2018 marked another good year for the Hong Kong stock exchange. Initial public offerings (IPOs) raised HK$240 billion (US$30.65 billion) in the first nine months, up nearly three times from year-ago levels.

But it hasn’t been smooth sailing for the IPO market. Amid a broader emerging-market selloff, stock fell 34% on average below their initial share sale prices on their first day of trading in Hong Kong.

 

New economy IPO, smartphone maker Xiaomi traded 16% below its IPO price as of end-November. Its peer Meituan was down 24%. The two IPOs accounted for 23% of the total funds raised in Hong Kong in the first three quarters of 2018.

 

For the Hong Kong Exchanges and Clearing (HKEX), Nasdaq has always been a top competitor in luring Chinese unicorns.

 

Nasdaq has the largest market share of global tech IPOs at 28% as of end-November, data from Dealogic show. In 2014, Chinese e-commerce giant Alibaba chose New York over Hong Kong for its IPO. HKEX considered this its biggest miss of the decade. This prompted the exchange to re-evaluate its listing rules and introduce a dual listing in 2018.

 

The new year should bring new opportunities for the exchange amid plans by a number of Chinese unicorns to raise funds via the IPO market.

 

Hong Kong remains a solid market for IPOs. The Chinese unicorn story, after all can be better understood by Hong Kong investors given the language advantage. However, investment bankers struggle with pricing new economy companies in Hong Kong.

 

“It has to do with expectations. You need to give banks time to adjust to the new economy stocks. In the US, bankers are more used to this – sky-high valuations. They understand pre-revenue biotech stocks. They seem to know how to price new TMT stocks properly,” says an investment banking head of a Hong Kong-based Chinese bank.

 

There is also the issue of market liquidity.

 

“The reason for having the dual class structure is to cultivate a broader audience and to allow more flexibility to compete with US exchanges,” says the deputy head of a European investment bank, “The liquidity in the US is still more than Hong Kong.”

 

For now, at least, the US is favoured by Chinese technology and IT companies planning an IPO. Bilibili, Iqiyi and Tencent Music were all listed in the US in 2018, attracting robust interest from investors.

 

In terms of the regulatory environment, Hong Kong is believed to be more of a “vetting requirement” rather than a “disclosure requirement”.

 

“For some industries in China like P2P (peer-to-peer) and education, there are constantly new regulations coming out and lawyers have difficulties giving out very clean legal opinion on what licenses they should operate under,” says the European investment banker.

 

“In the US, P2P companies without a license could bypass this through disclosure, whereas in Hong Kong, you need to have a clean opinion that the Hong Kong Exchange is satisfied with it because the exchange needs to protect retail investors. In the US, so long as you sell to institutional investors and qualified professional investors, you are under the safe harbour exemption,” he adds.

 

 

In mainland China, exchanges are looking to retain onshore issuers though new initiatives such as Chinese depositary receipts (CDR) and a new tech board.

 

In November, Chinese President Xi Jinping unveiled plans during China International Import Expo in Shanghai to launch a technology board in Shanghai that will adopt a regulated mechanism for IPOs.

 

“The new board will be used as a pilot for a registration-based IPO system. Rather than needing specific regulatory review and approval, issuers will just need to submit specific documents, without having to go through a regulatory approval process, which can often take time,” explains Nikki Tanner, head of APAC market infrastructure at Deutsche Bank in an interview with The Asset.

 

Currently, companies who have yet to make profits for three consecutive years, are only able to apply for listing on National Equities Exchange and Quotations (NEEQ), the Chinese OTC stock exchange, which adopts a registration-based IPO system.

 

With the launch of the new tech board, IT companies and biotech companies that have yet to make profits will be able to tap the onshore capital market easier.

 

Chinese media reported that the government will issue detailed regulations soon. The Shanghai Stock Exchange will accept applications from issuers in March. Dual share structures and T+0 settlement are also under discussion.

 

“In the long term, the key to success of the new tech board is to find a balance between technology innovation and investment return, which is determined by the market.” notes a report from Citic Securities. “Investor threshold, issuer threshold and delisting rules should be set to enhance market efficiency, referring and even competing with Nasdaq.”

 

Chinese regulators also plan to revive CDRs, a financial instrument that will allow local investors access to tech behemoths listed offshore. Regulators are planning to revive the scheme in time for the official launch of the London Shanghai Connect.

 

“It takes small steps. It is never going to be a big bang approach.” says Tanner, “They want the initiatives to work. You don’t want initiatives which would otherwise seem very good and positive, but just don’t happen to work because the market is not performing.”

 

Overseas firms issuing depositary receipts in China will need a minimum market value of 20 billion yuan (US$2.9 billion), according to a separate consultation document from Shanghai Stock Exchange. London Stock Exchange companies listing in Shanghai will need to issue depository receipts with a value of at least 500 million yuan, the document said.

 

Huatai Securities was reported to be the first Chinese company listed in the London Stock Exchange. HSBC has said it is considering taking part in the pilot programme.

 

Investment banks have been chasing tech IPOs over the past few years. Yet, with the recent market correction, some investment banks had become more cautious in assessing IPO candidates.

 

“For 2019, we need to focus more on good companies with cash flows. Unicorns that are burning money won’t have it easy,” says one investment banker.