David Neuville and Joseph Lee, Cadwalader, Wickersham & Taft LLP in association with Joseph PC Lee & Associates, assess the implications of the Stock Exchange of Hong Kong decision to reject the proposal by the Alibaba Group to list in Hong Kong with a ‘partnership structure’ designed to entrench control of the company with the founder/ senior management group.

L ast year Alibaba Group, the holding company for a group of PRC-based Internet e-commerce companies with sales that exceed those of eBay and Amazon combined, announced plans to make an initial public offering of its shares and to list those shares in, most likely, Hong Kong or the US. The company’s plans and resulting pressure on the Stock Exchange of Hong Kong to capture this highly-prized listing have forced the Exchange to look at certain of its corporate governance standards for listed companies and assess whether they permit the Exchange to compete effectively with stock exchanges in other major global financial centres – and to engage in some soul-searching as to whether the ability to compete in this regard is even a high priority at this point in time. Alibaba’s ultimate choice, and the results of the Exchange’s self-contemplation, will likely have a significant effect not just on Alibaba, but on other Asian companies seeking Hong Kong listings and, increasingly, on nonAsian businesses seeking primary or secondary listings on Hong Kong’s stock exchange.

Hong Kong or the US?

At present, when private companies are rarely shy about speaking publicly of IPO plans, even in the earliest stages of planning, Alibaba’s potential IPO has been the source of international media publicity for a long time. The biggest question about the IPO, other than perhaps its timing, has been whether the company would choose to list in the US, historically the biggest market for technology-related public companies, or in Hong Kong, the premier ‘overseas’ market for PRC businesses. Since 1992, when Brilliance China Automotive became the first PRC business to list in the US, and 1993, when Tsingtao Brewery issued the first H-shares, companies from Mainland China have confronted the question of which overseas listing venue would be best for them. In the early years, Hong Kong achieved a clear edge, mainly for the two types of reason outlined below.

1. Valuations.

PRC issuers found that Hong Kong listings tended to generate a greater level of ‘buzz’ – media coverage, attention from financial analysts and investor interest – than US listings, resulting in higher valuations and enhanced liquidity in both primary and secondary markets, a strong enticement towards Hong Kong. In addition, as a number of PRC companies have begun to adopt dual listings in Shanghai and Hong Kong, the typically higher domestic valuations may push Hong Kong valuations upward, despite a lack of fungibility between domestic and foreign-owned shares.

2. Compliance and potential exposure.

Compliance costs, and resources required, may generally be somewhat higher for a PRC business listing in the US than for one listing in Hong Kong. Probably more importantly, most companies (and most market observers) believe that the potential exposure to shareholder claims and securities fraud actions is significantly greater for US-listed than for Hong Konglisted companies. These views have only been further strengthened over the years as a result of the Sarbanes-Oxley and other reforms in the US.

Other factors, such as the issuer’s industry segment, sometimes countered the Hong Kong edge. Technology companies have long been wary of Hong Kong, believing it to be a ‘bricks and mortar’ market where investors would not fully understand their businesses or, as a result, properly value them. Only in the past several years has this perception begun to temper.

Alibaba has, through very visible discussions with the Exchange and Hong Kong’s Securities and Futures Commission (SFC), brought another factor to the forefront of the listing venue discussion: corporate governance.

The dilemma for Hong Kong

While it has long been possible for a company listing in the US to maintain dual classes of common equity – typically, one class having the traditional one vote per share on matters brought to a shareholder vote, with the other class having supervoting rights, thereby entrenching control in a founder or management shareholder group holding collectively a minority of shares – this structure has not been accepted by the Exchange for new listings for many years.

Knowing this, but still remaining interested in a Hong Kong listing, Alibaba’s controlling shareholders sought to explore alternatives which might concentrate power in a way that would satisfy the pre-IPO shareholders (led by a senior management group loyal to Alibaba founder Jack Ma, who collectively own approximately 10% of the equity, and by affiliates of Yahoo and Softbank, which own in aggregate approximately 60% of the company) while also passing muster with the Exchange. The proposal by Alibaba has come to be known as a ‘partnership structure’ under which the founder/ senior management group would be granted, presumably in the company’s articles of association, the absolute right to nominate a majority of the members of the company’s board of directors, regardless of the group’s equity ownership or, therefore, degree of voting control.

By virtue of the partnership structure, the controlling group would at the same time have both a lesser degree of control over Alibaba than with a dual voting class structure (with the concentration of power going only to board elections, not all matters brought before the shareholders) and a greater degree (with power to put into position, through the nomination right, a majority of the board being absolute, rather than merely exaggerated, as with dual voting classes). The partnership structure proposal opened up the proverbial hornet’s nest in Hong Kong.

Following months of speculation by the media and a wide variety of financial pundits, the Exchange told Alibaba that it would not accept the listing of the company with the partnership structure in place. Though nominally a limited decision, the result is generally viewed as a statement by the Exchange that not only is a dual voting class structure taboo, but also any structure that has the effect of concentrating power in a manner that diverges from one-share-one-vote shareholder democracy.

