In 2018, Hong Kong brought in changes to its listing regime. CGj interviews Paul Lau, Head of Capital Markets and Professional Practice, KPMG China, on whether the governance safeguards built into the new regime are proving to be effective.
Many thanks for giving us this interview, can we start by discussing your background and career?
‘I was born and grew up in Hong Kong. After graduating here in the late 1980s, I moved to the US and got my master’s degree there. I started my professional career in the US with the accounting firm Arthur Andersen. When Andersen collapsed in 2002, I joined KPMG in Boston. In 2006, I got the opportunity to come back to Hong Kong to work on capital market-related transactions. I have stayed in Hong Kong, and in capital markets practice, since then. Currently, I head the Capital Markets Group and Department of Professional Practice for the China firm of KPMG, and I'm also a member of the Listing Committee of the Stock Exchange of Hong Kong (the Exchange).’
In 2018, Hong Kong Exchanges and Clearing Ltd (HKEX) made some changes to Hong Kong’s listing regime. In general, do you think the new listing regime achieves the right balance between market competitiveness and good governance standards?
‘I think, overall, Hong Kong’s listing regime achieves that balance, but making Hong Kong competitive and having good governance should not be mutually exclusive. In fact, they are very much aligned since raising the quality of the market by maintaining good governance standards helps Hong Kong to be competitive in the long run. Having quality doesn’t necessarily make you competitive, but, where you have an opportunity to make the market more competitive, you do need to consider whether that is going to create risks from a governance and investor protection perspective.’
Among other things, the changes to the listing regime permitted companies with weighted voting rights (WVRs) to list in Hong Kong. Four years on, do you think the governance safeguards relating to WVR are working as planned?
‘I think it is difficult to just talk about one chapter of the new listing regime. Chapter 8A permits listings of innovative companies with WVR structures, but HKEX also brought in two other new chapters to the Listing Rules – Chapter 18A relates to pre-revenue biotech companies and Chapter 19C relates to secondary listings of overseas listed issuers.
These three chapters were designed to improve Hong Kong’s competitiveness. Many companies in emerging and innovative sectors with high growth potential were listing in the US for a number of reasons – one of which was the fact that they preferred to have WVR structures. But if you look at the number of listings we have had under the three new chapters, we're only talking about around 80 companies. That is not a very large number compared with the total number of IPOs in Hong Kong and that was exactly the intention.
The idea was never to make WVR a common thing in Hong Kong, but to allow a selective route for companies with high-growth potential to have that sort of governance structure. I think, if we’re talking purely about the number of companies that have listed with a WVR structure, excluding the secondary listings, that only amounts to eight companies. But the market capitalisation of the companies that have listed under the three chapters represents about 20% of the total. So that indicates that the new listing regime has attracted exactly the types of companies it was designed to attract.
From a theoretical perspective, I don’t think anyone is going to argue with the fact that one share one vote is more equitable, but it’s important to look at everything in context. I think we learned a lot from the healthy debate and the due process that took place back then. The rule changes didn’t happen overnight; they were preceded by several years of debate and some good empirical studies of the risks and opportunities involved. Quite a number of safeguards were put in place and we haven’t experienced any significant abuse or misconduct since 2018.’
On the question of the investor protection safeguards, was there anything that you think should have been built into the regime that wasn't? Hong Kong is a very different jurisdiction from the US of course, so are there safeguards specific to the Hong Kong market that you would like to see in place?
‘Certainly, we are talking about two very different systems. The US takes a more risk-based, disclosure-based and “investor beware” approach. They complement that with class action rights and other measures that enable shareholders to seek remedies where corporate misconduct is involved. In Hong Kong, the approach from a regulatory perspective is more front-loaded. The regime tries to minimise the risk of misconduct by building extra safeguards into the framework.
So, in terms of WVR structures, Hong Kong only allows individuals to hold WVR shares. In other words, a corporate entity cannot hold such shares. Moreover, those individuals have to be directors – ensuring that they have fiduciary roles as directors of the company. One of the things that I think we could have added to the safeguards would have been a mandatory sunset clause, meaning that the extra voting rights cease after a fixed term. We have a sunset clause, but it is tied to the WVR beneficiary dying or retiring. I don’t think it would hurt to have a fixed-term sunset clause, but I don’t think investor protection is much worse off without it.’
Without such a clause is there a danger that, over time, WVR structures will become common in the Hong Kong market?
‘You raise a good point and that is one reason why, personally, I think the fixed-term sunset clause is a good idea. Also, as the target companies get beyond their high growth stage and become more established listed entities, they will presumably have less need of WVRs. I think we should bear in mind that this is a journey. In 2018, WVR were very new to Hong Kong, but as we get used to them there are further opportunities for discussion. The debate over whether to permit corporate WVRs is a good example of that. HKEX launched a consultation on corporate WVRs three years ago, but the proposal to allow corporates to be WVR beneficiaries did not get enough support to proceed. HKEX listened to the market and put the thing on hold. The due process aspect of bringing in regulatory changes, in particular getting feedback from the market, including professional practitioners and investors, is very important.’
