HK’s IPO gatekeeper status in question after arrests

Booths stand emptied on the trading floor of the Hong Kong Stock Exchange. Photographer: Anthony Kwan/Bloomberg

Hong Kong Exchanges & Clearing Ltd.’s dual role — as a major Asian equities trading exchange as well as the arbiter of which companies get listed on it — is being called into question again.

That’s after graftbusters on Wednesday said they arrested the former joint head of the exchange operator’s IPO vetting team and two others on charges of corruption and mismanagement in relation to two listing applications, without naming them. Hong Kong’s securities regulator also said it’s reviewing aspects of HKEX’s approach to vetting initial stock sales.

HKEX enjoys a rare status among major exchanges in that it holds primary power over which companies get to go public. Critics contend that sets it up for potential conflicts of interest because it’s heavily dependent on trading volume to drive revenue, giving it a commercial incentive to accept more listings.

“It tarnishes the reputation of Hong Kong a lot as the exchange is the main regulator for companies seeking listing,” said Kenneth Leung, a lawmaker and deputy chairman of the Legislative Council’s Committee on Financial Affairs. “There needs to be a thorough overhaul of the listing proceedings.”

Alibaba Coming

The incident comes at a sensitive time for HKEX Chief Executive Officer Charles Li, who is looking to move beyond a series of scandals on its small-cap market and welcome Alibaba Group Holding Ltd., which is said to be preparing to raise as much as $20 billion in a secondary share sale in Hong Kong. Alibaba’s decision to list there validated Li’s successful campaign to permit stocks with weighted voting rights.

“HKEX will be under pressure to show that it can effectively govern IPO approvals,” said Will Cai, a partner and the head of capital markets at Cooley Asia. Otherwise, “this would trigger more inspection of the Hong Kong IPO vetting process,” he said.

The exchange’s screening process is subject to clear checks and balances and no single person makes the decision whether to approve IPOs, Li said in a June 14 WeChat post in response to media queries about issues with listings.

HKEX currently oversees listing approvals with input from the Securities and Futures Commission. The bourse has seen off successive efforts to remove its IPO screening powers, including a 2003 proposal to hand them over to the SFC. A contentious consultation two years ago left the structure of HKEX’s Listing Committee unchanged, and dropped plans that would have given the SFC more responsibilities for approving IPOs.

Anonymous Letters

SFC chief Ashley Alder, who said at the time that the plan’s opponents might come to regret the decision, has restructured his agency’s enforcement approach to target problematic IPOs more aggressively. Hong Kong, which acts as a key financial gateway to China, has at times struggled to protect investors from fraudulent companies going public.

The former HKEX official who was arrested is Eugene Yeoh, people with knowledge of the matter said. Yeoh, who resigned from HKEX in May, didn’t respond to calls seeking comments. He co-headed a team that vetted IPO applications and prepared reports for the Listing Committee, a rotating panel of external industry experts that reviews applicants.

Earlier this year, HKEX had received anonymous letters alleging that an unidentified Chinese private equity firm had been raising money from Chinese investors to create shell companies that it planned to list in Hong Kong, a person with knowledge of the matter said. The letters also alleged that a person inside one of the regulators had promised to help make sure the listings were successful, the person said.

It wasn’t clear whether the shell companies ended up going public in Hong Kong, and whether HKEX took any action based on the letters. A spokesman for the bourse declined to comment. Regulators have in recent years tweaked regulations to make it more difficult to list shell companies.

Anthony Neoh, who chaired the SFC in the late 1990s, said this week’s scandal is unlikely to lead to any major changes in the listings system since it appeared to be tied to personal misconduct rather than structural problems. He said his “long-term preference” is for HKEX to cede its regulatory listing powers to the SFC, although added that’s unlikely to happen soon.

Leung, the lawmaker, said he had no plans to call a committee hearing on the arrests while the ICAC investigation is in progress. But he’s written to the government’s Financial Services and Treasury Bureau asking for ideas on how to better scrutinize IPO applicants.

With the exchange and the SFC periodically at odds over who should have the final say on listings, it’s time for the government to make a decision, he said.

“The stock exchange would like listings to be done more easily,” said Leung. “And the SFC would like only quality companies to be listed and for investor rights to be protected.”