In a memorable blog post on the website of the Exchange’s parent company, Charles Li, the CEO of the Exchange, spoke of the ‘voices arguing endlessly’ in his head, then proceeded to lay out the cross-section of views on what path the Exchange should take, ranging from maintaining its longtime status quo, to taking an innovative stance to empower visionary company founders, to adopting a US-style model in which, as long as the company’s public disclosure is accurate and sufficient, investors are left to make their own decisions, to advancing the Exchange’s commercial opportunities and the ability of Hong Kong retail investors to invest in Asian companies. Ultimately, Li concluded that the decision made was one specific to the Hong Kong market: ‘In the end, we should take responsibility for doing what is right and best for Hong Kong, not just what is safe and easy’

The implications of the Exchange’s decision

To the surprise of none, Alibaba announced immediately after the decision that it was ending discussions with the Exchange, and Joe Tsai, the Executive ViceChairman of Alibaba, put out a statement openly critical of the Exchange’s decision. To the surprise of many, Alibaba also said that while it would focus its efforts on a US listing, it would seek approval there of its partnership structure, rather than moving towards the previously-accepted dual voting class structure.

In the aftermath of the Exchange’s decision, commentators were split on whether the seeming inflexibility of the Exchange would lead it to be unable to compete with more innovative stock exchanges in other financial centres, whether the Exchange was to be applauded for staying true to its previously-expressed principles and acting to protect the interests of company shareholders, or even whether the whole argument was irrelevant because potential investors would never have accepted the novel partnership structure in the Hong Kong market anyway.

It remains unclear just how much, if any, flexibility on corporate governance issues the Exchange will be willing to exhibit in the future, or what effect the Exchange’s position will have on its own operations or on Hong Kong’s status as a major global financial centre. A number of conclusions, however, may be drawn from the debate to this point.

Credit where credit is due

Even if one considers the Exchange’s position to be shortsighted, there is a degree of nobility in its decision to follow its longstanding principles of protecting shareholder interests and enforcing its views about proper corporate governance for listed companies. Clearly, the Exchange was focused not just on Alibaba and on bringing that company to Hong Kong, but also on the potential effects of ‘opening the floodgates’ to other infringements by other issuers of basic principles.

The Exchange is not exactly analogous to the US exchanges

The Exchange has historically taken a much more paternalistic approach to vetting and regulating listed companies than have regulators in the US market. This is partially due to conceptual differences – as noted above, US law and regulation focuses principally on adequacy of disclosure, leaving ultimate investment decisions to investors – but also reflects market development, to the extent that there is a long history of shareholder derivative and minority shareholder litigation in the US in which US courts have acted to protect public company shareholders, a litigation history largely absent in Hong Kong. Without these protections for shareholders, Hong Kong regulators clearly have felt, and continue to feel, strong pressure to protect those parties.

Issues among the controlling shareholders?

As with any private company, the dynamic and issues among the controlling shareholder groups (the management ‘partners’, plus Yahoo and Softbank) are not fully open to public view. If the three groups, together controlling approximately 70% of Alibaba’s pre-IPO equity, were completely in sync, Alibaba should be relatively free of control issues, as the shareholders would be able to enter into a voting trust or voting agreement, or (assuming a US listing is pursued) amend the memorandum and/ or articles of association to put into place a dual voting class structure, or even exert virtually complete control by acting in concert, without any written agreement.

Relations among the major shareholders were recently, if fleetingly, brought into the public light as a result of Alibaba’s termination of a variable interest entity, or VIE, structure which had been used to give Alibaba the economic benefits of a business it was prevented from owning directly by PRC regulations. One or more of the Alibaba controlling shareholders was thought to have been both surprised and disturbed by the action. This, and the founder/ senior management push for the partnership structure, even in the context of a US listing, may perhaps indicate that there are issues among the three controlling shareholder groups, effectively freezing the current arrangement in place.

It ain’t over ’til it’s over

The Alibaba situation brings to mind the words, long ago, of that eminent observer of emerging markets, Yogi Berra. While Alibaba announced that it ceased discussions with the Exchange relating to a Hong Kong IPO, the most recent word on the subject is that the company is now planning to avoid a decision on listing venue for some period of time. Would anyone really be shocked if the door was reopened and the Hong Kong option is once again considered? Until a US listing is actually completed, Hong Kong should not be ruled out. Further, even if a US listing does come to pass, it seems likely that Alibaba might wish to position itself (including through its choice of corporate structure) such that a later secondary listing or subsidiary spin-off in Hong Kong would be a possibility.

Global effect Finally, it is worth noting that, over the last few years, the Exchange has put a substantial amount of time and resources into wooing non-Asian companies to list in Hong Kong, either for their primary listing (Prada), or on a secondary basis (Vale, Glencore, Coach), in order to exploit Asian connections in their businesses or to open up a new pool of capital and investors. All of these companies, including future listers, will be subject to the Exchange’s ultimate policy position on corporate governance. Therefore, the outcome of Alibaba’s battle with the Exchange and SFC has consequences that will stretch far beyond the borders of Asia as financial globalisation continues.


David Neuville, Partner, Cadwalader, Wickersham & Taft LLP, and Joseph Lee, Prinicpal, Joseph PC Lee & Associates.

In Hong Kong the firms operate together as Cadwalader, Wickersham & Taft LLP, in association with Joseph PC Lee & Associates. Copyright: Cadwalader, Wickersham & Taft LLP