The proliferation of sponsors on initial public offerings doesn’t just lower fees for investment banks, it also encourages fraud, a gathering of bank executives and regulators heard on Tuesday.
Investment banks in Asia are getting whacked because deals are getting smaller and market valuations are not as big as they once were. The double whammy is that the number of banks chasing this shrinking pot is increasing.
The knock-on effects of the trend were outlined at the launch summit of the Asia Capital Markets Institute in Hong Kong — supported by FinanceAsia — which was created to promote professionalism and innovation in Asia's capital markets.
In short, fees might be shrinking but the risks associated with sponsorship are increasing with it.
The logic, according to one of the summit panels, is that trust becomes diluted as more banks jump on a deal because clients become more selective about the information they disclose to the banks, increasing the potential for fraud or misdirection.
“In many cases we were in the position of thinking why would we even want to be a sponsor. Should we just be a joint global coordinator or a senior bookrunner, where you don’t have to face any liabilities of due diligence and you can … still take away a lot of economics as long as you sell stocks,” Heidi Yang, Deutsche Bank’s head of corporate advisory group for Asia, said.
Banks complaining about fees is nothing new but the risks have certainly jumped since last year, when the Securities and Futures Commission amended IPO sponsorship rules.
The rule changes make sponsors squarely responsible for irregularities in listing documents in an attempt to encourage, or force, them to bring the best quality companies to Hong Kong.
Penalties for irregularities include forcing a sponsor to reimburse investors who may have lost money on the IPO.
“When you have a smaller number of banks people tend to be more honest when they provide advice to the client. But when you have 30 or 40 banks competing against each other, there are certain banks that are willing to sweet talk and try to keep the clients,” Yang said, without elaborating. “This turns out to be very damaging because the client will not get the best advice and it can lead to the wrong decision at the end.”
The problem is particularly acute, according to the panel, with mainland Chinese companies coming to list in Hong Kong.
While state-owned-enterprises are more sensible in choosing “the right number” of sponsors on an IPO, private companies “think that the higher number of banks have the greatest chance of success of the deal, which in reality is not true,” said Yang.
“We are dealing with smaller companies with shorter [histories] and with management who are younger. [And] we are facing more challenges of understanding our clients and vetting the background as well as understanding the financials given the very short track record of the company,” Yang said.
The message was supported Zhou Jiaxing, executive director, legal department, at Chinese bank CICC, who said it was “ridiculous” that some banks became sponsors not for money but for the league table rankings.
“With [private companies] compared to SOEs, the fraud risk is much larger, and for us we are very nervous and have to do 360 degree due diligence on the client before we take them on. Then after we sign we do very rigorous due diligence. The risk that your client tries to cheat on you is very high,” he said.
Zhou said that CICC had given up its role as sponsor at various times in order to not face the risk.
The message from the regulators is that banks should maintain pristine standards of record keeping and due diligence and ask clients the same questions regulators would.
“I want you guys to focus not just on getting your [own] house in order because trouble can come to your door even if everything behind the door is in order. There is almost a trouble by association,” said Laurence Li, a Temple Chambers barrister and member of the Hong Kong Financial Services Development Council.
Judy Vas, regulatory leader, financial services, Ernst and Young, told FinanceAsia that sponsor compliance is one of the SFC’s themes of review in supervisory visits. “After months of preparation, the regulators would expect sponsors to be in good shape of compliance with the new regime,” she said.
Li cited one recent case, which he said raised a few key points he wanted to impress on banks that lamented the lack of “decent” fees. “One [point] was that you [banks] can be doing [sponsorship] for free and you have the same liability. The defence counsel [on the case] said ‘You cant expect to get a Rolls-Royce for the price of a Mini’. The tribunal shot back with ‘it’s not about what car you get, it’s about whether it’s road worthy’.”
“Bargaining power has still not shifted to the sponsors,” lamented Zhou.
There is clearly some way to go.