In Part 11 of this eUpdate series, we discussed the reasons why Hong Kong regulators did not approve of share structures with disproportionate voting rights, also known as the “weighted voting rights structures” in Hong Kong or the “dual share class structures” in other markets2, whether this could be an impediment to the listing of new wave large technological companies in Hong Kong and whether Hong Kong needs to amend its restrictive rules. We noted that Hong Kong regulators staunchly adhere to the principle of equality of treatment for all shareholders.
In June 2015, the Stock Exchange of Hong Kong Limited3 (“SEHK”) published conclusions to its concept paper on weighted voting rights (“WVR”) and announced that it will proceed with conducting a formal consultation process to review the current regulatory framework. The Securities and Futures Commission of Hong Kong (“SFC”), however, published an objection to the SEHK’s proposal in late June.
SEHK’s concept paper
In August 2014, the SEHK issued a concept paper4 on WVR structures (“Concept Paper”), seeking comments from various market participants on whether WVR structures should be permissible for companies looking to list in Hong Kong.
In the Concept Paper, the SEHK acknowledged that the permissibility of WVR structures is an important factor affecting its competitive position vis-à-vis other markets, principally the United States, in attracting Mainland Chinese company listings5. For instance, as of May 2014, 102 Mainland Chinese companies had chosen to primary list in the United States, rather than in Hong Kong, and almost one-third (29%) of these companies had a WVR structure, representing 70% of the total market capitalization of all U.S.-listed Mainland Chinese companies.
The SEHK anticipated that the Concept Paper would lead to either of two conclusions:
- That no amendment to the Listing Rules should be made to allow companies to use WVR structures; or
- That there is sufficient support for a material change to the Listing Rules on the acceptability of WVR structures, which would require proceeding to a second stage formal consultation process.
In June 2015, the SEHK published the consultation conclusions to the Concept Paper6 and outlined some of the relevant features of the draft proposal for a second stage consultation. Opinions of respondents to the Concept Paper varied. Very few respondents believed that WVR structures should be permitted unconditionally and used by all companies under any circumstances. The demand for a more stringent regulatory regime for companies wanting to use WVR structures was bolstered by the opposition from a number of large international investment managers, which warned that their introduction could diminish minority shareholders’ voting rights.7 The clearest opposition to WVR structures came from retail investors and the SEHK’s participant staff in their individual capacity. The majority of respondents, however, expressed support for the use of WVR structures under some circumstances with certain safeguard measures in place. Particularly strong support came from accountancy firms, sponsor firms, banks, law firms, listed companies and professional bodies representing these industry groups, including the Law Society of Hong Kong.
Based on the responses to the Concept Paper, the SEHK concluded that there is sufficient support for a second stage consultation on the proposed changes to its Listing Rules with respect to the acceptability of WVR structures. As the SEHK explained, “we are considering proposing that, generally, ‘one share-one vote’ should prevail but that WVR structures should be allowed for certain companies in certain circumstances and with certain safeguards”.8 David Graham, the HKEx’s chief regulatory officer and head of listing, said that “it is not our intention that such structures become commonplace in Hong Kong”. He added that he expected these structures would only be allowed for large, fast-growing, companies, under certain conditions.9
The SEHK came to some other important conclusions:
- WVR structures should be restricted to new applicants only (with anti-avoidance measures in place to prevent circumvention of this restriction);
- WVR structures should not be restricted to particular industries or “innovative” companies;
- Companies with WVR structures should have certain pre-determined characteristics (e.g., size or history) and meet higher eligibility standards;
- Such companies should not be listed only under “exceptional circumstances” as this could act as an effective ban;
- A number of restrictions applied in the United States and other jurisdictions where such structures are allowed should be put in place to protect investors;
- Changes to the Listing Rules and, possibly, the Takeovers Code may be necessary and will be proposed as part of the second stage consultation process;
- A class action regime is not a pre-requisite for the acceptability of WVR structures;
- Neither the Growth Enterprise Market (GEM) nor any separate platform should be used to list companies with WVR structures; however, such companies should be differentiated by other methods, such as a stock name that includes a marker;
- The use of WVR structures should not be restricted to overseas companies only, however, this has to be considered in relation to secondary listing; and
- Consideration of the current ban on companies with a Greater China “center of gravity”10 from secondary listing in Hong Kong should be discussed at the second stage consultation.
Next steps and draft proposal
The SEHK is in the process of preparing a draft proposal for the second stage consultation, with a view to start the formal consultation in the third quarter or early in the fourth quarter of 2015. Among other questions, the SEHK will seek the market’s feedback on the question of relative importance of the permissibility of WVR structures to a company’s choice of a listing venue.
