March 22, 2017 / 11:08 PM / in 4 months

China tells cornerstones to bring money home in blow for smaller HK IPOs: sources

FILE PHOTO - A Hong Kong Exchanges flag (L) is hoisted beside a Chinese national flag outside the Hong Kong Stock Exchange in Hong Kong June 7, 2016.Bobby Yip/File Photo

HONG KONG (Reuters) - China has made it mandatory for mainland cornerstone investors in Hong Kong IPOs to repatriate funds when they sell their shares, a rule likely to hit smaller, cornerstone-reliant listings, four people with knowledge of the matter told Reuters.

The State Administration of Foreign Exchange (SAFE) has informed investment bankers and lawyers of the rule, borne out of government concern that cornerstone investment allowed large amounts of funds to leave the country and contribute to a decline in the value of the yuan, the people said.

Prospective cornerstone investors in Hong Kong initial public offerings (IPOs) of mainland firms now have to inform Chinese regulators of their intentions and promise to return funds to the mainland whenever they sell holdings, the people said.

"What the regulator is basically saying is that they won't let the non-serious Chinese investors exploit the cornerstone route to take capital out of the country and park it offshore," said one of the people.

SAFE, part of the People's Bank of China, did not respond to a faxed request for comment. The four people were not authorized to discuss the matter with media and so declined to be identified.

Hong Kong Hopefuls

Cornerstone investors are usually institutions that agree to buy a large proportion of shares sold through an IPO, which they are bound to hold for at least six months. Such investors dominate in Hong Kong to an extent unseen in other countries.

China's new cornerstone rule comes as Hong Kong braces for a high number of potential IPOs spurred by a 10 percent rise this year in its benchmark share index - the best-performer among major Asian stock markets.

The rule could make IPOs more difficult for small and mid-sized listing hopefuls, as well as firms that would struggle to attract foreign investors, which often fall back on "friendly" funds and wealthy individuals in China, the people said.

"Regulators are not outrightly restricting outbound capital flows per se, but they are certainly trying to clamp down on methods that are less visible and manageable," said Jonathan Ha, chief executive of Shanghai-based markets researcher Red Pulse.

"The likely impact of this new policy is a moderation of demand for investment into these IPOs, without necessarily a bias based on smaller versus larger IPOs."

Capital Outflows

Last year, the 10 biggest listings of Chinese firms in Hong Kong saw cornerstone investors - nearly all mainland entities - buying 50 percent to as much as 78 percent of shares on offer, Reuters calculations showed.

Some IPOs last year were subject to the new cornerstone rule which was informally implemented from the $7.4 billion September listing of Postal Savings Bank of China Co Ltd, two other people familiar with the matter also said on condition of anonymity. The bank did not respond to a request for comment.

SAFE started to enforce the rule more broadly at the beginning of this year, they said.

Cornerstone investors bought about a third of shares in Chinese companies listing in Hong Kong in January, from 43 percent in December, showed a Thomson Reuters calculation based on public data.

The government has been trying to reduce the amount of money flowing out of the world's second-largest economy to support a yuan that last year fell 6.5 percent against the U.S. dollar.

But it is likely to continue supporting Hong Kong IPOs of mainland firms and the participation of cornerstone investors, said Tiecheng Yang, partner at law firm Clifford Chance.

"The special arrangement will be quite useful to open up a new channel for Chinese cornerstone investors to invest in overseas securities, especially under the current climate of tightened foreign exchange outflow control in general."

Reporting by Sumeet Chatterjee and Julie Zhu; Additional reporting by Elzio Barreto, Katy Wong and Elaine Tan; Editing by Anshuman Daga and Christopher Cushing

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