We remind the board of MTRC that although they hold a blanket waiver of the Listing Rules on connected transactions, they cannot agree to amend the Fare Adjustment Mechanism if they expect it to reduce profits, because it would breach their fiduciary duty to minority shareholders. If the Government really wants to run the transport system and set fares, then they should nationalise it.

MTRC (0066) and the FAM
27 March 2013

Back in 2007, the MTR Corporation Ltd (MTRC, 0066) surrendered its fare autonomy, a key selling point in the 2000 IPO prospectus, and hand-cuffed itself to a "Fare Adjustment Mechanism" (FAM) linked to inflation in transport wages and the Composite Consumer Price Index. This was bundled into a set of "Transaction Agreements" relating to a so-called "Rail Merger" with the Kowloon-Canton Railway Corporation (KCRC), although in reality, it was a 50-year lease arrangement with a badly-designed rental formula, not a corporate merger. The KCRC continues to exist.

The details of this were well-documented on Webb-site at the time, and you can also find them in the circular dated 3-Sep-2007. Prior to that deal, as the circular notes on page 17:

"both the Company and KCRC have fare autonomy, and they set their fares in accordance with prudent commercial principles having regard, amongst other things, to prevailing market conditions, competition from other transport modes and their respective financial objectives"

In getting minority shareholders to swallow the FAM, one of the selling points, on page 17 of the circular, was that it would address:

"the common concern of public transport operators and the Government that fare adjustments should not be politicised as it is not conducive to efficiency and social harmony"

This was either naive or disingenuous. The more power a government holds to intervene in the process, including any scheme of control, the more politicised it becomes. If transport fares, whether on trains, buses or ferries, were a purely commercial and competitive decision, like the price of rice or vegetables, then the Government could validly say that it was not within their control, and consumers should shop around. Nobody really expects the Government to set the price of rice.

Page 161 (PDF) of the circular, which summarises the "Operating Agreement" between MTRC and the Government, states:

 "The FAM shall be subject to review every five years upon request by either the Company or the Government."

 The Government has now requested such a review. Importantly, however, the circular continues:

"If the Company and the Government do not reach agreement on amendments to the FAM within a specified period after commencement of the review, the prevailing FAM shall continue to apply."

The circular does not disclose what the "specified period" is. Under the terms of a disgraceful announcement on 13-Jan-2005, the Stock Exchange granted a blanket waiver of the connected transaction rules set out in Chapter 14A of the Listing Rules, so that MTRC would not need minority shareholders' approval to vary the terms on which it does business with its majority shareholder, the Government. This was done on the specious grounds that MTRC "has been a public sector transport provider". Its past status as a public-sector entity (like the Airport Authority) is of course irrelevant; by listing MTRC and selling shares to minority shareholders, it became a private-sector entity.

The Stock Exchange is of course owned by Hong Kong Exchanges and Clearing Ltd (HKEx, 0388), the only other listed company controlled by the HK Government (shareholders can only elect 6 of its 13 directors). Indeed, the former CEO of MTRC is now the Government-appointed Chairman of HKEx.

However, this wholesale waiver of the Listing Rules does not remove the fiduciary duty that the directors of MTRC owe to all shareholders of MTRC, including the minority shareholders. It would be a breach of that duty to deliberately amend an agreement if they expect that it will reduce the future profits of MTRC, as that would reduce shareholder value, and would open the directors to potential law suits and their decision to judicial review on the grounds of unreasonableness.

A report today quotes Michael Tien Puk-sun, a former Chairman of the KCRC, as saying that "he believes the government is looking for a formula that will halve the fair increases produced by the current system". If nothing else is on the table to offset that reduction in revenue, then the board would be unable to approve it without breaching their fiduciary duty. They would be like turkeys voting for Christmas.

The Government and politicians keep bleating about their perceived need to introduce some kind of "affordability" factor into prices - but that is exactly what fare autonomy produced, because the MTRC would only be able to charge what the market could afford, given the alternative modes of transport and the costs of travel. Charge too much, and revenue drops as customers shift away; charge too little, and your revenue and profit drops. Besides, the Government is already engaging in massive subsidies to anyone over 65 (reducing fares to $2, regardless of wealth) and provides a Work-Incentive Transport Subsidy of $600 per month for those on lower incomes, regardless of what it costs them to get to work.

Incidentally, the Government has recently announced that the median monthly wage in Hong Kong in Q2 of 2012 was $13,400, a 1-year increase of 4.3%. That is more than the 3.7% 1-year increase in the CPI for Jun-2012, so real wages increased by about 0.6%. So don't believe everything you read about real wages going down.

Liberalisation

Rather than continuing to intervene and therefore politicise and distort the transport sector, the Government should conduct a root-and-branch liberalisation of the transport sector.

The alternative to liberalisation is, of course, nationalisation. If the HK Government wants to plan everything, and either subsidise even lower fares with taxpayers money or degrade the service through under-investment, then they should buy out the minority shareholders of MTRC at a fair price, buy out the bus and ferry operators, and show what a grand job they can do by following the "big government, small market" approach.

© Webb-site.com, 2013


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