In response to recent media reports on Justice Rogers' remarks about the listing regime, Hong Kong Exchanges and Clearing Limited (HKEx) issued the following statement today to clarify some misunderstandings.
Out of respect for Justice Rogers' position, we feel bound to comment on his remarks in a recent widely reported speech insofar as they relate to the listing regime.
The thrust of Justice Rogers' argument (as set out in his speech) is that the poor performance of many recently listed companies indicates that the regime for vetting listings is faulty and needs to be changed. Justice Rogers does not see a need for the recently-appointed Expert Group to deliberate on the matter, since the solution in his view is simple: move management and enforcement of the Listing Rules to "an independent body". He believes the root problem is that HKEx is a "trading company" whose primary interest therefore lies in pursuing profit, which (in his view) conflicts with its being allowed to administer the Listing Rules. He sums it up in his memorable, but in our view highly misleading, analogy: "You cannot have the rabbits in charge of the lettuce".
We believe the foregoing views rest on a number of serious misunderstandings:
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First, it is not true that HKEx's pursuit of profit as a "trading company" does, or could, take precedence over its public interest responsibilities.
There is an explicit provision in Section 8 of the Exchanges and Clearing Houses (Merger) Ordinance requiring HKEx to act in the interests of the public, having particular regard to the interest of the investing public, and to give precedence to those interests if they conflict with HKEx's own commercial interest while discharging its obligations. The manner in which HKEx discharges its public interest duty is closely monitored and regulated by the SFC, and the SFC has power to give directions to HKEx if it considers that a conflict of interest exists between HKEx's public interest functions and any of its other interests.
To re-inforce this primary public interest role, the "public interest" directors on the HKEx board (who comprise a majority) are appointed by the Financial Secretary, the Chairman is appointed directly by the Chief Executive of the SAR, and the CEO's appointment is subject to the approval of the SFC.
Additionally, the level of fees and charges levied by HKEx for ALL ITS regulated activities (including listing fees) is subject to SFC approval.
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Second, in addition to the statutory provisions, there is a host of carefully designed institutional arrangements to eliminate or control conflicts of interest, which were established when the exchanges were demutualised and merged in 2000. They are contained in Memoranda of Understanding between the SFC and HKEx/SEHK. There is a clear separation between the Board of HKEx (which is primarily responsible for its business management) and the Listing Committee, which carries the responsibility for decisions on listing matters. The Listing Committee is a body of independent professional and market people, and its composition and membership are subject to SFC approval. Listing Committee members have no interest whatsoever in the bottom line of HKEx.
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Third, the criteria set out in the Listing Rules for determining the eligibility of a company for listing are not (as suggested by Justice Rogers) more lax than those of other major international markets. The opposite is the case. Hong Kong's main board requirements in relation to such matters as length of track record, minimum level of profitability, and minimum market capitalisation are higher than those in the majority of major world markets. A study by PricewaterhouseCoopers done for the UK Listing Authority and published in April this year shows that the coverage of admission criteria in Hong Kong is more comprehensive than in any of the other markets studied (UK, US, France, Holland, Germany and Australia).
Moreover, the criteria for listing are in any event subject to a rigorous process of examination and approval (thus ultimately controlled) by the SFC.
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Fourth, even if we ignore HKEx's statutory duty to give precedence to the public interest (which we do not), it is self-evidently in HKEx's best commercial interest to perform its public interest functions (including listing regulation) in a diligent, responsible, and effective manner. The soundness and fairness of the market is one of an exchange's most important selling points in attracting investors and issuers, which in turn is what drives our revenues. International experience demonstrates this beyond doubt. HKEx knows this perfectly well and has no interest in doing anything other than administering the Listing Rules impartially and with adequate resources.
Thus, in our view, Justice Rogers' allegation that HKEx does, or could, approve the listing of "shonky" companies because it is a "trading company" does not stand up to examination.
