Alibaba listing debate puts HKEx’s future in the frame

The Chinese internet company could yet list in Hong Kong, but even if it does other mainland tech companies are unlikely to follow unless the city’s bourse conducts far broader changes to its rules. Ian Driscoll reports.

  • 05 Feb 2014
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The most eagerly awaited event in Hong Kong’s 2014 (or even 2015) business calendar could be an initial public offering (IPO) of Alibaba, the Chinese internet and ecommerce giant whose assets include Taobao, China’s best known online shopping platform.

Alibaba executives have reportedly held exploratory discussions with representatives of the London Stock Exchange about a listing, plus more advanced discussions with representatives of Nasdaq and the New York Stock Exchange.

The conversations follow Alibaba in September ditching its initial plan to list on the Hong Kong stock exchange, after the bourse refused to let company founder Jack Ma and senior executives retain shares that would let them nominate most of its board of directors. Essentially, the exchange refused to budge on the one-share, one-vote principle enshrined in its rules.

But officials at the exchange seem keen to find a solution to assuage Alibaba. The Hong Kong stock exchange is said to have approached the Securities and Futures Commission (SFC) about initiating a public discussion about Hong Kong’s listing requirements, opening the door to possible changes to the exchange’s rules.

This also fits in with the thoughts of Charles Li, chief executive of the Hong Kong exchange. “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,” Li wrote in a now infamous blog entry after Alibaba’s IPO rethink.

Li, who declined to be interviewed for this article, clearly felt it was time to revisit Hong Kong stock exchange listing rules – or at least contemplate the sort of changes that might lure Alibaba back.

The city’s financial secretary, John Tsang Chun-Wah, also told the Financial Times he was open-minded about the exchange revisiting its listing requirements.

Some analysts say that Li simply voiced what others have long believed: the Hong Kong exchange needs to adjust to a new paradigm, namely the era of e-commerce and internet companies.

But attracting such companies in bulk would entail a rewriting of the bourse’s regulatory requirements well beyond what Alibaba has demanded. Hong Kong’s bourse and financial markets’ regulator needs to decide whether to abandon the exchange’s current philosophy to attract more electronic-age companies, or stay true to its roots and lose high-growth companies to less high-minded rivals.

The decision they make could also affect the bourse’s ability to compete with rivals in both the US and, increasingly, China.

Time for a change?

At present, the Hong Kong stock exchange’s laws require all shares to be treated equally for voting, so it will not approve the listing of any company whose bylaws (or articles of association) give disproportionate voting rights to certain shareholders. All listed companies’ bylaws have to comply with the listing rules requirement.

Were the exchange to agree to Alibaba’s request, it would likely need to amend its rules to allow for a disproportionate vote on director appointments, and then allow (or accept) a company whose bylaws grant that power.

Observers don’t expect Alibaba to be granted this privilege without it being extended to other companies. And that could fundamentally change the character of the Hong Kong exchange.

That’s made it a sensitive issue. The HKEx itself declined to comment on potential listing rules changes, other than to say: “Listing committee members discussed a possible market consultation on different shareholding structures at the meeting in late October as part of its regular agenda on policy matters. Progress was made in developing a course of action which may lead to a public consultation exercise.”

Oliver Rui, professor of finance and accounting at the China Europe International Business School (CEIBS) in Shanghai, says that officials in Hong Kong are divided into roughly two camps: “One in favour of giving special treatment to the Alibaba group, and the other that wants to maintain the existing listing rules.”

Put simply, one side believes that the Hong Kong exchange’s reputation for transparency and sound guardianship of shareholder rights has enabled it to flourish. The other side believes the exchange’s even-handedness and rectitude is now an Achilles heel, especially if it wishes to lure high-tech companies.

Internet and ecommerce companies argue that traditional company ownership models are too cumbersome and restrictive for their businesses. Instead of seeking shareholder approval for transactions, they need to move quickly to stay ahead of the competition, they claim. Hence Alibaba’s desire for a listing structure that would give Ma and his closest executives a degree of control similar to that vested in the founders of Facebook and Google through their companies’ dual-share structures.

Elinor Leung, head of Asia telecoms and internet research at broker CLSA, says Ma has a point: “A lot of what these companies do is trial and error, but minority shareholders may not have the foresight of the founders.”

Huoy-Ming Yeh, head of venture capital fund SVB China and a former microprocessor engineer, warns that the Hong Kong stock exchange’s doctrinaire approach to Alibaba could impede the city’s ambitions to become a magnet for high-tech companies, whether headquartered in Hong Kong or listed on its main board.

“The Hong Kong stock exchange has historically focused on real estate and other more traditional businesses,” says Yeh. “But if you don’t have an exit route for high-tech companies, you can’t really help further the city’s ability to attract high-tech firms to its exchanges; you can’t grow the ecosystem.”

Yeh, a confessed free-marketer, says Hong Kong needs to change its mindset. “Hong Kong should see this [Alibaba] not as a compromise but as an opportunity.”

It’s a view to which CEIBS’ Rui subscribes. “If Hong Kong loses Alibaba, it will send a bad signal to other high-tech firms,” he says. “Most likely there will be a compromise, because otherwise Hong Kong is going to lose its competitive edge.”

Race to the bottom

Not everyone agrees. David Webb, a Hong Kong-based corporate governance activist and founder of, believes that adopting a short-term approach to the Alibaba conundrum could have long-term consequences for Hong Kong’s exchange.

