Hong Kong Exchanges and Clearing Limited (HKEx) today (Friday) released a Consultation Paper on the Growth Enterprise Market (GEM).  The paper puts forward HKEx’s proposals for further developing GEM as a second board and invites comments from interested parties on the proposals.

Prior to issuing the Consultation Paper, HKEx released a Discussion Paper in January 2006 to invite market comments on three possible structural options for GEM -- (a) GEM as a second board; (b) GEM and the Main Board to merge as a single board; and (c) a new alternative market.  In the main, respondents to the Discussion Paper favoured option (c), a new alternative market along the lines of London’s Alternative Investment Market (AIM).  The merger of GEM and the Main Board (option (b)) did not attract support because of concerns about the dilution of Main Board listed company quality.

After serious consideration and in consultation with the Securities and Futures Commission (SFC), HKEx concluded that it is too early to adopt the AIM model in Hong Kong.  AIM is a “buyer-beware” market in which the approval of admissions is in effect delegated to the issuers’ sponsors (“nominated advisers” or nomads).  The London market is dominated by institutional investors, while the Hong Kong market has a large retail component that necessitates a more active role on the part of the regulators.  The revised Hong Kong sponsor regime under the supervision of the SFC became effective only on 1 January 2007 and more time is needed to see its full effect.  Statutory backing of the Hong Kong Listing Rules is not yet in place.  Overall, conditions in the Hong Kong market are not yet ripe for the AIM model.  Market comments strongly supported continuing to have a growth company market in Hong Kong.  Accordingly, HKEx considers option (a) -- positioning GEM as a second board -- the best feasible option.  At present, many GEM issuers already regard GEM as a stepping stone to the Main Board.  HKEx proposes codifying existing practice on GEM and streamlining procedures to increase the attractiveness of GEM as a second board for medium and smaller issuers.  Our major proposals are that:

HKEx believes that the greater transparency of the rules and the streamlining of procedures would, to a certain extent, help to reduce the cost of listing on GEM to issuers.

HKEx would also take the opportunity to integrate the rules of GEM and the Main Board as much as possible, with the aim in the longer run of developing a single consolidated rule book covering both markets.

HKEx invites market users and interested parties to submit written comments on the proposals in the Consultation Paper no later than 31 October 2007.  Following confirmation of the concepts in the proposals, HKEx will develop proposed rule changes and expose these rules in turn to the market for consultation.

The Consultation Paper can be downloaded from the HKEx website: 
www.hkex.com.hk/eng/newsconsul/mktconsul/marketconsultation.htm.  Hard copies are also available from the HKEx office from 30 July 2007 at 11/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong.

Written comments may be sent:

HKEx's submission enquiry number is (852) 2840-3844.

The attachment below provides answers to some possible questions on the proposals.

Q1.  How would the revised GEM model help growth companies?

A1.   The revised GEM model would help strengthen market confidence in GEM by raising standards.  With higher market confidence, GEM would become more attractive to eligible issuers.  Under the proposed model, GEM would no longer admit start-up companies.  This is necessary to protect investors, which is HKEx’s first priority.  HKEx understands that there is an active private equity sector in Hong Kong which is keen to fund companies with high growth potential.  Enterprises that have reached a certain size, whether funded by private equity or otherwise, would be welcome to list on the revamped GEM.  With an improved regime and streamlined procedures for transfer to the Main Board, the revamped GEM would serve as a better channel and a stepping stone to the Main Board for more established growth companies which are not yet able to meet the Main Board initial listing requirements.

Q2.  What new quantitative admission requirements are proposed for GEM?

A2.   The only new quantitative requirement is the introduction of a requirement for adjusted cash flow from operating profits before changes in working capital and taxes paid of $20 million in aggregate for the preceding two financial years.  Other existing quantitative admission requirements are modified as follows.  The minimum market capitalisation requirement would be standardised at $100 million.  The minimum public float requirement would follow the Main Board requirement, i.e. 25 per cent or 15-25 per cent if the market capitalisation is greater than $10 billion, except that the minimum amount would be set at $30 million (compared to the Main Board’s $50 million).  Interested parties are welcome to submit their views on the proposed admission requirements in this consultation exercise.  Implementation of the proposals would depend on the response received.

