Hong Kong: Alibaba Structure Forces Hong Kong Stock Exchange To Assess Its Position On Corporate Governance

Alibaba Group, the holding company for a group of People's Republic of China-based Internet e-commerce companies with sales that exceed those of eBay and Amazon combined, has announced plans to make an initial public offering of its shares and to list those shares in, most likely, Hong Kong or the United States.  The company's plans and resulting pressure on the Stock Exchange of Hong Kong to capture this highly-prized listing have forced the SEHK to look at certain of its corporate governance standards for listed companies and assess whether they permit the SEHK to compete effectively with stock exchanges in other major global financial centers – 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 SEHK'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 non-Asian businesses seeking primary or secondary listings on the SEHK.

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 U.S., 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 U.S., and 1993, when Tsingtao Brewery issued the first H shares (Hong Kong-listed shares of a PRC corporation), companies from 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 two types of reasons:

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 U.S. 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.

Compliance and potential exposure.  Compliance costs, and resources required, may generally be somewhat higher for a PRC business listing in the U.S. 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 U.S.-listed than for Hong Kong-listed companies.  These views have only been further strengthened over the years as a result of the Sarbanes-Oxley and other reforms in the United States.

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 SEHK and Hong Kong's Securities and Futures Commission, brought another factor to the forefront of the listing venue discussion: corporate governance.

While it has long been possible for a company listing in the U.S. 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 SEHK 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 SEHK.  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 control 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 SEHK 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 SEHK 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 SEHK's parent company, Charles Li, the CEO of the SEHK, spoke of the "voices arguing endlessly" in his head, then proceeded to lay out the cross-section of views on what path the SEHK should take, ranging from maintaining its longtime status quo, to taking an innovative stance to empower visionary company founders, to adopting a U.S.-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 SEHK'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."

To the surprise of none, Alibaba announced immediately after the decision that it was ending discussions with the SEHK, and Joe Tsai, the executive vice chairman of Alibaba, put out a statement openly critical of the SEHK's decision.  To the surprise of many, Alibaba also said that while it would focus its efforts on a U.S. 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 SEHK's decision, commentators were split on whether the seeming inflexibility of the SEHK would lead it to be unable to compete with more innovative stock exchanges in other financial centers, whether the SEHK 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 SEHK will be willing to exhibit in the future, or what effect the SEHK's position will have on its own operations or on Hong Kong's status as a major global financial center.  A number of conclusions, however, may be drawn from the debate to this point:

Credit where credit is due.  Even if one considers the SEHK'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 SEHK 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 SEHK is not exactly analogous to the U.S. exchanges.  The SEHK has historically taken a much more paternalistic approach to vetting and regulating listed companies than have regulators in the U.S. market.  This is partially due to conceptual differences – as noted above, U.S. 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 United States in which U.S. 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 U.S. 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 U.S. 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 SEHK relating to a Hong Kong IPO and listing, 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 U.S. listing is actually completed, Hong Kong should not be ruled out.  Further, even if a U.S. 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 SEHK 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 and/or to open up a new pool of capital and investors.  All of these companies, including future listers, will be subject to the SEHK's ultimate policy position on corporate governance.  Therefore, the outcome of Alibaba's battle with the SEHK and SFC has consequences that will stretch far beyond the borders of Asia as financial globalization continues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions