The Delisting Fiasco
29 July 2002
On Thursday 25-Jul-02, the Stock Exchange of Hong Kong Ltd (SEHK), a wholly-owned subsidiary of Hong Kong Exchanges & Clearing Ltd (HKEx, 0388) announced a consultation paper with proposals for new initial listing criteria, continuing listing eligibility and cancellation of listing procedures.
We'll deal with the initial listing criteria and cancellation procedures in a later article, as these are not very controversial. What caused calamity was the proposed criteria for continuing listing eligibility, better described inversely as the "delisting criteria". The proposed delisting criteria include:
- market capitalisation under HK$30m (US$3.85m) for 30 consecutive trading days; or
- 3 years of losses, with negative equity; or
- 3 years of losses and a market cap under $50m for 30 consecutive trading days; or
- winding up, receivership or liquidation of the listed company; or
- a total disclaimer of audit opinion or an "adverse" audit opinion (whatever "adverse" means); or
- a share price below $0.50 for 30 consecutive days.
The result of the proposals was a panic sell-off of micro-cap stocks on Friday, as investors quite rationally believed they were about to lose both the market place for their shares and also the protection of the listing rules, which require a certain level of financial reporting, corporate disclosure and approvals of connected transactions. The Listing Rules may be inadequate in many areas, but they are a lot better than no rules at all, which is what you get with a delisted stock.
At Webb-site.com, we believe that once a stock has been admitted to listing, HKEx has a duty to the public to provide a marketplace for those shares, and such facility should only be withdrawn if either the company has ceased business (in a winding up, receivership or liquidation) or it has been privatised (100% acquired by its controlling shareholders). By all means, tighten the initial listing criteria, but once a company is listed, you have to live with it.
Delisting would boost HKEx profits
Under Section 27 of the Stock Exchanges Unification Ordinance, SEHK has "the exclusive right to establish, operate and maintain a stock market in Hong Kong". In other words, it is a legally protected monopoly. We believe that with privilege comes responsibility to provide a universal service - just as a monopoly electricity company cannot disconnect unprofitable customers. Investors and listed companies have nowhere else to go in Hong Kong.
As we explained in yesterday's article, the HKEx has a conflict of interest between being a regulator and a for-profit company. Both buyers and sellers pay a trading fee of 0.005% on each stock transaction as well as a CCASS settlement fee of 0.002% (subject to a minimum of $2 and a maximum of $100). So overall it has income of at least 0.014% on each transaction, and it also gets listing fees from listed companies.
Obviously, for similar velocities of turnover (the percentage of a company's stock which changes hands in a given period), micro-caps generate far less revenue for HKEx than blue-chips. Hutchison Whampoa, for example, has a market cap of $238.75bn, which is almost 8,000 times larger than the proposed $30m delisting criterion. Last month alone, it turned over $9.19bn and generated income of at least $1.29m for HKEx. A typical blue chip generates more income for HKEx in a single day than most micro-caps can generate in an entire year. Indeed, the top 100 companies (by size) normally account for about 90% of market cap and turnover, and hence 90% of HKEx's trading and settlement revenue. But it has to regulate the other 800 listed companies too.
On the expenses side of HKEx, the costs of regulating a micro-cap are of course not 1/8000th the cost of regulating a blue chip. On the contrary, regulating a micro-cap often costs a lot more than regulating a blue chip, because micro-caps tend to do more corporate transactions which are large in relation to the size of the company, and when they get into financial difficulty, they generate voluminous restructuring proposals and documentation.
So it should be quite clear that these are loss-making "customers" and HKEx has a direct financial interest in proposing to delist them rather than regulate them.
After the crash in micro-caps on Friday, HKEx initially put out a clarification announcement on Friday, then on Saturday announced it would extend the consultation period from 31-Aug-02 to 31-Oct-02, and finally on Sunday, in a press conference, HKEx Chairman Charles Lee announced that HKEx would take out the whole of the section on the delisting criteria from the consultation paper, and publish another version at the end of October. We can hardly wait till Halloween.
It is extremely unusual to announce policy initiatives on a Sunday, and this followed furious lobbying by "market participants" (probably small brokers) with the Chairman of the SFC, the Chairman of HKEx and Secretary for Financial Services Frederick Ma Si-hang (Mr Ma), who all turned out in a variety of colourful Sunday shirts for the hastily arranged press conference. Why the big hurry? Rumours suggest that a number of brokers who have margin lending exposure against such stocks, or have used such stocks as collateral for their own financing, may have faced financial difficulty if the plunge had continued on Monday.
Alexa Lam, Executive Director of the SFC, told Webb-site.com that:
"Based on the market movement of penny stocks on Friday, we managed to identified (sic) brokers with potential FRR [Financial Resources Rules] problems. We then contacted them individually to ascertain the latest position and the results were satisfactory."
