A Time to Advance and Optimise Hong Kong’s Listing Requirements

News Featured Stories A Time to Advance and Optimise Hong Kong’s Listing Requirements

By Prof. Kalok Chan, Dean of The Chinese University of Hong Kong (CUHK) Business School and Wei Lun Professor of Finance

In June 2016, the Securities and Futures Commission (SFC) and the Stock Exchange of Hong Kong Limited (Exchange), a wholly owned subsidiary of Hong Kong Exchanges and Clearing Limited (HKEX) jointly issued a Joint Consultation Paper on Proposed Enhancements to The Stock Exchange of Hong Kong Limited’s Decision-Making and Governance Structure for Listing Regulation. The consultation period has been extended to mid-November. The proposals in the paper involve multiple stakeholders, thus causing a huge response in the market.

The paper proposed that two new Exchange committees will be established, namely the Listing Policy Committee and the Listing Regulatory Committee. Generally speaking, small brokerages are opposed to the enhancements, whereas medium and big brokerages and investment banks express their support.

The Listing Policy Committee will steer the overall listing policy and its member composition, with members comprising senior management from the SFC, the Chairperson and the two Deputy Chairpersons of the Listing Committee, the Chief Executive of HKEX, as well as the Chairperson of the Takeovers and Mergers Panel.

The Listing Regulatory Committee, on the other hand, will decide upon matters concerning individual new listing applicants and the suitability for listing of new applicants, with members comprising senior management from the SFC, as well as the Chairperson and the two Deputy Chairpersons of the Listing Committee.

Who Should Approve Listing Applications?

Regarding the recommendations, there are opposite viewpoints: People who object think that they are burdensome. Others feel that increasing SFC’s approval power may lead to stricter regulations, thus suppressing the development of the market.

Actually, all these objections point to one fundamental question: Who should approve listing applications? From a historical perspective, there is a development about the allocation of approval authority.

In the 1980s and 1990s, the approval authority has always rested in Exchange. But after the “Penny Stocks Incident” in 2002, an evaluation was carried out to improve the quality of listed companies. According to the advice from the inquiry panel on the Penny Stocks Incident, the dual filing regime of SFC and HKEX was established. Listing companies must file their applications and disclosure materials with the SFC via Exchange, which offers SFC the authority to take part in the decision making process. Therefore, this consultation can be regarded as part of the development process.

Tremendous Market Change in the Last Decade

In fact, in the last decade or so, there has been a huge change in Hong Kong stock market, in terms of market volume and scale, especially with many mainland private enterprises listing in Hong Kong, also with some new stocks got busted shortly after listed and the problem of “shell planting” in the stock market. There is a need to review whether the system which was established more than ten years ago should continue to be the basis for market order and operation. In fact, Hong Kong should be keeping up with the time and optimise its listing procedure and system.

Balance Between Supervision and Promotion of Market

In this regard, a compromise could be adopted by having multi-stakeholders which includes the SFC, HKEX, together with the listing committee comprising many market participants such as lawyers, accountants and investors. This will help to maintain a balance between supervision and promotion of market development. In this regard, this consultation paper has kept such balance. The only question is in terms of procedure: Whether the Listing Regulatory will be able to review the suitability of companies efficiently and before the Listing Committee approves their applications for listing.

Indeed, some relatively complex listing cases may not be a quick and easy decision for the 28-member Listing Committee whose members normally work on a part-time basis, having their own professions. They may not be able to join every discussion on the cases and the whole group may not ensure their participation for future discussions on same cases. As a result, there may be delays before unanimous agreements can be reached on some complex cases.

Therefore, for complex cases, reviewing as earlier as possible and at the Listing Regulatory Committee level can help to handle the “day-to-day listing matters concerning individual new listing applicants or listed issuers that have suitability concerns or broader policy implications” (Item 15 of the consultation document). Undoubtedly, it can also help to achieve smooth vetting procedure on the overall listing approval process as well as send clearer messages to the market. From an efficiency point of view, this is an enhancement.

Prevention Is Better Than Enforcement

On the other hand, there are people concerning that SFC will have excess power with the proposed change. If the SFC officers, who are market participants without a deep understanding of the market, get too much power, market development may be stifled.

