Infrastructure listings in Hong Kong – easier times to come?

With the PRC’s Belt and Road Summit 2017 having just taken place in May 2017, one of the key messages from the summit was that, even with over US$100 billion in funding pledges from the PRC government and other participating countries, greater private sector participation will be required to bring the Belt and Road projects into fruition. With a recent Asian Development Bank report estimating that developing Asia will require infrastructure investment of US$26 trillion from 2016 to 2030 for the creation of new infrastructure and to maintain or upgrade existing infrastructure, it is clear that the Belt and Road initiative is not unique in seeking private sector investment to address such massive investment needs.

For infrastructure projects globally, private sector investment represents an important source of funding as governments look for ways to reduce spending (or exhaust traditional ways of raising revenue). Due to increased regulatory capital needs, lending banks may also face greater difficulty in providing the long-term project finance needed by infrastructure projects. Listing infrastructure projects and raising funds from the equity capital markets can be a dynamic way for infrastructure companies to tap into greater numbers of private sector investors, providing investors with access to infrastructure assets while maintaining flexibility on the size of their minority stakes and exits.

Against that background, certain timely developments have taken place in Hong Kong which may help to lay the foundation for more Asian infrastructure listings.

In April 2017, the Hong Kong Securities and Futures Commission (SFC) released a statement on its approach regarding proposed listings of infrastructure project companies on The Stock Exchange of Hong Kong Limited (SEHK) in response to a number of such companies expressing an interest in listing in Hong Kong, in particular those falling within the Belt and Road Initiative. The SEHK has also stated in various news reports that it will start consultations at the end of May 2017 on the launch of a new listing market in Hong Kong (the “third board”, after the Main Board and the Growth Enterprise Market), with new rules which would allow more listings of infrastructure firms and overseas companies on the Belt and Road initiative, and also companies with dual share-class structures.

While the SFC’s statement provides a measure of clarity regarding its view of such listings, it also underscores the caution it exercises in welcoming such “risky” listings. The introduction of the third board, however, with more flexible rules for listings of infrastructure projects, could result in Hong Kong becoming an attractive listing venue for infrastructure projects in Asia and play a key role in bridging the infrastructure funding gap.

Nonetheless, project owners and investors contemplating a listing of infrastructure projects in Hong Kong should consider from the outset the SFC’s mitigation factors and the current requirements of the SEHK Listing Rules, as the ability to satisfy the SFC and the SEHK on these matters will be critical to a successful listing in Hong Kong.

All companies seeking a listing on the SEHK must comply with certain basic listing requirements under the Rules Governing the Listing of Securities on the SEHK (the SEHK Listing Rules), unless waivers are granted by the SEHK. The SFC may also object to a proposed listing if the SEHK Listing Rules are not met (or a waiver granted by the SEHK) or if, in the SFC’s view, the proposed listing would not be in the interest of the investing public or in the public interest.

Infrastructure project companies, in particular, are recognised by the SFC and the SEHK as having special risks attached to them, and are accorded greater levels of scrutiny during the listing application process to ensure that the infrastructure project companies are suitable for listing on the SEHK.

With the SFC’s recent statement, the SFC has set out a list of factors which, if one or more are present, will improve the risk profile of an infrastructure project company and reduce the likelihood of the SFC blocking the proposed listing.

The SFC recognises that not all of the mitigating factors may be applicable and that there may be other factors which may be relevant and which the SFC has not listed; however, the SFC has also stated that if more of the mitigating factors apply, then the level of risk to potential investors will be perceived to be lower (and the chance of the listing application being rejected also lower).

The SFC’s risk-mitigation factors can therefore be regarded as pre-qualification considerations, without which a listing on the SEHK will be virtually impossible even if the project company is able to meet the basic requirements for a listing and/or the conditions for any waivers granted under the SEHK Listing Rules.

SFC’s risk-mitigation factors

• Large shareholding by a relevant PRC SOE, sovereign wealth fund, substantial listed company or substantial and globally-active institutional investor
• Committed project financing from a sizeable PRC, Development or International Bank
• Government where the project assets are located has direct involvement or shareholding
• The project is located in a jurisdiction that is a signatory to the IOSCO MMOU, or where the SFC has sufficient comfort that it can obtain relevant public and non-public information about the activities of the company in the jurisdictions in which it operates

Under the SEHK Listing Rules, a listing applicant must have a minimum trading record period of three years and meet certain minimum financial standards requirements (e.g. profits of at least HK$20 million in the last financial year) in order to qualify for a listing on the SEHK. With newly-formed infrastructure project companies, however, the SEHK may grant a waiver and permit the company to proceed with its proposed listing if certain conditions are satisfied.

