Listing Chaos

We review a chaotic month on the Government policy front in general and the HKEx in particular, and look at the broader issues surrounding the current proposals, or rather the lack of them. Merging two issuer-dominated Listing Committees together will not address the needs of investors, while the Government ducks the real problem of having a for-profit toothless regulator rather than SFC regulation and statutory backing for the Listing Rules.

Listing Chaos
28th July 2002

Phew! What a month it has been on the policy front. In fact, from a period of policy paralysis up to 30-Jun-02, while Hong Kong Chief Executive Tung Chee-hwa was preparing his new ministerial "accountability" system and nobody wanted to make any decisions, we have now transitioned into a period of policy chaos, with newly-appointed ministers, many of them either tycoons or their friends, seek to make an impression by disgorging a stream of consciousness and random policy proposals on the unprepared public. It's a new kind of heuristic approach to policy formation - launch a balloon, see if it flies, and if not, declare that it was just a personal idea and not government policy. The media have been scrambling to try and make sense of it all, which in several cases is probably a futile exercise.

Even hereditary tycoon James Tien Pei-chun, head of the Liberal Party and Chairman of Manhattan Garments, began wondering out loud if, as a member of the Executive Council, he would ever be consulted on these policies. Perhaps Mr Tung thought that wasn't necessary, since Mr Tien has proudly announced that he and the other seven Liberal Legislative Councillors would always vote in favour of Government policies - whether or not they agreed with them.

Our prize for wackiest and most retrogressive proposal of the month goes to former civil servant and Secretary for Financial Services Stephen Ip Shu-kwan, now Secretary for Economic Development and Labour, who proposed government hand-outs, such as tax-breaks and land, to get factories to relocate from mainland China back to Hong Kong, allowing them to import mainland labour so long as a proportion of employees were Hong Kong residents, suggesting 30% as a target. So we might yet get back into the T-shirt and plastic flowers business after all. But why stop there - let's roll the clock all the way back and provide subsidies to rejuvenate the opium and tea trade, which was the true foundation of Hong Kong's economic success.

In a founding contribution to the Yin and Yang branch of economic theory, Mr Ip said the government should not be afraid of interfering because "the market can't be open if there is no interference". This, you may recall, is the man who postponed abolition of the minimum brokerage cartel in April this year. It's a huge irony that the only grain of truth in Mr Ip's statement is that you can't have a free market without an effective competition law to prevent that kind of price-fixing and abuse of monopolies, a law which the HK Government refuses to introduce.

Close on Mr Ip's heels was hereditary tycoon Henry Tang Ying-yen, Chairman of Peninsula Knitters Ltd, an old Hong Kong garment manufacturer, and now Secretary for Commerce, Industry and Technology. Mr Tang said he would "not rule out" tax or land incentives to promote private sector investments in "research and development" including "traditional or foundation manufacturing industries" such as toy and garment manufacturers. There we go again - Mr Tien and Mr Tang can set up new garment factories together. Maybe we could build one of them on Lower Albert Road after the government offices move to the Tamar site.

Governance of HKEx

Against this background, newly-appointed Secretary for Financial Services and the Treasury, Frederick Ma Si-hang (Mr Ma), stands out in policy formation as being more coherent and organised but misguided. Immediately prior to his appointment, Mr Ma was finance director of Li-family Pacific Century Cyberworks Ltd and a member of the GEM Listing Committee and the Takeover Panel. Your editor also sits on the Takeover Panel.

Now in case you were thinking that Hong Kong Exchanges and Clearing Ltd (HKEx) is a public listed company with no controlling shareholder, think again - that is only half true. The Government is not a shareholder, but appoints 8 out of the 15 directors on the board, ensuring control. The HKEx chief executive, currently former civil servant Mr Kwong Ki-chi, sits on the board, and the other 6 directors were elected by former members of the Stock and Futures Exchanges before the flotation of HKEx. After the 2003 AGM, the number of directors appointed by the Government will be "no more than" the number of directors elected by shareholders.

It was this power that was used to propose and then delay scrapping minimum brokerage commissions, which are required through the rules of the Stock Exchange. So be in no doubt that corporate policy of HKEx is ultimately determinable by the Government. What it wants, it gets.

