Should Hong Kong permit weighted voting rights?
CSj conducts an unofficial poll on the most hotly contested corporate governance issue in Hong Kong at the moment.
A quarter of a century ago, the Hong Kong stock exchange came under pressure after three of the city’s most powerful conglomerates – Jardine Matheson Holdings and Li Ka-shing’s Hutchison Whampoa and Cheung Kong – announced their intention to switch to dual-class share structures by issuing ‘B’ shares, which in practice would have increased their voting control without changing their equity stake. Uproar followed, and the Hang Seng Index tumbled in fear that more companies would follow suit.
On 8 April 1987, the stock exchange and the then Office of the Commissioner for Securities declared that the listing of ‘B’ shares would no longer be permitted. The market drew a sigh of relief and stock prices bounced back.
Fast forward to the present and the issue of dual-class share structures and weighted voting rights (WVR) is back on the agenda in Hong Kong. Chinese e-commerce giant Alibaba’s decision
to list in New York – where it broke world records by raising US$25 billion – followed Hong Kong’s refusal to allow the company’s self-selecting partnership, including founder Jack Ma, to control the majority of board nominations irrespective of their equity stake in the company.
The stock exchange’s decision was both praised and criticised; investor protection principles were safeguarded but the city lost a monumental deal. In the aftermath of the decision, many have been asking how many more Alibabas Hong Kong will lose if it upholds the ‘one share, one vote’ principle? And, on the other hand, what would be the cost of relaxing the rules in terms of investor protection?
In an interview with CSj at the stock exchange’s office in Central, Hong Kong Exchanges and Clearing (the Exchange) Chief Executive Charles Li explained that the question needs to be carefully discussed as the future of Hong Kong’s long-term competitiveness is at stake.
‘The globalisation of financial markets has meant that Chinese companies and overseas companies seeking to raise capital with a WVR structure have the option to list elsewhere rather than list in Hong Kong,’ he explains, adding that Hong Kong investors can easily trade on overseas markets via brokers or online services. ‘For these reasons, arguments relating to Hong Kong’s competitive position vis-à-vis other markets, principally the US, require consideration and debate.’
He adds that the main issue is not the competitiveness of the Exchange, but of Hong Kong’s future as a financial centre. He has previously said in a blog post: ‘The market needs to be regulated, but it also needs to be developed’.
Under the current rules, a shareholder cannot have greater voting power than another if both have the same amount of equity in a company. This is commonly known as the ‘one-share, one-vote’ concept. But Charles Li points out that the listing rules should ‘reflect currently acceptable standards in the market place’ and, since the issue was last reviewed, much has changed, especially regarding the growing influence of Mainland Chinese technology companies and increased competition from overseas markets.
Dual-class share structures are relatively common in the US and account for around 14 percent of the market capitalisation of all large cap companies. In the late 1980s, the New York Stock Exchange lifted its ban on WVR after increased competition from NASDAQ. Many tech and media firms, including Google, Facebook and Mastercard, adopted a dual-class system when they went public to enable the founders and main leaders to retain control of the company’s operations despite the dilution of their ownership stake.
Time for a rethink?
Neither Charles Li nor the Exchange has formed any view for or against WVR, but they believe that the issue needs to be debated. ‘We believe’, Charles Li says, ‘that there is sufficient merit in WVR structures being the subject of review and a comprehensive public debate’.
Hong Kong’s Financial Services Development Council (FSDC) also recommends that the ‘one share, one
vote’ concept should be reconsidered via a public consultation. ‘If the right balance can be struck between market efficiency and high regulatory standards, introducing a suitable level of flexibility in the rules may help attract more types of enterprises to the market and diversify the range of companies listed in Hong Kong,’ the FSDC states in its paper Positioning Hong Kong as an International IPO Centre of Choice.
In August 2014, the Exchange issued a Concept Paper seeking views on whether governance structures that give certain persons voting power, or other related rights, disproportionate to their shareholding should be permissible for companies listed or seeking to list on the Exchange’s markets. The deadline for responses to the Paper was 30 November 2014. If the Exchange finds support for changing the listing rules, it will then embark on a second stage with further, more detailed, consultation. If not, the issue will be dropped.
The ‘yes’ vote
Given the number of companies interested in listing with a WVR structure, this is an important decision for Hong Kong. Dr Brian Lo, Vice-President and Company Secretary of APT Satellite Company Ltd, believes the current rules are outdated and in need of modification in order to maintain or strengthen Hong Kong’s position in the global arena.
