by Koo Lap

Paul Chan’s Budget speech addressed a myriad of topics in the financial industry, including asset and wealth management, international financing, insurance and risk management, offshore RMB hubs, etc., praising the industry as the key of value-added activities that make up 21% of Hong Kong’s GDP, and 7.1% of the employment rate. He said that the industry’s contribution does not stop at being “an important support for the real economy”, but that it also carries the important responsibility of “assisting in the safe and orderly promotion of financial opening up in the mainland to support the country’s development in the real economy”; thus it must “continue to strengthen Hong Kong’s leadership role in global finance” and on and on. How to “strengthen”? To increase stamp duty by 30% on the financial industry!

While Paul Chan was still intoxicated in the dream that tax increases could “bring Hong Kong’s financial industry to a higher level”, our newspaper has reported that Li Ka-shing, Hong Kong’s richest man, and his youngest son Richard Li, third-generation New World Development heir Adrian Cheng, and veteran investor V-Nee Yeh have gone to raise funds on Wall Street, where there is no stamp duty. This has not bothered Paul Chan, or stopped him from being pleased with himself. He claimed that Hong Kong is “the preferred international fund-raising platform”, with “the initial public offering amounting to HK$397.5 billion (US$51.2 billion), a 27% from the year before” last year. Yet the Hong Kong wealthy and successful have given up on this traditional fund-raising approach and opted for something else. Why is that?

The Li’s and the Cheng’s, and even the Yeh’s, have given up on IPO – what Paul Chan called the “initial public offering” – and instead adopted SPAC (Special Purpose Acquisition Company) that has been in vogue on Wall Street since 2009 to raise funds. In the past 11 years, there have been a total of 304 such SPACs to be listed in the United States and raised a total of US$78.3 billion. Initially, the average amount of funds raised by these companies was only US$36 million, but by last year, it had reached tenfold to US$ 400 million. There is indeed a lot of support. These companies have no business, and some bank on the reputation of the “sponsors” such as Li Ka-shing and V-Nee Yeh.

Investors are betting on these “sponsors” with the confidence that they will be acquiring companies within two years, and indirectly list those on the market. The whole operation is like cocooning unlisted companies in a shell company; the role of the SPAC sponsor is a reverse takeover, find investment targets, and give idle capital a way out; once successful, the profits from the rising stock price will be shared with the investors Why has “reverse takeover” fundraising become popular in this decade? This is of course inseparable from the two major factors of supply and demand.

On the demand side, although Paul Chan takes pride in the amount raised in Hong Kong’s IPO, this way of fundraising can be expensive and passed up by Wall Street investors. How expensive? Research shows that, generally speaking, 7% of the funds raised must be paid to financial institutions, lawyers, and accountants who sponsor the listing. In addition, in order to attract investors to subscribe for new shares, the subscription price has an average discount of 31%, meaning that the total fundraising expenditure can be as high as 38% (7%+31%=38%). Raising funds through SPAC eliminates the red tape of auditing performance and due diligence, which can greatly reduce operating costs. From 1980 to 2019, an average of 215 companies raised funds on Wall Street IPOs each year, however in the past four years, the number has dropped by half to an average of slightly over a hundred companies per year. IPOs are costly, and this is why people hesitate.

On the supply side, since the financial tsunami, quantitative easing in the United States alone has brought about more than US$4 trillion in new banknotes in the country. Since the Wuhan virus, an additional US$4 trillion was printed last year; the money supply according to M2 increased by 26% within one year; such magnitude was unprecedented since 1943. That was the year when the United States was at war in both Europe and the Pacific, and its military expenditure was unprecedented! Without even getting into how much inflationary pressure this massive printing of banknotes would bring, it is evident that with the flood of hot money, interest rates have slipped below the horizon. There is no way out for funds, and investors are therefore betting on “sponsors”.

Of course, SPAC is by no means a sure-win, guaranteed investment. This kind of investment with no practicality, and is solely relying on the credibility of a “sponsor” reminds one of the junk bonds in their various forms that eventually detonated the financial tsunami. It is still too early to tell if SPAC will trigger another financial tsunami. The undisputed fact here is that when Wall Street is trying its best to lower the cost of fundraising, Paul Chan has instead taken pride in the costly IPO fundraising method, a poisoned chalice, with the illusion of taking the financial industry to a whole new level through tax increases. How is this not some nonsensical somniloquy by someone with his head in the clouds?

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