My three concerns on HKEx allowing dual-class shares

December 19, 2017 16:46
Charles Li, chief executive of Hong Kong Exchange & Clearing Ltd. The stock market operator has unveiled a revamp of IPO rules in a bid to attract more ‘new economy companies'. Photo: Bloomberg

Hong Kong's stock exchange has unveiled its most drastic revamp of initial public offering rules in decades, allowing 'new economy companies' with the controversial dual-class share structure to list on the bourse.

A dual-class shareholding structure usually consists of Class A and Class B shares, which have distinct voting rights. Each of the Class A shares, which are usually sold to the public, would get just one vote, while Class B shares reserved for the company founder(s) or executive(s) would carry more than one vote.

According to the new rules, a shareholder is required to own a minimum stake of 9.1 percent of Class B shares, and the ratio of the voting rights of the different classes of shares cannot exceed 1 to 10. These two requirements ensure that the Class B shareholder(s) controls the majority vote.

Companies with multiple classes of shares must be engaged in businesses classified as the new economy, with at least HK$10 billion in valuation and annual revenue of at least HK$1 billion. However, there will be no revenue threshold for businesses with valuations exceeding HK$40 billion, according to the new rules.

Though there is no time limit for the special voting rights, sunset clauses are inserted in the case of the company founder's demise, stock disposals or resignation as directors.

Hong Kong’s market operator clearly intends to attract more ‘new economy companies' into launching their IPOs in the city. The initiative comes as a new wave of fast-growing Chinese firms approach a stage where they might go public -- entities such as Xiaomi, Ant Financial Services, Ping An's Lufax and Good Doctor, Tencent Music, DJI, Toutiao, Meituan-Dianping and Didi Chuxing, as well as Huawei, Oppo and Vivo.

The planned changes also lift restrictions on secondary listings for “innovative” mainland Chinese companies worth more than HK$10 billion, targeting US-listed tech giants such as Alibaba and

The bourse will also create an additional chapter in its listing regulations for biotechnology firms that are at least HK$1.5 billion in valuation. They need not have any revenue track record to raise funds in the city, but they must have at least one product which has completed Phase I testing in relation to the clinical trial of a drug regulated by relevant drug and safety authorities such as the FDA (US), CFDA (China) or EMA (Europe) and has received the necessary regulatory approvals to proceed to Phase II.

The exchange plans to proceed with the formal consultation on the proposed rule amendments in the first quarter of 2018, expecting there will be ‘new economy companies' to be listed in the second half of 2018.

In the past, dual class shares were opposed by Hong Kong's securities regulator, the Securities and Futures Commission (SFC), which seems to have softened its position for now. With only a handful of large asset managers including BlackRock on the opposite side, overhaul of the listing rules was clearly in order.

I believe the rules amendment is a right move if Hong Kong wants to attract more companies to land their IPOs in the city, which will benefit HKEx’s business. Yet, I have some concerns about investor rights protection under the new rules.

Here are my three concerns:

1) Unequal voting right structure

In high-tech and internet companies, company founders contribute their effort, time and specific expertise in terms of product innovation. The public shareholders contribute by supplying equity financing, but their role in monitoring corporate governance should not be undermined.

If founders need control to focus on the long-term growth of the company, why don’t they sell fewer shares to other investors? Or raising the price of each share of the company in public offering? Why bother to adopt such a complicated shareholding structure?

The variable interest entity (VIE) arrangement is widely adopted by US-listed Chinese tech firms. Small shareholders can hardly affect the operation of the company, or even convene any special shareholders' meeting.

Advocates suggest that a dual-class structure is necessary for founder-led startups to spur innovation and maintain focus on long-term growth and vision, particularly in their early stage of the long-run product cycles. However, this argument cannot be justified as we see many more well-established tech behemoths, such as Google parent Alphabet, prefer to issue shares with less voting rights to the public, while keeping control by their super-voting powers.

The bourse has included restrictions on the special voting rights, but I would suggest building a time-defined sunset clause for it, e.g. it can only last 10 years post-IPO.

2) 'New Economy Company'

The new rules only favor 'new economy companies' to raise capital in the city; 'traditional businesses' such as property developers and banks are not applicable. However, the market operator did not give a definition of a 'new economy company', and it would be hard to define them indeed.

At present, traditional businesses are disrupted by innovative and new technologies. Leading Chinese insurance firm Ping An Insurance, for instance, is set to transform into a technology-driven financial conglomerate, and is widely conceived as one of the global leaders in artificial intelligence (AI) tech. If Ping An is to apply for the multiple-class shareholding structure, will it get a green light from the market operator? That's a question to be answered.

Furthermore, excessive worship and admiration of 'new economy company' has become a worrying trend in markets worldwide. These entrepreneurs are idolized for innovation and vision, as well as their moral standards. However, as a matter of fact, many startups are unethical in terms of their business models, operating like corporate Ponzi. They hardly have any profit generated from the business, or even subsidize the business with money raised.

One of the best examples would be Uber. The ride-hailing giant has established an edge over traditional car-rental companies by operating in a grey zone. Its services have been declared illegal in many regions worldwide, and it provides subsidies to its drivers, which can be considered as an anti-competitive act under traditional laws.

3) Investor rights protection

Class-action lawsuits and champerty, which many believe could serve the purpose of protecting the interests of individual investors, are not allowed in Hong Kong.

All in all, I have no intention of ruining the moment, and I truly welcome more good companies to land their IPOs in Hong Kong. Yet, what needs to be given a thought is whether the new rules will compromise the corporate governance of Hong Kong-listed companies in the long run.

At a time when Chinese authorities are imposing more stringent company listing rules in Mainland China market, Hong Kong should not fall back.

This article appeared in the Hong Kong Economic Journal on Dec 19

Translation by Ben Ng

[Chinese version 中文版]

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Eddie Tam is the founder and CEO of Central Asset Investments.