Firms review strategies as HK IPO numbers fall

Hong Kong initial public offering (IPO) listings have long held the position of a necessary evil for international law firms in the city. It is widely recognised that they are a good way for firms to get name recognition with banks and build a brand in the region, but competition and the ongoing instability in equity capital markets have meant firms are looking at changing their strategies on IPO work.

Listing on the Hong Kong Stock Exchange – main board and Growth Enterprise Market – fell 20% in Q1 compared to the same period the year before, according to Mergermarket figures. In the first quarter of 2015, there were 24 listings raising $6.3bn and in the first quarter of 2016 that fell to 19 listings raising $3.6bn.

The decline has caused a reassessment that bears some similarity to the slump in IPOs in 2013. Then, DLA Piper cut ten capital markets jobs in Hong Kong, with other firms such as Allen & Overy and Herbert Smith Freehills also affected by the IPO slump.

This time around there have been less obvious scaledowns but whispers of firms dramatically cutting fees to win work persist. One Hong Kong corporate partner cites cases of firms dropping fees by to a third for mid-market Hong Kong IPO work, including the drafting.

“Firms are going really low bar to get the deal,” he adds. This situation is only exacerbated by the drop in the number of top and mid-market deals available.

“Most of the deals are below mid-market deals – anything between $300m and $600m – I do not think there are a lot of deals right now within that range,” says Simmons & Simmons corporate partner Joseph Lee. “Some of the bigger firms will have to change their strategy as there are very few big deals around.”

Shearman & Sterling has turned its attention to mid-market transactions, in response to the dwindling number of top-tier mandates in the market.

“The capital markets in China have experienced a downturn in terms of the number of transactions and major players are wading through a challenging market that has not been seen for the past four to five years,” says Colin Law, Shearman & Sterling’s China managing partner and head of its Asia capital markets group. “Even market leaders involved in significant China capital markets transactions will have to compromise on their deal selection.”

This drop in work may lead to divergent strategies by firms – those that feel they need to reduce the size of their equity capital markets (ECM) teams on one hand and, on the other, those that feel they need more exposure and will look at boosting their practice offering.

“I think it is just a matter of time in the current state of the market – I cannot see practices staying the current size,” comments one capital markets partner.

Nevertheless, a number of firms feel that ensuring ECM lawyers are equipped to do more general corporate work is key to maintaining work flow.

“Simmons & Simmons right now is not heavily reliant on IPO because we have a general corporate practice,” says Lee. “If firms do not have this skillset then they might have the problem of suffering from the downturn in the market with the diminished dealflow.”

King & Wood Mallesons M&A partner Gary Lock agrees, adding that IPOs are a way for a firm to build its corporate client list but can no longer sustain a practice, and firms need to think more strategically about what they want to offer in the market.

One of the suggested causes of the pressure on IPO work is the attitude adopted by the Hong Kong stock exchange in its approach to listings. One partner argues that if the exchange subjected issuers to more scrutiny, they would be less likely to take changes and more inclined to mandate higher tier law firms.

“The exchange keeps telling people we want to have good quality on the professional parties working with the issuer to get listed,” he says. “But when you look at it, the best thing they could do is reject applications – and there are only a few being rejected.”

Lee has some support for the argument: “It has, on one hand, to promote listings in Hong Kong and, on the other hand, to maintain the quality of those listed companies as well. It is inevitable that how the exchange strikes the balance between these may have an impact on the provision of professional services by the various professional parties and the potential issuers’ choice of professional firms, which will ultimately shape the ECM service provider landscape in Hong Kong.”

However, others disagree with this analysis of the situation, pointing to the naming and shaming of JP Morgan last month (May 2016) as a sponsor for a Chinese company that had its listing application rejected.

“That’s not an easy regulator that sets off a process that places an emphasis of naming and shaming,” says one Hong Kong corporate partner. “No one wants to be on the naughty step like that and if that’s going to happen, people will demand that people do a good job to make sure that doesn’t happen. Smaller houses have had similar treatment but it doesn’t make the news because it’s not JP Morgan.”

Lock says the exchange has taken more of a back seat recently in reviewing applications – instead relying on the sponsors to “do the job properly and make the right disclosure”.

“I think that is the right way to do it,” he adds.

Austin Sweeney, Herbert Smith Freehills’ Asia corporate head, says the drop in IPOs is due to external factors, such as the China market selloff at the start of the year and the traditionally quiet period around Chinese new year.

Looking ahead, partners within the market are more optimistic about the latter half of the year.

Linklaters’ Asia corporate head Robert Cleaver says: “When a good deal gets away, people take confidence from that so I will say there is cautious optimism on the back of some better deals in the market very recently.”

The firm is currently advising on BOC aviation’s $1.5bn Hong Kong offering, alongside Allen & Overy and Freshfields Bruckhaus Deringer.

“Once we get past some of the economic and political factors that are holding listings back, then I expect to see listings return – there is a strong pipeline of listings queuing up for Hong Kong and plenty of liquidity in the markets for the right offerings,” concludes Sweeney.