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Hong Kong Watchdog Proposes Tough New Rules for IPO Sponsors

Hong Kong Stock Exchange
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Hong Kong Stock Exchange

Banks preparing companies for listing on Hong Kong's stock exchange will be made explicitly liable for IPO prospectuses, although they will also have more powers to ensure that their clients play by the rules, under proposals released by the city's market watchdog on Wednesday.

The Securities and Futures Commission's (SFC) new rules follow a six-month consultation period but are still likely to draw opposition from a Hong Kong banking community which forced the abandonment of similar ideas in 2005.

Bankers had hoped for a watering down of the proposals, which would change Hong Kong company law to ensure that sponsors of initial public offerings face the same civil and criminal liability as company directors if a listing prospectus is found to have misled investors.

"There was quite a lot of pushback from sponsor firms about increased liability on sponsor firms, which is not unexpected, but fundamentally we followed through on the proposals," said SFC Chief Executive Ashley Alder during a news conference.

The clampdown comes at a tough time for Hong Kong's stock exchange, where IPO volumes have fallen 63 percent this year, according to Thomson Reuters data, while issuance has increased at rival Southeast Asian markets in Malaysia, the Philippines and Thailand.

(Read more: Can Hong Kong Regain IPO Crown?)

"There is a real risk that the desired improvements in market transparency and investor confidence will be eclipsed by the loss of good IPOs to other financial centres such as Singapore and Shanghai," said Angus Ross, a partner at law firm Ashurst.

The proposals were first aired in May, when the SFC launched the consultation period and some banks lobbied to reduce the severity of penalties they would face for improperly preparing listing documents.

A group comprising most of the major investment banks operating in Hong Kong, including Goldman Sachs, Morgan Stanley and Bank of China International, hired law firms Davis Polk & Wardwell and Clifford Chance to represent them in the consultation.

The lawyers said in a statement that they would examine the proposed rules in detail and consult with the SFC, the Hong Kong Exchange and others in the market on their implementation.

IPO sponsors, usually banks or corporate finance houses, prepare a company's listing documents and perform due diligence to ensure they comply with Hong Kong's listing rules.

New Requirements

The main source of relief for bankers in the published proposals is the emphasis that companies as institutions rather than individual bankers will be subject to increased liability for the accuracy and reliability of a company's prospectus.

The SFC added that criminal liability will depend on whether a sponsor "knowingly or recklessly" signed off on a prospectus containing an untrue statement.

That reduces the possibility of individual bankers ending up in prison if they are found not to have followed the rules when preparing a client to list, although any individual who colluded in preparing an untrue statement could still be prosecuted under general Hong Kong law.

The SFC's new recommendations on prospectus liability are not legally binding and the regulator will now have to apply to the government to put the proposals before the city's Legislative Council.

Alder also told the news conference that the SFC may separately look at changes to current law on IPO prospectuses next year, possibly including a change in penalties for misleading investors, which are currently capped at HK$700,000 ($90,300).

(Read more: PICC Debut Shines Through Hong Kong IPO Gloom)

The SFC decided not to proceed, however, with new rules to ban companies from having multiple sponsors, an idea which had been floated in its consultation paper.

But it will adopt new regulations giving banks greater authority to scrutinise their clients before they list and ensure competitive pressures will not hamper them from performing their role as market gatekeepers.

The SFC said a sponsor will have to tell the regulator if their client is not following the rules, or explain why if it decides to stop acting for them.

Investment banks have argued that competitive pressures and resistant clients can make it impossible for them to detect fraud.

A company wanting to list in Hong Kong will also have to commit from the outset that it will fully cooperate with the sponsor and agree on the sponsors' fees at the start of their relationship. Applicants will also have to name their sponsors two months ahead of their listing application.

These new requirements, along with the proposed new code of conduct for sponsors, will apply to listing applications submitted on or after October 1, 2013.

The SFC's proposals followed a series of scandals at mainland Chinese companies that have listed in Hong Kong.

Shares in Chinese textile maker Hontex International Holdings were suspended in 2010, just three months after listing, when regulators alleged it had overstated its financial position in the listing prospectus.

In April, the SFC revoked the licence of the sponsor of the Hontex listing, Mega Capital (Asia), and slapped it with a record fine.