It is currently envisaged that the draft proposal for the second stage consultation will include the following topics.
- Restrictions on new applicants only (with appropriate anti-avoidance measures in place);
- A very high expected market capitalization test in addition to the existing eligibility criteria for listing on the SEHK’s Main Board;
- “Enhanced suitability” criteria to identify certain features that the SEHK would expect such companies to have (regarding the applicant’s business and the contribution of the founder(s), for instance); and
- Restrictions on who can hold WVR structures at any point in time and the percentage of shareholding interest such persons can hold in a company prior to listing.
- A restriction to WVR structures in the form of different classes of shares, although such shares can carry differing levels of WVR;
- A minimum shareholding level to be maintained by the permitted beneficiaries of WVR after listing in order for those rights to survive, among other requirements for such beneficiaries;
- Beneficiaries of WVR to be deemed “connected persons” under the Listing Rules, irrespective of whether they would otherwise fall within the definition; and
- An issuer with a WVR structure would need to:
- be clearly differentiated with a stock name marker;
- include prominent and ongoing disclosure around the WVR structure; and
- make detailed disclosure on the voting activities of those holding WVR.
Corporate governance measures
- An issuer with a WVR structure would be expected to put in place certain enhanced corporate governance measures with respect to:
- independent non-executive directors;
- corporate governance committee;
- compliance adviser; and
- communication with shareholders.
Secondary listing and Greater China “center of gravity”
- An ability of the companies with WVR structures to secondary list; and
- A possibility of a limited waiver from the current “center of gravity” test for Greater China companies that were primary listed on a recognized exchange with or without a WVR structure.
Soon after the publication of the SEHK’s conclusions, the SFC announced that it did not support the SEHK’s draft proposal for the second stage consultation. “The SFC is of the view that Hong Kong’s securities markets and reputation would be harmed if WVR structures became commonplace,” the SFC expressed.11 The SFC criticized the SEHK’s draft proposal and highlighted a number of concerns. For instance, the SFC underlined that it was not clear how the SEHK’s proposed safeguards and conditions could be monitored on an ongoing basis and what actions could be taken either by the regulators or public shareholders if they are not complied with.
Ashley Alder, the SFC’s chief executive officer, raised concerns about the integrity of Hong Kong’s securities markets if the Listing Rules were amended and warned that the whole picture and the overall regulatory environment have to be considered before any amendment.12Carlson Tong Ka-shing, the SFC’s chairman, said that the SEHK should re-consider the need for further consultation on the listing reform that would permit WVR structures. Tong indicated that “as the regulator, we had strong reservations over the details of the proposed second phase consultation and would not be able to approve any eventual listing rule changes as they have not satisfactorily addressed our questions as to how to ensure that the interests of the shareholders are fully protected. The SFC has said earlier that the commission would only support any rule changes that provide sufficient safeguards to investors’ protection. We do not think these initial proposals can achieve the goal.”13
Another major concern which remains is that if a jurisdiction, e.g., the United States, allows WVR structures, it may provide a way to protect the rights of investors through, for example, class action litigation. Investors in the United States can litigate in a way they cannot in Hong Kong. Also, as noted in the press, some academics are of the view that dual class shareholding can be detrimental to companies.14 For instance, a study conducted for the European Central Bank established that European companies that depend on equity capital are sooner or later forced by the market to unify their shares. As a consequence of the unification, the market value and sales growth of the companies go up as compared to such companies’ market value and sales growth before the unification.15 A separate U.S. study found that companies with multiple classes of shares generally underperform over the long term. Such companies experience more stock price volatility, increased material weakness in accounting controls, have more related party transactions, and offer fewer rights to unaffiliated shareholders. The study notes that its findings present a challenge to advocates of companies with WVR structures and their claims that such structures ultimately benefit all shareholders. While insiders may favor the combination of public market liquidity with private market autonomy, it does not appear that shareholders benefit from this arrangement.16 Some econometric studies, therefore, are of the view that WVR structures may not necessarily benefit Hong Kong’s companies or add to the city’s competitiveness as an international financial center.
In response to the SFC’s objection, the SEHK issued a news release stating that, since any rule amendment requires approval by the SFC’s board of directors, their view would be material to the final proposal that the SEHK puts forward for the formal second stage consultation. The SEHK will further engage with the SFC, and the SEHK’s Listing Committee will decide the best way forward in light of the views of the SFC.17