In recent years, various exchanges across the Asia-Pacific region have provided issuers and investors with a wide range of opportunities and challenges for initial public offerings (IPOs). Kroll has had a unique vantage point on this activity; in 2018, Kroll assisted Asian stakeholders across industry sectors, country domiciles and market exchanges in more than 90 capital markets and IPO diligence projects. Many of these involved cross-border listings into various APAC and U.S. exchanges by Asian-based firms, including Chinese firms.
On the Hong Kong Main Board alone (excluding the Growth Enterprise Market [GEM] board), Kroll provided diligence-related services for IPO deals that comprised approximately 73% (US$23 billion) of the total proceeds raised in 2018, and 67% (US$26.7 billion) in 2016 and 2017. Much of the activity in 2017-2018 was centred in fintech and other technology sectors (proceeds raised of US$25 billion, with US$10 billion pending).
We have witnessed how philosophical and pragmatic shifts in issuer and investor thinking – as well as regulatory focus – are having a profound effect on decision-making regarding IPOs in the region and globally. The tech sector especially reflects the forces and choices at work in today’s IPO milieu.
For example, employees of several pre-IPO companies in the technology sector are being allowed to sell their equity stakes on private-company marketplaces.1 Meanwhile, Cisco’s last-minute acquisition of AppDynamics in 2017 (which had already completed its IPO roadshow), last year’s acquisition of Glassdoor by Recruit Holdings and Walmart’s purchasing 77% of Flipkart, show how the prospect of a young tech company’s going public can spur large acquirers to head off an IPO at the pass.2
Indeed, in recent years many companies and owners have pursued a “dual track” strategy of preparing for an IPO while concurrently considering opportunities to be purchased.3 This strategy holds a special appeal for those seeking greater certainty over the valuation of the assets, particularly during periods of high market volatility.
A recent study of U.S. IPO activity also found that “newly public companies are prolific acquirers”; more than one-third will complete at least one acquisition in their IPO year, while most will make four purchases in their first five years as a public company.4
Government policymakers and regulators, particularly in Asian countries, are also affecting IPO activity and placements. For example, 2018 IPO activity on mainland China exchanges was substantially less than the same period in 2017 due in large part to stricter regulatory approval criteria. Interestingly, as of this writing, China also held the number one spot in 2018 when looking at the number of IPOs placed by companies outside their domicile countries.5
Conversely, new rules instituted by Hong Kong to attract new economy IPOs, e.g., from the biotech sector, translated into a 300% increase for 2018 in IPO filings in Hong Kong as compared with 2017. Hong Kong also emerged as the number one market globally for IPOs in 2018, beating out New York.6
With so many competing interests at work in today’s IPO markets, rigorous due diligence is more important than ever. Timely pre-transaction due diligence regarding owners, board members, executive teams, related entities and competitors – as well as ongoing monitoring – is crucial for helping stakeholders mitigate the risks that are inherent in IPOs and M&A, particularly in multijurisdictional deals. Due diligence is also helpful for demonstrating to regulators the quality of a proposed IPO.
Asia’s 2018 IPO market turns in a positive year, despite lower deal numbers
2017 was a banner year for IPO activity in Greater China markets – i.e., Hong Kong, Shanghai, Shenzhen and Taiwan – as compared to 2016. While 2018 IPO filings came in lower than those posted in 2016, the year in APAC overall ultimately ended on a positive note with a 28% increase in funds raised over 2017.7
While the final tally for 2018 IPOs issued in Greater China markets was about half as many issued in 2017 (307 vs. 582, respectively), the value raised increased by nearly US$7 billion.
| IPOs Issued
|| Value Raised
|| US$46.2 billion
Greater China market IPO activity in 2018 represented almost one-fourth of the total global IPO activity.
|| IPOs Issued
|| US$204.8 billion
|| US$188.8 billion
|| US$132.5 billion
Mainland China’s slower 2017 IPO market sees bright spot in 2018
Amidst a general slowdown in Q1 and again in Q3 2018, the Shanghai Stock Exchange (SSE) did host Q2 2018’s largest IPO globally – Foxconn Industrial Internet Co. Ltd. – raising US$4 billion on the SSE with a US$270 billion market cap as of October 2018 and was second among exchanges for Q2 by proceeds.
However, the mainland China IPO market again slowed substantially in Q3 and Q4 2018, both in terms of deal numbers and proceeds. Analysts expect a steady pace of new mainland China IPO listings in Q1 2019, with more than 270 IPOs in the pipeline (as of December 2018) as authorities work to standardize listing assessments and shorten wait times for IPO applicants. In particular, companies that have invested heavily in the electric vehicle industry may be motivated to go public as they anticipate the end of Chinese government subsidies in 2020.8
The mainland China government’s stricter criteria for approving IPOs on its exchanges has had the short-term effect of holding back IPOs from China markets while pushing some deals to other countries, such as Hong Kong and the United States. One of the government’s goals of this approach was to encourage the listing of higher-quality IPOs on the SSE.
