Since I published my "dream blog" a few weeks ago, a lot has happened. Now that the dust has settled and people have moved on, it’s time to figure out the next steps. In this blog, I want to ask a few more questions that are yet to be addressed in order to deal with future challenges. Just to avoid any misunderstanding, I want to make clear that these are my personal views for the purpose of furthering this debate.
1. It seems the debate on investor protection has died down and people may have already moved on. Why are you bringing it up again?
The debate may have subsided, but the issue has not been resolved. The Hong Kong market has still not reached a consensus. Some think that we’ve won a moral victory by maintaining the one-share-one-vote principle, while others are disappointed because they believe Hong Kong isn’t adapting to change fast enough. The two sides are as entrenched as ever.
What’s lost in the debate is whether Hong Kong should embrace new, innovative companies and, if so, how. Losing one or two listing candidates is not a big deal for Hong Kong; but losing a generation of companies from China’s new economy is. And losing it without a proper debate is even more unacceptable. We can’t ignore this question just because raising it might ruffle feathers or make us uncomfortable; all of us have the responsibility to find an answer.It is in this spirit that I’ve decided to come forward and share my thoughts as a way to kick off a broader debate that leads towards a solution.
2. Why do innovative companies deserve special consideration when it comes to governance?
Innovative companies are distinct in two ways. First, their success largely comes from the founder’s unique vision and plan, rather than other factors that drive business success in traditional companies. The vision and ideas of these founders are core assets of these companies. Protecting the founders and allowing them to deliver on their vision is usually in line with shareholders’ interests. The founders deem these companies "their baby" and are generally more focused on their long-term development.In many ways, the business is all they have, unlike other subsequent investors who can more readily exit.
Secondly, these founders tend to start with nothing and usually had to rely on outside funding when they started out. By the time they consider a public listing, the founders’ shareholding may have been diluted from rounds and rounds of financing. Therefore, they have a legitimate fear of being removed from the board at the whim of a short-term activist outside investor.
Arguably, because these founders are so vital to their companies, protecting them is also a form of investor protection. In fact, most international markets are willing to allow shares with differentiated voting rights.
3. Is the conflict between protecting shareholders and giving founders these special concessions a truly irreconcilable one?
Not if the system is designed properly. The key is to find the right balance between the concessions allowed to founders and the strength and effectiveness of the counter-measures available to public shareholders in the event of disagreement or conflict.Founders can build great companies, but they can also destroy great companies and their interests are not always aligned with public investors. I believe the stronger the checks and balances are,such as in the US markets,the greater the concessions that can be allowed for founders.In a less institutionalised and less litigious market such as Hong Kong, such concessions, if given, would need to be moderate and come with checks and balances for use in the event of abuse or true conflict.
4. What options are there between doing nothing and adopting dual class shares?
On one extreme is the status quo. This would mean we do nothing. Hong Kong can maintain the moral high ground and the purity of its investor protection principle. On the flip side, this option comes at a cost. First, we have to ask ourselves whether our moral high ground is really so high, or whether we are actually intervening too much in the relations between issuers and investors.Secondly, we could lose the chance to embrace the future and all the benefits it would bring in the long run.Hong Kong lost out in the last technology revolution in the US and many believe we can’t afford to lose out in the next one, especially since so many of the large future new economy companies are likely to come from China and would otherwise consider Hong Kong their top choice.
At the other extreme is dual class shares. While this is a big departure from our current system, it’s used in other markets in the world. The US, in particular, adopts a primarily disclosure-based approach, while in Hong Kong we supplement this with vetting by regulators. There have been more voices recently calling for Hong Kong to adopt a more disclosure-based approach. But this is a broader debate with many aspects that would need to be considered.For example, the US has a whole range of other key differences in its market structure that we don’t have in Hong Kong.
In between the status quo and allowing dual class shares are a wide range of possibilities that could be considered. The main differentiating factor is whether founders have the right to nominate a minority or a majority of board directors.
A minority nomination right, if adopted, would preserve the proportionate voting power of shareholders, albeit within certain limits, while founders are given some leeway to influence the company without fear of being kicked off the board at the whim of activist shareholders or of being stuck with a CEO who has no roots or credibility within the company. What is trickier is how to structure founders’ influence on senior management appointments without encroaching on the fundamental power of directors to appoint the leadership on behalf of shareholders.
