Contributed by Research & Policy Corporate Strategy Unit

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1 Contributed by Research & Policy Corporate Strategy Unit The major element of listing costs is the underwriters fee. This tends to be a standard percentage in each market, although the percentage may differ between markets. Professional fees are the next largest item; exchange fees are generally a relatively small component. Factors other than listing costs tend to govern issuers decision to list and their choice of exchange. Listing costs have recently attracted public attention in Hong Kong, and commentators have asked whether the costs of listing in Hong Kong are too high. This article seeks to explain what the costs of listing are, how listing costs weigh in the issuer s listing decision, and how Hong Kong compares with overseas markets. What are the costs of listing? In order for a company to list, many tasks have to be completed, and for each of these tasks there is a cost. Some of these costs are explicit out-of-pocket items, such as the fees of the investment bank and the reporting accountant, and the exchange fees. Other costs are implicit, such as the absorption of management and staff time by the listing process, and the effort of any necessary restructuring. Another kind of implicit cost is the discount on the sale of shares at initial public offering (IPO), which can sometimes be very large. This article focuses mainly on the explicit out-of-pocket costs of listing. However, the implicit costs should not be overlooked. Explicit costs The typical explicit costs of a Hong Kong IPO include underwriting commission, professional services fees, share certificates and fees of the registrar and receiving banks in the IPO, publicity costs and exchange fees. The different cost items in each case may differ by factors like the issuer s size (especially when restructuring is required), the amount of funds raised, the listing board, the kind of listing (primary listing or secondary listing), and the issuer s status - for example, whether the issuer is a Hong Kong company or a Mainland China company. The example given in Table 1 is that of a Main Board IPO for a Hong Kong company with a capitalisation of HK$1.6 billion and a public offering of HK$400 million. The main cost components are estimated as percentage of funds raised 1. 1 Based on informal discussion with investment bankers. 31

2 32 Table 1: Cost of listing in Hong Kong % of funds raised % of total costs Underwriting commission 2.5% 42.7% Professional fees 2.2% 37.8% Investment banks 0.6% 10.7% Legal advisors 1.1% 17.9% Reporting accountant 0.4% 6.4% Property valuer 0.1% 1.1% Others Translation and public relations 0.1% 1.7% Registrar and receiving banks fees 0.1% 1.9% Communication support 0.6% 10.5% Roadshow 0.2% 3.4% Announcements 0.2% 2.8% Public relations materials and printing 0.3% 4.3% Exchange fees 0.1% 2.1% Initial listing fee 0.1% 1.9% Trading fee (in respect of public offering) 0.0% 0.2% Miscellaneous 0.3% 5.1% Total 5.9% 100.0% Note: columns may not cast because of rounding. Underwriting commissions are the biggest component of total listing costs, and professional fees are the second biggest item. Exchange initial listing fees are a relatively small component some 1.9 per cent of the total in the example, representing 0.1 per cent of the funds raised. Among the cost components, the underwriting fee, the biggest cost item, is rather standard in the industry. Out of 84 Main Board IPOs during the period January 2000 to June 2002, in 77 or 92 per cent of cases, the underwriter s fee was 2.5 per cent of the funds raised. Uniformity of pricing might raise the question of whether the market for IPO services is competitive. However, there are numerous players providing investment banking services, and the barriers to entry are not very high. New players do enter the market and win considerable market share from time to time. A similar phenomenon is observed in the US market, where over 90 per cent of IPOs that are neither large nor small pay a gross underwriter spread of exactly 7 per cent 2. US studies indicate that a possible reason for the standardisation of pricing, notwithstanding considerable competition, is that price reductions might be perceived by investors, and perhaps by the issuer, as a mark of lower quality. 2 The determinants of successful micro-ipos, Brau and Osteryoung, Journal of Small Business Management, July See also Do investment banks compete in IPOs?: the advent of the 7% plus contract, Hansen, Journal of Financial Economics 59 (2001).

3 Although underwriting fees tend to remain a fixed percentage of the funds raised, the professional fees do not increase in proportion to the issuer s size 3. Therefore, there are economies of scale enjoyed by large companies. That is, smaller companies pay proportionately more. For illustration, the listing costs of companies listing on the Main Board from January 2000 to June 2002 are summarised in Table 2. For larger companies, they contribute a much smaller proportion of funds raised. Table 2: Listing costs of Hong Kong listed companies (Jan Jun 2002) Listing fees as Listing costs as Criteria No. of companies percentage of funds raised percentage of funds raised (median) (median) Large-cap companies MC at listing over HK$1 bil % 7.51% Medium-cap companies Small-cap companies MC at listing between HK$501 mil and HK$1 bil MC at listing between HK$100 mil and HK$500 mil MC at listing less than HK$100 mil % 10.26% % 19.12% % 19.05% Total 84 MC = Market capitalisation Note: Based on Main Board listed companies excluding companies listed by introduction. The other factors may also be significant. A secondary listing is likely to be less costly than a primary initial listing, especially when the issuer is already listed on a recognised exchange. The listing of a Mainland China company in Hong Kong will incur higher cost than that of a Hong Kong company of a similar size and with similar amount of funds raised. This is because Mainland China companies will have to comply with the Mainland regulations for overseas listing and Hong Kong s regulatory requirements for clarification of its Mainland business and legal obligations. Costs of a listing on the Growth Enterprise Market (GEM) will also differ from that on the Main Board. Although listing fees will be smaller (a small cost component anyway), it appears that underwriting commission for GEM listings is considerably higher than for the Main Board per cent to 4.5 per cent instead of 2.5 per cent. 3 The initial listing decisions of firms that go public, Corwin and Harris, Financial Management Spring Corwin and Harris quote five studies published from 1986 to 2000 that find evidence of economies of scale in the offering process. 33

