HKEx: no reform to placing mandate...or anything else
27 October 2009
On 9-Oct-09 Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) announced the conclusion of its consultation on the general issue mandate, one of 18 areas covered in a consultation paper way back on 11-Jan-08. Citing "current facts and circumstances", HKEx concluded that no amendments will be made to the Listing Rules.
This conclusion is offensive to investor opinion, as expressed by voting patterns against the issue mandate in AGMs, something which HKEx didn't even mention in its conclusions, but which we analyse below. Investors' interests have been disregarded in favour of politically powerful tycoons who continue to hold back corporate governance reforms and prevent Hong Kong from building a competitive advantage as a financial market.
The general issue mandate is a mandate which directors can seek from shareholders at each annual general meeting to allow the board to issue new shares, equal to 20% of existing issued shares, without offering them to existing shareholders first, at any time until the following AGM. In other words, the directors get to pick the owners of the company, rather than the other way around, subverting the governance chain of command. In the case of cash placings, the shares are almost always issued at a significant discount (the Rules allow 20%, or more in "exceptional circumstances"), thereby transferring value to the subscribers from existing shareholders and diluting their voting power and economic interest in the company's assets.
The AGM vote requires only an ordinary resolution, with 50% majority of votes cast. By comparison, in the UK, such a waiver of pre-emptive rights is taken more seriously and requires a special resolution, with 75% majority of votes cast, just as if the class rights attaching to the shares are being temporarily varied. The right to maintain your percentage share of ownership of a company is fundamental. The HK Companies Ordinance Section 57B is deficient in this respect. Even for PRC issuers, the mandate requires a special resolution with two-thirds majority, and even then, it cannot be used to issue domestic A-shares without further specific shareholder approval for each issuance.
Since our launch in 1998, Webb-site.com has regularly criticised the issue mandate and in 2003 we launched a campaign called Project VAMPIRE (Vote Against Mandate for Placings, Issues by Rights Excepted) urging investors to vote against the mandate. At the same time, our Project Poll also made sure that, in the blue chips, those votes were properly counted rather than binned in favour of a show of hands in the room, as was the prevailing practice. On 1-Jan-09, six years after we launched Project Poll, poll-voting became mandatory for all HK-listed company meetings.
As Project Poll lifted the veil, it became blindingly obvious by 2004 from the voting patterns in general meetings that a substantial majority of public votes are cast against the issue mandate. Gradually, a few of HK's more enlightened blue-chips cut their mandates in response to investor pressure. HKEx, itself a listed company, persisted with the issue mandate until 2004 when it was almost voted down. In 2005 it finally heeded our advice (your editor was a director of HKEx from 2003 to 2008) and stopped asking for the issue mandate. HKEx cannot claim to be unaware of how investors feel about the issue mandate, having dropped its own mandate in response to investor pressure.
The voting patterns have not changed much over the years since votes were first counted, in 2003. Controlling shareholders and directors, who run the companies, naturally vote to give themselves as much power as possible, in favour of the issue mandate, and public investors generally vote against, if they manage to vote at all.
Public investors comprise institutional and retail investors. Voting in HK is difficult for retail investors for the simple reason that the SFC does not require brokers and banks (intermediaries) to request voting instructions from retail investors for whom they hold shares. That would cost money, so almost no intermediary bothers - they just put it in the small print of client agreements that they don't have to tell you about shareholder meetings, in essence waiving their duty of care. You will find abundant online dealing systems, but no online voting systems at these firms.
For larger companies with institutional investors, the voting turnout (shares voted) averages about 40% of the public float, but for small caps, particularly some of the more abusive ones which institutions have managed to avoid, there is often nearly zero public vote, which tends to facilitate abusive acquisitions from supposedly independent vendors, connected transactions, open offers and intra-year refreshments of the issue mandate. The "public float" will inevitably include close relatives and employees of the company whose votes can be mustered to push things through if the turnout of the real public is low enough.
Under Listing Rule 13.36(5) introduced on 31-Mar-04, issuers under the general mandate are limited to a 20% discount to market price at the time the placing is announced, except in exceptional circumstances. To avoid this, some issuers enter placing agreements on a "best efforts" basis with long completion deadlines (or deadlines which are repeatedly extended), turning them into call options. If the market price rises, the discount expands, handing the benefit to the placees. If the price falls, the agreement lapses.
