Recent developments of CG Policy in Hong Kong
…and why progress has been so slow
David M. Webb
editor of
Webb-site.com
at the inaugural conference of
Asian Institute of Corporate Governance
at Korea University
14th December 2001
© Webb-site.com 2001
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Recent Developments
• Takeover code amended (19-Oct01)
– “Trigger threshold” reduced from 35% to 30%, in line with UK
– “Creeper” limit reduced from 5% to 2% per year
– David Webb appointed to Takeovers & Mergers Panel (5-Apr-01)
• Standing Committee on Company Law Reform (SCCLR)
– Formed in 1984. Consultant’s report on Companies Ordinance (CO)
commissioned in 1994, delivered in 1997, put to market consultation in 1998, then
SCCLR wrote a “report on the report” published in Mar-00. Slow progress!
– In 2000, commenced review of CG aspects of Companies Ordinance.
– Formed 3 sub-committees on: Directors, Shareholders and Corporate Reporting.
– Good news: David Webb appointed to Shareholder Sub-committee.
– Bad news: David Webb is the only investor on Shareholder Sub-committee.
– SCCLR published “Phase 1” Recommendations in Jul-01 for market consultation,
and results are awaited.
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SCCLR Recommendations: Directors
• SCCLR chose not to enact directors’ duties into statute; compares badly with
UK, Australia, Malaysia, Singapore.
• No intention to create criminal penalties for breach of directors’ duties generally.
• Law to contain general provision that director cannot vote in board meeting on
transaction in which he is interested.
• Statutory requirement for circulation of notices to allow shareholders to
nominate directors before the election.
• Companies should be “encouraged” to adopt cumulative voting procedure on
directors’ election (not clear how this “encouragement” will make it happen).
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SCCLR Recommendations: Shareholders
• Shareholders to have statutory right of derivative action, replacing common law
right. SFC to have right to bring derivative actions without first obtaining court
approval (but will they?)
• Clarify the statutory unfair prejudice remedy so that court has clear powers to
award damages and interest.
• Court to have clear power to award costs to shareholders taking action.
• Shareholders to have statutory method of securing access to company records
subject to court approval and other safeguards.
• Disinterested shareholders’ approval required for related-party transactions (all
companies, not just listed companies).
• Generally, intent is that CO should apply to all companies with a place of
business in HK, including oversea companies registered under Part XI. This
includes the 75% of listed companies which are incorporated in Bermuda or
Cayman Islands.
• Still no class or quasi-class action system - these laws are not worthwhile unless
shareholders can afford to use them.
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SCCLR Recommendations: Corporate Reporting
• Private companies to be required to file accounts, available to public inspection.
• Floats the idea of a body like the UK’s Financial Reporting Review Panel to
review problems with audited accounts.
• Proposes a system for amending audited accounts if they are subsequently found
to contain material misstatements
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Listing Rules
• Listed companies are regulated by a listed, for-profit monopoly - Hong Kong
Exchanges and Clearing Ltd (HKEx) which owns SEHK. Big conflict of interest:
incentive to under-spend on regulation to maximise profit.
• SEHK consulted market on key sections of main board listing rules in early 1999.
Results sank without trace. Now they are preparing a full-scale review of entire
rules.
• Some of the things we have called for on Webb-site.com:
– Independent directors to be re-elected by minority shareholders only
– All resolutions to be on a poll: 1-share-1-vote, not 1-hand-1-vote
– Reduction of disclosure and approval thresholds
– Quarterly and prompt reporting, including balance sheets and cashflow statements
– SEHK Listing Division to be transferred to the SFC, creating single securities
regulator
– Statutory backing for Listing Rules, with power to fine directors and companies
for breach.
– Full on-line disclosure
– Limitation of general mandate for non-pre-emptive share issues for cash.
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Securities Law
• SFC Bill is now in its 3rd draft since 1996
• Legislative Council is examining the draft, and hears lots of complaints from
issuers and advisers (but no input from investors)
• Maybe it will pass early next year
• Bill proposes:
– Market Misconduct Tribunal (MMT) - broader than current Insider Dealing
Tribunal, to including market manipulation and false or misleading disclosures,
but cannot make punitive penalties - only disgorgement of profits plus interest and
costs.
– Option to treat insider dealing as criminal offence with jail time and fines.
– Reduction of ownership disclosure threshold from 10% to 5% (UK=3%)
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Other areas
• Dematerialization
– Currently scrip is immobilised in Central Clearing & Automated Settlement
System (CCASS) run by Hong Kong Securities Clearing Company Ltd (HKSCC),
a monopoly owned by HKEx.
– Almost all public shareholders hold stock via brokers/ custodians, and then via
HKSCC, which registers as HKSCC Nominees Limited
– Hence there is only one shareholder, which creates big problems with voting and
shareholder communications.
