In another exclusive, five years after the market intervention, an investor with over HK$87bn of stocks has claimed exemption from the new law which protect investors in Hong Kong, which includes disclosure, insider dealing and market manipulation. The Government claim comes from a written response to questions we raised at the MTRC AGM. We look at the implications.

State Securities Above the Law
8 June 2003

Today we exclusively bring you disturbing revelations about the Government's attitude towards its new Securities and Futures Ordinance (SFO), arising from questions we asked at the 15-May-03 annual general meeting of MTR Corporation Ltd (MTRC, 0066), which have now been answered in writing.

A stain on the market

In Aug-98, in a move which permanently stained its hands-off-the-market track record, the Government, using the Hong Kong Monetary Authority (HKMA)'s Exchange Fund, intervened, pushing the Hang Seng Index up with an avalanche of taxpayers' money and acquiring about 15% of the entire free float of the Hang Seng Index, as we correctly estimated in Sep-98.

The HKMA later set up and owns Exchange Fund Investment Limited (EFIL), to manage the equity portfolio. After sales through the Tracker Fund program, the Exchange Fund's holdings were reduced to HK$51bn at 31-Dec-02. That's equivalent to 2% of the Hang Seng Index market value and 4% of the index free float.

In 1998, we complained to the SFC and through the newspapers that the Government, in its market intervention, was breaking its own laws by failing to disclose its substantial shareholdings and engaging in blatant market manipulation. The Government claimed exemption from the laws, and the SFC backed it up. The directors of the SFC are appointed by Government, so they are unlikely to publicly oppose Government policy on this or any other matter. was launched soon afterwards, in Nov-98.


The MTRC is currently the only listed company controlled by the Government, although they hope to float more. We'd better sort this out before they do. According to the MTRC annual report, page 62, the "Financial Secretary Incorporated" (FSI) owns 3,928,221,249 shares (76.14%) of the MTRC, now worth about HK$36bn. That takes total government holdings of listed shares to at least $87bn.

As the SFO was only introduced on 1-Apr-03, at the MTRC AGM, and in a written follow-up on 16-May-03 to Frederick Ma Si-hang (Mr Ma), Secretary for Financial Services and the Treasury Bureau (FSTB), we asked:

  1. Does the Government, either directly or through any entity it controls (including the HKMA, Exchange Fund, Housing Authority, MPFA, etc), own any shares in MTRC other than the holding disclosed by the FSI?
  2. Does the Government consider itself bound by the provisions of the SFO and in particular the disclosure of interests provisions therein, and if not, why not?
  3. Whether or not the Government considers itself bound by the SFO, will the Government comply and inform the board of MTRC of its total interest in shareholdings, including shares held by the FSI, for publication in the interim and annual reports of MTRC and through the Stock Exchange disclosure of interests system?

On 6-Jun-03, Martin Glass, a Deputy Secretary at the FSTB, replied on behalf of Mr Ma. He wrote:

"a) according to the latest records of the HKMA, the Exchange Fund held 69,863,918 MTRCL shares. Neither MPFA nor Housing Authority hold any MTRCL shares. The Treasury manages a number of small funds through financial institutions acting as agents, which together hold around 0.1% of the issued shares of MTRCL as at 31 May 2003.

b) EFIL, which has been appointed as the investment adviser and manager of the Hong Kong Equity Portfolio of the Exchange Fund, has obtained the approval of the Financial Secretary and the HKMA to disclose on a voluntary basis any of its shareholdings which exceed the threshold stipulated in the SFO. FSI also discloses its shareholdings on the same basis."

Five years after the intervention, and having introduced a comprehensive new law, it is clear that the Government still regards itself as being above that law. FSTB's use of the phrase "on a voluntary basis" clearly implies that they do not regard themselves as legally obliged to disclose their shareholdings, unlike any other shareholder.

Abuse of immunity clause

We believe the Government is abusing Section 66 of the Interpretation and General Clauses Ordinance (IGCO, Chapter 1 of the Laws of HK) which states:

"No Ordinance...shall in any manner binding on the State unless it is therein expressly provided or unless it appears by necessary implication that the State is bound thereby."

Ironically, 66 is also the stock code of MTRC. Section 3 of IGCO defines "State" to include the HK Government. Of course, the SFO does not "expressly provide" that it applies to the Government - but then it does not expressly provide that it applies to you either. So we are left with whether it appears "by necessary implication" that the law applies to the State.

Surely it is obvious that if the SFO did not apply to the Government, then it would be free to conduct insider dealing in the stock market, manipulate the price of shares, (yes, it did that in 1998), engage in false and misleading disclosure and accumulate undisclosed shareholdings, and vote them on connected transactions. It seems to us that it must be a "necessary implication" of the SFO that it applies to ALL shareholders, without exception.

Indeed, the regulatory objectives of the SFC listed in Section 4 of the SFO include as the first item:

"to maintain and promote the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry"

How can the SFC achieve that if one investor, with tens of billions of dollars invested in the market, is exempt from the law?

Undisclosed holdings

The FSTB's response for the first time reveals that the Government holds not 76.14%, but at least 77.60% of MTRC, or 1.46% more than we all knew. If the Government was bound by the SFO, then it would have to disclose this combined interest.

That disclosure reduces the free float from 23.86% to 22.40%, a reduction of about 6% in share terms. Those index compilers such as MSCI who produce their index based on free float may have to reduce their index weighting for MTRC, and funds which track those indices may have to do likewise.

