Investors are becoming increasingly concerned about Hong Kong's listing regulations, which allow firms to dilute individual shareholdings.
Amid the towering skyscrapers of Hong Kong, the scent of change is in the air as investors sense an opportunity to bring the city’s listing regime into line with those of international peers such as New York and London.
In many ways, Hong Kong, a city built on trade and finance, styles itself on the UK. While UK listing rules have modernized with respect to preemptive rights to share placements, however, in Hong Kong things have moved more slowly. In the UK, for example, shareholders are protected through a statutory right of preemption guaranteed by the Companies Act. There are no such legal safeguards for shareholder rights in Hong Kong.
Under the current listing rules of the Hong Kong Stock Exchange (HKEx), last revised in 2004, a company may apply to its shareholders for a general mandate to make new, non-preemptive share issues of up to 20 percent of the company’s shareholding, at a discount of up to 20 percent of the market price. Companies may also reissue previously bought-back shares, normally up to 10 percent of the share capital, on an annual basis.
This has led to a rising number of complaints from shareholders whose stakes are diluted by up to 30 percent annually, with controlling shareholders forcing through the mandate at AGMs and diverting the new shares to close friends and business associates.
In Hong Kong, a simple 50 percent majority of shareholders is needed to agree to the issue of a general mandate; in countries such as the UK, a listed company needs at least 75 percent of its shareholders to agree. Until recently, this mandate could be refreshed an unlimited number of times, potentially opening up a drastic dilution of shareholders’ stakes. Following the listing rules revision in 2004, however, companies now need to seek approval for minority shareholders every time they want to refresh the mandate.
David Webb, an outspoken corporate governance champion based in Hong Kong, says that by keeping to its old ways, Hong Kong was falling out of line with international best practice and risked losing investment to other jurisdictions. ‘If you’re offered less protection as a shareholder, your shares are worth less and it becomes a lower quality market,’ he explains. ‘Over time this could deter some quality companies from listing in Hong Kong.’
All change, please?
There is hope on the horizon, however. Hong Kong Exchanges and Clearing, which operates the city’s stock exchange, has recently finished a consultation with the corporate sector on a range of topics, one of which concerns a potential reduction of the general mandate. While the final outcome of the consultation is still unknown, there seems to be a general consensus among companies that Hong Kong needs to move with the times.
‘The issue is market-wide, so it’s a case of a few firms being first movers, then maybe more will follow, as with most corporate governance developments,’ says David Smith, director of Hong Kong and Singapore research at RiskMetrics Group, the risk management and corporate governance service provider.
Indeed, opposition to the laxity of the current listing regime appears to be increasing, with a steady growth in votes against general mandates at AGMs. Companies with large free floats have been put under increasing pressure from minority shareholders, and firms such as Li & Fung and Esprit would have lost the general mandate if their vote had been held in the UK, according to Webb.
In the consultation paper, HKEx suggests several options, including cutting the general mandate to issue non-preemptive shares for cash to a maximum of 5 percent of outstanding share capital. Some companies have already seen the writing on the wall and voluntarily adopted resolutions to limit the general mandate. While these are still a minority – a mere 20 out of more than 1,200 listed companies – it is an encouraging trend, Webb says. Among the early movers are CLP Holdings, Cathay Pacific and Hang Seng Bank; the latter, a subsidiary of HSBC Holdings, is likely to have been brought into line as its parent follows the stricter UK preemption regime.
‘Since 2005 we have put forward a resolution to shareholders to limit the general mandate to no more than 5 percent of the aggregate nominal value of the issued share capital as at the date of each AGM,’ says CLP Holdings in its submission to the consultation paper. ‘Over the years, these resolutions have received over 80 percent support from shareholders voting at the AGMs.’ CLP goes on to say it supports concerns about unfair dilution and expresses support for the reduction of the 20 percent general mandate.
Dissent in the ranks
Many companies are still opposed to change, however. Some remain adamant the current regime offers a good mix between shareholders’ rights and companies’ need for a cost-efficient and quick way to raise money.
‘Clearly, preemptive rights – and hence rights issues, rather than placings – are what investors want, but whether we will get them is not yet known,’ says Webb. ‘Apart from listed companies, there is opposition from investment banks, which like the easy fees of overnight placings without all the documentation and underwriting risk of rights issues.’
During the recent consultation, law firms Freshfields and Herbert Smith – answering on behalf of a consortium of investment banks including Citi, Morgan Stanley and UBS – argued that the general mandate should not be amended in the forthcoming review of the listing rules. The law firms said the previous consultation in 2002 ‘adequately addressed the main potential for abuse of the general mandate.’
In February RiskMetrics issued a new set of policy guidelines for Hong Kong, following a lengthy consultation with the fund management industry in the city. It said many asset managers were uncomfortable with the current general mandate and the share reissuing mandate; taken together, these could lead to an annual shareholder dilution of up to 30 percent.
‘During our policy formulation process, most of the fund managers we spoke to recognized that companies need the flexibility to make placements, but many were uncomfortable about annual dilution of up to 30 percent,’ explains Smith.
RiskMetrics’ new policy guidelines state that it will vote against any combined general mandate and reissuing of shares totaling more than 10 percent of issued share capital per annum, or if the issue is at a discount of more than 10 percent of the current share price. ‘The change in policy essentially codified a general trend we have seen on the part of investors that have been increasingly concerned about dilution of their holdings through these types of issuings,’ Smith says. ‘This is perhaps a natural progression of investors becoming increasingly engaged with corporate governance issues, and moving toward actively managing corporate governance risk rather than dealing with it on an ad hoc basis.’
On the company front, some firms have noted this over the last few years and have moved toward reducing the limits they request annually, he adds.
It seems companies can protest all they like, but Hong Kong is slowly waking up to a creeping form of activism. As the bandwagon picks up more speed, it will be harder for firms to resist investor demands.