He acknowledges that WVR would pose risks for minority shareholder protection, but points out that measures could be introduced to guard against these risks. ‘Even though the new system may have weaknesses, I think we can cope with that.
If it’s well studied, planned, regulated and balanced, I think Hong Kong can manage it. Investors are very smart’, he says. In addition to minority shareholder protection, Dr Lo believes regulators would need to consider measures designed to ensure the full disclosure of risk and the implications of the absence of a class-action legal system in Hong Kong would also need to be examined.
For Dr Lo, however, the bottom line is the fact that Hong Kong needs to keep pace with the global trend. ‘Hong Kong needs to be more competitive,’ he says. ‘The listing system has a gap with reality and we have to review it so we can follow industry trends. We need an open system and an open mind.’
He adds that Alibaba will not be an isolated case and this seems to be confirmed by the increasing number of WVR listings in overseas markets. Of the over 100 Mainland Chinese companies that have chosen to list on US exchanges, almost one third have a WVR structure. These companies include tech giants such as Baidu, Weibo and JD.com. This third represents 70 percent of the market capitalisation of all New York listed Mainland Chinese companies.
Moreover, this trend seems to be accelerating. Since 2011, the number of Mainland Chinese companies listing in the US with WVR structures has been greater than those listing without them. Up to October 2014, 10 of the 13 Mainland companies opting for a primary listing on the NYSE or the NASDAQ did so with these structures.
Lei Jun, founder of Chinese mobile phone giant Xiaomi, was quoted by the Hong Kong Economic Times as saying that Hong Kong has an advantageous position in attracting Mainland technology companies as it already has many Mainland investors and customers. But in order to be appealing to these talent-based tech firms, the city must follow the reform trend and allow dual-class share structures.
‘If Hong Kong doesn’t change, quality companies will go to the US and so will market liquidity’, said Mr Lei. Xiaomi is currently the world’s third-largest smartphone maker after Samsung and Apple and is reportedly aiming for an initial public offering as early as next year.
Mr Lei said that Hong Kong’s prohibition of dual-class shares, as well as the Main Board’s profits test and market capitalisation requirements, put a lot of pressure on tech firms. Unlike traditional businesses, which are capital-intensive, IT companies’ most important assets are its people and their vision. Therefore, Mr Lei said, founders of innovative companies treat their businesses as their children, which should bring long-term stability for the company and its shareholders.
Also the launch of the Shanghai-Hong Kong Stock Connect, which establishes mutual stock market access between the two markets, adds urgency to the question. The link would fundamentally alter Hong Kong’s attractiveness as a listing venue for overseas companies, given the possibility of accessing Mainland investors directly through Hong Kong. But, under current rules, companies such as Google and Facebook with dual-class share structures would not be welcomed.
‘Our current restriction on WVR structures would prevent any of these companies from listing in Hong Kong’, Charles Li points out.
The ‘no’ vote
Michael Cheng, Research Director at the Asian Corporate Governance Association (ACGA), whose members include big funds and institutional investors, believes it would be a big mistake to introduce WVR as it would deteriorate investor protection and create mistrust in the Hong Kong market.
‘We strongly oppose the separation of economic interests and ownership rights’, he said. ‘Global investors would oppose this as a basic principle when controlling shareholder interests are not aligned with other shareholders, especially minority shareholders’.
Earlier this year, a survey of 54 fund managers by the ACGA found 98 percent opposed to listed companies having structures with classes of shares allowing controlling shareholders to have more votes than others. No one was in favour. Non-standard partnership structures – such as those giving partners the right to nominate a majority of the board of directors – met a similar level of rejection (94% against).
Investors would also be likely to apply a significant discount to the Hong Kong market – on average more than 13 percent – if non-standard shareholding structures became common, the survey found.
‘That would be greatly unfavourable for Hong Kong’s long-term position as a global financial centre. Just picture the scenario where investors would apply a double-digit discount to every stock listed on the Hong Kong Stock Exchange’, Michael Cheng says.
Respondents to the ACGA’s fund manager survey were also sceptical about the option to permit exemptions from the WVR prohibition for ‘innovative companies’. Respondents felt that ‘innovative companies’ as a group would be extremely difficult to define and the move may open the door to multiple exemptions.
Mr Cheng also highlighted the fact that, unlike in the US, there is no class-action lawsuit system in Hong Kong. ‘It is very clear that we must protect Hong Kong’s competitiveness by maintaining quality’, he said. ‘If you only ask for more flexibility and it becomes a race to the bottom, then the short-term increase in turnover or business would ultimately threaten long-term development
April Chan, Company Secretary of CLP Holdings, one of the largest investor- owned power businesses in Asia Pacific, and former President of the HKICS, believes fair treatment of all shareholders remains of fundamental importance to investors and that ‘one share, one vote’ continues to be the best structure to promote good corporate governance.
