The Hong Kong stock exchange’s refusal to grant Alibaba an exemption to its strict listing rules has forced the Chinese company to pursue a New York IPO, reopening the debate over what constitutes appropriate corporate governance for a listed entity. How Hong Kong reacts could define its future.
After almost a year of talks with Hong Kong regulators and stock exchange officials, Alibaba Group announced to the world in March that it would pursue an initial public offering (IPO) in the US. At a stroke, the decision wiped out almost US$300m in anticipated advisory fees for Hong Kong’s banking community, not to mention the resulting loss in trading volumes and prestige.
While the US capital markets celebrate the forthcoming arrival of one of China’s e-commerce champions, believing this IPO cements the country’s position as the dominant market for technology companies, the loss of Alibaba – which was widely unexpected – has come as a huge blow to Hong Kong.
Beyond the obvious financial cost, Alibaba’s loss of patience with Hong Kong’s regulators has come at a time when choppy equity markets and weak debuts for newly listed floats have left the city struggling to attract new offerings.
Fourteen out of 16 recently listed companies have fallen below their debut prices while, in contrast, China’s securities regulator continues to unveil a plethora of preliminary listing prospectuses. Most recently, Chinese pork producer WH Group scrapped its proposed Hong Kong IPO, having already cut the size of the deal – and delayed pricing – due to weak demand.
Market commentators have suggested that Alibaba may sell a 12 per cent stake in itself, which could result in an offering of more than US$18bn, based on a speculated market valuation of around US$150bn.
‘Alibaba highlighted a fundamental difference in philosophy between the US and much of the rest of the world’
Partner, Debevoise & Plimpton; Co-Chair,
IBA Capital Markets Forum
Hong Kong hasn’t hosted an IPO of more than US$4bn since late 2010. With the Hang Seng Index down about 5.2 per cent so far this year, the loss of Alibaba has added to a growing sense of anxiety over the future of this proud harbour city.
Further, the city is currently reminded, on a daily basis, of the challenge it faces as it attempts to evolve from being the entry point to China, to being the exit point for Chinese capital and enterprises with increasingly global ambitions. One form the reminder takes is a prominent marketing campaign, displayed across the city, promoting a series of South China Morning Post(SCMP) seminars entitled ‘Redefining Hong Kong’.
Hong Kong had always been Alibaba’s – and the Chinese authorities’ – preferred listing venue and, towards the end of last year and beginning of this, many legal commentators were convinced that the e-commerce titan would ultimately bow down to the demands of the city’s regulators.
That the Hangzhou-based company did not was mostly due to its reluctance to amend its dual class share structure, which allows its founder and senior executives (the company has 28 ‘partners’ in total) to nominate most board members, despite holding minority stakes.
Most internet companies have a multiple-tier stock structure that allows a small number of people to control the company’s fate. The US permits such arrangements, which explains how Facebook founder Mark Zuckerberg and Google co-founders Larry Page and Sergey Brin were able to keep control of their companies following their respective IPOs.
But the Hong Kong stock exchange – run by operator Hong Kong Exchanges and Clearing Ltd (or HKEx) – does not allow share classes with different voting rights.
‘Stock markets should keep in mind cultural concerns, the history of their own local markets, and the possible reaction of other markets in the event that exemptions are granted’
Managing Partner HJM Asia Law & Co;
Senior Vice-Chair, IBA Asia Pacific Regional Forum
‘Alibaba highlighted a fundamental difference in philosophy between the US and much of the rest of the world,’ says London-based Debevoise & Plimpton corporate partner Kate Ashton, who sits as Co-Chair of the IBA’s Capital Markets Forum. ‘The US believes that disclosure is adequate for corporate governance issues like these. So it’s possible to have two classes of shares with different voting rights. But this can be anathema to other parts of the world.’
Not that the objection came from the HKEx itself. With Alibaba at least partially located in Hong Kong, with many of its senior executives based there, the HKEx was desperate to lure the tech company to list on its exchange, as it seeks to diversify its stock-hold away from Chinese financial and property companies.
Led by determined chief executive Charles Li, the HKEx drafted proposals for a raft of listing rule changes that would have accommodated Alibaba’s IPO. But these were rejected by the city’s financial regulator, the Securities and Futures Commission (SFC), which felt that Alibaba’s structure violated Hong Kong’s strict one-share-one-vote principle, and that any changes should not be dictated by the company’s listing agenda.
Alibaba certainly had an agenda. Having already missed a late 2013 listing deadline, executives at the company grew increasingly frustrated as the stocks of other tech rivals surged – principally those at Facebook, Google, Tencent and Baidu – while the likes of JD.com, Weibo and other competitors closer to home pressed ahead with their plans to go public.
While the public consultation process of reviewing local listing rules dragged on in Hong Kong, the tech-heavy Nasdaq Composite index jumped 34 per cent, with many investors increasingly confident that tech companies in the US and elsewhere are profiting from smartphone users.
Guangzhou-based HJM Asia Law & Co managing partner Caroline Berube, who is Senior Vice-Chair of the IBA’s Asia Pacific Regional Forum, says it is difficult to criticise the HKEx from a legal perspective, as it rejected Alibaba’s requests based on HKEx legal requirements. ‘But from a commercial/business perspective, it may be relevant at some point for the HKEx to review their requirements, allow room for exceptions and reflect the competition that other markets provide as options for large companies such as Alibaba,’ she says.
