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By Elzio Barreto
HONG KONG, June 24 Hong Kong has a deepening
love affair with a system that allows major institutions or rich
individuals to buy stakes in IPOs before the companies' sell
shares to the public but it may be undermining the vibrancy of
the city's stock market.
The Chinese territory, the world's biggest initial public
offering venue, has been unique in the way it has used so-called
cornerstone investors, who agree not to sell the stakes they
acquire in the IPO within a specified "lock-up" period, to a
much greater extent than any other major market.
The Hong Kong system has often been held up as one that
bolsters confidence. It signals that big investors and the smart
money are committed to the company doing the IPO, and they
aren't going to bail out as soon as the shares start trading.
But now, the cornerstone investors are taking up such a
large percentage of the IPOs that there is little left for other
investors, hurting liquidity once the shares start trading. The
cornerstone money also becomes an overhang over the stock as the
expiration of the lock-up period nears, and there are wider
fears that the system is one of many signs that the market is
losing its mojo.
Average daily turnover in the first five months of the year
totalled HK$68.8 billion ($8.87 billion), down nearly 44 percent
from the same period in 2015, while the benchmark Hang Seng
index has tumbled about 27 percent in the past 14 months.
"Large cornerstone tranches ... create issues in terms of
after market liquidity and share overhang, nearer the time of
expiry of the lock-up," said Philippe Espinasse, a former banker
at UBS and Nomura.
China Development Bank Financial Leasing Co IPO-CDBL.HK is
the biggest poster child yet for the trend. The leasing unit of
China's state-owned development bank has already pre-sold
between 68 percent and 78 percent of its IPO, which could raise
as much as $1.13 billion. That means it is set to take the
questionable honour of having the Hong Kong listing with the
biggest-ever percentage level of cornerstone investment.
The IPO itself is pricing on June 30 and the shares are due
to start trading July 11. CDB Leasing declined to comment on its
It has attracted six cornerstone investors, including Three
Gorges Capital, China Reinsurance and Hengjian International,
the overseas investment arm of China's southern Guangdong
CDB Leasing is not alone. Nine out of the top 10 IPOs in the
territory over the past year counted on cornerstones for about
50 percent or more of their deal proceeds, underscoring the
growing influence of these share sales in Hong Kong IPOs. Just
two years back, cornerstone investors would typically account
for only about one-quarter to one-third of an IPO.
When the cornerstone system first came to prominence about
10 years ago at a time when there were a lot of large Chinese
company stock listings in Hong Kong, it was widely regarded as
being complementary to the sale of shares to other investors in
the IPO. The presence of big names on the share register gave
investors increasing confidence and the lock-up period helped to
put a floor under the share price when trading began.
In those days many IPOs were heavily oversubscribed,
sometimes by more than 500 times, and the cornerstone holdings
were more modest, usually well below 50 percent of the overall
allotment of shares.
Now, many companies have allocated more than 50 percent to
the cornerstone investors. Bad debt manager China Huarong Asset
Management Co had 63 percent of its $2.5 billion IPO,
the largest in the past year in Hong Kong, bought by
cornerstones, while for China Reinsurance (Group) Corp's
$2.12 billion deal the figure was 52 percent. Aircraft
lessor BOC Aviation, which went public last month and
has a similar business to CDB Leasing, also had a 52 percent
cornerstone tranche for its $1.13 billion deal.
Such a high percentage of cornerstone investors sharply
reduces trading volumes on the stocks, because shares are locked
up for at least six months. It also creates the overhang as
investors fret about a sudden supply of shares hitting the
market once the lock-up period expires.
China Huarong has traded only $3.2 million a day on average
since going public, a fraction of its $15.4 billion market
capitalization, while ChinaRE has traded an average $9.2 million
and BOC Aviation $35.6 million on average a day.
The move underscores the strategy that some companies,
particularly Chinese state-owned enterprises (SOEs), and their
underwriters go through to get their deals completed despite
market jitters, including the make-or-break European Union
referendum in Britain this week.
"We've got the Brexit vote this week and the IPO market
volumes have been down this year. It's still a large amount of
stock and you can't really rely on retail investors to
participate these days," said a Hong Kong-based equity capital
markets (ECM) banker in reference to the CDB offering.
The trend has become more prevalent the past year as global
markets have been on edge over a slowdown in China's economy and
on concerns that U.S. interest rates were heading higher.
Chinese state-owned companies tend to rely more heavily on
cornerstone investors even during market downturns and they can
often count on other state firms when global pension funds and
asset managers stay on the sidelines, bankers said.
"SOEs make a plan to list and they stick to the plan.
They're not going to pay attention to the realities and vagaries
of the market," said an equity capital markets banker. "Unlike
most issuers elsewhere, they also have the ability to call in
some favours and make things happen if they need to."
($1 = 7.7570 Hong Kong dollars)
(Reporting by Elzio Barreto; Editing by Denny Thomas and Martin