Reining in IPO Share Price Volatility

On 20 January 2017, the SFC and the HKEX issued a joint statement regarding the price volatility of GEM stocks and a guideline to sponsors, underwriters and placing agents involved in the listing and placing of GEM stocks (the “Guideline”). This was in part a response to the volatile price movements of an increasing number of GEM stocks in recent years – some with first-day share price surges reaching 500 percent!

The Guideline serves as a stern reminder to GEM listing applicants to abide by the GEM Listing Rules. The Guideline especially focused on the importance of respecting the spirit of GEM Rule 11.23 – that there must be an open market in the securities for which listing is sought – which is to ensure there is sufficient liquidity of the shares in the market to protect minority shareholders.

According to GEM Rule 11.23(2)(b), the equity securities in the hands of the public should be held among at least 100 persons, but, as the Guideline points out, this is merely a guideline, and even if this minimum number has been met, it does not necessarily mean GEM Rule 11.23 has been satisfied. There were cases where the top 25 placees took up more than 90 percent of the offering. This scenario is quite common on GEM: the conditions for an open market may not exist even if securities are held by more than 100 persons.

Soon after the Guideline was published, a few companies that were undergoing the listing process postponed their planned listings “due to enquiries made by regulators in relation to requirements under GEM Rule 11.23”. This may suggest that the Guideline is effective in curbing undesired behaviour from GEM applicants, but it is yet to be seen whether the SFC and the HKEX will take stronger actions to enforce the Listing Rules against already listed companies.

While the Guideline appears to be relevant only to GEM listings, the Guideline reiterates the general obligations of placing agents, applicable to both GEM and Main Board listings, to (i) conduct adequate “know your client” procedures under the Code of Conduct for Persons Licensed by or Registered with the SFC, (ii) have a robust marketing and placing strategy and allocation basis with a view to achieving an open market in the offered securities, including an adequate spread of shareholders, and (iii) ensure that the percentage of securities in public hands meets the relevant regulatory requirements. Counsel for underwriters in Main Board listings may want to follow this development and see whether the Guideline will have any repercussions on tightening the requirements of sponsors, underwriters and placing agents for Main Board listings as well.