Take this one, for example, entered into by Byford International Ltd (8272) on 9-Apr-09 with a placing price of $0.20 when the market price was $0.24, with a 3-month deadline. It finally completed on 29-Jun-09, when the share price was $0.53 and the discount was 62%. Ironically, defenders of the general mandate proclaim how speedy it is as a way to raise funds - but companies then drag this process out when it suits them. To prevent such abuse, the Listing Rules should impose a completion deadline of 14 days on each use of the general mandate, because any placing agreement longer than that allows enough time to call a shareholder meeting to approve it before it completes.
Another way to avoid the discount limit is to issue convertible notes with a conversion price within the discount limit under the general mandate. If the market price falls, you can just redeem the notes. If it rises, the notes convert. The broker can even hold the cash as collateral until one of these two events happens. HKEx noted this problem in para 11.34(b) of its consultation paper but has done nothing about it. Such issues should be subject to specific shareholder approval.
Refreshments at EGMs
By "refreshments at EGMs" we don't mean the tea and dim sum. Under Listing Rule 13.36(4) introduced on 31-Mar-04, issuers need approval of independent shareholders for any 2nd or subsequent general issue mandate in a year, known as a "refreshment" of the mandate, with the controlling shareholder or, if none, the directors, abstaining from voting. Issuers have found ways around that rule too - just call the mandate "specific" or "special", but do not specify the subscribers up front, only a friendly "best efforts" broker. In our view that is not a specific mandate at all, but a general mandate in disguise. A specific mandate would be to introduce a particular new shareholder (or convertible note holder) to a company for some strategic reason (and it had better be a good one).
HKEx "noted with concern" this problem in para 11.36 of its consultation paper, but has done nothing about it.
We do note that one company, Sino Katalytics Investment Corp (SKI, 2324) went too far even for the Exchange's relaxed position, seeking a "specific mandate" without even signing a placing agreement, giving the board approval to enlarge the share base by 675.7%. There are no institutions in this stock, so a low voting turnout of 22.98% of the company (presumably including the 11.85% owned by the directors) unanimously thought this was a great idea at the EGM, and ten days later, on 12-Oct-09, the company launched a placing of 38.8% new shares. It was only at this point that the Exchange woke up and, on 22-Oct-09, rejected the listing application for the new shares (something almost unheard of), on the grounds that (according to SKI) "the proposed issue of the Placing Shares bears many of the characteristics of those of a general mandate". Surely the Exchange should have said so before the EGM was called.
Take a look at another example from China Strategic Holdings Ltd (0235) on 8-Jun-09, which proposed to place up to 78 billion shares (yes, billion) in tranches of not less than 2 billion shares each at $0.1 per share. This would increase the issued shares by more than 38 times, raising $7.8bn without any stated purpose at the time, and with no stated completion deadline. That agreement was terminated on 20-Aug-09 and replaced with a proposed issue of $7.8bn of zero-coupon notes convertible at the same price, by then a 69.7% discount to market, with a completion deadline of 30-Jun-10, more than 10 months away, and with no specific subscribers. If that isn't a general mandate, then what is?
These pseudo "special mandates" should be stopped. Shareholders should either be told before they vote who is getting the shares and why, or the proposal to place shares or convertibles through a broker should be regarded as a refreshment of the general mandate on which directors and controlling shareholders should abstain.
The Listing Rules should not regard a mandate as "specific" or "special" unless the subscriber(s) are named and have signed subscription agreements. Otherwise, the proposal should be treated as a refreshment of the general mandate, with controlling shareholders and directors abstaining from voting.
Latest votes: status quo unacceptable
To leave HKEx in no doubt about where investors stand on the general issue mandate, we have done what they should have done, and analysed the votes at the latest AGM of each of the top 30 HK-listed companies, ranked by market value of HK-listed shares on Friday, 23-Oct-09. These top-30 cover 61.7% of HK market capitalisation (as defined below). We excluded the votes of the controlling shareholder(s) from the "For" vote of each company, and then looked at how the rest of the votes were cast; "net for" and "net against" as a percentage of the remaining votes.
We consider that a proposed issue mandate conforms with international best practice (a "Y" in the Conform column) if it limits the number of shares which can be issued for cash to 5% of the existing issued shares. This is in line with the UK practice, although the UK guidelines also limit it to 7.5% in a rolling 3-year period and a maximum discount of 5%. We also want that discount limit, because if you want to use a larger discount, then you should offer it to existing shareholders, but for the purpose of this study, we will ignore it. We also note whether the mandate extends to shares which are repurchased - we always vote against that extension, because issuing a repurchased share (or one held in treasury) is no different to issuing a shiny new one as far as dilution of economic and voting interests are concerned.
