On 27 November 2020, The Stock Exchange of Hong Kong Limited (the “Exchange”) published a consultation paper (the “Consultation Paper”) introducing its proposal to increase the profit requirement for a Main Board listing. Under the proposed changes, the Profit Requirement (defined below) will undergo either a 150% or a 200% increase, as explained further below. The consultation will last for two months, ending on 1 February 2021.
In proposing the change, the Exchange intended to align the current Profit Requirement with the increased Market Capitalisation Requirement (defined below) that was effective from February 2018, and which together with the current Profit Requirement had given rise to an increase in listing applications from small cap issuers with a relatively high historical price-to-earning (P/E) ratios. The Exchange commented that these small cap issuers tend to respond to the increased Market Capitalisation Requirement by justifying their higher valuations by reference to potential growth, supported by profit forecasts that they in certain cases failed to meet post listing. The Exchange has also quoted relevant regulatory concerns, such as the drop or volatility of share prices post listing, as well as potentiality of shell creation and market manipulation post listing, as the relevant mischiefs.
Current Profit Requirement
New applicants may be considered eligible for listing on the Main Board by satisfying, among other things, either one of the three financial requirements under Listing Rule 8.05. These requirements are as follows: the Profit Requirement[1] – that, among other things, a new applicant shall have a minimum amount of profit attributable to shareholders, currently (1) HK$20 million in the most recent financial year and (2) HK$30 million in aggregate in the two preceding financial years (collectively, the “Profit Requirement”); the market capitalisation revenue cashflow requirement[2]; or the market capitalisation revenue requirement[3]. The Exchange has also introduced other eligibility requirements to attract different types of companies to list in Hong Kong, including the well-known Chapter 18A for biotech companies, and Chapter 18 for mineral companies.
An applicant relying on the Profit Requirement is also required to have an expected market capitalisation at the time of listing of at least HK$500 million (the “Market Capitalisation Requirement”)[4]. The current Market Capitalisation Requirement, i.e. HK$500 million, was effective from 15 February 2018, which was increased from HK$200 million previously. With the Profit Requirement being unchanged at the time, this implied an applicant’s historical P/E ratio from 10 times to 25 times.
Proposed Changes
In the Consultation Paper, the Exchange proposed to increase the Profit Requirement by two options:
- Option 1 – 150% increase, which will increase the minimum amount of profit attributable to shareholders to (i) HK$50 million in the most recent financial year and (ii) HK$75 million in aggregate in the two preceding financial years; and
- Option 2 – 200% increase, which will increase the minimum amount of profit attributable to shareholders to (i) HK$60 million in the most recent financial year and (ii) HK$90 million in aggregate in the two preceding financial years.
According to the Exchange, Option 1 is based on the percentage increase in the Market Capitalisation Requirement in February 2018, while Option 2 is based on the approximate percentage increase in the average closing price of the Hang Seng Index from 9,541 in 1994 when the Profit Requirement was introduced to 27,569 in 2019.
To cope with relevant side issues, the Exchange also proposed temporary relief and transitional arrangements in association with the change proposed, as further explained below.
Temporary Relief
The Exchange recognised that, against the backdrop of the COVID-19 pandemic and the uncertainties arising from the economic and political tensions between the US and China, many companies’ businesses have been adversely affected. Therefore, subject to the adoption of the proposal to increase the Profit Requirement, the Exchange has proposed to introduce a temporary conditional relief from the profit spread in the increased Profit Requirement for applicants that are able to meet certain conditions set out in Chapter 2 of the Consultation Paper, summarised as follows:
- its aggregate profit during the track record period meets the aggregate profit threshold (i.e. HK$125 million under Option 1 or HK$150 million under Option 2);
- it had a positive cash flow generated from operating activities in the ordinary and usual course of business before changes in working capital and taxes paid in the last financial year during the track record period;
- it demonstrates that the conditions and circumstances leading to its inability to meet the profit spread in the Profit Requirement are temporary;
- the track record period must have at least consecutive six months that fall within the calendar year 2020; and
- adequate disclosure is made in its listing document, including:
(i) the likelihood of continuance or recurrence of the circumstances leading to the applicant’s inability to meet the spread of the increased Profit Requirement;
(ii) measures which were taken or will be taken by the applicant to mitigate the impact of those circumstances on future profitability; and
(iii) a profit forecast covering the period up to the forthcoming financial year end date after the date of listing with detailed bases and key assumptions.
An applicant seeking the temporary relief will be required to submit an application to the Exchange for consideration on a case-by-case basis.
Transitional Arrangements
Pursuant to the Consultation Paper, the change will come into force (the “Rule Amendment Effective Date”) not earlier than 1 July 2021. To reduce the impact of the proposal on companies that have commenced plans to apply for a Main Board listing relying on the current Profit Requirement, the Exchange will introduce transitional arrangements.
Main Board listing applications (including GEM Transfer applications) will be assessed under the current Profit Requirement if they are submitted before the Rule Amendment Effective Date and remain active as of the Rule Amendment Effective Date. Such application will be allowed to be renewed once after the Rule Amendment Effective Date for continued assessment under the current Profit Requirement. For any subsequent renewals, the application will be assessed under the increased Profit Requirement.
Analyses and Takeaways
The Exchange’s proposal aims to improve the overall quality of Main Board issuers, which will be conducive to promoting post-listing liquidity, increasing investors’ confidence in the market and strengthening Hong Kong’s position as an international financial centre. However, as noted in the Consultation Paper, on average, the proposal would have barred approximately one-third of the listing applications under the current Profit Requirement which are able to meet the Market Capitalisation Requirement.
With such proposed change in sight, it is advisable that prospective listing applicants which intend to benefit from the current Profit Requirement with a lower threshold should seek early legal advice regarding listing plans, including preliminary preparation such as corporate reorganisation and pre-IPO investments, so that the same can be implemented in an opportune time.
Furthermore, should the change be introduced, it is expected that there may be an influx of applications for listing on the Main Board ahead of the change in the Profit Requirement. As such, as the Rule Amendment Effective Date draws closer, the time required for the Exchange’s vetting of Main Board listing applications may be longer, thus posing uncertainties to and incurring extra costs for listing applicants.
Prospective listing applicants should bear these in mind when planning for listing of their businesses and are advised to take early and effective steps. Meanwhile, companies at an early development stage or small or mid-sized companies may still consider accessing the capital market by utilising a listing on GEM.
Please contact our Partners Mr. Hank Lo or Mr. Rodney Teoh for any enquiries or further information.
This newsletter is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.
[1] Listing Rule 8.05(1)
[2] Listing Rule 8.05(2)
[3] Listing Rule 8.05(3)
[4] Listing Rule 8.09(2)