FSTB's reply also segregates the "voluntary" disclosures of the FSI and Exchange Fund, so that the Exchange Fund holding would only be disclosed if it exceeds 5%. As the Exchange Fund only holds about 1.4%, that means that we will not be getting regular updates on the Government's separate holdings, and the reply did not even mention the aggregate Government holding, so it remains unknown whether other government entities besides the ones named in the response hold any shares.

More market interference

Another revelation in the FSTB's response was the statement that "The Treasury manages a number of small funds" which hold about 0.1% of MTRC. That's about $47m worth, and makes us wonder what else they own. We had previously believed that the Government's only interference in the stock market was via the Exchange Fund, which is managed by the HKMA, not the Treasury. Now it emerges that the Treasury also manages equities. According to its web site, the Treasury manages funds with a total size of $38.3bn, the bulk of it for Schools Provident Funds, although we don't know how much is in equities.

How big is this iceberg - are there any other Government entities in the market, we wonder? Do Legislators know what the Government is doing here?

Potential to rig the MTRC-KCRC merger vote

Another reason why it is a "necessary implication" that the law should apply to the Government is the fact that it has connected transactions with the MTRC. As we reported in 2000 at the time of the IPO, in another example of the "corporate governance is good, but not for us" school of thought, the Government obtained a blanket waiver from the Stock Exchange from the requirement to obtain minority shareholder approval on connected transactions, which was ironic given the advertising campaign of "you're the boss" which accompanied the IPO.

However, it is accepted that this would not apply to a proposed merger with Hong Kong's other railway-cum-property developer, the KCRC, on which the Government said on 25-Jun-02 that it would conduct a feasibility study. Such a merger would require approval of minority shareholders, but the continued refusal of the Government to be bound by the SFO raises the spectre of the Government using undisclosed shareholdings to vote in favour of the merger and push it through, even if the majority of the public vote is against the plan.

Vampire finds another win

To demonstrate how easy it would be to rig the vote, look at the results of the MTRC AGM - thanks to our Project Poll, the antiquated show-of-hands was scrapped, and votes were counted properly this year. Under Project Vampire, we recommend investors to vote against the general issue mandate. We aim to show that minority shareholders (i.e. the investing public) were opposed to the mandate, by deducting the votes of the insiders from the poll results. Initially, it looked like we had lost, with the public vote, excluding the known Government shareholding and directors, being as follows:

  Votes Share
In favour 119,359,344 60.91%
Against 76,613,659 39.09%
Total 195,973,003 100.00%

However, if the Exchange Fund's 1.35% and the "around 0.1%" held by the Treasury-managed funds are included in the "yes" vote, then we should deduct those too, which would leave the result as:

  Votes Share
In favour 44,336,312 36.66%
Against 76,613,659 63.34%
Total 120,949,971 100.00%

So Vampire can claim another win, the 9th in the Hang Seng Index. Now take the first table in the above figures and imagine that this was a vote on the KCRC merger. Makes you kind of nervous, doesn't it? The Government's secret holdings could determine the outcome of the vote.

PRC Government could be at it too

Now take a look at the definition of "State" in Section 3 of IGCO. Given the Government's position that it is exempt from the SFO, we presume that they and the SFC would also exempt anyone else covered by the definition of "State" in the IGCO.

Hence, it appears that the President of the PRC, the PRC Government, and organs such as the People's Bank of China, which manages the country's massive foreign reserves, could also have undisclosed holdings in HK-listed companies that the State ultimately controls. Other possible candidates for exemption might include the new PRC State Social Security Fund Management Council. This means that:

Government should be bound by the law

In the wake of the market intervention, on 20-Oct-98 the Legislative Council Panel on Administration of Justice and Legal Services debated whether the Government should be bound by the securities laws. Representatives of both the Law Society and the Bar Association told the panel  (paras 31 and 35 of the minutes) that the laws should bind the Government. Indeed, the Law Society's David Stannard (who two months later was appointed as an executive director of the SFC, and last year returned to private practice) said that the Government's exemption would:

"prejudice the interests of other private sector investors who were entitled to know whether there were substantial shareholders of the companies whose shares had been actively traded at the time. This would defeat the fundamental intent underlying the relevant Ordinances which was to ensure a level playing field for all investors in the interests of the market as a whole."

Of course, the Government disagreed, and claimed in a submission that none of the securities laws applied to it. In the meeting, the Government sought to defend its behaviour by claiming that disclosure of its portfolio during the intervention would have "undermined the effectiveness of its actions" (the intended effect being to ramp the market in order to squeeze short-sellers). Clearly if that was the Government's only excuse for exemption, it only existed during the intervention itself and is no excuse today.

At the next panel meeting on 2-Nov-98, the Government submitted a paper in which it undertook (see page 3) "to review any Ordinance in respect of its binding effect when the need to do so has been identified". Will it now honour that undertaking?

Unless and until the HK Government confirms that the Securities and Futures Ordinance applies by "necessary implication" to the State, or amends the law to "expressly provide" that it applies to the State, investors will continue to run the risk of hidden shareholdings, rigged votes, insider dealing and market manipulation, amongst other SFO offences from which the Governments of both HK and the PRC would be exempt.

In these circumstances, it is a "necessary implication" that any Government claim that Hong Kong offers investors a transparent and level playing field is transparently false.

©, 2003

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