At last year's AGM, editor David Webb was elected to the board of HKEx on a shareholder nomination, a first for a HK-listed company, we think. Now we give you our voting recommendations for the 2004 AGM, and the reasons.

HKEx voting recommendations
14 March 2004

Company: Hong Kong Exchanges and Clearing Limited (HKEx)
Stock code: 0388
Date of meeting: 31-Mar-04
Time of meeting: 16:30
Advice date:  14-Mar-04
Notice of Meeting: Click here
Shareholder circular Click here
Proxy form Click here
Voting method: HKEx has stated that the Chairman intends to demand a poll on each resolution. If he doesn't, we will!
How to vote: See our voting guide

Note to journalists:
We have up to 5 proxy seats available inside this AGM. Please contact us if you want a seat.

Item Description Vote
1 Adopt the accounts FOR
2 Declare a final dividend FOR
3 Declare a Special Dividend (see notes) FOR
4.1 Elect John Estmond Strickland (see notes) FOR
4.2 Elect Wong Sai Hung, Oscar (see notes) FOR
5 Re-appoint PriceWaterhouseCoopers as Auditors FOR
6.1 Mandate to issue additional shares (see notes) AGAINST
6.2 Mandate to repurchase shares on-market FOR
6.3 Extend the mandate granted pursuant to item 6.1 AGAINST
6.4 Approve the payment of remuneration to the non-executive directors FOR
6.5 Adjust the terms of share options due to the special dividend FOR
6.6 Amend the articles of association (see notes) FOR

Reasons for recommendations

This is probably another first for a HK-listed company - an independent director actually telling you directly what he thinks about the board's proposals.

Item 3 - Special Dividend - the background

HKEx has proposed a special dividend of $1.68 per share, in addition to the final dividend of $0.42 per share. We recommend you to vote in favour of this. However, we believe that, having regard to its foreseeable cash requirements, and having regard to the need to maintain prudential reserves due to the special role of HKEx as operator of the clearing systems, it would have been possible to pay more. After the final dividend and special dividend totalling about $2.2bn ($2.10 per share), HKEx will still have about HK$2.8bn of cash and trading securities in its corporate account, outside of the clearing house funds, and no borrowings other than HKD50m in the form of a Singapore dollar loan to finance its 1% stake in SGX.

The board of HKEx has an "Investment Advisory Committee" whose job it is to advise the board on investment policy and oversee the investment of the corporate funds. Three external fund managers manage part of these funds, including all the equity positions (other than the stake in SGX), to avoid HKEx, as a market operator, picking equities itself. Your editor is a member of that committee.

The dilemma that HKEx faces is that it is not an investment company, and does not behave like one. It does not publish a monthly net asset value or give regular disclosure of its portfolio. Analysts and fund managers who follow HKEx probably find it quite easy, on a daily basis, to estimate the year-to-date core earnings of HKEx, which are highly correlated with stock market and derivatives market turnover, but find it much harder to estimate the investment income, which depends on the portfolio and strategies adopted by the managers of the funds from time to time (although you will find a snapshot analysis in the annual report).

As an investor ourselves, we believe that companies in which we invest should not retain cash beyond their foreseeable requirements, because we would rather invest it ourselves than have investee companies do it for us, unless asset management is their core business. We also do not think that there is a "goldilocks" amount of risk (not too little, not too much) that should be taken with the spare cash - instead, we advocate taking as near-zero risk as possible, so that investors in HKEx will at least have greater certainty of the outcome, and if they wish, they can neutralise the effect of the cash by borrowing the corresponding amount against their position. However, as you can infer from the results, your editor is in a boardroom minority on this, and the majority view is currently that some risk is good, which is reflected in the portfolio.

The biggest variable in determining how much money to retain in corporate funds is one which anyone who invests in HKEx should think hard about. In the event of a severe market crisis (for example, if Beijing nuked Taipei), then a large proportion of investors could default on their settlement and margin obligations, and then the existing reserves held within the clearing house funds of $1.55bn could be exhausted. At that point, it is likely that the Government, which, you recall, effectively appoints half of the HKEx board, would lean on the company to pony up the money to prevent the system locking up and trades failing. From a commercial perspective, HKEx would also have an incentive not to allow the clearing companies to become insolvent, as this would destroy a key part of the business and leave HKEx as just an exchange without clearing and settlement businesses, as these would likely then be taken over by whoever bails them out (probably the government or the banks who are most exposed to defaulting brokers).

