Huang Tianyou: GEM reform has seen initial recovery one year later, the IPO sponsor should enhance value contribution to help companies achieve long-term success.

On January 17th, at the seminar "The Future of Hong Kong Capital Market - GEM" hosted by the Hong Kong Securities and Futures Commission (SFC), Dr. Carlson Wong, Chairman of the SFC, delivered a keynote speech titled "Enhancing the Value of Sponsor to Drive GEM's Soaring Flight". He mentioned that as the second board of the listing market, the GEM system is sound and well-regulated, providing long-term capital for small and medium-sized enterprises, promoting their innovation, value creation, and business growth. After a year of GEM reform, preliminary signs of recovery have been seen, which is encouraging. Furthermore, he emphasized that sponsors of initial public offerings (IPOs) should leverage their unique role and enhance their value contribution to strengthen the corporate governance and resilience of companies, leading to long-term success. Sponsors must conduct thorough due diligence on the business situation of companies and meet the strict standards of the SFC. They should critically review the accuracy and integrity of information and follow up on any warning signals. Sponsors have the opportunity in the early stages of a company's preparation for listing to comprehensively assess the sustainability of the business model and ensure accurate and full disclosure to investors. In doing so, they can exert unique influence to promote board efficiency and internal monitoring measures of companies, as well as propose corrective measures before their clients go public. The importance of stable GEM for small and medium-sized enterprises and the listing market After years of continuous development, GEM has witnessed the growth of hundreds of small and medium-sized enterprises in Hong Kong and mainland China. As Confucius said, "A jade stone is useless before it is polished; a man should be educated to be virtuous." This applies especially to today's small and medium-sized enterprises and GEM companies. Small and medium-sized enterprises are crucial to society and economic development, serving as the backbone of the Hong Kong economy. In 2023, small and medium-sized enterprises accounted for over 98% of total enterprises in Hong Kong and employed around 44% of the private labor force. According to a report from the Organization for Economic Co-operation and Development, there are about 52 million small and medium-sized enterprises in mainland China, contributing to 80% of urban employment, 60% of GDP, and 70% of technological innovation. As a financial regulatory agency, the SFC is committed to working with the Hong Kong Stock Exchange (HKEX) and stakeholders to promote the development of companies of different sizes in the Hong Kong listing market. Optimization of GEM measures in 2024 Furthermore, under the new simplified transfer mechanism, HKEX has received three applications from GEM issuers to transfer to the main board. The average sponsor fee for GEM listings increased to HK$6.8 million by 2024, up 25% from 2020, and the average fee as a percentage of fundraising remains around 9%. Enhancing the value contribution of the sponsor However, sustaining the momentum of recovery is a challenging task, requiring continuous improvement in the quality of issuers in GEM and the entire market. Sponsors and financial advisors play crucial roles in helping clients ensure regulatory compliance and navigate the complex IPO process. As unique gatekeepers, sponsors and financial advisors must enhance their value contribution by assisting listing applicants in establishing corporate governance. Thorough due diligence by sponsors and their recommendations will have a lasting impact, benefiting the long-term sustainable development of companies after listing. Promoting the sustainable development and governance of companies after IPO Sponsors can shape a culture of good corporate governance by discussing deficiencies in internal control with the boards of listing applicants and proposing remedial measures, ensuring that these measures are implemented before listing. Some feasible measures include providing customized training for directors and senior management. Sponsors should review the past performance records of each director to understand their individual and collective experience, qualifications, abilities, and integrity, ensuring that the board has a good grasp of financial knowledge and a full understanding of corporate governance. Indeed, the benefits of sponsors' work are already evident at the beginning of company listings. Research has shown that reputable sponsors often lead to smaller IPO price discounts and lower initial stock price fluctuations, with their reputation stemming from their strong value contribution. They can effectively reduce information asymmetry between issuers and investors, thus enhancing the quality of gatekeeping. Facilitating communication between listed companies and investors and establishing a brand for their stocks in the market is another way to enhance the value contribution of sponsors. Through a series of investor relations activities and ensuring continuous coverage by stock analysts, transparency of information can be maintained, enabling companies to be continuously monitored by the public after their IPO. Public scrutiny will serve as a driving force for listed companies to improve their operations, accountability, disclosure levels, corporate governance, and shareholder returns. Furthermore, sponsors can continue to play an important role as compliance advisers to companies post-listing, providing advice on regulatory compliance (such as regulations on disclosures and company transactions) until the release of the first year-end performance after listing. Therefore, for sponsors and financial advisors, an IPO should not just be a single transaction, but an opportunity to enhance their value contribution and effectively prevent continuous price wars resulting from vicious competition. The importance of corporate governance for long-term success Corporate governance is undoubtedly crucial for the long-term success of companies post-listing. In order to strengthen investor confidence in Hong Kong as a world-class capital market, we need to have world-class corporate governance in our listed companies. Numerous studies have shown a strong correlation between corporate governance and a company's profitability and sustainability. Good corporate governance includes establishing an excellent board of directors, implementing sound internal controls and management systems, and ensuring effective risk management. In today's rapidly changing global macro environment, the board of directors must shape the corporate culture and values from top to bottom to build the company's resilience.In the face of emerging technologies, online security threats, climate change, and other new challenges, the flexibility of enterprises is particularly important. (For the importance of corporate governance, please refer to the speech titled "Promoting Performance with Good Governance: Corporate Governance as a Driving Force for the Long-Term Growth of the Listing Market" on January 15, 2025.)Misconduct and good examples of sponsors Given the long-term impact of a sponsor's work on a company and its vital importance throughout its lifecycle, the Securities and Futures Commission of Hong Kong takes a zero-tolerance approach to misconduct by sponsors. The stringent due diligence of sponsors is crucial for maintaining Hong Kong's reputation as an international fundraising center. If investor confidence wanes, the difficulty and cost of corporate financing will increase, leading to a chain reaction that weakens Hong Kong's competitiveness. For example, in December 2024, the Securities and Futures Commission of Hong Kong condemned a financial intermediary and imposed a fine for failing to fulfill its responsibilities as the sole sponsor for a GEM listing application. The intermediary did not conduct appropriate due diligence on significant issues related to the business arrangements between the applicant's subsidiary and its largest client. On the other hand, we have also seen examples of due diligence by sponsors over the years, which encourage market participants to emulate. Some of these measures include establishing robust due diligence plans in the early stages, tailored for clients, appointing an independent person for each transaction team, and establishing a due diligence committee composed of senior management.