Of the 30 companies in the study, 5 did not ask for a mandate at all (ICBC, CCB, BOC, Bank of Communications and HKEx) while 5 had mandates which comply (HSBC and Standard Chartered, because they are UK-listed, Hang Seng Bank, which is majority-owned by HSBC, BOC Hong Kong, which is majority-owned by Bank of China, and CLP). In one case (HK & China Gas) the number of votes in favour was less than the controlling shareholding, so some of the controller's votes were not cast, and we exclude the unreliable result from our study. That leaves 19 non-conforming issue mandates. Here are the voting figures:
The table shows that of the 19 non-conforming mandates, an average of 60.4% of the public votes were against them, out-numbering those in favour (39.6%) by more than 50%. Without the controlling shareholder, only 4 of the 19 would have passed as an ordinary resolution and 15 would have been voted down. If held to the UK standard, where waiving pre-emption rights requires a special resolution, all 19 of them would have failed to get the necessary 75% approval. And we've been generous to the supporters in our calculations: where there is a controlling shareholder, we haven't assumed the shares held by non-family directors were in favour.
We note that of the 19, three of them (SHKP, MTRC and Li & Fung) have made half-way steps towards compliance, cutting their mandate to 10%, as has HK & China Gas. That leaves 16 who are still going for the full 20%. Issuers won't get credit for half-way measures though.
By comparison, for the 5 conforming mandates, the average support was 67.5%, although this includes HSBC and Standard Chartered of the UK, which bring up the average. Indeed, the default 20% mandate is so widely proposed in HK that many investors don't bother to try and spot the companies which have voluntarily cut their mandate. Instead, they just vote against all general mandates. Just ask Esprit, which cut its mandate to 5% for cash and imposed a 10% discount limit but still got voted down at its AGM, possibly because it bolted on an extension of the mandate to repurchased shares. Investors could have supported the issue mandate and voted down the extension, but it's too much trouble.
Below the top 30, but still in large-cap territory, honourable mentions go to Swire Pacific Ltd (0019/0087, 34th/54th largest) and associate Cathay Pacific Airways Ltd (62nd), which both have complying mandates and no extension to buybacks. They may be hopeless at fuel hedging/speculation but at least they get some things right. Swire would actually be 22nd largest if it unified its share classes - its' the last holdout with two classes of voting shares on SEHK.
A note on market cap
H-share issuers (incorporated in the PRC) have other shares which are not listed in HK (and in some cases are listed in Shanghai) and those non-listed shares don't count towards the HK market cap. Some, particularly China Construction Bank Corp (CCB, 0939), have it both ways, listing almost all their shares in HK but having some of those listed in Shanghai. So there's no consistency. This originally happened when CCB listed on 27-Oct-05 and wanted to be in the HSI, but HSI wanted all the issued shares to be listed as H-shares, even though the state retained most of them. HSI has quietly dropped that criterion, still listed on its web site, when it moved to a free float model. Index member PetroChina, for example, has 21.0989bn shares listed in HK, but it has about 183.02bn shares in total. It ranks 15th by HK market cap, but if you applied the HK price to all its shares, it would be worth about HK$1.92tn, bigger than CCB. ICBC (1398) would be even bigger, at $2.17tn, and BOC (3988) would be $1.18tn. Looked at this way, it puts the old tycoon-run companies of HK into the shade and is a taste of things to come - the tycoons are far less important to the market's future than they think, or than HKEx seems to think.
The conclusions paper
HKEx's conclusions paper looks like it started with a conclusion and worked backwards in a futile effort to find plausible reasons to justify it. The paper makes no analysis of public voting figures on the general issue mandate, even though this is surely the most obvious way to measure what investors think. It only took us a few hours' work to gather the data and produce the table above, and the results are no different to what we found in 2004. We didn't bother to launch an opinion poll or make a submission on this issue because it was quite clear from the previous consultation in 2002 and from voting figures since 2004 what investors think. In any case, the Exchange would just play the numbers game, counting each listed company's identical submission separately and treating an opinion poll as a single response.