So clearly the SFC had sufficient concern about certain brokers to make enquiries. Whatever the reason, it appears that the HKEx felt this couldn't wait until Monday morning. We can't help noticing that a few of the worst affected stocks are ones which we believe have been manipulated and ramped by syndicates, so they were bound to fall hardest. Other stocks, however, simply suffered from being small and falling into the net.
It should be obvious, but we'll say it anyway - whenever a company gets remotely near fulfilling the delisting criteria, investors would all start selling out at the same time, causing the market cap to crash and the criteria to be fulfilled. If the limit for 3-year loss-makers is a market cap of $50m, then you wouldn't find any with market caps of $51m or $52m for more than a nanosecond, because as soon as they got down to about $70m, the price would start to collapse. The only people that benefit in that situation are controlling shareholders who might see it as an opportunity to force a delisting and pick up all the minority stock on the cheap. It's like flying a spaceship across the event horizon of a black hole - there is no way back and the gravity will suck you in and crush you to a singularity.
Today the finger-pointing began, with Financial Secretary Antony Leung claiming that HKEx didn't consult the Government and failed to think through the consequences. That just doesn't stand up to scrutiny.
Secretary for Financial Services Mr Ma either knew or should have known what the proposals were. It's his job to know. The Government appoints 8 of the 15 directors of HKEx, and so controls its board. In any case, the proposals were foreshadowed at a press conference last Wednesday in which Mr Ma said "HKEx will shortly conduct a public consultation on a proposed framework for continued listing and delisting arrangements". At the same press conference, it was Mr Ma who announced the new Listing regime which he had "jointly reviewed" with the SFC and HKEx. It is quite clear that he was in a position to know. And he would certainly understand what he was looking at - from years of experience as a former member of the GEM Listing Committee and former director of several listed companies.
HKEx cannot have been unaware of the consequences, even if they didn't figure it out for themselves. The SFC Shareholders Group, of which your editor is a member, discussed this matter in a meeting on 6-Mar-02. Your editor made clear that it was unacceptable to remove the market place of minority shareholders so long as there is value in the shares.
Instead, your editor recommended that HKEx, through its trading-screen system, should display a warning "flag" on listed stocks which would not meet the listing criteria if they were applying for listing. That would put them in the "sick ward" and give investors due notice that the stocks may be riskier than normal. In fact, we already do this for GEM stocks - all of which begin with the number "8" to denote that they are on the GEM, which has lower entry criteria than the main board and is meant to be a higher risk market.
The case for an alternative "over the counter" board can only be made if investors have the same degree of protection as they get under the listing rules, which in essence means that if the Stock Exchange won't regulate them, then someone else must. But this should be an all-or-nothing deal; either HKEx gets out of the regulatory business and hands it over to the SFC, as we believe it should, or else it must provide regulation of any company it has listed, both the winners and the losers.
No doubt the SFC forwarded the views of the SFC Shareholders Group to the HKEx, which appears to have ignored them.
Time to test the Government's new accountability system - Mr Ma and the HKEx owe Hong Kong an explanation. Our bet is that Mr Kwong Ki-chi, Chief Executive of HKEx and a former civil servant with no previous market experience, will be the fall guy.
Quality of Markets
HKEx should note that no such delisting criteria exist in the UK Listing Rules - and yet the UK's quality of market is higher. In the environmental sphere, the solution to air pollution is not to give everyone gas masks, but to limit pollution in the first place and fine and jail polluters. The same applies to listed companies - we need stronger listing rules, more rigorous interpretation of them, statutory backing for them, and the ability to punish offenders in a meaningful way to provide a deterrent to abuse of minority shareholders. An effective means of compensation for abuse, through a class-action system, would also help share the regulatory burden between government and shareholders.
The HKEx is misleading both the public and itself if it thinks that by delisting defrauded companies (and sweeping innocent but sick companies into the waste bin with them), it will prevent more fraudsters coming to market. It won't. You've seen the real reason - small companies are loss-makers for HKEx.
Ironically, the proposal that has attracted the most media attention is actually well-intended, to require companies with stock prices below $0.50 to consolidate their shares (also known as a reverse stock split). We support that requirement, because it would open the door to lower trading spreads (the minimum gap between the bid and offer), as we explained in our article Cut the Spread, on 6-Jan-02. Investors will have the same percentage of the company (ignoring fractional shares) before and after consolidation, and the market capitalisation will be theoretically unaffected.
In fact, this is nothing new. As we pointed out in January, paragraph 30 of the Listing Agreement already states:
"Where the market price of the securities of the Issuer approaches the extremities of HK$0.01 or HK$9,995.00, the Exchange reserves the right to require the Issuer... to proceed with a consolidation or splitting of its securities."
The Exchange has rarely enforced this, but the principle is there and all they need to do is change "$0.01" to "$0.50" and actually use the rule. However, a breach of this rule should be treated in the same way as other breaches of the listing rules, not by delisting, as this just penalises minority shareholders.
© Webb-site.com, 2002