– Need to move to electronic register with “voter of record” as well as “holder of
record”. Then we can think about electronic voting with digital certificates.
– Reform in this area was accelerated by the MTRC duplicate share certificate
fiasco. Typical of the crisis-driven approach to reform in HK.
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Key Dynamics in CG Reform
• Company representation
Issuers are represented by chambers of commerce, and leading companies have
representatives on Government bodies such as SFC, Stock Exchange Listing
Committees, Standing Committee on Company Law Reform and Takeover Panel.
• Indirect Company representation via professionals
Issuers are also represented by professional firms, such as leading local law firms
and accountancies, who are present on aforementioned bodies and derive the bulk of
their income from the companies they advise.
• Professional bodies
“Issuer-side” professionals also reflect their wishes through industry bodies such as
the Law Society, Society of Accountants, Institute of Company Secretaries,
Stockbrokers Association and Institute of Directors.
• Investors have almost no representation
Consequently the debate is one-sided, normally arguing for status quo and against
reforms, and the reform process is slow. For example:
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Why Activism is Rare in Emerging Markets
• Short-term investment
Local pensions markets are underdeveloped, so there’s less focus on long-term
absolute returns. Asset managers are often judged on short-term performance. Longterm overseas investors have minimal portfolio allocations to EMs.
• Relativist fund management targets
Most funds track, or benchmark, against market indices, so bad CG affects funds
and the indices fairly evenly and relative performance is unaffected. Same applies to
“league table” peer-group rankings – the whole group is dragged by bad CG.
• Conflicts of interest
Fund managers are often affiliated with banks, so cannot criticise bad governance of
the bank’s corporate or Government clients.
• Defeatism
Circular problem – with a dominant shareholder and an unfavourable legal and
regulatory framework, no point in making a noise. Investors will pay a premium for
good governance, but they discount “emerging markets” for the risk of bad
governance. This lowers the market ratings of EM issuers and increases the cost of
equity and debt capital, making them less competitive globally.
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Catalysing Activism:
Hongkong Association of Minority Shareholders
HAMS
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Governance of HAMS
• Investor membership
HAMS would admit any shareholder or potential shareholder as a member, for a
nominal annual fee to cover communications:
HK$100 - individual with internet communication
HK$200 – individual with postal communication
HK$1000 – others (institutions)
• Practice what you preach
The non-executive governing board of HAMS would be elected by HAMS members
annually and hence accountable. One member, one vote. Full-time executive staff
would be accountable to the board of Governors through the CEO.
7 Governors elected by individuals
7 Governors elected by institutions
1 Chief Executive Officer
Possibly 1 representative each from SFC, LegCo, MPFA, Consumer Council
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HAMS: Three divisions
• Policy
• Appraisal
• Enforcement
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HAMS – Policy Division
• Aggregation of opinion
HAMS would poll members on proposals and speak with authority. Institutions
would have no conflict in speaking anonymously.
There are an estimated 500,000 regular investors in HK stocks. We would expect
50,000 to join within one year of full launch.
• Promote CG Reform
Provide the “missing voice” of investors in the CG debate. Promoting CG reform at
the governmental, legislative and regulatory levels (HKEC, SFC, HKSA, Law
Society etc). Both proactive and reactive.
• Professionally staffed
with experienced lawyers, accountants and practitioners to formulate and lobby for
proposals.
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HAMS – Appraisal Division
• Numeric and objective ratings system for CG
Skilled professionals would continuously assess all 800 companies on multiple
parameters. Summary ratings would be freely published - next to P/E and Yield in
newspaper listings, on web sites and via HKEx trading system.
Upgrades and downgrades would be explained, and voting recommendations would
be given if HAMS analysts found resolutions against minority shareholders interests
or in breach of Good Governance Guidelines.
• Incentive/Deterrent for good/bad CG
Increased demand for stocks with higher CG Ratings. Good score = Higher p/e =
lower cost of capital and increased competitiveness. Will fuel HK economic success.
Badly rated stocks will suffer more discount. Some funds may refuse to hold stocks
below a specified CG Rating as being “non-investment grade”.
• Mutual Fund Disclosure
SFC/MPFA could require disclosure of portfolio CG Rating in authorised mutual
fund and MPF reports.
• Statutory immunity
HAMS staff would need statutory immunity, which is already granted to staff of
SFC and Consumer Council.
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HAMS – Enforcement Division
• Deterrent
This division would produce a credible deterrent both from existing laws and from
future laws achieved by the Policy division.
• Professional
HAMS would run a team of lawyers to select and pursue targets for claims based on
merit and recoverability. If a settlement is not reached, litigation would be pursued.