Here are some of the specious reasons given in the paper, and our response to them:
|The Exchange's conclusions||Our response|
|We are mindful of profound changes in market conditions since 2004 when the general mandate rules were last amended, in particular the increased volatility and difficulties faced by issuers in raising funds since the financial turmoil of 2008.||Rubbish. There has been no "profound change" in market conditions or market structure. There has been a temporary financial crisis, and a period of higher volatility which has abated. During that crisis, HSBC successfully raised HK$140bn in HK's biggest ever rights issue, respecting pre-emptive rights that HKEx clearly does not. And for what it's worth, the Hang Seng Index is up 70% (ex-dividend) from 31-Mar-04 to the date of your conclusions paper.|
|We also note the lack of a clear consensus on what, and the extent to which, change should take place since the responses did not demonstrate overwhelmingly strong support for any particular size limit option.||Take your blindfold off and look at the voting figures in AGMs and the fact that HKEx itself no longer has an issue mandate. There is a clear consensus of investors that the status quo is unacceptable. You proposed a range of reductions in the consultation. Naturally then, you didn't get overwhelming support for any particular option, but that is not an excuse for doing nothing. Those who wanted a 5% limit would obviously regard 10% as better than the status quo.|
|a reduction in the size limit for general mandates would have a substantial impact on H-share issuers. In considering any reduction of this kind for issuers, we would also need to consider to what extent H-share issuers should be treated differently.||Again, this is not a reason for inaction. In fact, mainland law
offers greater protection of pre-emptive rights, because it
doesn't allow directors to issue A-shares without
specific approval in shareholder meeting. So
some H-share issuers (including the 4 banks above) don't ask for a
mandate, and those that do still need subsequent shareholder approval if they use it
in Shanghai or Shenzhen.
But investors would not object if a 5% limit on cash placings applied to the number of all issued shares (not just the number of H-shares) and allowed the new shares to be issued as A-shares or H-shares, within the overall (20% A, 20% H) allowed under the Listing Rules. What matters to investors is the dilution to economic interests and voting rights, which relates to the entire share base, not the market in which the dilution occurs.
|Pre-emption restrictions can only go so far in fostering and promoting good corporate behaviour.||So what? Laws against theft can only go so far in fostering good social behaviour. Is that a good reason not to have them?|
|Over-regulation would only serve to curtail bona fide corporate activity ultimately intended to benefit issuers and their shareholders||Ah yes, the old "investors don't know what's good for them" argument. It's patronising and insulting. Clearly from their votes, investors do not regard the existing general mandate as beneficial to their interests. There is no evidence that the UK pre-emption limits, in place since 1987, have curtailed bona fide corporate activity or damaged shareholders' interests.|
|The [UK] Pre-emption Group's Statement of Principles...is not a legal or regulatory instrument and allows deviation for good reason. In Hong Kong...we do not think that this should be compensated for by means of formal Rules mandating the same higher standards as the UK Statement, non-compliance with which would render the Hong Kong issuer liable to disciplinary proceedings.||It is extremely rare for UK issuers to deviate from the Pre-emption Guidelines on size and/or discount. The Hong Kong Listing Rules, particularly Rule 2.04, provide flexibility for the Exchange to waive any Rule in "exceptional circumstances", and some Rules specifically allow for that, as does the existing 20% discount limit. The same approach can be taken with size limits. The possibility that occasionally a company may be able to justify a waiver is not a good reason for not having rules. Anyway, in most such cases, seeking a specific mandate from shareholders, for example, to allow a strategic investor or rescuer to subscribe more than 5%, will be more appropriate than applying for a Rule waiver from the Exchange.|
|We have not seen any evidence of widespread abuse of the general mandate||Then you don't understand that the general mandate itself, on current terms, is abusive to shareholder value, which is why the substantial majority of public investors are voting against it. The deeper the discount and the larger the issue, the greater the abuse. Even assuming the same rate of return on new equity as existing equity, a 20% issue at a 20% discount amounts to a 3.33% loss of value (116/120-1 = -3.33%) and a 16.67% loss of voting weight for existing holders, and that can be repeated every year. If more than 5% of shares are to be issued at more than a 5% discount, then they should be offered to existing owners.|
|we published a Consultation Paper proposing the shortening of timetables on rights issues. With pro rata fund-raising a more attractive alternative, use of the general mandate...may become commercially less justifiable and abuses less widespread||In the line above you said that you do not see any evidence of widespread abuse, and now you say there are widespread abuses which may be mitigated by your proposal - which is true? Anyway, this statement is hopelessly naive because it assumes that abusive controllers will change their ways in response to investor pressure. They won't.|
Investor reaction to the HKEx decision
"We are very disappointed with the decision of HKEx not to amend and update the general mandate rules in Hong Kong. This is an issue that global institutional investors have been voting against in large numbers over the past five years, and it is a pity that their views have been disregarded by regulators."