‘Stock markets should keep in mind cultural concerns, the history of their own local markets, and the possible reaction of other markets in the event that exemptions are granted.’
Horses for courses
Given that the US views itself as the natural ‘home’ for tech stocks, its accommodation of the dual class share structure should not come as a huge surprise.
Unlike in Hong Kong, the more disclosure-orientated approach in the US, combined with its culture of litigation, provides investors with what is deemed to be a necessary level of protection.
‘Disclosure obligations are a must and should be similar in every market for the benefit of investors,’ says Berube. ‘Penalties in cases of breach of disclosure should be applicable in all markets.’
In contrast, Hong Kong is a city dominated by family run businesses and tycoons and has a higher-than-usual ratio of retail investor participation. Its rigid shareholding rules, with its one-share-one-vote guarantee, are designed to protect retail investor interests.
Some commentatorsquestion whether this continues to be the right thing to do. ‘The SFC clearly applied the rules consistently, and has taken a firm stance on this,’ says Ashton. ‘But it could be argued that retail investors can think for themselves and should be given the same opportunities as institutional investors.’
Some have also been tempted to suggest that Alibaba’s decision to pursue a US listing should be viewed as evidence of renewed confidence in New York IPOs on the part of Chinese companies.
Following a number of accounting scandals, many US-listed Chinese companies decided to go private through buyouts (also known as take-privates), as US regulators and investors turned hostile.
Listing in the US will certainly provide Alibaba with access to larger pools of money from investors with extensive knowledge of the technology sector, which could possibly further boost its valuation. But it will also bring with it a different level of scrutiny from US regulators and class action lawyers.
With the unique set of circumstances surrounding its efforts to go public, Alibaba is likely to be viewed more as an anomaly rather than heralding the introduction of a new era of Chinese IPOs in New York – with Chinese companies expected on the whole to continue to prefer a listing in Hong Kong, or China.
In an admission of just how big a blow the loss of Alibaba was, and in an attempt to ensure that such an episode is never repeated, the HKEx is embarking on a range of initiatives to position itself as a more competitive listing venue.
This includes introducing changes to sponsor regulations and a stricter disclosure regime for companies seeking to list, as well as the recent announcement of a trading link with the Shanghai stock exchange: the Shanghai-Hong Kong Stock Connect scheme.
And, together with the government-appointed Financial Services Development Council, HKEx continues to review local listing rules with a view to accommodating future tech companies seeking to go public.
For example, some have suggested changing the listing rules on the Growth Enterprise Market (the Hong Kong version of the US Nasdaq, which is tailor-made for tech companies) to allow such companies to list with special shareholding structures.
When approached for comment, the HKEx issued the following statement to Global Insight: ‘HKEx’s Stock Exchange discharges its regulatory function generally on a confidential basis to preserve the integrity of its process and ensure that it meets its statutory obligation to maintain confidentiality with respect to regulatory information in its possession. It is therefore the Exchange’s general policy not to comment on individual companies, individuals, or cases.’
However, chief executive Li has repeatedly spoken about the need for the HKEx to be more responsive and competitive for ‘innovative’ companies. In response to media requests for comment earlier this year, he was quoted as saying: ‘We have to consider possible changes where they might be necessary, with everything according to our due process. The Listing Committee’s work on shareholding structures didn’t start because of Alibaba and will not end now because of Alibaba. We need to ensure our markets continue to be relevant.’
‘Adapting HKEx regulations so that they are similar to other markets will help to attract future listings. The beneficiaries of that will be Hong Kong, the listing companies, and investors’
Managing Partner HJM Asia Law & Co;
Senior Vice-Chair, IBA Asia Pacific Regional Forum
This is the challenge facing not only the HKEx, but also the SFC. The extent to which they can join together to reach a compromise on a raft of initiatives and proposals to reform their listing regime will be decisive in securing the future of Hong Kong as a competitive financial centre.
‘Charles Li is trying to ‘update’ HKEx regulations to reflect new trends and ensure that Hong Kong continues to be an attractive market in which to list for local and overseas companies,’ says Berube. ‘Investors have a more micro management approach and wish to protect their own interests, rather than those of the HKEx.But, at the same time, investors may lose a return on their investments if companies choose to leave the HKEx due to its strict rules, and fewer companies opt for a listing in other markets.’
Berube adds: ‘Adapting HKEx regulations so that they are similar to other markets will help to attract future listings. The beneficiaries of that will be Hong Kong, the listing companies, and investors.’
The Chinese internet is increasingly the most important part of the Chinese economy, with Alibaba its leading commercial company. Like its closest domestic rival Tencent – whose purchase of WeChat recently pushed Facebook into acquiring Whatsapp – Alibaba has global ambitions. But it did not need a US listing to pursue them; Hong Kong must find a way to accommodate the next Alibaba if it wishes to remain relevant.
Stephen Mulrenan is managing editor of Compliance Insider at The Red Flag Group (HK) Limited. He can be contacted at firstname.lastname@example.org