Cannot afford to pursue all cases, but a representative sample.
• Quasi-class-action
HAMS would represent any member who held the stock in question at the relevant
time, at no charge. Non-members could join HAMS to participate.
Costs would be drawn from the HAMS budget and deducted from winnings. This
would produce a quasi-class-action system without reforming the entire legal
system. It overcomes the prohibitive costs for most investors to enforce their rights.
Compensation net of expenses would be distributed pro rata to shareholdings.
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Endorsing and Funding HAMS
• No spontaneous combustion
No material shareholder activism has happened yet, and shareholders have no voice.
HAMS has not and will not happen spontaneously. Private sector effort would not
achieve critical mass of funding or action.
• Government catalyst required
Government should care about HK’s competitive position. Good CG lowers the cost
of equity and debt capital for our issuers, increases the quality of market and attracts
new issuers and investors. A “World class” financial centre cannot be achieved
without good CG, which will take years without shareholder participation in reform.
• No taxpayer support needed - “User pays”
HAMS should be funded by the people it represents, the public investors,
proportionately to their financial interest. The closest practical proxy for portfolio
size, which does not rely on investor disclosure, is the volume of trading. Therefore
a “Good Governance Levy” is the fairest way to go. “User pays” principle.
Year 2000 transaction volume was HK$3,048bn (US$391bn). A levy of 0.005% on
the purchase and sale (total 0.01%) would raise over HK$300m per annum. A
reserve would be needed to cover volume fluctuations, but this should support
running costs of up to HK$200m (US$25m) per annum.
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The Good Governance Levy
• Minimal or no effect on transaction cost
Currently, investors pay government stamp duty of 0.1%, an SFC/SEHK trading
levy of 0.01%, and brokerage of 0.25% or less. SFC gets most of its funding from
levy. The recent budget cut stamp duty by 0.0125%, two and a half times the Good
Governance Levy.
Levy works out at 0.008% of free float - it would take 125 years to pay 1%. You lose
more than that each year from bad governance or outright theft.
• LegCo as a balance
The Good Governance Levy and enabling legislation would require Legislative
Council approval. Although HAMS Board of Governors would be investor-elected
and would determine policy, HAMS would report regularly to LegCo on its
progress, and the check and balance lies in the levy which can be amended or
removed.
• Start-up loan
Based on the certainty of an income from the Good Governance Levy, an initial
start-up loan could be obtained from banks on normal commercial terms.
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Hong Kong’s Competitive Position
• Bad CG costs far more than a Good Governance Levy
The estimated bad governance loss of 2.5% p.a. is 300 times the Good Governance
Levy as a percentage of free float.
HAMS won’t prevent all CG failures, but if just 1 in 10 “bad CG” events could be
avoided by the action of HAMS, then it would reduce the “bad CG” drag factor by
0.25%, giving a 30-fold payback on investment.
• WTO and Globalisation
Increasing globalisation forces HK issuers to compete at home and abroad with
better-governed western companies who have lower cost of capital. We need good
CG to remain competitive. Funding costs will be a key issue in competing in China
post-WTO.
• HK is now a Service Centre
HK’s manufacturing sector has moved to Southern China. Now more than ever, HK
relies on Services – and at the heart of its services are trade and finance. Without a
strong financial infrastructure, including good governance, the economy will suffer.
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Hong Kong’s Competitive Position
• An example to the Mainland and rest of Asia
Aside from its world-class aspirations, Hong Kong must not forget its leadership
role as an Asian and Chinese financial centre. With the continued opening and
reform of the mainland economy, and its need for strong and viable markets, it is
crucial to Hong Kong’s role as a financial centre that we take the lead on CG reform.
• The CSRC is serious about reform
Recent appointment of an ex-SFC Deputy Chairman to be Vice-Chairman of the
CSRC underlines CSRC’s reform goals. Announcement of quarterly reporting from
2002 overtakes HK in disclosure for the first time! Latest news is a proposal to
establish entity to take legal actions for damaged investors - is this CAMS?
• China’s role in reform
A bubble market in mainland stocks forces regulators to address the bad corporate
governance of the past decade since the market opened
The goal is to produce underlying fundamental substance when the bubble deflates.
If a burst makes the mainland equity markets dysfunctional, then the whole
economic reform process from central planning to free market will be derailed,
threatening the stability of the whole mainland system.
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The Government’s Position
“Our aim is to establish Hong Kong as a paragon of corporate
governance”
- Donald Tsang
Budget Speech, March 2001
“ the HAMS proposal is a novel idea… we would welcome the
views of the public on this proposal”
- HKSAR Financial Services Bureau
24th May 2001
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Some Names from the HAMS Endorsement List
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