Hong Kong watchdogs raise alarm over GEM volatility

Wild fluctuations in alternative stock-listings regime prompt regulators to issue new guidelines to professional advisers

Two of Hong Kong’s biggest financial regulators have expressed “grave concerns” over prolonged volatility in the special administrative region’s Growth Enterprise Market (GEM) system.

In a joint statement issued on 20 January, the Securities and Futures Commission (SFC) and Stock Exchange of Hong Kong (SEHK) highlighted wild fluctuations in the GEM since the beginning of 2015, indicating that practitioners are not abiding by a key rule designed to foster fairness and openness.

The GEM was set up in 1999 to provide an alternative source of funding for higher-risk firms – particularly growth-focused start-ups – and operates in parallel with Hong Kong’s primary, or ‘Main Board’, stock market.

However, in their analysis of its trading patterns, the SFC and SEHK found that:

• For GEM stocks listed in 2015 and 2016, the average, first-day price gains were 743% and 454% respectively – compared to comparable, Main Board figures of 5% and 15%.
• Among the GEM’s top 10, first-day gainers in 2015, half saw their share prices plunge by more than 90% from their peak within a month. On average, trading prices of GEM stocks listed that year fell by 47% within a month of peaking.
• Sharp, first-day price movements of more recently listed GEM stocks were accompanied by thin trading. On average, first-day turnover ratios for stocks in 2015 and the first half of 2016 were 13% and 15% respectively. Comparable ratios for Main Board stocks were 42% and 61%.
• During the period under scrutiny, almost all GEM initial public offerings (IPOs)
  were conducted by placing only. In the GEM IPOs listed during 2015 and the first half of 2016, the top 25 placees took up an average 96% of the shares offered for placing. The average number of placees for the entire issue was 135. As such, GEM stocks have highly concentrated shareholdings and small shareholder bases.

Based on its review of IPO placings in the GEM, the SFC observed that, in a number of cases:

1. Allocations of a large majority of the offered shares were attributable to a small proportion of the relevant placing agents, who allocated those shares to a small number of places.
2. Meanwhile, the remainder of the shares were placed in small quantities (usually one or two board lots) to a large number of placees.

The joint statement noted that, while the number of placees exceeded 100, the final allocation was significantly similar, in effect, to a placing of the offered shares only to the top placees – resulting in a high concentration of shareholdings at that level.

Moreover, the SFC observed, a handful of investors repeatedly appeared as top placees in otherwise unconnected IPOs in the GEM system.

With that in mind, the regulators noted: “[We] consider that these market developments and practices may undermine GEM Rule 11.23, which provides that there must be an open market in the securities for which listing is sought.

“The principal function of the SEHK,” they pointed out, “is to provide a fair, orderly and efficient market for the trading of securities, and the SEHK has a statutory duty to ensure an orderly, informed and fair market in securities that are traded on its market or through its facilities.”

As a result of their analysis, the SFC has issued a set of new guidelines urging sponsors, underwriters and placing agents to step up the quality of their work with GEM IPO applicants. In particular, the regulator is eager to ensure that applicants receive scrupulous advice on stock allocations and shareholding concentrations.

SFC Intermediaries Division executive director Julia Leung said: “Sponsors, underwriters and placing agents all play an important role in the listing and placing of GEM IPO stocks.

“Sponsors should advise the new applicant on the overall strategy and allocation basis to achieve an open market, and an adequate spread of shareholders. Placing agents should put in place appropriate policies and procedures to avoid any undue concentration of shareholding.”

David Graham, chief regulatory officer and head of listing at SEHK’s managing body Hong Kong Exchanges and Clearing, added: “This joint statement is an initial step to address some of the current concerns with GEM IPO placings while we continue to work on a broader GEM reform.

“Meanwhile, the SFC or SEHK will make enquiries if there are concerns that the holdings of the placing securities are overly concentrated.”

Find the SFC's guidelines here.