In fact, besides monitoring the market operation, it is also SFC’s responsibility to promote market development. If Hong Kong securities market gets stagnated, SFC will be under pressure and also to be blamed. As for the comment that SFC officers are not familiar to market operations, it is not necessarily the case. Since SFC needs to meet the regulatory requirement to understand market needs, they also employ market participants with rich market experiences. Therefore, this worry is not necessary.

In response to the worry by some market participants that the approval system will become stricter than ever, I don’t think it is necessarily the case. In fact, SFC can help strengthen the enforcement towards violations. However, when investors’ interest is damaged or irregularities been exposed, it will cost a lot of time and effort for the authority to perform law enforcement, which includes, for example, evidence collection and verification. The crackdown of illegal listing activities may not be carried out in a timely fashion. Therefore, being a “gatekeeper” and prevent these activities in advance can better protect the reputation of the overall Hong Kong securities market.

Also, the prohibition of class-action lawsuits in Hong Kong may lead to the situation that numerous suits would be filed at the same time by shareholders against a company to pursue claims for damages, and investors’ confidence on Hong Kong’s financial market may be shaken.

The Cost of “Disclosure-Based” Policy

Taking a deeper look, although Hong Kong has been implementing a “disclosure-based” rather than “regulatory-oriented” policy, some worry that putting more emphasis on regulation will stifle the development of the market. However, in accordance with the principle of “disclosure-based” policy, when there are inaccurate or deliberately misleading messages from listed companies, the authority will handle the cases by taking the action of prosecution, litigation or judicial enforcement.

Nevertheless, past cases show that most of the misleading messages were mostly about small business enterprises, and the information mostly affected small investors. Without the right to conduct class-action lawsuits in Hong Kong also makes it difficult for companies to carry out any litigation or seek any compensation.

There is a cost for “disclosure-based” policy. Let’s take the United States as an example, the country fully pursues “disclosure-based” policy, which makes the listing cost extremely high. This policy actually kills some companies’ attempt to get listed. We can see in the last decade or so, the number of companies listed in US, especially of those small-scale companies, has been decreasing continuously. The reason behind is simple: In terms of cost and effect, it is not worth for small and medium-size companies to pay such high price to be listed in the market, though many large companies still choose to be listed in the US market. However, if Hong Kong does not want to kill the chance for small-size companies from listing on the market, it must find an appropriate balance between disclosure and regulation. Over-relying on “disclosure-based” policy to regulate without some basic supervisory measures will cause an imbalance. This is also a biased approach.

A Time to Advance and Optimise

In conclusion, I feel that there is no big policy change in this consultation. In terms of exercising the right to listing approval, an enhancement would be adopting a three-party approach involving SFC, HKEX and market participants. From an objective viewpoint, the consultation proposal is an enhancement of the listing system which optimises the current system in terms of its efficiency and accountability, which is beneficial for the development of Hong Kong market.

Last, there is a fly in the ointment in one item proposed in the consultation.

Under section 28, it says:

“Under the Proposals, the Listing Policy Committee will replace the Listing Committee as the body responsible for oversight of the listing function and the Listing Department’s performance within the Exchange. The Listing Department will remain within the Exchange and will remain responsible for the day-to-day administration of the Listing Rules but, going forward, will report to the Listing Policy Committee on its work. To reinforce this oversight role, and establish clear accountability, the Listing Policy Committee will have primary responsibility for appraising senior executives of the Listing Department in the performance of their regulatory responsibilities. HKEX’s Remuneration Committee, which is responsible for determining the overall compensation of the Listing Department and its senior executives, will take into account the assessment of the Listing Policy Committee when determining such compensation.”

In other words, the new-established Listing Policy Committee will evaluate the performance of the senior executives of the HKEX Listing Department. This gives people the impression that the SFC will assess the performance of the HKEX officials. With such assessment linked to the determination of the overall compensation of HKEX, this will create a misunderstanding that SFC is trying to pressure HKEX, which is a flaw in the consultation paper.

This article is a translation of the original Chinese article published in Hong Kong Economic Journal on 8 September 2016. Huang Feifei, PhD student in CUHK Business School’s Department of Marketing, contributed to the English translation. This article was first published in the China Business Knowledge (CBK) website by CUHK Business School.