Date
25 April 2019
UBS has been penalized by Hong Kong's securities regulator for due diligence lapses in relation to some IPOs. Photo: Reuters
UBS has been penalized by Hong Kong's securities regulator for due diligence lapses in relation to some IPOs. Photo: Reuters

Regulators’ tough stance to make IPO sponsor role more demanding

Hong Kong’s securities regulator has suspended the IPO sponsor license of UBS for one year, and fined the Swiss bank and three other institutions a combined HK$790 million for due diligence failures in relation to some IPOs.

The Securities and Futures Commission (SFC) fined UBS, Morgan Stanley, Merrill Lynch and Standard Chartered for lapses pertaining to IPOs of China Forestry and Tianhe Chemicals. The banks were accused of failing to check the forest assets of China Forestry and the factories of Tianhe as part of their sponsor due diligence. Two companies were found to be fraudulent after being listed.

Some industry insiders contend that sponsoring banks can do little to verify the mainland Chinese customers’ assets and clients.

It’s argued that investment banks may be good at sensing market opportunities and marketing, but spotting irregularities like auditors or investigators is typically not their strength.

The way I look at it, since they make greasy profits from these deals, the banks should assume certain responsibility. So it makes sense for the SFC s to impose heavy fines to ensure investments banks do their best.

Nonetheless, no matter how tough the rules are, or how stiff the fines, there may always be someone violating the rules as they are focused more on lucrative rewards.

Chinese authorities have come up with a new idea to plug the hole. In a trial plan announced recently, securities regulators requested sponsors to buy a certain portion of the shares of potential listing candidates during pre-IPO, which would tie their interest with that of public investors.

This way, investment banks would be more careful in due diligence, and they would have incentive to avoid pushing for excessively high offering prices.

The new requirement would increase the capital needs for investment banks.

Say, for an investment bank to sponsor a 50 billion yuan IPO deal, it needs to set aside up to 2.5 billion yuan for two years if it is required to buy 5 percent of shares. (The exact details like lockup period and share purchase percentage are yet to be finalized)

That will change the capital-light model of investment banks.

This explains why mainland brokerages including CSC Financial (6066.HK) and Guoxin Securities (002736.CN) have all issued additional shares to raise capital recently.

The new tech board in Shanghai is expected to be the first to implement the new initiative. If proved a success, it will probably be rolled out to cover all other Chinese equities.

This article appeared in the Hong Kong Economic Journal on March 25

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

RC

Hong Kong Economic Journal columnist

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