Q3.  What major changes are proposed for continuing obligations on GEM?

A3.   The only major revision is to the minimum public float requirement, which would become the same as for the Main Board.  A three-year transition period is proposed to be given to existing GEM companies for compliance with the requirement.  Other proposed revisions are minor.  It is HKEx’s intention to harmonise the GEM and Main Board continuing obligations to the fullest extent possible.  Interested parties are welcome to submit their views on the proposed continuing obligations in this consultation exercise.  Implementation of the proposals would depend on the response received.

Q4.  How would the proposed revisions to admission requirements and continuing obligations help increase GEM’s liquidity?

A4.   The proposals would help raise standards on GEM, thereby enhancing market confidence.  Confidence in turn should gradually result in improved liquidity.

Q5.  How many existing GEM companies are expected to be transferred to the Main Board under the new regime?  Would the process be automatic?

A5.   Based on data in the year 2006, over 30 existing GEM issuers appear to comply with the quantitative Main Board admission requirements.  However, these issuers would also need to comply with the qualitative Main Board admission requirements concerning corporate governance and other matters.  Even if a GEM company complies in full with the Main Board’s admission requirements, the decision to transfer its listing from GEM to the Main Board would be the company’s own.  There is no automatic transfer.  All transfer applications would be subject to a reduced application fee and a streamlined approval process.  HKEx hopes to see migration of GEM companies to the Main Board on a regular basis.  Listing transfers from GEM to the Main Board would be regarded as one success measure of the revamped GEM.

Q6.  How will the process of transfer to the Main Board for GEM companies be streamlined?

A6.   At present, GEM companies wishing to transfer to the Main Board have to go through the full normal application process, like other Main Board applicants.  In addition, they are required to go through a formal process of delisting from GEM.  Under the proposed regime, GEM companies may apply to the Main Board if they meet the Main Board quantitative requirements, have been listed on GEM for two years, and have a “good behaviour” record, i.e. no material rule breaches for the past two years.  No sponsor would be required, and HKEx’s review would be based as far as possible upon the company’s existing recent public disclosures.  The current delisting process from GEM would be removed and replaced by a simple notification arrangement.

Q7.  How will the proposed delegation of listing approval on GEM from the Listing Committee to Listing Division help improve the market?

A7.   In developing GEM as a second board, HKEx aims to streamline procedures so as to make listing more attractive to growth companies.  HKEx is aware of the market concerns as to the duration and predictability of the listing process for potential GEM companies.  For smaller potential companies, these concerns translate into high costs relative to the small amounts of capital raised.  In order to streamline GEM admission procedure, and so help reduce the cost of listing, which is disproportionately high for growth companies, it is proposed that the power to approve new listings will be delegated from the Listing Committee to the Listing Division.  The power to approve further listings of securities after admission is already delegated to the Listing Division. 

In the proposed new market model for GEM, new quantitative admission requirements will be introduced.  HKEx believes that the greater transparency and explicitness of the proposed new regime for GEM should lead to reduction in cost and duration of the listing process, as well as market confidence in the listing process. 

The proposed new regime will not abolish the Listing Committee.  Instead the role of the Listing Committee will be refined and there will be an increased emphasis on arrangements to monitor the work of the Listing Division on new GEM listing applicants. The Listing Committee will retain the power to determine policy and to direct the Listing Division’s administrative practices.  GEM applicants will also have the right of appeal to the Listing Committee against the Listing Division’s initial decision on an Initial Public Offering.  It should be possible to develop monitoring and control mechanisms to ensure the Division achieves suitably high standards in its performance of this administrative task.  The design of those systems will depend on an assessment of what are the material risks. For example, if a concern is how the Listing Division might exercise its discretion in considering applications for certain types of non-standard waivers then a suitable control might be to require those waivers to receive the Listing Committee's blessing.

Q8.  What is the implementation time frame for the new GEM model?

A8.   Subject to market comments received on the proposals, HKEx would proceed to develop proposed rule changes which would in turn be subject to further market consultation.  There is no definite time frame for the completion of the process but HKEx would proceed at full speed once market views have been obtained.  Ideally HKEx would like to see the revisions implemented during 2008.