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HKEx: Down Market? (The Economist)

On June 24, 2017, ACGA was quoted in a story in The Economist on a proposed new Third Board on the Hong Kong stock exchange. Hong Kong Exchanges and Clearing (HKEx) proposes to allow dual-class shares on the new board, a policy direction that ACGA believes is wrong for Hong Kong. For strategic economic and governance reasons, we oppose market development in the city through the lowering of standards.

While the article is necessarily brief, ACGA provided the following written answers to The Economist in addition to a telephone interview. These elaborate on our basic point above.

1. On your suggestion of "raising governance requirements as a better way to enhance the exchange", would you be able to flesh that out? 

Over the past 15 years, we have witnessed Asian capital markets growing strongly at the same time as corporate governance standards have been improved. Contrary to what some argue, we can see no evidence that higher standards of governance (for example in corporate disclosure, board governance or fair treatment of shareholders) inhibit IPOs or market development generally. On the contrary, we believe that modern capital markets need high standards of corporate governance. With public equity investment increasingly channelled through institutional investors, with the rise of passive over active management, and the development of “investor stewardship “ (ie, active ownership), governance is becoming more not less important. This is why there was such a strong reaction from the investment and governance communities against the SGX proposal to introduce dual-class shares.

We cannot say that better governance and disclosure leads to higher share prices, bigger IPOs or less volatility, since all of these things are influenced by numerous factors both external and internal to companies. But there is evidence showing that over the medium to long term, investors have higher trust in well-governed companies (hence the flight to quality whenever there is a market collapse) and that such companies outperform on metrics such as balance sheet and earnings management, risk mitigation and so on. See pp28-32 of our CG Watch 2016 report attached. (Please note that this is CLSA’s part of the report. We do the market ranking and regulatory analysis.)

2. Do you mean that higher corporate governance standards would enhance the exchange even if it meant having fewer listed companies?  (We have another interviewee, a broker, who argued that more listings don't necessarily equate to higher turnover.) 

Yes, I think that is a fair assessment and I would agree with the broker. In most markets, the vast majority of issuers are not on the radar screen of investors or brokers. A very small number account for most of the market cap. There are numerous economic and organisational reasons for this, but one factor is that smaller issuers tend to have weaker governance, worse disclosure, inbred boards, etc. They are not good at telling their story and gaining investor trust/acceptance.

We are not concerned so much about the number of listed companies, rather the quality of their governance and their investability. Companies with poor governance tend to have less support from the market (exceptions like Alibaba are riding a sectoral and technological wave that is unlikely to last). I believe a higher proportion of really well governed companies would probably lead to higher share prices. I am not so sure about the volume-of-trading argument, however. There are so many market participants trading for different reasons—and again the volume of trading is often influenced by macro factors.