‘Any deviations from this structure would require adequate minority protections, which are at risk of abuse’, she says, highlighting the fact that the culture and legal environment of US is very different from that of Hong Kong. ‘We don’t see there is any scenario where investor protection could be improved by introducing a WVR structure’.
While some people say introducing WVR structures would enhance the city’s competitiveness, April Chan fears it could have the opposite effect. She warns that any divergence of economic and voting interests may lead to agency problems. ‘Should anything go wrong on the board or business of a dual-class company, it would be hard for the investors to have an equal say with the “privileged” members,’ she says.
A recent case highlights just such a scenario. Founder of China dating app Momo was accused of graft and theft just days ahead of Momo’s NASDAQ IPO in 2014. The company has a dual-class share structure with its co-founder, chairman and chief executive officer Yan Tang owning all class B shares, retaining 78 percent of the aggregate voting power, according to the filing. The allegations might leave investors concerned about the firm’s leadership but with little they can do about it.
David Webb, an activist shareholder and former HKEx independent non-executive director, has been a vocal critic of WVR. ‘The problem is that it opens the door to greater abuse of minority shareholders, which is already quite bad’, he says. As part of his submission to the Exchange’s Concept Paper, he launched a petition against the idea of WVR.
The whole idea of protecting founding managers from being outmaneuvered by shareholders is contradictory, according to Webb. All these American companies with dual-class structures would be better off without them in the long run, as they insulate management from accountability, he argues. This is a particular risk where a company is run by founders who have an emotional and sentimental attachment to their life’s work and don’t realise when outside help or a change of management is needed.
‘The reality is that if they have good managers and confidence in their abilities, then they shouldn’t be worried about the remote possibility that they might one day be removed from the board. They should regard that as a healthy mechanism’, Webb says.
Webb cites the ‘trapdoor articles’ of e-commerce firm JD.com, listed in New York, as a good example of the risks of these types of control structures. JD’s articles state that a board meeting is not valid unless the founder and CEO Liu Qiangdong attends. Liu also has the final word in approving any appointment of a director to fill a casual vacancy.
Despite having listed on the New York Exchange, Alibaba’s control structure (whereby the company’s founder and selected partners retain control of the majority of board nominations irrespective of their equity stake) still has its critics. The governance team at MSCI, one of the world’s leading index providers, labelled Alibaba’s corporate governance structure ‘worst in class’. In a critical report they highlighted ‘a high level of risk’ to public shareholders ‘due to a lack of shareholder rights and independent board representation’. Therefore, Alibaba is not included in the benchmark MSCI China Index.
‘Companies with these structures can basically write their own listing rules by modifying their company’s constitution’, Webb says. ‘For Hong Kong, that would be a nightmare’. In his submission to the Exchange’s Concept Paper, Webb warned that, if listing applicants are allowed to opt out of selected listing rules via their constitutions, then the very fabric of the market is undermined, and investors would have to attach a discount to the whole market for the risk that companies will adopt such structures, either directly or by spinning off their assets into new listings.
Room for compromise?
Views on both sides of this debate seem to be fairly entrenched, so is there any room for compromise? The HKICS submission to the Exchange’s Concept Paper outlines a possible way forward. The consensus among members of the Institute is that the ‘one share one vote’ structure is the best structure to promote corporate governance and safeguard minority protection, but many take the view that WVR structures could be considered to enhance Hong Kong’s competitiveness as an international financial centre as long as enhanced minority protections are put in place.
‘The fundamental issue is what are the enhancements for investor protections given the trade off from the “one share one vote” structure,’ says the Institute’s Technical and Research Director Mohan Datwani. ‘These have to be made clear before the issue of adopting WVR structures can be considered. These may include introducing statutory derivative actions amongst other enhancement for investor protections.’
Perhaps then, opinions on both sides of this debate are more nuanced than they might at first seem. Charles Li points out that if you ask institutional investors if they favour ‘one-share one-vote’, they will say ‘Absolutely!’ If you ask them if they are against any attempts to introduce WVR as a matter of principle, they will say ‘Absolutely!’ ‘If you then ask them if they have invested in Google – Absolutely!” In Facebook – “Absolutely!” In Alibaba – “Absolutely!” Why? The risk is priced in there’.
Johan Nylander, Journalist
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