HKEx, having announced a commitment to co-operate with Government's adoption of the Expert Group's plan to shift its regulatory role to the SFC, is now fighting it. We sat down last Monday with Charles Lee, who said that HKEx was obliged to put the public interest first and co-operate with the Government's proposal. Now he has done a U-turn. Did HKEx make a false and misleading announcement? And what about dictum meum pactum?

Disserving the Public Interest
31 March 2003

On Friday 21-Mar-03 the Expert Group to Review the Operation of the Securities and Futures Market Regulatory Structure (Expert Group) released its report. While the name of the group may have lacked punch, the report certainly did not.

The recommendations

The report was thoughtful, deliberative, almost comprehensive and certainly far reaching. We believe its recommendations should be adopted without further delay - and give those men a Gold Bauhinia Medal. The group listened to the views of anyone who wished to express them, and there is no need for further consultation.

The recommendations will establish a regulatory framework which is a necessary part of the improvements needed to raise Hong Kong to international standards. Beyond the terms of reference, the Expert Group even urged the government to consider class actions and contingent fees, which in our view are another necessary step to make shareholder actions a reality rather than a theoretical legal concept, and add to the deterrent for malfeasance. Until we have such powers, the full burden of enforcement rests squarely on the Government through the SFC and criminal courts.

The report's central recommendation is that Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) should get out of the business of regulation - a term which in itself is an oxymoron. The report calls the present structure "fundamentally flawed". You cannot be both for-profit and regulate in the public interest. Indeed, last year, according to HKEx's own annual report, there were 275 listing applications, and only 1 was rejected. That's nothing to be proud of.

The report calls for the Securities and Futures Commission (SFC) to establish the Hong Kong Listing Authority (HKLA), headed by an executive director, which will take over the regulatory role from the existing Listing Division from HKEx.

Furthermore, the report calls for the Listing Rules of the HKLA to be given statutory backing, but that the rules should not be statutes themselves. This will make it an offence to break the Listing Rules and allow for prosecutions with meaningful fines, while also allowing the rule-making process to be conducted by the professionals of the SFC and not by legislators, who are not sufficiently qualified to do so. The report states that the Securities and Futures Ordinance already contains the necessary legal framework, so no new legislation is needed to bring the HKLA into existence. The check and balance is that if any Listing Rule made by the HKLA is found by a court (on appeal of an HKLA decision) to be inconsistent with the legislative framework, then the rule will be overturned.

While it is clear that the Expert Group did not set out to copy any particular model, and great care was taken to look at the particular circumstances of Hong Kong, the end result looks very similar, but not identical, to the UK regime in which the Financial Services Authority runs the UK Listing Authority. All that shows is that logical reasoning brings reasonable people to the same conclusions.

The report also calls for an advisory "Listing Panel" to be established, in a similar format to the SFC's Takeover Panel (on which your editor sits). The Listing Panel would include a much greater proportion of investor representatives (currently, there is only 1 fund manager on the 25-member Listing Committee). The Listing Panel would hear appeals of decisions of the HKLA, and would also advise the HKLA on amendments to the Listing Rules. The key word here is "advise" - unlike the existing Listing Committee, the Panel would not have a veto over new Listing Rules, which would be "made and administered" by the HKLA within its statutory powers.

In our submission to the Expert Group, we called for the Listing Committee to be scrapped, for the reason that an issuer-dominated group of part-timers should not be making and interpreting the rules of the market. Instead, we said that an "Issuers Group" advisory committee could be formed, similar to the existing SFC Shareholders Group. So we agree with the advisory function of the new Listing Panel. However, we think it is unnecessarily complicated to have the Listing Panel involved in appeals of HKLA decisions, because this inserts an additional layer between the HKLA and judicial review by the courts. Given that the Listing Rules will have statutory backing, it would be simpler for appeals to be handled by the courts.

We also argued that the Takeover Code and the Code on Share Repurchases (Codes) should be given statutory backing. It seems inconsistent to regulate one aspect of corporate behaviour through Listing Rules with statutory backing while regulating another with a non-statutory code, where the worst penalty is a "cold-shoulder" order. The latter has been shown to be ineffective, just as the "name and shame" approach by HKEx to enforcing its listing rules is also ineffective. What is needed are meaningful financial penalties to offset the financial rewards of wrongdoing. It is unclear why the Expert Group did not comment on the question of statutory backing for the Codes - perhaps this was an oversight which can be resolved in the implementation phase, as it would be consistent with their other recommendations.


One widely misunderstood aspect of the report, perhaps caused by an ambiguous comment from the Financial Secretary, is the timing of its implementation. Media have been reporting that it will take 18 months for the HKEx to be relieved of regulation. This is not true.

In fact, the only reference in the report to "18 months" is that after the shift to the HKLA, the new Listing Panel will remain involved in approvals of new listings for an 18-month transition period while the HKLA gets up to speed. This is partly because HKEx has under spent on regulation for many years, leading to high staff turnover and a lack of experience. So the HKLA will have to cut out some dead wood and hire some experienced talent in order to raise the ability of the current listing division to handle new listings on their own.