4 34 Certain of the cost items may reduce in the future. For example, printing costs may be reduced if, as intended, the Companies Ordinance is amended to permit electronic prospectuses. Other automation of the IPO process would reduce the need for printed application forms. Professional fees are dependent on the amount of work required to comply with the regulations and properly communicate the company s value. Over time, the regulatory requirements tend to be tightened as the expectation of the local and international investment community rise; this exerts upward pressure on fees. From time to time, regulators attempt to counter such trend by simplifying or eliminating requirements, or by establishing concessionary regimes for certain categories of companies. The establishment of GEM in Hong Kong was intended to facilitate capital-raising for smaller companies. However, the main differences in the regime for GEM are in respect of the quantitative requirements for listing. The qualitative requirements, including those mandated by the Companies Ordinance, are similar, hence the professional fees cannot be reduced much. Implicit costs discount on issuance IPOs are normally issued at a discount to the potential equilibrium market price; hence they normally exhibit a significant price rise on the first day of trading. This phenomenon is particularly strong in bull markets. A discount is regarded as commercially necessary to make the IPO a success. The underwriter will also want to reduce his risk, hence the amount of the discount may vary depending on the public offering mechanism. A longer offering period increases the underwriter s exposure and so would tend to indicate a larger discount. One study 4 found that the average first-day gain in US IPOs during the 1980s was 7 per cent, average gain during the 1990s was 15 per cent, but during , the dotcom boom years, the average first-day gain was 65 per cent. This was equivalent to some US$63 billion of underpricing an enormous sum. It is hard to explain why companies should leave so much money on the table. One possible explanation 5 may lie in the fact that family and friends allocations were present 25 per cent of the time in 1996, but more than 90 per cent of the time in 1999; in other words, insiders had more to gain from boosting the market price so that they could cash in later when the lockup period ended. A study of Hong Kong IPOs listed from 1993 to 1998 found that 72 per cent (206 IPOs) were issued at a discount as evidenced by first day returns averaging 20 per cent 6. How important are listing costs to the issuer? Although the costs of listing matter to the issuer, it appears that other factors are more important to their listing decision. A study in the US 7 found that listing fees and issue costs do not appear to be important considerations in the initial listing decision. Peer-firm and related-firm listings appear to be important factors in the choice of listing venue. Other criteria for choosing listing venue include initial and continuous listing requirements, exchange expertise, expected costs of delisting, visibility and investor base, sponsorship, liquidity and future financing. 4 Why has IPO underpricing changed over time? Loughran and Ritter, 5 Suggested by IPO Pricing in the Dotcom Bubble, Ljungqvist and Wilhelm, 6 Underpricing and post-listing price and profit performance of initial public offerings in Hong Kong, SEHK Research Report, 3 January The initial listing decisions of firms that go public, Financial Management, Vol 30, No.1.

5 Recent HKEx survey findings indicate that of nine possible factors important to their listing decision, Mainland China issuers rated cost factors the lowest. They were more concerned about the market s fund-raising capability and the market s international status and reputation for quality. The price-earnings (PE) ratio was also very important to them: this probably relates to the very high PE ratios obtaining on the Mainland markets. Figure 1. Factors in selecting the venue for listing for Mainland companies Mean score Fund raising capability (5.90) International status (5.61) Market reputation for quality (5.44) Price-earnings ratio (5.38) Available professional service (5.07) Regulatory issues (5.04) Quality of investors (4.99) Initial listing costs (4.49) Continuous listing and compliance costs (4.48) 0% 20% 40% 60% 80% 100% Percentage of respondents Significant (5-7) Neutral (4) Insignificant (1-3) Don t know Note: Rating was made on a scale of 1-7, the neutral score was 4. Source: HKEx Survey 2001 Although discounts on listing can be large, there is little evidence that this is a concern to issuers (other than perhaps indirectly in respect of the above mentioned importance Mainland issuers attach to the PE ratio). As regards Hong Kong issuers, this apparent lack of concern 8 may perhaps be because a low IPO price may result in oversubscription, and the issuer earns interest on the oversubscription money. There also appears to be a certain status attached to a high oversubscription rate. Findings from the same HKEx survey indicate some issuer dissatisfaction with the costs of listing 9. This may relate to the more difficult economic and market conditions of the last couple of years a similar survey conducted in 1998 did not find dissatisfaction A 1998 survey by the Stock Exchange of Hong Kong found that 41% of respondents agreed that the price determination mechanism of the IPO process was efficient and only 10% disagreed. 49% agreed that the pricing of IPOs in Hong Kong was competitive and only 12% disagreed. 9 19% of issuers found overall costs for obtaining a listing in Hong Kong competitive, while 42% found them uncompetitive, Primary Market Survey In the Primary Market Survey 1998, 38% of respondents (comprising issuers, investment bankers, professional advisers and fund managers) agreed with the assertion, Overall costs for IPOs in Hong Kong are competitive and 16% disagreed. 35

