Hong Kong Stock Exchange Makes Massive Blunder With Dual-Class Decision

 | Dec 18, 2017 | 10:00 AM EST
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Hong Kong is wrong to revise its listing rules. It is allowing itself to be held to ransom by arrogant tech bosses who want to take public money but allow the public no influence over their corporate decisions in exchange.

The Hong Kong Stock Exchange has announced changes to its standards for public companies that would allow dual-class share structures. The changes, due to go into effect by the middle of next year at the latest, would also allow companies with dubious viability as ongoing business operations to list.

These dual-class share structures are plain wrong. They shouldn't be allowed. And Hong Kong shouldn't cave in to pressure to grant them.

The exchange has tried to make this look as if it is actually getting tough on listing rules by letting tech bosses get away with murder, figuratively speaking.

At the same time, it is raising the minimum market capitalisation for listing on the main Hong Kong stock market to HK$500 million ($64 million), from HK$200 million ($26 million) now. Companies must also have cash flow of at least HK$30 million ($3.8 million) and a free float of at least HK$45 million ($5.8 million), both increases over the old rules.

But it will permit dodgier listings on the Growth Enterprise Market, or GEM board, where companies will now have to have a minimum market cap of HK$150 million ($19 million), up from HK$100 million ($13 million).

Biotech companies need not demonstrate any profitability. To list in Hong Kong before, you had to show three years of making money.

The operators of the Hong Kong stock exchange are showing classic symptoms of the concept of kiasu, the "fear of missing out" that's common in Chinese culture. It's why you in Hong Kong sometimes see long lines for some tiny "freebie" that people could quite honestly do without. Sometimes people don't even know what they're queuing for!

"If we don't change our listing rules, we will miss the boat," stock exchange CEO Charles Li said.

It's a boat that Hong Kong should miss. You don't have to get on every single one.

BlackRock (BLK) , the world's largest asset manager, agrees, and has argued against the dual-class protocol. Yet companies such as Action Alerts PLUS charity portfolio holdings Facebook (FB) and Google's parent, Alphabet (GOOGL) , have deployed share classes deliberately to prevent shareholders from influencing corporate decision-making.

Most dual-class share structures grant powerful voting rights to holders of one category of shares, which are inevitably held very tightly by company founders. The other shares with little influence over voting or corporate decisions get sold off to anyone stupid enough to accept those terms.

I'm sorry, but when a company goes public, it goes public. You take in the public's money and, in exchange for that money, you give them shares in the company. This means you give up control over the part that you have, effectively, sold off to investors. You vouchsafe part of the company to those members of the public who have shown enough confidence in your vision to back you financially.

What you don't do is take the money and run. But that's basically what tech companies with dual classes of shares want to do.

They want to take the money, but give the people supplying it absolutely no (or at least very limited) control over how it is spent. They want to take your cash, and give you no influence over how it is used in return.

Sure, you get to share in the profits if the company pays out any in dividends. Those, however, are normally small in tech and other emerging companies, which rightly use most of the cash they have on hand to fund further growth.

Let's not forget that top executives making board decisions may well be paying themselves very handsome salaries.

The complaint is that Hong Kong "missed out" when Alibaba Group Holding (BABA) considered, then moved on, from listing in Hong Kong before launching its $25 billion IPO in New York, the largest in history at the time. It's now listed on the New York Stock Exchange. 

But Hong Kong was right not to bend the rules for Alibaba. Alibaba's founders have special shares that allow them to appoint the directors to the board. Its 36 senior managers have far greater voting power over corporate decisions than rank-and-file investors -- making a public company their private fiefdom.

Basically, they can determine whatever the company does (including how much they are paid), and you as a shareholder can't do a damn thing about it if you don't agree. Even if you actually own more of the company than they do.

Here's an idea. If you don't want to give public shareholders any say in your company, DON'T GO PUBLIC. Even the name, "Initial Public Offering," shows that you are offering something to the public -- and they should get something in return for their money.

You can't go public, then claim that, hey, we actually want to remain privately held. Thanks for the capital and the cash and all that, we'll take it from here.

No one is forcing you to give up shares in your private company to the public. But once you do, you give up control over that bit of the company, too.

Hong Kong has still attracted tech listings such as Tencent Holdings (TCEHY) , which is now the largest listing on the exchange. So much so that it has an outsize influence on the benchmark Hang Seng, accounting for around one-third of its gains so far this year.

To benefit from Hong Kong's new rules allowing dual share classes, companies must qualify as "new economy," although that's so vague I'm sure virtually anybody can apply. Companies must also have annual revenue of at least HK$1.0 billion and a valuation of at least HK$10 billion, although if they're valued at HK$40 billion and above, they can get away with having less revenue. 

The ratio of rights in the owner's share class vs. the dirty-people's share class cannot be greater than 10 to 1. And there must be sunshine clauses in case the owners die or resign from the board.

Tech companies that are already listed elsewhere can also come in via the back door: if they have a market cap of at least HK$10 billion, they can deploy their multiple share classes in Hong Kong for a secondary listing.

At least Hong Kong Exchanges and Clearing, the for-profit company that operates the Hong Kong stock market, scrapped its idea to establish a third market, besides the main board and the GEM. The GEM market is already populated by a bunch of dubious companies that are penny stocks and highly susceptible to "pump-and-dump" schemes.

Shareholder activist David Webb, for instance, outlined the links between a cabal of "50 stocks not to own" in which a group of people combined control the companies but avoid rising above the 30% ownership limit at which point it's mandatory to make an offer for all shares.

Hong Kong started in June soliciting opinions from market participants about potential changes in its listing regulations. Hong Kong Exchanges and Clearing insists that markets like New York, Shanghai and Singapore will steal its rightful business of listing China's best and brightest companies.

There has been one immediate beneficiary of the changes in listing requirements: the shares of stock-exchange operator Hong Kong Exchanges and Clearing (HKXCY) have risen 5.1% since the new rules were announced on Friday.

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