A majority nomination right, if adopted, would entrench the founder and his or her team. The key here is to ensure a proper check and balance mechanism is in place. Shareholders should be able to veto nominations at the shareholders’ meeting.If the nomination right is more moderately structured so that it would be forfeited in appropriate circumstances, eg after shareholders vote down the founder’s nomination, say, one or two times within a given period, it would ensure that the founders will exercise this right very judiciously.In the event of real conflict, shareholders could effectively take back the nomination rights by voting down the founder’s nominees on successive occasions.
5. How do we ensure due process if the market decides to adopt any of these possible changes?
If the market decides to keep the status quo, I hope that it would be a proactive decision we reaffirm after thoughtfully debating the issues and concluding that it is the best course of action. We should not become victims of inaction out of fear or inertia.
If the market decides to choose to consider other policy changes, we should adopt a decision process appropriate to the scale of the proposed change. Slight changes may be made within the existing discretion of the regulators, although a soft consultation with practitioners may be helpful sometimes to ensure a robust solution. More significant changes normally require a full market consultation, while major changes may require legislation and the involvement of the entire community.
In reality policy considerations are complex with many issues on each side.However, the points I am trying to make really are simple – that we should have a proper debate before making a decision, that the decision should be made in accordance with due process, and that we should make the decision proactively.
6. Does a partnership mechanism help?
There has been a lot of news coverage of partnerships lately, but frankly I am not sure how this fits in the context of listed companies. Partnerships are not new; in fact, anybody can form one. It’s simply an agreement among people, enforced by the partners themselves.Certain shareholders, directors or senior management members of a particular listed company are free to organise themselves into a partnership for whatever motive, but in the eyes of regulators, you are a shareholder, director, or manager or all three; whether or not you are a "partner"is of little relevance.
Therefore, the partnership issue is a bit of a red herring. Any special rights that are generated from the regulatory debate on weighted share structures will attach to a person in their role as a shareholder, director or manager, respectively. If management forms a partnership among themselves that acts in concert in terms of management decisions, this would be a significant factor for the company’s operations and clear disclosure will need to be made.
Overall, the regulator will tend to look through any partnership to the underlying structure and persons beneath. The regulators will not be able to "codify" the partnership concept in the context of governance structures of listed companies.In other words, you can’t mix oil with water.
7. If we decide to make changes, how can we limit who qualifies to receive special consideration?
The companies that qualify for special consideration would depend on the reasons behind the change. If it is because of the uniqueness of founders and innovative companies, then we would have to carefully define these terms to limit their application. They shouldn’t apply to everyone.
We could also potentially consider imposing a minimum market capitalisation or public float to ensure an adequate level of large and sophisticated international institutional holdings to maintain a healthy counterbalance of power. There could also be a requirement that the founder or members of the founding team maintain a minimum shareholding within the company to ensure there is a sufficient alignment of interests with public shareholders.There could be other approaches, too – one of the benefits of having a proper debate is to flush out new and better ideas.
So what about a partnership mechanism? As I said, it has little relevance here. If the partners fulfill the criteria above, they would be eligible for the concessions.
8. As the Chief Executive of HKEx, you have clear business interests involved here. Are you worried about being criticised for raising this issue again?
I am not worried because I think the subject is a matter of public interest and I feel that I have a duty to make sure that such an important question is properly considered. No doubt some people will criticise me, but I am not paid to be comfortable.
What is the public interest that HKEx is required to promote and protect?Public interests encompass first and foremost the respect of the rule of law and the due process, which represent Hong Kong’s core value. Public interests include maintaining an open, fair, and orderly market for the protection of investors and other users. Last but not least, public interests also include seeking the sound development of our markets and maintaining and promoting the long-term competitiveness of Hong Kong as an international financial centre.
As market operators and regulators – and as leaders – we have the responsibility to act for the betterment of Hong Kong. This is not about one listing candidate or fees earned from a listing here or there, it is about choosing a future path and all the responsibility that entails.We need to have broad perspectives and base our decisions on sound judgment. And we need a debate that focuses on the merits of the arguments, and not the person giving his or her opinion.
Lastly, just to be clear:what I say in this blog reflects my personal view only. Here I don’t represent the views of the HKEx Board; nor do I represent the views of the Listing Committee, nor am I speaking even in the capacity of a member of the Listing Committee.It is the Committee which has the primary role, subject to the oversight of the SFC, in deciding whether to take matters like this forward.
I hope this blog is taken in the spirit in which it is intended, which is to promote an objective debate that takes a serious look at the benefits and risks of the choices before us and leads to action.Let us have the confidence to embrace this responsibility and do what’s right for the long-term interests of Hong Kong.
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