More recently, Hong Kong has opted to allow special purpose acquisition companies (SPACs) to list here. What’s your view of the risks and opportunities of this move?
‘SPAC regimes allow a shell company to list with the sole objective of making an acquisition and turning it into a listed company. Introducing the SPAC regime in Hong Kong was preceded by a lot of discussion about how to manage the risks, as well as studies of SPAC regimes around the world.
Our SPAC regime had to reflect the special circumstances of Hong Kong, of course, and one requirement that emerged as non-negotiable for regulators was that any business acquired by a SPAC would have to meet all the usual requirements of an IPO. Regulators have done so much work over the years to prevent circumvention of Hong Kong’s listing requirements via backdoor listings, so allowing SPAC acquisitions to bypass those requirements was not something they would consider.
During the pre-acquisition phase, however, there is a risk of investor losses as a result of misconduct, such as market manipulation. In this phase, a SPAC doesn't have any operations so the movement of the share price will largely be affected by news. If a SPAC enters into discussions to acquire a very promising target, for example, that is going to drive up the SPAC share price. There's nothing wrong with that, and Hong Kong already has a pretty robust regulatory framework to prevent market manipulation and to ensure the proper disclosure of price-sensitive information, but extra safeguards needed to be in place.
One such safeguard is for the shareholders to have redemption rights, another is to limit SPAC investments to professional investors only. The Hong Kong regime also focuses on the credentials and the suitability of the promoters. Similar to a normal IPO, at least one sponsor is required to be involved in a SPAC and the corporate governance requirements for the SPAC entity are the same as for any listed company.
I think this makes the roles of the independent non-executive directors (INEDs) very important. This is not something that has been widely addressed, but, because of the uniqueness of SPACs, I think the skill sets and the mindsets of the INEDs involved will need to be different. There is an inherent potential conflict of interest for the promoters because they need to make sure that the acquisition of a target business happens within the timeframe of the SPAC or they lose their investment. There is a risk, therefore, that they may wish to overestimate the potential of target companies. This is where it becomes especially important for INEDs to ensure due diligence – in particular ensuring that the quality of the target company is fairly assessed. This is something that needs to be emphasised because SPACs are new to Hong Kong. Even an INED who is experienced in ensuring due diligence for other companies may not know exactly what to look out for.’
Given the existing issues that regulators have about the independence of INEDs, could the issues you raise about the INED role in SPACs prove to be a serious weakness of the new regime?
‘I would advise the INEDs to be laser focused on ensuring due diligence. It will be hard for them to say they did their due diligence if it turns out that problems with the acquisition target were overlooked. But having said that, there are other safeguards in place. We have had 10 applications and one listing under the new regime, and the vetting by the Exchange and the SFC has focused on the credibility and the suitability of promoters. I should add that the intention of the SPAC regime is not to make SPACs commonplace, so the bar is set pretty high.
In addition, we have talked a lot about the risks, but we should bear in mind that the SPAC regime provides opportunities to professional investors to participate in these activities, thus helping to develop Hong Kong as an asset management hub. From a business perspective, it also gives companies another channel to raise capital, so I think, if it's done right, we can achieve a situation where everybody wins.’
Hong Kong’s regulatory regime is largely based on international governance principles and standards – do you expect to see that change in the years ahead? One issue in particular is whether there will be a move away from the principles-based approach to regulation towards the rules-based approach that is more common in the Mainland?
‘Hong Kong has always been unique and has always been able to adapt well to changing circumstances. I think there is no question that Hong Kong has to continue to be aware of international standards of corporate governance to maintain its status as an international financial centre. We have to be aware of those developments and take them into consideration when formulating our own corporate governance requirements, but, since a lot of Hong Kong listed companies are Mainland-based companies, or have operations in the Mainland, we also need to take into consideration the Mainland requirements. This is just a part of the uniqueness of Hong Kong – we take a hybrid, flexible and agile approach to forming our governance framework.
Regarding the future of the principles-based approach, I think this and the rules-based approach are not mutually exclusive. There are usually principles behind rules and sometimes you need a bright-line requirement. For example, HKEX defines long-serving INEDs as those who have served on a board for nine years or more. But why not eight years? Why not 10 years? The point is that we use nine years as a benchmark – at some point INEDs risk losing their independence, their freshness, and may have a negative impact on succession planning. So is that a rule-based requirement? There is a principle behind it.’
Do you have any advice to governance professionals in terms of their roles in the issues we've discussed?
‘One of the things that corporate governance professional practitioners have in common is that we have to focus on compliance risks. The word “risk” has negative connotations, but risks often create opportunities for improvement. About a decade ago, Hong Kong brought in much more stringent requirements relating to the disclosure of price-sensitive information and companies were very concerned about the new compliance risks. 10 years later, however, companies have turned those risks into opportunities – they have much better internal controls, governance frameworks, corporate communications and investor relations as a result. So, rather than purely looking at these issues through the lens of compliance, governance professionals can emphasise that compliance exercises are actually opportunities for improvement.’