The Listing Committee

In Hong Kong, the Listing Division of the Stock Exchange of Hong Kong Ltd (SEHK), which is wholly owned by HKEx, processes applications for listing on the main board and GEM, and the listings are subject to approval by the main board and GEM Listing Committees, each of which normally meets once a week and consists predominantly of people who either represent or get their fees from listed issuers, including lawyers, accountants, investment bankers and brokers, all of whom are involved in IPO and secondary issue work. We call these the "issuer-based" members of the committees. Listing Rule 2A.17 sets out the composition of the main board committee, and you will note that a maximum of 4 members out of 25 can be engaged in fund management, or "investor-based". Even then, they can be working for the fund management subsidiaries of integrated investment banks. So as you can see, decisions are likely to be heavily tilted in favour of issuers rather than investors.

One can sympathise to some extent that even if the management of HKEx and its Listing Division were minded to be more vigorous in the application of listing criteria, they could still be overruled by the Listing Committee. Indeed, having been consulted as a member of the SFC Shareholders Group on the SEHK's internal draft of the corporate governance proposals for the Listing Rules, your editor could not help noticing that by the time the final consultation paper came out in Jan-02, these proposals had been watered down, presumably by the Listing Committee (for our series of articles on that consultation, click here).

Conflicting interests

HKEx, as a for-profit company, has a vested interest and duty to its shareholders to maximize profits. It receives initial and annual listing fees, and it receives a trading levy of 0.01% on each transaction (0.005% from buyer and seller). It can also boost short-term profits by minimizing expenditure on regulation, even if the quality of markets and profitability is degraded in the long term. HKEx incentivises its employees (as any for-profit company should) to maximise profits. At the time of its 2000 flotation, 143 directors and employees had been granted share options which vest between 2002 and 2005.

Mr Ma's proposals

This week, Mr Ma announced a "restructured listing framework" which was more notable for what it didn't propose than what it did. You can watch the press conference at this link. The announcement reversed changes announced by HKEx on 6-May-02, which would have seen the Listing Committee abolished and a new "Listing Matters Committee" to deal with appeals of decisions of the full-time Listing Division, including the rejection of new listing applications. That structure was in line with proposals outlined by the Financial Services Bureau in a report published in Jul-99 (you'll find it on page 30 of the report).

Vested interests have been fighting the abolition of the Listing Committees ever since, which is why we didn't see corresponding proposals announced until nearly 3 years later. In the meantime, we've seen the launch and collapse of the GEM market, and a GEM Listing Committee, of which Mr Ma was a member, which waived and bent rules to allow companies with engineered track records to be spun off from tycoon-controlled conglomerates. The GEM index is down 85.7% from its high, but look on the bright side - there is only 14.3% left to go!

Mr Ma's announcement also included internal restructuring of the Listing Division and the way in which it processes listing documents and circulars, and creation of the two new committees envisioned in the Jul-99 paper under new names - the "Listing Policy Appeals Committee" to deal with appeals of the Listing Division decisions on the Listing Rules, and the "Disciplinary Appeals Committee" to hear appeals of disciplinary decisions.

Who does the Listing Committee serve?

In his announcement, Mr Ma proposes to keep the Listing Committees (after merging them together), which he claims have served Hong Kong so well in the past. On the one hand, they claim that the listing admission criteria are "objective" but on the other hand, they want the Listing Committee to retain subjective "gatekeeper" control over who gets listed or delisted and who does not. If the criteria were really so black and white, then we wouldn't need any committee to consider whether or not a company meets the listing criteria, as it would be obvious from the facts of each case. Of course, the reality is different, and some judgement is always required.

So there is nothing wrong with the principle of having a committee to render this final judgement (whether on appeal or in the first instance), but there is plenty wrong with the way Hong Kong approaches it. When a company comes to market, who buys the shares? Not the issuers, not their bankers, lawyers, brokers or accountants, but the investors. And when it comes to appeals of the SEHK's decisions on on-going Listing Rules, who suffers the consequences? Investors, again. This simple fact argues for the majority of the Listing Committee to be formed of investor-based representatives, not issuer-based as is currently the case. Give professional investors a choice, and they will reject a scam far more often than the people who promote them for a living.