The primary job of a listing regulator (whether an exchange or a statutory body) is to set objective criteria and require disclosure of all information necessary to enable investors to make informed decisions. The regulator gets onto dangerous ground if he tries to make subjective judgements about the "quality" of individual companies or to second-guess the market about the likely share price performance post listing. The stock exchange is a marketplace. If companies meet the criteria set, and investors want to buy their shares, they should be allowed to do so. It is quite unfair to blame the Listing Committee or the exchange if investors later find that the price they paid was too high, or the companies' financial performance did not meet their expectations, provided the companies met in full the listing criteria (and any continuing listing eligibility criteria), and made (and continue to make) full and accurate disclosure.
The issue of conflicts of interest in demutualised exchanges has been addressed in great depth in various markets, including Hong Kong (at the time when both the Merger Ordinance and the Securities and Futures Ordinance were considered). The International Organisation of Securities Commissions ("IOSCO") published several papers identifying in detail the potential conflicts of interest faced by exchanges when they demutualise and become commercial enterprises. These describe various acceptable ways to deal with such conflicts. The solutions adopted by Hong Kong fall well within the parameters described by IOSCO.
Nor is it true that exchanges, prior to demutualisation, were free from conflicts of interest. The potential conflicts were of a different nature, stemming from broker ownership rather than being accountable to public shareholders. Becoming a "for profit" organisation in fact aligns the interests of the exchange more closely with those of the public than was the case previously. The exchange has become more, rather than less, accountable for the quality of its market.
Justice Rogers' "rabbits and lettuce" analogy is also unfortunate in that it gives the impression that decisions of the Listing Committee have been or might be biased by the commercial interests of its members or of the exchange. This would be unfair. There is no evidence to support such a suggestion. There are extensive safeguards to protect against such conflicts. We believe the general view of those familiar with the circumstances is that Listing Committee members have consistently been both diligent and impartial in doing their job.
While Justice Rogers admitted that "statistics can be the subject of amazing manipulation", he did make extensive reference to the analysis in an SFC paper of 12thDecember 2001 entitled "Quality of the H.K. Listing market-- a Critical Review", and he appears to have relied on that analysis in arriving at his conclusion that the poor performance of many recently listed companies indicates that the regime for vetting listings is structurally flawed. Poor share price performance of recently listed companies does not necessarily mean that they are poor quality companies; much less does it lead to the conclusion that the system for vetting listings is faulty.
As not a few international academic studies, e.g. Ibbotson and Jaffe (1975); Ritter (1991); Loughran and Ritter (1995); and a working paper by Cheng, Cheung and Tse (City University of Hong Kong, March 2002) have shown, IPOs more often than not under-perform the market over an initial three year period. The economic downturn since the third quarter of 1997, which inevitably hit the profitability of our listed issuers, no doubt exacerbated this. Moreover, the fact that the Hong Kong market was shifting from a lengthy bull run into a bear market phase during the period covered by the SFC study must also be taken into account when trying to draw conclusions from stock price movements and market capitalisation.
It is also relevant to point out that as the SFC's review covers the period from 1996 to September 2001, a substantial part of it pre-dates the demutualisation of the stock exchange. It is therefore mistaken to link its conclusions to the view that HKEx has become a "trading company".
We would also caution against Justice Rogers' suggestion to transfer responsibility for listing matters to "an independent body". This would risk turning the present three-tier structure into a four-tier structure. As Justice Rogers concedes, HKEx must inevitably have a system to approve who should be listed on its market. The involvement of an additional body would be likely to create confusion and add to the cost of compliance in Hong Kong.
Justice Rogers also states that "Hong Kong is the only jurisdiction that attempts to control such matters as disclosure requirements and liability for inter- and intra-company dealings by directors through rules made and enforced by a trading company". We believe this also gives a wrong impression. Front-line responsibility for such matters in fact rests with demutualised stock exchanges in (among other places) Australia and Singapore. In numerous other markets, the relevant stock exchanges also perform this role, albeit that they are commercial enterprises of a different kind.
What the remarks of Justice Rogers do indicate is that if one of our most respected judges in his field, and the Chairman of the Standing Committee on Company Law Reform, is apparently unclear about HKEx's mission and position and the role it performs, it is understandable that the general public may also be uninformed about these matters. This statement seeks to make a start in clarifying the position.