Dual-class shares — perils lurking beneath
Experts call for tighter control over listings to protect investors after key revamp
Hong Kong retail investors must, by now, be familiar with the dual-class share structure, understand what rights and protection they have, and comprehend what the limitations are under the safeguards provided by Hong Kong Exchanges and Clearing (HKEX), given that they can invest in dualclass stocks in the near future.
Mainland electronics giant Xiaomi Inc has become the first company to apply for dual-class share listing on the Hong Kong Stock Exchange since the city’s bourse began accepting listing applications on April 30 from innovative companies with dual-class shareholding structures, biotechnology enterprises that are yet to generate revenue, as well as mainland technology companies seeking secondary listings in the SAR.
The new rules, aimed at broadening the city’s listing regime, mark the biggest overhaul of local initial public offering rules in more than two decades.
Earlier this month, Beijingbased Xiaomi — the world’s fourth-largest smartphone maker — filed for an IPO in Hong Kong that could raise at least $10 billion by the end of June, based on the latest market valuation of between $60 billion and $70 billion, according to market sources. It would be the biggest global technology listing since mainland e-commerce behemoth Alibaba Group Holding’s flotation in 2014 and the largest IPO in the SAR since AIA’s listing in 2010.
Xiaomi said in its application it would have a weighted voting rights (WVR) structure, or dual-class shares.
Based on an investment prospectus document prepared by Xiaomi, the company will introduce Class A and Class B shares after the listing. One Class A share will be entitled to 10 votes, while one Class B share will adopt the “one-share one-vote” principle. Currently, only Lei Jun and Lin Bin — the two company founders — hold Class A shares, while other investors own Class B stocks.
According to Xiaomi’s shareholding structure before the listing, Lei and Lin hold 31.4 percent and 13.3 percent of Class A shares, respectively. Based on the one-share for 10-votes mechanism proposed by HKEX, Lei and Lin’s ownership of Class A and Class B shares will entitle them to hold up to nearly 86 percent of the company’s voting rights after the company goes public.
“The WVR structure would allow the company to benefit from the ‘continuing vision and leadership’ of the dual-class share beneficiaries, who would control the company for its ‘long-term prospects and strategy’,” Xiaomi said.
Financial analysts, however, are worried that allowing a dual-class share listing structure in Hong Kong would lead to corporate governance vulnerabilities.
“If the Securities and Futures Commission and/or HKEX cannot detect corporate malaise when supervising the IPO process, share prices of these technology companies or biotech firms may fall drastically after listing,” warned Mike Suen, a partner at international law firm Withers.
“However, shareholders cannot sue HKEX, or will find it extremely difficult to sue the company management under the dual-class share listing regime. I’m worried about such a listing platform being introduced hastily,” he said.
Billy Mak Sui-choi, an associate professor at Hong Kong Baptist University’s Department of Finance and Decision Sciences, said the safeguards put forward by HKEX should protect investor interests.
“It depends on how much investors are willing to sacrifice some bits of investor protection in exchange for the long-term high growth prospects of those innovative companies,” Mak told China Daily.
HKEX has proposed various investor protection safeguards, including restricting companies from increasing any further dual-class shares after listing, and capping the voting power attached to dual-class shares at more than 10 times the voting power of ordinary shares. The WVRs attached to a WVR beneficiary’s share will also lapse permanently if a WVR beneficiary transfers his/ her interests in those shares to another person.
Certain key matters are also required to be decided on a “one-share one-vote” basis, including the appointment or removal of non-executive directors, the appointment or removal of auditors, the voluntary winding-up of the company, and changes to the company’s constitutional documents.
HKEX also requires dualclass share companies to establish a corporate governance committee and a nomination committee for enhancing investor protection. Shareholders are also allowed to take civil action to enforce provisions in the constitutional documents against dual-class share companies.
However, Patrick Shum Hing-hung, investment manager at Tengard Fund Management, is rather pessimistic.
“The proposed safeguards may not be effective in protecting shareholders’ interests. Once there is any corporate malaise, investors may suffer heavy losses if they still hold those shares.”
Shum said investors must exit those shares as a last resort for self-protection. “The most important thing for retail investors is whether dual-class share company directors will work for shareholder interests. If they don’t, the best way is to sell all those shares as quickly as possible.”
Global investment management organization CFA Institute firmly supports the corporate governance principle of “one-share one-vote”.
“It’s important that they (local investors) have sufficient information and understanding to allow them to evaluate these companies properly as they are pragmatic and will look for value. Knowledge and awareness are key to investors,” asserted Mary Leung, CFA Institute’s Asia-Pacific head of advocacy.
Lawyers are also worried that regulating IPOs in Hong Kong may become subjective henceforth.
“The Main Board Listing Rules have detailed the exact requirements of an IPO listing. However, under the dual-class share listing framework, the suitability of an IPO listing is laid down under the Guidance Letter section whereas it can be modified. Regulators may evaluate the suitability of IPOs based on the current economic environment. I’m afraid that some degree of subjectivity may be injected into the regulation of the IPO process,” Suen told China Daily.
Shum predicted that the share price performance of the first batch of dual-class share companies, such as those of Xiaomi and other technology giants, may be alright.
Mak agreed, saying those technology titans with strong brand names and high market penetration rates may perform strongly.
“Many retail investors in Hong Kong have little experience in investing in biotech companies and evaluating the associated risks. Even with the best checks and intentions, it could be a long time before these investments pay off, so the risks in the market will be much higher than people are used to,” Leung reckoned.
Dual-class share structures, which enable founders to maintain control of the company even though they only hold a minority of the listed shares, have been banned in Hong Kong since the mid1980s for better investor protection. This rendered Hong Kong less attractive to big technology firms, many of which use such corporate governance structures.
The Hong Kong Stock Exchange has been reforming its IPO listing rules to lure new-economy company listings to remain competitive among bourses in New York, Shenzhen, Singapore and many others. In September 2014, Hong Kong lost Alibaba’s $25-billion IPO to the United States — the biggest in US IPO history.
The most important thing for retail investors is whether dual-class share company directors will work for shareholder interests.” Patrick Shum Hing-hung,