So let's be clear - if everyone co-operates, it should only take 2 to 3 months for the transfer of the staff of the Listing Division of the Stock Exchange to the new HKLA under the SFC. Any financial bickering over the split of listing fees can be settled afterwards and need not delay the implementation. After all, agreement on the division of fees is not a condition of the proposal, and it has been accepted by all parties that HKEx will be left "neutral" in profits terms (translation: they were making a profit on regulation and they will get to keep the profit without doing any more work).

Co-operation and resistance

The Expert Group held a press conference on 21-Mar-03, and you can watch the video (free RealOne player required). The same day, the Financial Secretary endorsed the report in a statement and committed the government to implement its recommendations "as soon as possible".

HKEx responded the same day with an initial statement that it "is disappointed with the conclusions and recommendations" but continued:

"in the light of the Government's intention to adopt the Expert Group's recommendations, HKEx will work closely with the Government and the [SFC] on their implementation."

This was followed on Sunday 23-Mar-03 with a formal announcement by the board of HKEx repeating this commitment.

Dictum meum pactum?

As readers will know, your editor David Webb is standing for election to the board of HKEx, in an attempt to introduce some investor-based representation to the Board. Indeed, the Expert Group report noted "at present there are no investor representatives on either the HKEx Board or the [SFC]".

At the invitation of HKEx's chairman, Charles Lee, we sat down with him last Monday, 24-Mar-03, and amongst other things, discussed the Expert Group report. He said:

"We will co-operate with government. This is a public policy decision, and of course you know that, from the Merger Ordinance, the first duty of the regulator is to safeguard the public interest, so we have a public duty, and if government tells us this our public duty, then of course we will do it, this is our public duty. And the ordinance goes on to say that, after the public interest, we would then have to look after [HKEx] shareholders interest, second duty, and in case of a conflict, the public duty shall prevail, so that's very clear." (our hyperlink added)

Well, that was certainly clear to us and very reassuring. No more squabbling then. But 4 days later, Mr Lee was telling the newspapers the exact opposite. Far from "co-operating", he planned to send a letter to Secretary for Financial Services Frederick Ma Si-hang outlining HKEx's opposition to the proposals.

This brings into question whether the announcement last Sunday, made by the board of HKEx and filed with the SFC, was in fact false and misleading. In the usual terms, the Directors individually and jointly accepted responsibility for the accuracy of the announcement. These are the same directors who are now fighting the Government's proposal.

It also goes directly against what Mr Lee told us last Monday, that HKEx would co-operate and put the "public interest" first. Such assurances were disingenuous platitudes. So much for the old financial practice of dictum meum pactum - my word is my bond. The about-turn clearly and ironically illustrates what the Expert Group said in the first place - it is not realistic to expect a for-profit entity to act in the public interest.

Under the existing Listing Rules, there is a special provision that the SFC is the regulator of HKEx's own listing. So now, we call on the SFC to investigate whether the announcement of HKEx dated 23-Mar-03 was false and misleading. Did the board ever really intend that HKEx would co-operate with Government? There has been no announcement since then to the contrary, and in our view this is also a breach of paragraph 2 of the standard Listing Agreement whereby HKEx, as a listed company, is obliged to keep the market informed of material changes. This reversal is certainly one of them.

Indeed, in our view, the removal of the listing function to the SFC is beneficial to the long term development of the market and hence to the financial prospects of HKEx as a listed company. By opposing the plan, the board cannot even be said to be acting in the interests of its own shareholders, let alone the public interest, would should come first.

Public policy

Whether or not the Government's commitment to implement the report's recommendations is followed through is ultimately in the hands of Mr Tung Chee-hwa, Chief Executive of Hong Kong, and will be evident from his actions in the next two weeks.

Rumour has it that Charles Lee may resign as Chairman of HKEx if he does not get his way. That rather misses the point that the 3-year terms of all of the 8 "public interest directors" appointed by the government, including Mr Lee, expire on 15-Apr-03, right after the HKEx AGM. So he would be out of office anyway unless he is reappointed by Government.

That would be a welcome opportunity to revamp the boardroom of HKEx, along with the expected appointment of a new Chief Executive upon Mr Kwong Ki-chi's resignation.

Currently, 8 out of 15 directors are appointed by the Government, including the Chairman of HKEx who is subject to approval of the Chief Executive of Hong Kong. This will be reduced to 6 out of 13 after the AGM, the balance being 6 elected directors and the Chief Executive of HKEx, who is subject to approval by the SFC after consulting the Financial Secretary.

The Government has yet to announce who those 6 appointed directors will be (including the Chairman), so now more than ever, Government has the power to decide whether the appointed directors (and also the chief executive) are pro-reform or anti-reform. Those who are anti-reform, including Mr Lee, need not be re-appointed, but if they are, then we will know for sure which camp Mr Tung sits in. His Government's choice of directors, Chairman and Chief Executive will be a litmus test of whether he favours the vested interests of tycoons or the long-term interests of Hong Kong as a financial centre.


David Webb will be appearing before the Financial Affairs Panel of the Legislative Council from 10:00 on 7-Apr-03. This article constitutes his submission to that meeting.

©, 2003

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