To kick off his newly merged Listing Committee, Mr Ma announced nominations of Marvin Cheung Kin-tung as Chairman, and Moses Cheng Mo-chi and Vernon Francis Moore as Vice-Chairmen of the Listing Committee. Mr Cheung is local Chairman of big-5 accounting firm KPMG, which has over a hundred listed companies as clients, while Moses Cheng is Senior Partner of solicitors P.C. Woo & Co, whose numerous clients include Allied Group Ltd. Mr Cheng has been an independent director of many listed companies including Pacific Challenge Holdings Ltd. Mr Moore is a director of HK-listed conglomerate CITIC Pacific Ltd. Both Mr Cheng and Mr Moore are existing members of the main board committee. If this is an indication of the shape of the new Listing Committee of "24-30 members independent and broadly based" (others have yet to be announced), then it looks very much like the old one and we are not impressed.

Incidentally, Mr Cheung and Mr Cheng are the Chairman and Vice-Chairman of the Estate Agents Authority, of which Mr Ma is or was a member.

For-profit regulators are conflicted

Regardless of this, Mr Ma continues to duck the real issue: the admission and regulation of listed companies properly belongs with the SFC, not the SEHK. The entire Listing Division of SEHK should be transplanted to the SFC, and it should be given the resources and legal backing to do its job and to fine offenders. London got this right, and the UK Listing Authority was moved out of the London Stock Exchange and across to the UK Government's Financial Services Authority when the LSE was demutualised. The FSA has powers to fine listed companies and their directors for breaking the rules. There is no reason by Hong Kong should be any different.

The HKEx seeks to defend its position by comparing itself with Australia, Singapore and New York. We believe Australia and Singapore, where the listing divisions remain with the listed exchange, have got it wrong. It is only a matter of time before they recognise this, and situations like the collapses of HIH Insurance and OneTel in Australia may accelerate the debate. The third comparison is invalid because (i) the New York Stock Exchange is not-for-profit, (ii) the SEC has a much greater role in enforcement than our SFC does here, and (iii) there is civil enforcement from shareholder class actions as an additional deterrent to shareholder abuse. In any case, nobody is holding out the New York Stock Exchange as a safe haven of corporate governance and Hong Kong cannot seek comfort by comparison with it.

Incidentally, the Australian Stock Exchange does not have a Listing Committee, only a Listing Appeals Committee. The Singapore Stock Exchange has neither, reaching all decisions internally.

Statutory backing

The second reason why the Listing Division should be moved to the SFC is the lack of teeth in the Listing Rules. As a commercial entity, the SEHK can only enter into contractual arrangements with listed issuers, and cannot fine them or their directors for breaches of the Listing Rules, nor does it have any investigatory powers. In legal terms, it has no statutory backing, and as a commercial entity it would be inappropriate to give it those powers. To our knowledge, the SEHK has never sued a listed company for breaching the Listing Agreement or directors' undertakings to comply with Listing Rules, and it is difficult to see what damages the SEHK would claim to have suffered anyway.

So the deterrent for breaking the Listing Rules is incredibly low. In 2001, the SEHK processed 140 cases of Listing Rules breaches (these are just the ones they know about) which led to 8 public censures, 8 public criticisms (tell us the difference) and five private reprimands (otherwise known as the "get them round for a cup of tea" penalty). 117 cases got nothing more than a private warning letter. So in all, there were 16 public telling-offs in one year - is that enough to terrify 900 listed companies into compliance?

The recent announcement that regulatory disclosures would be dual-filed with the SEHK and SFC, go only a fraction of the way to dealing with this - while the SFC can then pursue cases of false and misleading disclosure, all other breaches of the rules will be dealt with by the SEHK in the traditional way.

Mr Ma promises a review of the "new" structure after two years - presumably, after two years of operation and another year of consultation. Can Hong Kong really afford to wait until 2006 to get a regulatory structure that works?

The merging of two Listing Committees and the retention of listing admission and regulation by HKEx is really just a new coat of paint on a rusting ship, and the track record show that our existing listing regime is defective. But then Mr Ma and his colleagues on the Listing Committees were never that good at rejecting duff track records.

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Listing Chaos 28th July 2002