Spotify and Slack have done it and AirBnB could soon follow: more and more renowned companies are going public by way of a so-called direct listing. Different from traditional IPOs, shares are only admitted to trading and no fresh money is raised. Capital market lawyers from different countries explain how this works and what to consider.

In order to illustrate the characteristics of direct listings, also called direct public offerings (DPO), it is worth first looking at Initial Public Offerings (IPO): the company offers its shares for the first time publicly for sale and allows them to be traded on the stock exchange. In order to raise fresh equity from investors, a capital increase is taking place. The share capital of the company is increased and new shares are issued which leads to a dilution of shareholders’ voting rights. Existing shares can be sold on the market.

No capital increase

In the absence of a capital increase during a direct listing, there is no dilution. Instead, only existing shares are offered on the market and admitted to trading on the stock exchange. On the one hand, the company does not receive any additional equity capital. In other words, direct listings are suitable for profitable or well-funded, sufficiently capitalised companies that do not need fresh money – as was the case with Spotify in 2018 and Slack in 2019.

No underwriting

On the other hand, the absence of a capital increase also means that an underwriting is not required: in case of a traditional IPO, investment banks undertake to place a defined number of shares on the market and, if this is not successful, to take them on their own books. Talking about direct listings, this is not necessary which is why investment banks only act as advisors.

Offer and demand decide on price

The issuer sets the offering price, the minimum investment amount and the maximum number of shares to be purchased per investor, the settlement date as well as the offer period. Unlike an IPO, the offering price is not predetermined based on a market sounding but on supply and demand on the first trading day. In addition, there is no lock-up period of usually 180 or 360 days for the existing shareholders in a DPO and no lock-up agreement. In addition, direct listings do not require price stabilization measures such as the exercise of the greenshoe option during an IPO.

>> Direct Listings in Hong Kong

“Hong Kong has not yet seen direct listings of the type seen in the Spotify and Slack listings on the New York Stock Exchange, although its own stock market, Hong Kong Exchanges and Clearing Limited, directly listed on its own market, The Stock Exchange of Hong Kong Limited (HKEx), as far back as 2000”, says Julia Charlton, Managing Partner at Charltons based in Hong Kong.

The new type of direct listing could be achieved on HKEx by means of a listing by introduction, a method of listing issued rather than new shares, where no marketing is required because the shares already exist in such numbers and are so widely held, that an open market for the shares can be assumed.

Listing by introduction on HKEx is normally appropriate for secondary listings on HKEx of companies primary listed elsewhere and for migrating shares from another stock exchange to HKEx. “Listing by introduction offers a well-trodden route to secondary listing, and was successfully used by NYSE-listed Alibaba Group Holding in its November 2019 secondary listing on HKEx”, adds Clinton Morrow, Partner at Charltons. For a direct listing of the type seen on the NYSE, HKEx would need to be approached to confirm that listing by introduction is appropriate.

Key Listing Criteria in Hong Kong

The requirements for listing a company by introduction are essentially the same as for a company listing by way of IPO. The following is a summary of the principal requirements for listing, although alternative requirements apply to specific types of company such as tech and other innovative companies with weighted voting rights structures, pre-revenue biotech companies and mineral companies.

  • Companies listing on HKEx’s Main Board must meet one of 3 financial tests: the profit test, the market capitalisation/ revenue test, or the market capitalisation, revenue, cashflow test. There are lower entry criteria for HKEx’s second board, GEM.
  • In addition, a company listing on the Main Board must have a track record of 3 years with management continuity of 3 years and 1 year of ownership continuity.
  • Moreover, companies applying to list on GEM require a 2-year track record, 2 years’ management continuity and 1 year of ownership continuity.

Public Float and Restrictions on Listing in Hong Kong

A free float of 25% of the company’s issued shares is required, although this may be reduced to 15% for companies with a market capitalisation of HK$10 billion.  A minimum of 300 shareholders is required for companies listing on the Main Board, while GEM requires a minimum of 100 shareholders.

The Listing Rules provide that the existence of significant public demand for the shares proposed to be listed would make listing by introduction unacceptable to HKEx. The application of this rule would need to be discussed with HKEx in the context of a proposed direct listing.

Other bars to listing by introduction are:
– marketing of the shares in the 6 months prior to a proposed introduction where marketing was conditional on listing being granted for those shares;

– and where a change in the nature of the business is contemplated.

Sponsor Due Diligence Requirement in Hong Kong

While there is no requirement to appoint underwriters for a listing by introduction, which will mean cost savings in terms of fees, a peculiarity of the Hong Kong listing regime is the requirement for the appointment of an independent sponsor to advise listing applicants. “The sponsor’s obligations include extensive due diligence on the listing applicant’s group to enable it to give the required assurance to HKEx that the listing document information is accurate in all material respects”, says Julia Charlton.

The sponsor will be an investment bank holding an SFC sponsor licence. The scope of the due diligence process is broad and must be tailored to the particular company’s circumstances. The due diligence process for a direct listing by introduction will be the same as for an IPO.  Accordingly, the cost savings on a Hong Kong direct listing would likely be less significant than for a comparable listing on NYSE.

>> Direct Listings in Brazil

“Brazilian securities law (Law 6,385, December 7, 1976) and regulations require that any listing or admission to trading to a stock exchange must be made by a member of the distribution system as defined by the law such as investment banks or broker-dealers”, says Luis Souza, Managing Partner at Souza Mello Torres based in São Paulo.

The Securities and Exchange Commission of Brazil (Comissão de Valores Mobiliários Busca Avançada / CVM) is currently submitting to a public audience drafts of new regulations intended to unify the self-regulation of organized markets and of financial market’s infrastructure employed for trading in the securities market (public audience SDM 09/2019, available at www.cvm.gov.br).

CVM as a justification for the new regulations recognizes that: “new technological reality together with the trade practices evolution resulted in a higher relevance of the final investor in the trading process, particularly in transactions within organized markets. Despite the fact that in an exchange market the participation of a member is a requirement, in practical terms this intermediary has a role increasingly less connected with the trade itself”.

Under the proposed rules listing is always made upon request of the issuer and involves various obligations for initial listing and for maintaining a listing and admission to trading is granted upon request of a participant and issuer consent is not necessary. “In a foreseeable future we may have direct listing in the local exchange”, comments Luis Souza.