In Asia, the ability to use, and abuse, cornerstone investors is a hallmark of IPOs. They provide a crutch in hard times, allowing bookrunners to quickly cover a trade even when the market is sinking. But relying on cornerstones is equally popular in good times.
They feature heavily in deals in China, Hong Kong, Malaysia and Singapore. The practice is gaining prominence as Chinese money goes offshore, and funds are coming to terms with the fact that signing up early is frequently the only sure way to secure allocations.
The majority of listings in Hong Kong are pre-sold to cornerstones, which enables banks to tell investors at the start of order-taking that an offering is fully covered. The others better move fast if they want a seat at the table.
That, of course, tips the scale in favour of the issuer, whose bankers can then tout the trade as having secured a cadre of high quality names to ensure a successful transaction.
But while it gives the book a sense of strength, it is also a regressive exercise because it can create an appearance of scarcity that then encourages a herd-like mentality among other investors, making them all the more eager to sign up for paper. They end up trying to keep up with the Joneses in order not to be shut out of deals.
In a mature market, banks start bookbuilding at a low valuation and then move higher. But by turning to cornerstones, market participants obfuscate the process of price discovery, letting the early investors dictate the terms for everyone.
And in cases where a large number of shares are locked up by the cornerstones, it leaves only a token amount of stock for bookbuilding. Demand for what is left for the broader book will look inflated.
Market participants need only look at last week’s crash in China’s domestic stock market to see how the herd effect can have grave consequences. There was almost no end to the panic, and Shanghai endured its worst loss in two decades.
Whether China’s latest state interventions to restore calm in its market will have the intended effect is an argument for another day, but what is relevant here is that trying to inject artificial momentum into a market can easily end up backfiring.
That's why leaning on cornerstones now more than ever would be the wrong approach — in fact, the objective should be to do away with such reliance altogether. ECM issuers and their advisers should instead focus on real money accounts and a bona fide bookbuilding process. In the US or Europe, for instance, cornerstone support is not a prerequisite.
It will take some getting used to. But it is a process that both the buyside and sellside in Asia have to take together if they want to see markets grow stronger. The outcome will be hard-fought, but well worth it.
Losing a limb that has been as vital as the cornerstone investor will be painful at first. But done right, it doesn’t need to be a handicap.