The introduction of dual-class shares in Hong Kong and Singapore has stirred something of a debate. There are those who support the new orthodoxy and those who are more skeptical. It is not difficult to assess the divide: broadly, the exchanges are supporters, while many asset managers are skeptics.
Hong Kong Stock Exchange (HKEX) CEO Charles Li has consistently presented a narrative that dual-class listing reform has been a top priority in order to secure the exchange’s position as a premier global capital market center. And things have already moved on. Since HKEX launched new rules at the end of April enabling companies to list with dual-class shares, and Singapore Exchange (SGX) followed suit in June, Hong Kong is now expected to take the title of top IPO destination for 2018, according to figures by KPMG China.
HKEX wants to attract companies with a market cap of not less than HK$10 bn ($1.3 bn) while Singapore will allow firms valued at S$300 mn ($217.7 mn) to list with dual-class shares. This has already had an impact: Chinese electronics firm Xiaomi became the first firm to list with a dual-class share structure on the HKEX in June, followed in September by Chinese services giant Meituan Dianping.
Looking at the boost dual-class shares has already given Hong Kong, Maggie Lee, head of the capital markets development group for Hong Kong at KPMG China, says: ‘The new listing regime for firms from emerging and innovative sectors has generated significant interest from new-economy companies globally. Three pre- revenue biotech firms and two with weighted voting rights structures completed their IPOs by the end of Q3. We expect to see six to 10 pre-revenue biotech companies list by the end of 2018 as the trend continues.’
This is only likely to continue to benefit the region as a whole. ‘Dual-class shares will help a lot of tech companies in China to consider coming to Hong Kong to list,’ adds Benson Wong, partner at PwC in Hong Kong.
Race to the bottom
A major issue for the skeptics is the way in which corporate governance may be compromised in pursuing the capital market gold offered by dual-class shares. Many fund managers have expressed apprehension about the development. It should be noted, however, that few are abstaining from investing – partly in fear of missing out on rewarding returns.
Jenn-Hui Tan, director of corporate finance at Fidelity International, sums up the concerns many managers have: ‘Offering regulatory flexibility can attract listings in the short term but potentially impact long-term market development if corporate governance standards are not maintained. Capital market development and investor protection should not be viewed as mutually exclusive. Exchanges competing to offer the most issuer-friendly environment can result in weaker standards across all markets. What we must avoid is a regulatory race to the bottom.’
This is an argument supported by a report entitled Dual-Class Shares: The Good, The Bad, and The Ugly, published by CFA Institute in October. It identifies risks for investors and proposes additional investor protection measures it says are needed as Asia embraces dual-class shares. The report cites three key risks associated with dual-class shares: insufficient or non-existent protection for minority investors, skewed proportionality between ownership and control, and a race to the bottom in terms of governance standards.
One of the report’s major findings is that a majority of respondents to CFA Institute’s survey had no experience investing in firms with dual-class share structures, which suggests that all market participants would benefit from further education about dual-class shares and the associated risks.
‘Everyday investors in Asian jurisdictions such as Hong Kong, where class and derivative actions are unavailable, are particularly susceptible to the entrenchment risks of super-shareholders created by dual-class share structures, and it is difficult for them to protect themselves against such risks without an appropriate regulatory framework,’ says Mary Leung, head of advocacy for Asia-Pacific at CFA institute.
HKEX argues that investor protection is high on the agenda. ‘We actually have a large number of companies that are family or state-controlled,’ notes Li. ‘So the entire protection measures of our regime are about protecting the little guy from abuse by the big guy.’ HKEX has also instigated a so-called event-based sunset, whereby the founders’ stronger voting rights end if they leave the company or transfer their shares.
SGX has also been quick to introduce rules to deal with such concerns and address specific risks, including capping each multiple voting share at 10 votes and limiting the holders of multiple voting shares to named individuals or permitted holder groups whose scope must be specified at the IPO. SGX has further specified a range of instances that require shareholders to vote via an enhanced voting process where all shares, including multiple voting shares, carry one vote each.
‘SGX’s framework for dual-class share structures strikes a balance between supporting high-growth companies and having in place safeguards to mitigate governance risks associated with such structures,’ says a spokesperson for the Monetary Authority of Singapore. ‘Dual-class share structure listings will broaden the range of investment options for investors and add vibrancy to Singapore’s capital markets.’
What cannot be debated is the number of fast- growing companies that want to list with the dual-class structure. And there is no doubt dual-class shares have a great deal of potential in Asia where there are many technology start-ups – which favor equity funding – and family-run companies, where founders want to preserve control to pass on to their children.
As a result of the move to dual-class shares, the technology IPO numbers already stand out. According to KPMG’s figures, it is the new-economy companies
– working in sectors associated with technology and the internet – that are driving Hong Kong’s success, with more than one fifth of IPOs in 2018 listed through traditional requirements being for new-economy firms, compared with less than 10 percent in 2017.
But while solid developments and reassurances mean things are moving on positively for the HKEX and SGX, there is still an undercurrent of concern that will not go away. One has only to look to North America to see how the debate on dual-class shares has developed.
The NYSE has held dual-class shares since the late 1980s, becoming the exchange for tech companies – a key motivational factor for the exchanges in Asia to plug into. But when digital social media company Snap listed last year offering investors no voting rights, this prompted FTSE Russell to exclude it from its indices. Index provider MSCI has also been talking to the market on whether to exclude certain companies with dual-share classes, referencing the argument about governance concerns.
Asian market observer Sheena Shah, Finsbury director in Hong Kong, gives a balanced perspective on the dual- class shares debate. ‘There is no right or wrong answer on whether dual-class share structures are a good thing – that is very much dependent on the company, the sector it operates in, the level of competition and where it operates,’ she says. ‘For some companies, particularly technology firms, it can be a good thing and can deliver growth and returns to shareholders.
‘The problems come when companies don’t explain the rationale for the structure clearly and why it is in the best interest of the company in the long term. The firm also needs to demonstrate to shareholders that it still employs the highest levels of corporate governance and looks after the interests of all shareholders.’
In addition, Shah highlights how dual-class shares bring the IR function into sharper focus. ‘In the past, investor engagement in Asia was done behind the scenes,’ she says. ‘This will no longer work, particularly with dual class structures – so regular, open communication to the public and investors is key.’