The key waiver condition is that the project company must be a “pure play” infrastructure project company at the time of listing. This would exclude service providers such as building and construction companies, even if solely servicing infrastructure assets, or any downstream sectors. One other condition to take note of is the minimum size of the project(s), with the project company’s share of the total capital costs being in excess of HK$1 billion (approximately US$130 million).

The other waiver conditions, such as having the right to operate the completed project; restrictions on other businesses which the project company is permitted to acquire or operate; and the technical skills and experience required of the directors and management team, go toward the nature and purpose of these companies and the likelihood of successfully completing the project and having a return on investment.

SEHK Listing Rules waiver conditions

• The project(s) must be for the creation of infrastructure, such as the construction of roads, bridges, tunnels, railways, mass transit systems, water and sewage systems, power plants, telecommunication systems, seaports and airport
• Listing applicant must be a party to and have the right to build and operate (or participate in the results from the operation of) the infrastructure project(s)
• At the time of listing, listing applicant must not be engaged in any businesses other than those stipulated in the infrastructure project mandate(s) or contract(s), restricted from acquiring other type of assets or engage in activities which will result in a change of business in the first three years after listing
• The infrastructure project(s) must be carried out under a long term (at least 15 years) concession or mandate awarded by a government and be of a substantial size (i.e. company's share of the total capital cost of the projects is at least HK$1 billion)
• If the listing applicant is involved in more than one project, the majority of its projects are in the pre-construction or construction stage
• The bulk of the proceeds of the offering must be used to finance the construction of the project(s), and not to repay indebtedness or acquire other non-infrastructure assets
• The listing applicant’s substantial shareholders and management must have the necessary experience, technical expertise, track record and financial strength to carry out the project(s) to completion and to operate it/them thereafter. In particular, its directors and management must have sufficient and satisfactory experience of at least three years in the line of business and industry of the new applicant
• Enhanced disclosure requirements must be met (e.g. business valuations, feasibility studies, sensitivity analyses and cash flow projections)

It is clear from the SFC’s statement and the current listing rules that Hong Kong regulators place a high priority on protecting the interests and investments of retail investors and, accordingly, have a low risk appetite for what is likely to be the large majority of infrastructure projects seeking to list.

Based on the current SEHK Listing Rules and the SFC’s mitigating factors, it is unlikely that we will see a marked increase in the number of infrastructure project listings in Hong Kong in the near term despite the recent statements made by Mr Fang Xinghai, a vice head of the China Securities Regulatory Commission, on allowing companies involved in the Belt and Road initiative to raise funds on overseas markets such as the SEHK.

This is largely due to the fact that many existing infrastructure projects do not meet the SFC’s or SEHK’s existing criteria, and in many cases will be unable to meet the criteria unless there is a major change in the ownership structure, nature of the project or funding arrangements.

For project owners, if a possible listing in Hong Kong is being contemplated in the near term, the SFC’s and SEHK’s requirements must be taken into consideration at an early stage. Without the right project partners and financial and governmental support for the project or the right corporate and project structure in place from the outset, a subsequent listing in Hong Kong based on the current regulatory requirements will not be achievable.

For infrastructure investors, there will continue to only be a handful of listings of “pure-play” infrastructure project companies in Hong Kong, although there may be some comfort that the ones that do manage to list in Hong Kong will have the regulators’ stamp of approval and can be considered “best in class”.

Considering the current stringent requirements for listing infrastructure project companies, the proposed plans for a third board in Hong Kong and the commencement of the public consultation is highly anticipated.

The main questions for the SEHK regarding the third board will be whether the listing rules for infrastructure companies will be relaxed to create a more favourable listing environment (and to what extent), whether the third board would only be open to institutional investors or whether retail investors will also be able to participate as they do on the Main Board and Growth Enterprise Market, and also whether the SFC will revisit its mitigating factors in light of such listings on the third board.

Should the plans for the third board proceed, and with new (and more accommodating) rules for infrastructure project companies, it is expected that there will be greater numbers of infrastructure projects seeking listings in Hong Kong, including those under the Belt and Road initiative, representing a wide range of opportunities for private sector investment into a variety of infrastructure assets and Belt and Road country exposure.