On 20 May 2021, the Stock Exchange of Hong Kong Limited (the “Exchange”) published the conclusions of its consultation on proposals to increase the Main Board profit requirement (“Conclusions”).
The Profit Requirement is one of the three pivotal financial eligibility tests for a Main Board listing. It has remained at HK$50M since 1994. After the minimum market capitalisation for Main Board listings under the Profit Requirement was increased to HK$500M (the “Market Capitalisation Requirement”) in February 2018, the Exchange experienced an unexpected surge in Main Board listing applicants that marginally met the Profit Requirement and only managed to fulfil the Market Capitalisation Requirement with very high historical P/E ratios at their IPOs compared with their listed peers.
While these Main Board listing applicants typically justified their higher valuations by reference to potential growth supported by optimistic profit forecasts they had filed with the Exchange as part of their listing applications, a number of them failed to meet these profit forecasts post-listing. This gave rise to regulatory concerns about whether the valuations of these listing applicants were reverse-engineered to fulfil the Market Capitalisation Requirement when there was no sufficient public interest from the market for their securities at such price, which in turn called into question the listing applicant’s suitability for listing, a fundamental listing principle under the Listing Rules.
The Exchange and SFC have also become aware of other instances of misconduct following the misalignment between the Profit Requirement and the Market Capitalisation Requirement, and therefore calling for re-evaluation of whether the current Profit Requirement is at an appropriate level taking into account the market positioning of the Main Board and the Exchange’s role in upholding the quality of the market.
In light of the above, the Exchange published a consultation paper in November 2020 proposing an increase to the Profit Requirement (the “Consultation Paper”) by either 150% to HK$125M (“Option 1”) or 200% to HK$150M (“Option 2”). (See our Capital Markets Update Issue 2020-08 for a summary). While the Exchange’s pursuit of market quality has been acknowledged, the majority of respondents indicated that the Exchange should consider alternative requirements, such as a smaller increase. After considering all feedback, the Exchange decided to modify the original proposals as follows:
- Modified Profit Increase - A smaller increase in the Profit Requirement of 60% with the profit spread amended;
- More flexible profit spread relief - Prepared to grant relief from the profit spread under the Modified Profit Increase on case-specific circumstances to provide flexibility, rather than through a set of fixed conditions; and
- Effective date - The Modified Profit Increase will be implemented on 1 January 2022.
In addition to the above, the Exchange will continue to work with the SFC to combat regulatory issues identified in the Conclusions and the Exchange will launch a review of GEM covering its positioning and market perception.