Mr Allen is also a member of the HKEx Listing Committee.
HKEx ices pro-investor reforms
This latest decision should be seen in the political context. Ever since the blackout controversy at the end of 2008, the Government, the SFC and HKEx have clearly been keen to avoid anything which might upset the tycoons, without whose support a Chief Executive of Hong Kong cannot get elected.
The Listing Committee has been revamped to put tycoon-friendly faces on the committee and in the top seats. The new Chairman of the Listing Committee, Teresa Ko Yuk Yin, is also a partner of Freshfields, and one of the two Deputy Chairmen, John Moore, is a partner of Herbert Smith. The two firms, on behalf of 12 investment banks, jointly opposed any change to the general mandate. Not surprisingly, investment banks like the easy money of instant placings, being able to offer discounted stock to their favourite clients, and not having to do any labour-intensive documentation work.
Quarterly financial reporting, first proposed by HKEx in 2002 (and mandatory in mainland China since then) and proposed again in 2007, has now been downgraded to a "long-term goal", and even a proposal on some wishy-washy quarterly management statement (words, not numbers) has yet to see the light of day. If you think management statements would be useful, take a look at London-listed Jardine Matheson's Q1 statement, which tells you nothing you didn't already know. Management statements in HK would be an exercise in obfuscation, like asking your kid what he did at school this term rather than getting test scores.
The latest official line-to-take on quarterly reporting is that "we might not need it if we have statutory backing for prompt disclosure of price-sensitive information". This is a complete non sequitur. What is or is not price-sensitive is hard to prove beyond a reasonable doubt, the standard needed for criminal prosecution, and non-disclosure is even harder to prove when the information never sees the light of day. If a company only reports half-yearly, a first quarter's (internal) results might be awful, and insiders might sell shares, while the second quarter's results might fortuitously turn out better. A half-year report would never reveal what insiders knew after 3 months. Alternately, the second quarter might turn out awful too, and the insiders would have avoided a loss, while claiming that they didn't know half-way through the period that the 6 months would be that bad, so they are in the clear. The public would get a profit warning only after the result was in the bag.
To see the flaw in the line-to-take you only have to look at the fact that A/H mainland-listed issuers who report quarterly are required to publish the same information here. It's price-sensitive, you see. But if it weren't for the mainland rules, you wouldn't see it. The same applies to companies with dual listings in Singapore, Malaysia, Taiwan or Canada, or those with parents listed in a jurisdiction which reports quarterly. Together, those account for nearly all the estimated 96 companies which currently report quarterly on the main board. There are just a few voluntary reporters, including HKEx.
But the tycoons don't want statutory backing for Listing Rules anyway - they are opposed to that just as much as they are opposed to quarterly reporting and have said so via spokesman Lo Ka Shui (a man for all seasons as long as they don't come quarterly), who seems to think the answer lies in a civil tribunal with fining powers. He must be unaware that tribunals cannot fine people, otherwise they become criminal courts in nature, as the Court of Final Appeal ruled in Koon Wing Yee v Insider Dealing Tribunal. The statutory backing saga has been dragging on since the first version was proposed in January 2005 (Government paper, SFC paper), with a watered down and probably-impractical "revised approach" announced on 28-Feb-07 and still no draft legislation.
Meanwhile a Law Reform Commission sub-committee on class action rights continues to labour harmlessly in obscurity. Their work will never see the light of day if the tycoons have anything to do with it.
Where does this leave us?
Investors continue to factor Hong Kong's weak protections into the price they are willing to pay for stock. We can't expect Hong Kong to achieve a competitive advantage in capital markets, in the form of higher pricing to attract issuers, unless we give investors a more trust-worthy market structure with appropriate laws, regulations and enforceability. It's time for the Government and regulators to start thinking about the long-term future of the Chinese capital market - one in which the RMB will be an international currency and large, widely held national and multi-national companies would vastly outweigh the small, tycoon-dominated companies of Hong Kong. In such circumstances, what will be Hong Kong's competitive advantage? HK's rule of law is often trumpeted (relative to the government-controlled and corruptible mainland judiciary), but it's seldom of any use to investors. The rule of law isn't worth much if the rules are stacked against you.
© Webb-site.com, 2009
Organisations in this story
- Capital VC Limited
- CHINA STRATEGIC HOLDINGS LIMITED
- SECURITIES AND FUTURES COMMISSION
- SEHK Listing Committee
Topics in this story
- Pre-emption rights/ general mandate
- Quarterly financial reporting
- Statutory backing of Listing Rules