“If you engage in a race to the bottom of corporate governance standards, you eventually scare away investors and good companies; they will go somewhere where they have to sign up to higher standards but where they will get a higher price for their shares,” says Webb.

Webb’s view is that the exchange’s Li is engaged in unnecessary scaremongering. He points to Hong Kong-listed Tencent, 10 % of which is still owned by co-founder Ma Huateng, as an example of a successful internet company with no special voting rights. Despite this, shareholders continue to support the founder’s vision. Why does Alibaba need to be different, asks Webb.

He also says that there’s been support for the exchange’s original position from some unlikely quarters.

“There’s been a remarkable consensus in the face of these proposals in Hong Kong that we should not change our system of one share, one vote, even from the Institute of Directors,” says Webb. “Their perspective is that most companies in Hong Kong do have controlling shareholders with one share, one vote…and see that they have earned their privilege by putting their capital at risk for the privilege of control, with the checks and balances provided in the listing rules.”

Webb’s other complaint – one echoed by others – is that while dual-class share structures exist in the US, they are rare elsewhere. Nor is there a global trend toward them. Furthermore, says Webb, there’s empirical evidence that companies with dual-class share structures underperform companies that adhere to the one share, one vote principle.

But Webb says the Alibaba discussion has distracted attention from a more important issue.

“The bigger-picture aspect of this is that, once again, it highlights the conflict of interest between being a regulator, which the HKEx is, and being for profit,” he says. “The HKEx needs to stop doing both and just be a for profit and hand regulation back to the SFC.”

Paul Smith, writing in the CFA Institute’s Market Integrity Column, also noted the conflict: “On one hand, granting special treatment to a large Chinese issuer would be publicly unpopular and viewed as an affront to Hong Kong’s rule of law and market fairness. On the other hand, it would mean foregoing possibly hundreds of millions in fees for the exchange and the banking industry, stamp duties for the government, and the loss of a prestigious issuer.”

Profitability problem

In truth, the HKEx is unlikely to suffer much of an immediate toll from not welcoming Alibaba.

“They [HKEx] don’t make huge amounts of money from IPOs. It’s the ancillary follow-on trading that tends to drive earnings for these guys,” says Matthew Smith, a senior analyst at Macquarie Securities, citing the heavy turnover that occurred following the listing of several large Chinese state-owned enterprises in the 2000s. And such trading might not happen following an Alibaba IPO or any other high-tech listing.

But the opportunity cost of the HKEx not compromising its listing principles to accommodate high-tech companies could be far higher over the coming decade or so as companies stay away because of a lack of Nasdaq-like listing structures.

“It’s already a shame that they have missed out on so many of these internet companies,” Smith notes.

Certainly, the stringency of Hong Kong’s listing requirements looks set to keep dissuading other new tech companies, Alibaba IPO or not.

“If a smaller firm is looking for a lower regulatory threshold then they might choose Hong Kong because you don’t have Sarbanes-Oxley and other rules, which can be a major cost,” says Michael Clendenin of RedTech Advisors in Shanghai. “Countering that, if you are a smaller firm trying to list in Hong Kong, you have to show profitability, whereas in the US you don’t. I don’t think Alibaba staying in Hong Kong will be a turn in the trend for the Hong Kong stock exchange.”

Christopher Betts, a partner in the Hong Kong office of law firm Skadden, Arps, Slate, Meagher and Flom, agrees. He says that the requirements – whether in the form of a profit test; a market capitalisation/revenue/cashflow test; or a market capitalisation/revenue test – continue to act as barriers to firms with the kinds of earnings profile often seen at start-up technology companies.

Changing the current listing rules in Hong Kong could benefit the city’s long-term competitiveness. However, he argues that rule changes shouldn’t constitute a move to lower standards.

“If the markets are going horribly,” he cautions, “any [rule changes] will be looked at in a very different light.”

Increasing competition

The pressure on Li and his staff to loosen the HKEx’s rules is only likely to increase as regional competition rises.

China’s Shanghai and Shenzhen exchanges have much room for improvement in transparency and law, but “a decade from now China may be a more legitimate place for listings and with a lower regulatory threshold”, says Clendenin.

Of course, as Peking University professor of accounting Paul Gillis points out, China’s attractiveness as a listing destination may hinge in part on dual-listing structures. And “right now, you can’t have a two-share structure in the mainland either”.

Other factors are also out of Hong Kong’s control, says SVB’s Yeh.

“If the renminbi continues to be restricted, then Hong Kong, being outside of China in a financial sense, may benefit as a separate exchange from the ones onshore in China,” Yeh says. But once the renminbi is freely convertible, there will be less of a need for Hong Kong as a standalone exchange for China-based high-tech companies.

“Hong Kong is caught between a rock and a hard place. And competition from China and the US means Hong Kong will feel the brunt of that,” says Clendenin.

Hong Kong’s stock exchange is at a crossroads. Investors appreciate its rigorous standards of listing, but it stands to lose out on some of China’s most exciting companies as a result. Worse, its local and international rivals are clamouring for such business, and may prove more willing to bend their standards to get it.

The exchange, it should be remembered, is a listed business in its own right with shareholders to answer to. It has to decide whether to stick to its beliefs and risk seeing its regional importance diminish as a result, or relax its rules at the risk of more scandals and bankruptcies.

Alibaba’s demands represent a mere taster of this dilemma. Hong Kong’s bourse has some trying times ahead.

  • 05 Feb 2014

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