Chapter 8 of the HKEX Listing Rules sets out the minimum requirements that a listing applicant must meet to be considered eligible for listing on the Main Board of the HKEX
the Profits Test
the Market Capitalisation/Revenue/Cash Flow Test
the Market Capitalisation/Revenue Test
The Current Main board Financial Tests
Profit Test
Market Cap / Revenue / Cash flow Test
Market Cap / Revenue Test
Profit attributable to shareholders
Profits of HK$50 million in the last 3 financial years with HK$20 million in the most recent year and an aggregate of HK$30 million in the 2 preceding years
–
–
Market Cap
HK$500 million
HK$2 billion at listing
HK$4 billion at listing
Revenue
–
At least HK$500 million for the most recent financial year
At least HK$500 million for the most recent financial year
Cash Flow
–
Positive cash flow from operating activities of at least Hk$100 million in aggregate for the 3 preceding financial years
The Proposed Changes to the HKEX Profit Requirement (Proposed Changes)
Current HKEX Profit Requirement
Option 1
Option 2
Percentage increase
150%
200%
Aggregate profits attributable to shareholders for financial years one and two
HK$30 million
HK$75 million
HK$90 million
Aggregate profits attributable to shareholders for the last financial year
HK$20 million
HK$50 million
HK$60 million
Total
HK$50 million
HK$125 million
HK$150 million
The Proposed Changes to the HKEX Profit Requirement
misalignment between the current Profit Requirement and the increased market capitalisation requirement
regulatory concerns in relation to the increase in the number of Small Cap Issuers (companies with a market cap of ≤ HK$700 mln) marginally meeting the current Profit Requirement
aim to enhance the distinction between the Main Board and GEM
there are no other regulatory concerns in relation to the profits test under Listing Rule 8.05
Temporary Conditional Relief Conditions
aggregate profit threshold of HK$125 million under Option 1 or HK$150 million under Option 2
positive cash flow in the ordinary and usual course of business
the conditions and circumstances affecting the listing applicant’s ability to meet the Profit Requirement are temporary
at least six consecutive months of the track record period must fall within the 2020 calendar year
additional listing document disclosures are required including a profit forecast
Transitional Arrangements
1 February 2021 – Responses to the consultation paper to be submitted before 1 February 2021
1 July 2021 – The earliest date that the Proposed Changes will take effect
Transitional Arrangements
transitional period to ensure that there is little disruption to companies who have already commenced their plans to list
companies who had started their listing preparations as at 27 November 2020 will have sufficient time to file their applications before the implementation date
Main Board listing applicants and eligible GEM transfer applicants who submit their respective applications before the implementation date will be assessed according to the current Profit Requirement
in certain circumstances, GEM transfer applications will be assessed under the current Profit Requirement
Rationale for the Proposed Changes
Why the Proposed Changes?
the current Profit Requirement has remained unchanged since 1994
the market capitalisation requirement was increased in February 2018 from HK$200 million to HK$500 million
since the increase in the market capitalisation requirement, there has been a significant increase in applications from listing applicants who only marginally met the Profit Requirement
Rationale for the Proposed Changes
82% – between 2016 and 2019, 82% of Main Board listing applicants relied on the profit test
51% – of the 82% Profit Requirement applicants 51% were Small Cap Issuers
The Small Cap Issuers who only marginally met the HKEX Profit Requirement had a relatively high historical P/E Ratio as compared to those of their listed peers
Previous Consultations on Profit / Market Cap Requirements
2002 Consultation
Retained current Profit Requirement
On par with other leading markets
Proposal to use pre-tax profits was not adopted despite support
June 2017 Consultation
Retained current Profit Requirement which was supported by 56% of respondents
13% of respondents favoured increasing the Profit Requirement if the market cap requirement was raised
Market cap requirement was increased from HK$200 million to HK$500 million (supported by 50% of respondents and opposed by 30%)
Rational for the Proposed Changes
Historically High Operations
the Small Cap Issuers justified their higher valuations by reference to potential growth. However, many failed to meet their profit forecasts post-listing
