There is a lot of excitement in our market over the new rules we introduced earlier this month to welcome new economy and pre-revenue biotech companies. We’ve already had several companies express interest in listing under the new rules, and we’ve heard a lot of positive things from investors who are excited about being able to invest in some of today’s most dynamic companies right here in Hong Kong.
While it’s exciting to have access to the new economy, some of these companies come from sectors that are not as familiar to Hong Kong investors. We have a lot of retail investors in our market and a strong regulatory regime that strives to protect investors as much as possible — but there are still inherent risks when investing in any company. Biotech, in particular, is one field where companies could become a wild success or flame out into nothing, quickly.
So why did we want to open our market to risky biotech companies?
Pre-revenue companies tend to be high risk and lack the usual metrics of revenue or profit that investors use as yardsticks for valuation. This is why our Rules have not allowed such companies to list in the past. However, biotech companies are something of a special case, since the very nature of the strict and lengthy approval processes for their products means that they are unable to produce revenues at precisely the time when they need capital the most.
On the other hand, since developing a new medication is a lengthy process that requires substantial research and development phases, multiple clinical tests, and ultimately an approval process by national healthcare regulators, biotech companies follow a path with clear milestones that can help investors judge their stage of development and level of risk.
I mentioned in my previous blog that there is growing demand for new healthcare products and services to meet the needs of China’s middle class, which numbers some 400 million people. Because of their potential to change people’s lives, heal ailments, cure diseases, and allow us to live healthier, happier and longer, it is important that we connect the capital market with the biotech industry so emerging companies in need of investment have access to capital.
What are the particular risks involved in investing in biotech?
As I mentioned, developing a new medication does not happen overnight. It could take years, and most drugs never make it. Because these products involve the health and safety of the public, they are strictly regulated by governments. So even if a company passes multiple clinical trials, there’s no guarantee a problem won’t emerge in the last mile. One poor test result could lead to a dramatic decline in a company’s market cap.
We tend to see a few big risks that investors should keep in mind. First, investors can become overly enthusiastic about biotech, especially when it’s newly available on public markets, and get ahead of themselves. It’s true that many of these companies are working on products that could literally change the world, so their potential can be limitless. This generates a lot of enthusiasm and excitement that often glosses over the potential risks. Second, we’ve seen some unsophisticated investors enter this space with confidence, thinking it’s like other sectors, when it has unique characteristics and a much higher degree of risk. Third, biotech is more susceptible to insider trading. The reality is the life sciences and biotech sectors are extremely complex and require very specific expertise to understand. Public information, especially during the research and testing stages, is scarce; it is much different from a car company or luxury goods brand, with huge returns from dealing on inside information even more tempting than usual.
If the risks are so high, why not just set the entry bar higher?
As the operator of a major global stock exchange, we knew we wanted to open our market to these companies – despite the risks – because they need funding and investors are eager to tap their vast potential. But as a responsible regulator, we had to ask ourselves: “How mature should a company be before we allow it to list publicly? Where do we set the bar?”
If we allowed early-stage companies to list, we would be exposing investors to a higher degree of risk. But if we allowed only late-stage companies, they would already be more established and have fewer funding needs. It’s a spectrum, and we needed to set the bar somewhere in the middle, somewhere it makes sense for Hong Kong — we want to ensure companies that need funding can get it, while the risk is kept as manageable as possible for investors.
Did we get it right? I don’t know. We spent a lot of time on it, we examined the experiences overseas, we looked at the needs of the industry, and we consulted with a series of experts as we drafted the rules. This is new to us, too, so we are in regular communication with the market, have hired people more familiar with the sector, and recently formed the Biotech Advisory Panel to help us clarify or answer questions that pertain to a specific biotech issuer, or more generally to the biotech industry as a whole.
What are the main risk mitigation measures for investors?
With the advice of experts in the sector, we have set a range of entry criteria that biotech companies must meet before they can list. These include a minimum market value, the need to have reached certain milestones in their research and development, and to have received investment from sophisticated investors. The most important measure, however, is ensuring relevant, accurate and adequate disclosure.
If a company meets these criteria, then they will be allowed to list. We cannot pick and choose listing candidates depending on our whims. As a regulator and market operator, we are never going to be as smart as the market and, while we will exercise due care in our review of listing applications, it is up to investors to determine value and whether or not to invest.
What’s the role of the Biotech Advisory Panel?
The Biotech Advisory Panel doesn’t have any authority to approve or reject listings, but members can advise the Listing Department and Listing Committee on certain areas that may need to be clarified or expanded on in a company’s draft prospectus, for example. In other words, the Panel will play the role of a passive advisor to provide guidance on information disclosure; it will not be vetting listing documents or play a gatekeeping role.
If the Exchange can’t pick and choose the optimal listing candidates, then why not control the number of applicants at the beginning to limit speculative activity?
It’s been a long road leading to this new Biotech Chapter of our Listing Rules and we are about to receive the first listings of pre-revenue biotech companies here in Hong Kong. While we hope for a steady and gradual development of the market, there is of course a risk that investors get carried away, leading to a market boom and bust. This is something that has happened in other markets, like the US, Europe and Taiwan. This can obviously be painful for investors, so it’s important we learn from their experience.
That said, Hong Kong has always operated an open and fair regulatory regime, adhering to the rule of law. Therefore, while we can set the listing criteria, clarify the rules, and require more stringent disclosure requirements for biotech, it’s up to market to set the pace and decide the inherent value of any given firm. Nobody can entirely eliminate risk in this sector, not even regulators. So it’s a “buyer beware” market.
So what should investors do?
With the first wave of these companies set to list soon, investors must be cautious and exercise good judgment when trading in these shares. Because of the complexity of the industry, investors should have good professional knowledge and be willing to take on substantial risk if they plan to jump in. It’s not for the faint-hearted investor. So do your homework, make sure you have a diversified portfolio, and seek advice if you’re not sure whether to invest in a specific company. If you want exposure to the sector but don’t fully understand its inner workings, a fund or ETF might be a more suitable option.
It will take a few years before we see a deep pool of talent, investors, and analysts in our biotech ecosystem. Our goal of a healthy and robust ecosystem could be threatened if a large number of investors jump in early and one or two companies ultimately fail. So let’s be patient, be prudent, and do our best to make this work over the long term.
Biotech is a burgeoning industry globally that is drawing a lot of attention and excitement. I am delighted that Hong Kong can play a critical role by providing needed funding to these firms so they can continue on their quest to create new medicines, treatments or services that could improve real human lives. With the support and understanding of our market, I have no doubt that we can make Hong Kong a leading fundraising centre for the best and brightest biotech companies in the world.
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