As part of the reforms put into place after China’s 2015 stock market crash, the China Securities Regulatory Commission (CSRC) constituted a new IPO application review committee in late 2017 that tightened approvals for IPO applications. The regulatory focus not only looks at the profitability of companies, but also factors in:
- authenticity of financial statements
- rationale for fund-raising
- investment plans
- corporate governance
- risk control
In the early months of 2017, the CSRC had terminated/rejected a total of 53 IPO reviews due to findings of “abnormal business operations or finances.” These findings included suspicious accounting methods, as well as adjustments in shareholder structure or company strategy, and false statements made in applications. The stricter scrutiny further resulted in the CSRC approving only 105 IPOs in 2018, a year-over-year decrease of 76%. Additionally, approximately 150 firms withdrew their IPO applications.
In light of the situations noted by regulators in rejecting IPO applications, the value of pre-transaction diligence for companies wishing to list in mainland China becomes very clear. Issuers and underwriters can discover potentially disqualifying information early in the process, giving them the opportunity to proactively address problematic issues, saving time, money and effort.
Hong Kong demonstrates staying power in IPO market
Hong Kong’s IPO market in 2017 had a record-breaking 174 new listings, of which 80 were GEM board listings. And while only 125 IPOs were issued on its exchange in 2018, Hong Kong was the number one global IPO market for the year, beating out the previous year’s top market, New York.
With changes to China’s listing review process (e.g., greater scrutiny over financial statements, fundraising rationale, investment plans, corporate governance and risk control), more companies were expected to flock to Hong Kong’s IPO market. Indeed, Hong Kong maintained a rich IPO pipeline that ultimately produced the China Tower (US$6.9 billion), Xiaomi (US$5.4 billion) and Meituan Dianping (US$4 billion) listings.9
In April 2018, Hong Kong regulators finalized changes to their own listing rules for pre-revenue biotech companies.10 The changes aim to attract more IPOs from new-economy companies, primarily those from mainland China. The relaxed rules allow the listing of biotech companies that do not meet any of the financial eligibility tests of the main board; high-growth and innovative companies with weighted voting right structures; and issuers seeking a secondary listing in Hong Kong.
Further, in an effort to protect the influence of founders and top executives – and thereby promote greater interest in their markets – Hong Kong and Singapore also revamped their listing rules to allow companies to list dual class shares.11 In Singapore, certain shareholders are given voting rights much higher than their shareholding. In Hong Kong, the dual class share structures (referred to as weighted voting rights) mean that issuers can issue different classes of shares, some of which carry one vote, whilst some carry more than one vote.
However, 2018 also saw Hong Kong’s Securities and Futures Commission (SFC) adding a continual monitoring requirement for IPO due diligence. One possible impetus for this requirement was that regulators found a large number of sponsors had failed to conduct adequate inquiries for IPO diligence. In its Report on the Thematic Review of Licensed Corporations Engaged in Sponsor Business issued in March 2018, the SFC highlighted a number of deficiencies and instances of non-compliance related to Code of Conduct requirements (e.g., due diligence, proper records, and resources, systems and controls); CFA Code requirements (e.g., Chinese walls and receipt or provision of benefits; and Listing Rules requirements.
Adequate inquiries that encompasses multiple facets of diligence – e.g., financial, legal, operational, cyber security – and ongoing monitoring are imperatives for IPO sponsors, especially given the significant repercussions for compliance failures. In addition to fines and bans, Hong Kong’s SFC has stated, “Sponsors with a history of returned or rejected listing applications or serious deficiencies and instances of non-compliance may expect more frequent inspection visits … Future listing applications submitted by these sponsors may also be subject to closer scrutiny by the regulators.”
From a personal perspective, executives have good reason to ensure their firms engage in high-quality diligence: The SFC has declared it “will not hesitate to take enforcement action against sponsors and their senior executives responsible for failure to comply with the expected standards in sponsor work.”
Southeast Asia markets reflect evolving landscape for IPO activity
Many other Asia-Pacific markets saw strong activity in Q1 2018, with 18 IPOs in Southeast Asia (20% increase compared with Q1 2017) driven by exchanges in Thailand, Malaysia, and Indonesia. While Southeast Asia markets were down overall for 2018, analysts expect the region to enjoy a modest increase in the number of small to mid-size IPOs into early 2019.12
In 2018, Japan posted 97 IPOs; while only a 2% increase over the prior year, the activity represented a 333% increase in proceeds compared to 2017. The year closed with a blockbuster unicorn IPO, this time from SoftBank Corp., with proceeds of US$23.5 billion, making it Japan’s largest-ever IPO.