So HKEx would likely inject as much money into the clearing companies as it could to bail them out. However, one must remember that given its monopoly position, HKEx also has substantial borrowing capacity against the cash flow generated by its franchise, so while we think it is appropriate to budget for a rainy day and a typhoon day, we do not think it is necessary to budget for Noah's flood. In the 1987 market crash, when the Hong Kong Futures Exchange suffered widespread defaults, a $2bn "lifeboat fund" (a lot of money in those days) was established by a group of lenders to bail out the market, and the Government then imposed a levy on the stock and futures markets to pay it back over time.

Remember that when things go wrong, those with the deepest pockets will feel hands inside them. When retail brokerage C.A. Pacific went bust in 1998, leaving over 5,000 clients in the lurch, the Stock Exchange ended up paying a total of $300m towards investor compensation.

Items 4.1 and 4.2 - Directors

The Board of HKEx comprises 13 directors, of whom 6 can be elected by shareholders, 6 are appointed by Government, and the remaining director is the CEO, who is appointed by the Board subject to the approval of the SFC. The Chairman of HKEx is elected by the Board, subject to approval by the Chief Executive of Hong Kong.

At the 2003 AGM, shareholders elected 5 directors, including editor David Webb. That left a vacancy. The Government waited until moments after the AGM to announce that it would not re-appoint John Strickland as a government-appointed director, and then the next day, at the first board meeting, he was appointed to fill the vacancy left by shareholders. This, in effect, gave the Government 7 seats on the board. At that board meeting, your editor objected to his appointment and proposed another candidate, because although Mr Strickland was an excellent candidate, we felt the Government had been underhand in the way it had removed him as one of the Government-appointed directors in the near-certainty that he would be reappointed to fill the shareholder vacancy the next day.

However, Mr Strickland (as he was not elected) must now stand for election by shareholders, as he should have done last year, and we have no hesitancy in recommending that you vote in favour. He does a professional and thorough job Chairing the audit committee (on which your editor also sits).

Of the remaining 5 directors, one third (rounded down) had to run for re-election by rotation. Since we were all elected at the same time, that meant one of us had to be chosen by random draw. Oscar Wong Sai Hung, who besides your editor is the only other investor-based representative on the board, drew that card, and is running again. He is CEO of BOCI-Prudential Asset Management Ltd, a joint venture between Bank of China and Prudential plc of the UK. We understand that Prudential owns just under 5% of HKEx.

In our view, Mr Wong has not been as much of an advocate for investor interests as we would have liked, often remaining silent where an extra voice or vote in the boardroom would have been helpful to investor interests. However, if he is not re-elected, then investors run the risk of being reduced to a single representative on the board, and the risk that the board, which is dominated by brokers, bankers and advisers to, or directors of, other listed companies, would fill the vacancy with one of their own. So in the absence of any other investor-based candidate, we recommend that you vote in favour of Mr Wong's re-election, and at the same time urge him to speak up for investor interests in his new term.

The above recommendations are subject to change if any other candidates come forward by the deadline of 7 days prior to the AGM, turning it into a contested election. If any candidates come forward, then we will review our advice and urge at the AGM (as we did last year, see minutes) that the meeting be adjourned to allow at least 14 days for shareholders to cast their votes. Last year was something of a fiasco when 2 last-minute candidates came forward, the Chairman refused to adjourn the meeting, and the new candidates received some 150-200 million fewer votes (for and against combined) than the other candidates, indicating that shareholders had not had sufficient time to react. As it turned out, under the net vote system, neither of the last-minute candidates was elected.

Government opacity

3 of the 6 incumbent government appointees, Charles Lee, Tim Freshwater and K.S. Lo, were only appointed for one year terms which expire at the AGM. One of the principles of good governance is full disclosure, giving investors all the relevant information on which to make a decision. In this regard, we reprimand the Government for failing to state who they are going to appoint or re-appoint to the Board, to work with the elected directors. As shareholders are being asked to elect two directors, one factor in their voting decision may be who these directors will have to work with, so investors should be told without further delay. It is shabby behaviour for the Government to leave it until the last minute as they did last year.