this called into question the reasonableness of their valuations
Listed Shell Creation
HKEX’s concern that Small Cap Issuers are engaged in creation of listed shells
inflated company valuations raise concern of whether or not the IPO offer prices genuinely reflect the expected market clearing prices
HKEX claims the price discovery process may have been compromised by rebates being offered to investors to entice them to purchase shares
the HKEX suspects abusive behaviour – the manufacturing of a shareholder base
These practices go against one of the fundamental principles of the HKEX Listing Rules – that the issue and marketing of securities should be conducted in a fair and orderly manner
Jurisdictional Comparison
The Consultation Paper compares HKEX’s Main Board financial tests with those of 6 overseas main markets
the Australian Securities Exchange
the London Stock Exchange (the Premium Segment of its Main Market)
the NASDAQ (Global Select Market) (NASDAQ)
the New York Stock Exchange (NYSE)
the Shanghai Stock Exchange (Main Board)
the Singapore Stock Exchange (Main Board)
HKEX LISTING RULE 8.05 – HKEX PROFIT REQUIREMENT
HKEX Profit Requirement
the current HKEX Profit Requirement is lower than both the NYSE and the NASDAQ
the profits test requirement in Chapter 8 of the HKEX Listing Rules is based on profit attributable to shareholders
HKEX Listing Rule 8.05(1) requires that a listing applicant when calculating profit attributable to shareholders must exclude any contribution from any associated companies and other entities whose results are recorded in the listing applicant’s financial statements usi g the quity method of accounting
NYSE AND NASDAQ EARNINGS REQUIREMENTS
the NYSE and the NASDAQ earnings requirement is based on the listing applicant’s pre-tax earnings
neither the NYSE nor the NASDAQ require the exclusion of associated companies’ profits
HKEX
the Profit Requirement is tied to a market capitalisation requirement and a listing applicant relying on the profit test under Listing Rule 8.05(1) must satisfy the Profit Requirement and a market capitalisation requirement
NYSE and NASDAQ
the NYSE and the NASDAQ’s earnings test is a standalone test
HKEX LISTING RULE 8.05 – HKEX PROFIT REQUIREMENT
if the HKEX Profit Requirement is increased as proposed, HKEX’s Main Board will have the highest 3-year aggregate profit requirement of the 6 overseas markets reviewed
the HKEX is of the view that the increased Profit Requirement will address the regulatory concerns the Hong Kong market is currently facing
current regulatory concerns include the implied historical P/E ratios and the quality of companies listing on the Main Board
ANALYSIS OF THE PROPOSED CHANGES
of the HKEX Profit Requirement Applicants between 2016 and 2019, Option 1 and 2 would have resulted in 59% (437) and 65% (486) of the applicants being ineligible for listing, respectively
under Option 1 and 2, 46% of the ineligible applications were Small Cap Issuers with proposed market capitalisations between HK$500 million and HK$700 million
comparatively, 10% (under Option 1) and 3% (under Option 2) of eligible applications had proposed market capitalisations between HK$500 million and HK$700 million
22% (under Option 1) and 25% (under Option 2) of ineligible applications were non-Small Cap Issuers with proposed market capitalisations exceeding HK$700 million
87% (under Option 1) and 95% (under Option 2) of eligible applications were non-Small Cap Issuers with market capitalisations exceeding HK$700 million
applicants with market capitalisations of less than HK$500 million would not have been eligible under the current Market Capitalisation Requirement even if the Profit Requirement is not increased
the listing applicants that will be impacted the most will be Small Cap Issuers
HKEX suggests that Small Cap Issuers can still access Hong Kong capital markets as they may alternatively pursue listings on the GEM
this approach aligns with the goal of the HKEX to further differentiate between Main Board and GEM listings in an effort to improve the overall quality of HKEX Main Board issuers, thereby strengthening Hong Kong’s position as an international finance centre
SPUN OFF NEW ENTITY
must satisfy all the rerquirements of the HKEX Listing Rules which apply to new listing applicants
Chapter 8 qualifications for listing must be complied with
PARENT COMPANY
subject to a waiver from the HKEX, the parent company, would itself be required to retain, in addition to its interest in the New Entity, sufficient assets and operations of its own, excluding its interest in the New Entity, to satisfy independently the requirements of Chapter 8 of the HKEX Listing Rules