The re-election of Shinzō Abe in September 2018 likely contributed to greater confidence among investors who sought to take advantage of a steady economy.13 Additionally, and perhaps more importantly, was the action taken by the Japanese Ministry of Economy, Trade and Industry (METI) in July 2018, announcing the launch of a startup support program (J-Startup) to promote overseas development of Japanese startups and creation of unicorns. The government’s ambitious goal is to produce 20 unicorns (listed companies) in five years.14
Australia also attracted a good measure of IPO activity in 2018, especially for small-cap companies. The Australian Securities Exchange (ASX) ranked fifth in the top 12 markets for number of IPOs issued for 2018. The country enjoys a stable political climate, strong economic growth (particularly in the metals and mining and technology sectors) and low interest rates, all of which contributed to a 129% jump in 2018 IPO proceeds compared to 2017.
Entrants into Australian markets should keep in mind the “recommendations for good practice due diligence” issued by the Australian Securities and Investments Commission in 2016. These include what the ASIC considers elements of a robust due diligence process; a “substance over form” approach; director involvement in the due diligence process; and engaging appropriate professional and expert advisors.
In early 2018, Korea’s Financial Services Commission (FSC) issued measures aimed at overhauling listing requirements for KOSDAQ, a trading board of the Korea Exchange.15 Some of these actions were driven by problems associated with a number of IPOs issued by Chinese firms on the Korean stock exchange since 2007. Over the past 12 years, a total of 23 Chinese firms became listed on the Korean stock market, of which nearly half have been removed so far.16 Six of the delistings occurred amid accounting irregularities (such as fabricating disclosures and accounting fraud); the remaining four voluntarily left. In 2018 alone, losses incurred due to the involuntary delisting of Chinese companies listed in Korea reached an estimated $236 million.
The new Korean regulations, which aim to attract quality IPOs while protecting investors and market stability, include the following:
- Allow KOSDAQ listing of a company if the company meets certain threshold requirements in one of three criteria: pre-tax profit, market capitalization and equity capital.
- Strengthen post-IPO supervision by applying stricter standards in reviewing and determining whether listed companies should be delisted or remain.
- Largest shareholders and underwriters are subject to stricter rules that prohibit them from selling shares for a certain period of time following IPOs.
Given the Korean government’s sensitivity to problematic behaviour and subsequent post-IPO reviews, issuers would be well-advised to conduct not only substantive due diligence pre-transaction, but also ongoing monitoring.
IPOs, dual strategies, mergers and acquisitions, sales of equity stakes and outright purchases … these options and more are available to company owners and investors around the world, including Asia, looking to maximize values and returns. Each approach carries benefits and potential disadvantages that stakeholders must carefully weigh from both sides of the equation.
Risk-based due diligence is key for nuanced decision-making no matter what strategy is ultimately pursued. As transactional, organizational and jurisdictional complexities evolve, so too must the approach to what constitutes adequate due diligence. The expectations of many regulators relating to due diligence are broader and more stringent than ever before. Many government regulators are increasingly inclined to reject IPO applications for reasons that range from protecting the integrity of their markets to improving the overall quality and size of IPOs being listed.
As we noted earlier, careful due diligence helps issuers and underwriters save time, money and effort by uncovering and resolving risks early in the process. Some other considerations include:
- Implement programmatic due diligence programs to help avoid acquiring a “bad reputation” among regulators who might deem your transactional inquiries as inadequate. For example, remember the remarks issued by Hong Kong’s SFC that “future listing applications submitted by these sponsors may also be subject to closer scrutiny by the regulators.”
- More frequent inspection visits and greater scrutiny by regulators can disrupt and put an expensive strain on staff and resources, not to mention playing havoc with deal deadlines.
- As in other regulatory enforcement regimes (e.g., the Yates Memo for U.S. Foreign Corrupt Practices Act violations), individual executives in Asia-based companies are finding themselves being held personally responsible for what regulators consider serious due diligence lapses. To mitigate this risk, companies and executives should proactively design and implement an effective compliance program that includes:
- Training for all senior executives and board members
- Ensuring management supports compliance efforts with adequate oversight and resources
- Responding immediately to potential noncompliance brought to their attention
Engaging due diligence experts with deep knowledge of local, regional and global markets can help you implement the optimal risk-based inquiries for your needs, especially when fast-paced, high-pressure or high-value deals are at stake.
* Unless noted otherwise, all statistics in this article were sourced from reports referenced in Notes “5” and “7” below