The Stock Exchange of Hong Kong Limited (the Exchange), a wholly-owned subsidiary of Hong Kong Exchanges and Clearing Limited, clarifies that it will consider granting waivers to individual applicants applying for initial public offerings on the Main Board from complying with the profit test requirements under Main Board Listing Rule 8.05(1)(a) (the Waiver), where their profit over track record has been temporarily and adversely affected by the financial crisis. 

Background

Existing Profit Test

Main Board Listing Rule 8.05 sets out the basic conditions applicants must satisfy in order to apply for a listing.  Applicants must satisfy either the profit test in rule 8.05(1), or the market capitalisation/revenue/cash flow test in rule 8.05(2) or the market capitalisation/revenue test in rule 8.05(3).

Under rule 8.05(1)(a), in order to meet the existing profit test, a new applicant must have an adequate trading record. This means that an applicant, or its group (excluding any associated companies and other entities whose results are recorded in the applicant’s financial statements using the equity method of accounting), as the case may be, must satisfy the following requirement:

“a trading record of not less than three financial years (see rule 4.04) during which the profit attributable to shareholders must, in respect of the most recent year, be not less than HK$20,000,000 and, in respect of the two preceding years, be in aggregate not less than HK$30,000,000. The profit mentioned above should exclude any income or loss of the issuer, or its group, generated by activities outside the ordinary and usual course of its business;”

The Exchange has recently published listing decision series 66 to clarify its position and assist potential applicants in understanding the facts and circumstances of different scenarios in determining whether particular financial gains or losses are within the “ordinary and usual course of business” for the existing profit test.

Impact of the Financial Crisis

The global market downturn has adversely affected the economy.  It has also highlighted a limitation of the existing profit test as an indicator of an applicant’s future performance where circumstances have changed radically.  The financial crisis may have negatively impacted the profit attributable to shareholders for potential applicants for a listing on the Main Board. This may be a result of mark to market write-downs or impairment losses, rather than because of recurrent losses or fundamental deterioration of commercial or operational viability. 

The Exchange considers that granting a Waiver to applicants from strict compliance with the existing profit test, may be warranted in certain circumstances.  The Exchange believes that in cases where the negative impact is temporary in nature, these potential applicants should not automatically be rendered ineligible for listing. 

The Waiver and the Factors

Potential listing applicants may apply for a Waiver to the Exchange who may exercise its sole discretion to grant a Waiver from the requirement of Main Board Listing Rule 8.05(1)(a).  The Exchange will consider each Waiver application on its own merits based on the facts and circumstances of each applicant.  The following factors are relevant in the assessment of any Waiver application:

1.	An applicant must have an aggregate profit attributable to shareholders of at least HK$50 million in respect of the last three financial years immediately preceding the application for initial public offering.
2.	An applicant should be able to show that, were it not for temporary condition(s), its operating profit over those three years would have been significantly in excess of HK$50 million.
3.	The three year track record period must include at least one financial year that ended on or after 31 December 2008.
4.	There must be a positive cashflow generated from operating activities in the ordinary and usual course of business before changes in working capital and taxes paid in the last financial year during the track record period.
5.	An applicant must demonstrate to the satisfaction of the Exchange that the condition(s) and circumstance(s) which led to its inability to meet the existing profit test are temporary.  The listing document must also contain adequate disclosure regarding:
	(a)	the likelihood of continuance or recurrence of these condition(s) and circumstance(s); and
	(b)	the measure(s) that it has taken or will take to mitigate the impact of these condition(s) and circumstance(s) on future profits.
6.	An applicant must demonstrate that it will have adequate working capital for 12 months operation after listing.

These factors are not exhaustive and will not by themselves determine the outcome of a Waiver application.  Listing applicants are encouraged to consult with the Listing Division of the Exchange at the earliest possible opportunity to seek informal and confidential guidance as to the likelihood of success of a formal Waiver application.

Review of the Existing Profit Test

We also note that certain market participants have expressed the view that the existing profit test may not be a useful indicator of an applicant’s future performance and questioned its appropriateness as an eligibility requirement for listing.  The Exchange will review the existing profit test and other components of the eligibility requirements at a suitable time.