Hong Kong's stock exchange has finally introduced new rules to accommodate companies with dual-class shares – a controversial structure favoured by many large technology firms that is expected to give the local IPO market a big lift.
In a move described by the exchange operator's chief executive as the "dawn of an exciting new era", three new chapters were added to the main board listing rules on Tuesday. These enable biotech issuers that do not meet financial eligibility tests to come to market, establish a new concessionary listing route for mainland Chinese and international companies seeking a secondary listing, and, crucially, permit listings from companies with weighted voting right (WVR) structures.
KPMG said it was lifting its 2018 fundraising forecast for Hong Kong by 25% to HK$250 billion ($32 billion) as a result of the new listing rules.
The move by Hong Kong Exchanges and Clearing (HKEx), which claimed "overwhelming stakeholder support for [the] new listing regime proposal", nonetheless drew a more muted response from some powerful quarters.
“Offering regulatory flexibility can attract listings in the short term but potentially impact long term market development if corporate governance standards are not maintained," Tan Jenn-Hui, head of equity of capital markets and corporate finance for Asia Pacific at Fidelity International, warned.
Discussions for allowing companies with dual-class shares to list in Hong Kong started when e-commerce giant Alibaba’s Jack Ma opted to list in New York rather than the Chinese territory in 2014. A dual-class share structure is a popular form of WVR that allows a company to have two classes of common stock with unequal voting rights.
After failing to amend its rules and missing out on Alibaba, the HKEx published the New Board Concept Paper in June last year. In conclusion, it said in December that it planned to expand the city's listing regime. The bourse operator subsequently initiated a one-month consultation on how to facilitate listings of companies from emerging and innovative sectors in late February.
As Francis Lun, chief executive of Geo Securities, explains, the proposal was withdrawn four years ago due to strong opposition from the Futures and Securities Commission to protect the interests of minority shareholders. But these days the regulator is less outspoken, partly because it does not want to stand against local financial interests keen on the new business, he said.
There is stronger support from the investment community this time around because of the relentless rise of new technology groups. In the US, after all, many of the biggest, most valuable companies are technology companies, said Irene Chu, partner and head of new economy at KPMG China.
Companies with WVR structures will be required to have a minimum expected market cap of HK$10 billion and, if less than HK$40 billion, would also need to meet a higher revenue test of HK$1 billion in the financial year before listing.
The voting power of shares with WVRs will be capped at 10 times that of ordinary shares, while non-WVR shareholders must hold at least 10% of the votes eligible to be cast at general meetings, according to the new rules.
Recognising the potential risks associated with WVR structures, a corporate governance committee made up entirely of independent non-executive directors would also be required, the exchange added.
There is no guaranteeing, though, that these provisions would protect minority shareholders, Lun warned.
“The problem will forever be there," he said. "Under dual-class shares, there is no problem when the CEO does not have any intention to cheat small shareholders [out of their] money. But when he has such an intention, there’s nothing they can do.”
Allowing dual-class shares in Hong Kong strips investors of an extremely important tool for holding the management of a listed company to account, the Hong Kong Investment Funds Association said in January.
Since board members have to be voted in by shareholders, it is doubtful whether the directors of companies that adopt dual-class shares can fulfil their fiduciary responsibilities to protect the interests of investors.
That is because under dual-class share structures, company founders with superior voting rights have greater control over who makes up the board of directors. Where the interests of the founding members goes against that of other shareholders, a company's directors are likely to act in favour of the founding members to whom they owe their positions on the board.
The Hong Kong market is under pressure to remain competitive, not just from New York and elsewhere but closer to home too.
China has already moved to make it more attractive for technology firms to list domestically with the launch of the Chinese Depository Receipt (CDR) system.
Under this new mechanism, qualified innovative companies with dual-class shares and with valuations of no less than Rmb20 billion ($3.2 billion) and annual revenue of at least Rmb3 billion can either float additional shares or launch initial public offerings on the Shanghai or Shenzhen stock exchanges, according to trial rules approved by the State Council on March 22.
Under the new Hong Kong rules targeting the biotech sector, meanwhile, companies seeking a listing but not yet making any revenue would have to have a minimum expected market capitalisation of HK$1.5 billion ($191 million). The exchange is also in the process of forming a specialist biotech advisory panel to help review listing applications from biotech firms, it said.
Both China and Hong Kong are keen to diversify the mix of companies listed on their capital markets and these changes are collectively designed to encourage that.
But as Fidelity's Tan put it: "Exchanges competing to offer the most issuer friendly environment can result in weaker standards across all markets. What we must avoid is a regulatory race to the bottom.”