6 36 How do Hong Kong s listing costs compare with other markets? In this section, we describe the listing costs in various overseas markets: Australia, Singapore, the United Kingdom and the United States, as compared with Hong Kong. The key findings are as follows. The main component of listing expenses is underwriting fees. The underwriting fees are around 7 per cent in the United States, 5 per cent in Australia, 1.25 to 3.5 per cent (plus a 1 per cent selling fee) in Singapore and generally 2.5 per cent in Hong Kong (Main Board). In all overseas markets, the initial listing fees charged by the exchanges are relatively negligible compared to the total listing expenses. In general, the exchange charges were less than 1 per cent of funds raised. It should be noted that exchange and regulatory fees will tend to reflect the functions of the institutions involved; therefore exchange fees may not be strictly comparable between markets. In Australia, the UK and the US, the securities commissions are involved in the public offering approval process (in Hong Kong this is handled solely by the exchange); therefore the commissions fees need to be taken in account as well. In the UK, for example, the London Stock exchange charges a fee for admission to trading, while the UK Listing Authority (UKLA, an entity within the Financial Services Authority), charges a flat fee of GBP5,000 for vetting any transaction and may charge a further GBP5,000 for prevetting supplementary listing particulars. With the above caveat, among the six markets in comparison, only Singapore has lower listing fees than Hong Kong. Table 3: Listing fees as a percentage of funds raised in overseas markets Assumptions United States (%) Market Size of Fund Shares capitalisation United funds raised issued at listing Australia Singapore Kingdom NYSE NASDAQ Hong Kong raised (HK$ mil) (mil) (HK$ mil) (%) (%) (%) (%) Large 1, , Medium , Small Note: Exchange initial listing fees only (i.e. excluding any securities commission fees), based on assumptions stated as applied to respective exchange fee schedules. In Table 4, we attempt an itemised comparison of the overall costs of listing in Hong Kong with those of listing on Nasdaq and (in the case of a smaller company) the Australian Stock Exchange. This should be viewed with caution as, with the exception of exchange fees, the cost items depend on market practice, and will also vary from one case to another. With this caveat, Hong Kong appears cheaper than Nasdaq overall, largely because of the much higher US underwriting fee (7 per cent compared with Hong Kong s 2.5 per cent).

7 Table 4: Costs of listing (HK$ 000) HKEx Nasdaq ASX Funds raised 400, ,000 21,000 Underwriting fee 10,000 27, As percentage of funds raised 2.5% 7.0% 4.0% Professional fees Investment banks 2, Legal advisors 4,200 } 107 Reporting accountant 1,500 7,800* 29 Property valuer Others translation and public relations 400 Sub-total 8,850 7, As percentage of funds raised 2.2% 2.0% 3.4% Registrar and receiving banks fees As percentage of funds raised 0.1% 0.2% Communication support Roadshow 800 1,794 Announcements 650 Public relations materials and printing 1,000 2, Sub-total 2,450 4, As percentage of funds raised 0.6% 1.1% 0.9% Exchange fee Initial listing fee Trading fee 40 Sub-total As percentage of funds raised 0.1% 0.1% 0.6% Regulatory fee US SEC / Australian Securities and 78 9 Investments Commission NASD filing fee 43 Sub-total As percentage of funds raised 0.03% 0.04% Miscellaneous 1, Total 23,440 40,710 1,951 As percentage of funds raised 5.9% 10.4% 9.1% ** * Does not include reporting accountant s fee ** The cost of listing for funds raised over AU$50 mil (about HK$200 mil) would be about 3.7% of the funds raised. Note: 1 USD = 7.8 HKD, 1 AUD = 4.27 HKD, source: Reuters Power PlusPro. Conclusion The costs of listing mainly represent the underwriter s fee and the fees of professionals such as lawyers and accountants. Exchange fees account for only a small proportion of the total costs of listing in Hong Kong around 2 per cent. Given that the market for underwriting and professional services is competitive (i.e. hence the fees charged are at reasonable market rates), the overall costs of listing are dictated to a great extent by the standards of the market concerned, as embodied in the relevant laws and regulations. The costs of listing in the US are higher than the costs of listing in Hong Kong because US liability and disclosure standards are more onerous. Any move to reduce overall listing costs significantly would have to incorporate a change in the philosophy governing listings. Nevertheless, it appears that factors other than the cost of listing are more important in the competition for listing candidates. 37