The challenge of backdoor listing in Hong Kong

HONG KONG - Chinese investors buying listed companies in Hong Kong reached record levels, prompting officials to look at ways to curb the practice amid concerns of market manipulation and volatility.

Hong Kong's Securities and Futures Commission is investigating the link between wild share price moves and such so-called backdoor listings after a survey found that between 2013 and 2015, 56 companies saw their market value jump more than 1,000 per cent within a six-month period, even though 39 of them were losing money.

Exchange officials say the swings and change of direction often associated with reverse takeovers can distort the market and also allow buyers to circumvent hurdles and scrutiny required for an initial public offering (IPO).

According to data compiled by Bloomberg, a record 45 Hong Kong-listed companies completed a change of ownership through majority equity sales last year.

Said Mr David Graham, chief regulatory officer and head of the listing division at Hong Kong Exchanges & Clearing, in an interview: "What a backdoor listing is in its worst incarnation is an opportunity to get a listed business, which wouldn't be able to go through the front door."

Acquiring a company solely to gain a listing for a business that would not otherwise meet the exchange's criteria is against the rules, as is taking a company public just so it can be sold. But in either case, intent can be hard to prove, and with almost 900 companies waiting for an IPO in China, it can be a lucrative business to provide ready-made traded units.

Mr Graham said shell companies are "a difficult theme to define", adding: "You have to find the balance between allowing genuine commercial transactions to happen and basically regulating the market appropriately."

The exchange has rules to try to prevent people listing companies just so they can sell them quickly as a shell for another business. IPO applicants must show three years of profit and at least HK$500 million (S$87 million) a year in sales.

The bourse also has a two-year look-back period after a company raises capital in the market or changes ownership to see if its business has changed substantially.

Mr Gary Cheung, vice-chairman of Hong Kong Securities Association, which represents more than 70 per cent of the city's brokers, said:"It's legal for shareholders to change their businesses under different considerations... Hong Kong is a free market."

Mr Francis Lun, chief executive officer at Geo Securities in Hong Kong, said a shell with a primary exchange listing is worth about HK$600 million and some brokers are collecting "huge fees". He estimates there are at least 100 shell companies out of the 1,900 listed securities in Hong Kong.

Mr Cheung said a way to deal with the problem might be to loosen IPO rules. That would make it easier for Chinese firms to have their own IPOs. More stringent rules targeting reverse takeovers also makes it harder to sell public companies that have failed and are trying to claw back residual value.

The Hong Kong stock market is not the only one affected. A similar practice by some Chinese firms in the United States has drawn increased scrutiny from American regulators, and reverse takeovers are common on the Chinese mainland.


A version of this article appeared in the print edition of The Straits Times on July 09, 2016, with the headline 'The challenge of backdoor listing in Hong Kong'. Print Edition | Subscribe