Items 6.1 and 6.3 - General Mandate urges all investors to vote against the general mandate for all listed companies, for the reasons explained in our article Project Vampire (Vote Against Mandate for Placings, Issues by Rights Excepted), unless a company complies with the recommendations in that article.

What you are being asked to do is give up your rights, known as pre-emptive rights, to be offered new shares if the board chooses to issue them for cash. The mandate would allow the board of HKEx to issue new shares for cash, up to a maximum of 20% of the existing shares, without offering them to existing shareholders first, and at discounts of up to 20% (this limit is introduced under new Listing Rules from 31-Mar-04).

When the agenda for this year's AGM was discussed by the board, your editor urged his fellow directors to set a good example to the market by rising above the minimum standards set out in HKEx's own Listing Rules, and restricting the issue mandate in line with international best practice (which in this case, is the UK), as recommended by Project Vampire. Indeed, on 30-Jan-04, when HKEx announced the latest  Listing Rules amendments, it said, in relation to further possible changes to those rules (paragraph 37):

"we will consider lowering the maximum number of securities that are allowed to be issued under the general mandate to bring our requirements closer to those of the United Kingdom."

Unfortunately, HKEx is saying one thing but doing another. It is a great pity that HKEx is not willing to lead by example, or rather, to build on the example set by some other listed companies in 2003 which adopted Vampire-compliant mandates. A majority of investor votes in 10 members of the Hang Seng Index last year (excluding directors and controlling shareholders) were against the general mandate. Two other index members complied - HSBC because it has to, being UK-listed, and Johnson Electric voluntarily.

If the board of HKEx thinks that the 20% general mandate is OK, then are the staff of its Listing Division ever likely to propose to the Listing Committee that this rule be tightened? This example again demonstrates that HKEx, as a listed company, has a conflict of interest in making Listing Rules on corporate governance and should be relieved of this role. Meanwhile, please vote AGAINST the mandate.

Item 6.6 - Articles of association

In Feb-03, launched Project Poll, in which we aim to abolish the show of hands system in shareholder voting, in favour of a 1-share-1-vote poll. The show of hands system has no place in a fair and transparent market, because:

So a year ago, we bought 10 shares in each of the then Hang Seng Index members and, of course, 10 shares of HKEx, split them into 5 registered holdings, and successfully required all of these companies to poll their votes, except for the AGM of HSBC (but we got an EGM done).

For the first time, HKEx has stated, in the Corporate Governance section of its annual report:

"For the sake of good corporate governance practice, the Chairman intends to demand poll voting at future general meetings for all resolutions set out in the relevant notice of meeting so as to allow shareholders to have one vote for every share held."

Now that is a good thing, but as readers will know, could require a poll anyway, so cynical readers might think that HKEx is making a virtue out of necessity.

Sadly, they are right. At the board meeting to consider the AGM agenda, your editor put it to the board, that if HKEx now believes that poll voting is "good corporate governance practice", and that the Chairman would require it for all resolutions at future general meetings, then why don't we just go the whole hog and delete the show of hands system from our articles, making poll voting automatic? Then the sword of Damocles hanging over shareholder democracy would be removed, once and for all. Investors would no longer have to rely on the Chairman's intent, or the actions of, to get their votes counted on a poll. We said that if the board was really committed to poll voting, then it would put this in the proposed amendment of the articles and let shareholders decide.

As you will see on page 18 of the AGM circular, the amendments to the articles do not include our proposal, and the show of hands system remains in the articles as the default voting system at shareholder meetings. It's one more example of form over substance at HKEx, saying one thing but doing another. We lost that battle, as we have so many others within the boardroom.

Nevertheless, although we do not agree with all the proposed amendments to the articles of association, many of them are necessary due to changes in the Listing Rules, so as this is an all-or-nothing proposal, we recommend that you vote in favour. We'll take what we can get.

©, 2004

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