Investors wave red flags at Hong Kong dual-class shares plan

The Hong Kong Exchanges flag, Chinese national flag and Hong Kong flag are hoisted outside the Hong Kong stock exchange.
The Hong Kong Exchanges flag, Chinese national flag and Hong Kong flag are hoisted outside the Hong Kong stock exchange.PHOTO: REUTERS

HONG KONG/SINGAPORE (BLOOMBERG) - Hong Kong Exchanges & Clearing is having trouble winning over money managers to its plans for dual-class shares in the world's fourth-largest stock market.

The Council of Institutional Investors, Hong Kong Investment Funds Association (HKIFA) and Asian Corporate Governance Association have all come out against HKEX's plans, as has Norges Bank Investment Management, the world's biggest sovereign wealth fund. The proposals would weaken corporate governance and encourage exchanges around the world to lower their standards, the three groups wrote in separate responses to a June concept paper that called for a new exchange allowing dual-class stocks.

The comments suggest that HKEX's efforts to remain competitive for corporate listings may run into opposition from firms which invest trillions of dollars, whose buy and sell orders make markets. Keeping money managers happy while positioning the exchange to win the next hot initial public offering (IPO) is shaping up to be one of chief executive officer Charles Li's most difficult tasks.

"I think the real worry for HKEX is that there will be more really significant companies like Alibaba, and Hong Kong will lose them if it doesn't do something to accommodate the special governance arrangements they have," said Mr Robert Cleaver, a Hong Kong-based securities lawyer at Linklaters. "But investors worry that if HKEX permits them, every company wanting to go public will ask for dual-class shares."

Alibaba Group Holding chose to debut in the US rather than Hong Kong in 2014 after the city's regulator stood firm on its dual-class ban. The Chinese company has since seen its value rise by about US$200 billion (S$272 billion).

HKEX's plans received support from some industry groups. The Asia Securities Industry & Financial Markets Association (Asifma) and The Chamber of Hong Kong Listed Companies backed the idea of dual-class shares. Asifma said, however, that there should be restrictions, including who can hold such stocks, sunset clauses and limits on the ratio of voting rights.

Dual-class shares allow founders and leaders of public companies to control their firms even with minority ownership. They have been a favoured tool of the tech industry since Google's 2004 IPO, though Snap's US$3.4 billion debut in March took the system to its extreme, becoming the first new listing in the US to issue only stock with zero voting rights. Last month S&P Dow Jones Indices and London Stock Exchange Group's FTSE Russell decided to bar such companies in response to feedback from clients.

Ms Lin Yu-Hsin, an assistant law professor at City University of Hong Kong, said the structures offer investors more opportunities. At the same time, she said, "regulators should ensure there's some balance of power and enhance corporate governance standards".

An HKEX spokesman said it had seen "a lot of constructive discussions since the papers were published in June and received a number of responses". The bourse operator is reviewing the feedback and will publish conclusions in due course, he said.

CEO Li said in a Bloomberg Television interview on Aug 10 that HKEX may not proceed with plans for the new exchange if there is not broad support.

There is evidence that dual-class companies can be good for investors. A recent study by Ronald Anderson of Temple University, Ezgi Ottolenghi of Texas Tech University and David Reeb of National University of Singapore found that 89 per cent of stocks with the structure are controlled by founding families and, on average, they outperformed the market by about 3.5 per cent a year. Dual-class firms that are not family-controlled are more likely to produce returns in line with the market, the authors said.

Investors seem unmoved. Mr Arthur Bacci, chairman of the HKIFA, said their interests are not served by dual-class shares and HKEX needs to consider its proposal more carefully.

"There is a cost to going public that firms have to pay, whether it is disclosure, voting rights, corporate governance or fiduciary obligations to investors," said Mr Bacci.