No quick fix for HK’s cornerstone problem
Hong Kong's IPO market relies heavily on Chinese issuers for deal flow, and with them a force of cornerstone investors. A much needed shake-up to the cosy cornerstone base is expected, thanks to new regulations by China’s foreign exchange regulator. But for those who view the change as a possible solution, the rules are likely to prove disappointing.
China's State Administration of Foreign Exchange (Safe) has come up with a way to tease out investment from Chinese companies into IPOs in Hong Kong.
The new system of cornerstone participation is based on FX quotas, allowing onshore investors to sign up for Hong Kong listings by Chinese names as long as they agree to various conditions — including exiting their positions at a certain time and bringing the returns back onshore. Also, the issuer must agree to repatriate some of the proceeds it raises from the listing.
This has led to optimism about the outlook for Hong Kong's primary equity capital market. The changes are seen as a way to deepen the pool of potential cornerstone investors and so provide more support for small and mid-cap size companies looking to float on the Hong Kong Stock Exchange, GlobalCapital Asia wrote in its cover story last week.
The new arrangement is expected to give issuers more access to investors that want to be cornerstones and also provide an outlet for investors that did not have the opportunity to be cornerstones before. As a result, the system is set to encourage more Mainland IPOs while also encouraging more onshore accounts to take on the role of a cornerstone.
All this certainly sounds appealing on paper. But while Safe has noble intentions, the change is unlikely to translate to a more robust IPO market in Hong Kong.
For starters, the problem of headline grabbing cornerstone tranches taken up by SOEs on jumbo deals will remain, if simply for the fact that these investors have huge balance sheets they are willing to use.
Take Postal Savings Bank of China’s IPO last September as an example. Of the HK$57.6bn ($7.4bn) deal, about 76% was mopped up by cornerstones, including SOEs like China Shipbuilding Industry Corp and State Grid Overseas Investment. Other examples include China Development Bank Financial Leasing Co, which signed over a whopping 78.1% of its HK$6.2bn IPO to cornerstone investors in June 2016.
And while Safe’s changes are expected to diversify the cornerstone pool, identifying new investors will be a long process. It will involve not only seeking out accounts that want to be cornerstones, but also educating them about Hong Kong IPO rules and the lock-up periods that come with being cornerstones.
Meanwhile, issuers will need time to become comfortable with investment from relatively unknown names, meaning any short-term benefits from the changes are likely to be slim.
The market instead needs to recognise the use of FX quotas instead of the Qualified Domestic Institutional Investor (QDII) scheme for what it is — a smart but political move by Safe. It has created a new way to meet China’s goals of managing capital outflows and boosting foreign exchange reserves by forcing both investors and issuers to mandatorily bring the money back onshore.
The change may prove a boon for Hong Kong’s IPO market with more money flooding in, but it is unlikely to solve the cornerstone problem anytime soon.