Analyses | Regional and economic development | 2008-04-25 | SCMP

Market-friendly Regulatory Framework is Needed for Hong Kong as an IPO Hub

It is pleasing to note the general consensus among the financial policy community in
Hong Kong is that there is going to be continuing achievements of Hong Kong’s equity
market in the future despite the intensifying credit crunch felt in other developed
financial markets, thanks to the concerted efforts by relevant authorities and
professionals. Of course, we are backed by a still burgeoning demand for capital by
Mainland businesses.

However, when a consensus is so clear, it is always time to wonder whether it might be
wrong. I am not talking about the ups and downs of market due to wider financial
environmental changes, of which policymakers and regulators have little control. I just
want to highlight the “contrarian instinct” despite the continuing success of Hong Kong
as an IPO hub so far. Such “instinct” was reinforced by Bauhinia Foundation Research
Centre’s “Hong Kong as a Preferred IPO Hub” Study.

In the study, we have called for initiatives to broaden Hong Kong’s narrow issuer base,
to rethink the merits of disclosure-based regulatory mindset, and to urge for
strengthened enforcement of regulations, including timely prosecutions, prompt
investigations of irregularities and efficient hearings and disciplinary actions.

It is most unfortunate that the above recommendations have been misinterpreted by
some as a call for relaxation of listing rules.

Yet considering that we are urging for a change of mindset which has been prevalent in
the city for over twenty years, the misunderstandings and misinterpretations are
sometimes unavoidable.

There are a few widely held myths in Hong Kong’s current approach of IPO listings.
First is that tighter the regulation the better. The other is connected with the first –
regulatory authorities and even government - have to ensure full protection of our retail
investors since they are most vulnerable in a globalised and volatile securities market.

First, while the study does not call for a relaxation of current regulations, some of the
current listing rules and practices have been found decidedly wanting in clarity and
consistency. In July 2007, the HKEx proposed changes that market participants believed
would further raise the entry requirements on GEM applicants. These changes, which
include raising the minimum market capitalization and cash flow requirements of listing
applicants, if adopted, would mean a further deviation of the GEM away from its
original design of serving as an incubator for small and fledging businesses.

Instead of burdening it with ever greater regulation and discretion by relevant
authorities, only a change of approach will provide a more transparent platform for
prospective issuers to seek listings in Hong Kong. What we want to avoid is that
regulations aplenty which can only stunt an enterprise-driven resurgence, which is at
the core of a truly vibrant preferred IPO hub.

At the heart of the paradigm-shift is a change to disclosure-based listing approach. Like
other major markets, the authorities should stop at ensuring full disclosure of company
information, no more and no less, while intermediaries are accountable for
representation of the facts disclosed. By ensuring proper disclosure on the part of listing
candidates, the market can be left to price investment risks themselves. UK’s Alternative
Investment Market (AIM), which adopts this approach, has proven to be a successful

Second, there are concerns that the “paternalistic assurance” culture is legacy of the fact
that our retail investors are not mature enough. Well, Hong Kong’s market has evolved
and retail investors have become more sophisticated. Given the different levels of
sophistication among investors, we may consider introducing market segments confined
to professional investors.

Furthermore, complacency with the current assurance approach will further breed
moral hazards among retail investors. Moral hazard is the risk that the behaviour of an
economic player will change as a result of the alleviation of real or perceived potential
costs. Attempts to ensure investment decisions are risk-free by the regulators will only
mass manufacture moral hazard. They remove the only immutable incentive to succeed
- market discipline and business failure.

We are living in a risk society. While more and more people are enjoying the fruits of
risk-taking in securities market, they should also be aware of and responsible for
uninformed risk-taking. Last but not least, Hong Kong lags behind other markets in
enforcement resources and length of investigations.

As a think tank poised for long-term competitiveness of the city, it is my humble wish
that though this study may not change the world, but it might just help change the way
you think about Hong Kong’s financial regime.