INTRODUCTION
1. The Council is pleased to submit its views on the consultation comprising various proposals and options put forward by the Hong Kong Exchanges and Clearing Limited (HKEx). Specifically, the consultation seeks comments on the following issues:
- whether there is any need for minimum standards to maintain listing status;
- what are the indicators and thresholds for triggering action to be taken by an issuer to meet the minimum standards for maintaining listing status;
- alternative treatments of securities delisted from the Main Board; and
- issues associated with low-priced securities.
2. The Council's comments in this paper are divided into two parts: overview and specific issues. Some of the comments are also based on the Council's previous submission to the Expert Group on the operation of the securities and futures market regulatory structure in October 2002, which raised similar issues.
COUNCIL RESPONSES
(A) Overview
3. Delisting reform is a complex, technical and sensitive matter, that relates to many stakeholders in the market. The Council is of the view that when considering any reform in the listing market, the HKEx should take into account local characteristics of the Hong Kong listing market which typically comprises a large percentage of retail investors and low-priced securities.
4. The Council's overall comments are detailed under the following issues:
- HKEx's public duty to retail investors and small companies
- Retail investors expect no change in listing rules
- The drawbacks of delisting
- The quality of market
HKEx's public duty to retail investors and small companies
5. As the HKEx currently enjoys a monopoly status in Hong Kong, it therefore has a public duty to look after the interests of smaller capitalization companies as well as those of the retail investors. An analogy can be drawn to the universal service obligations that other monopoly service providers, such as utilities, are compelled to observe.
Retail investors expect no change in listing rules
6. The retail investors who bought shares on the HKEx, did so on the basis of existing listing rules. Therefore they would have a legitimate expectation that no dramatic change or paradigm shift in the 'rules of the game' (such as the arbitrary cancellation of listing status) will take place.
7. The Council therefore recommends to the HKEx that any additional delisting criteria, if introduced, should not apply to existing shares but only apply to new issues listed after the new criteria becomes effective.
Drawbacks of delisting
8. The Council considers delisting has a number of drawbacks. In a previous submission, the Council urged the HKEx to make effort to examine alternatives to delisting, and find appropriate mechanisms that will provide retail investors with the means to trade the shares rather than merely resorting to delisting. The Council welcomes the fact that the HKEx has put forward for consultation alternative treatments of delisted securities.
9. It appears that the rationale behind listing reform is to eliminate consistently poor performers so that those remaining securities investors can pick are of reasonable quality. It is expected this can help boost investor confidence in Hong Kong. However, it is urged that the HKEx should consider the other side of the coin that retail investors may lose confidence in investing shares for fearing that their shares will be delisted. This would discourage retail investors trading in low-priced securities and affect potential issuers from raising funds, which may reduce the attractiveness of the market and impair market activities.
10. The delisting of corporations also ignores the plight of retail investors who get caught with shares in those corporations and are left with investments that they are unable to trade. Understandably, this may cause some panic reaction from retail investors to dump the shares resulting in a further drop of share prices. Given the significant contribution of retail investors to market turnover, their withdrawal from the market could have a substantial impact. The July 2002 Incident is a case in point.
11. The Council notes that the HKEx emphasizes that it will remain open-minded. However, from both the July 2002 Incident and this consultation, it appears to the Council that the HKEx favors de-listing corporations from the Stock Exchange rather than facilitating the rescue of corporations in financial difficulties.
12. To allow arbitrary de-listing, or make it easy to accomplish, diminishes the credibility implied in the initial listing on the exchange, and diminishes the expectation that the HKEx will exercise due diligence in allowing listing in the first place. This will also weaken investor confidence in investing in the stock market.
13. The stringency and inflexibility implied in arbitrary de-listing goes against the judicial trends in corporate rescue (both internationally and in Hong Kong) which are more supportive and amenable to giving companies a new lease of life and at the same time averting loss suffered by retail investors. It is not uncommon for corporate rescue to take 12 to 24 months to complete. Any measures taken against corporations that are facing difficulties should recognize the need for adequate time to attempt a resolution to problems.
14. One way the HKEx can assist corporate rescue is to clearly state what factors it will be examining when determining whether a rescue proposal to restore compliance with the listing criteria is acceptable. This can facilitate investors' understanding of the application of rescue measures, increase transparency, and investor confidence.
15. Therefore, the Council recommends that the HKEx should investigate why problems with a company's share price have occurred in the first instance. For example,
- the underlying reason for the company's non-performance which differed from the company's pledge that formed part of the HKEx's decision to list the company in the first place; or
- problems with corporate governance and whether action can be taken against the company based on findings of the investigation.
The quality of market
16. Prevention is preferable to a cure. This requires that effort should be put into ensuring the quality of the product on issue. Merely attempting to improve the quality of the market by eliminating 'penny stocks' is not addressing some core issues.
17. For example, the experience in the United States with misleading information being used to promote the chances of newly listed stocks rising significantly after an IPO, and the conflict of interest within a firm that both sponsors listings and gives investment advice, suggests that these issues should also be taken into account and measures adopted to avoid the same problems occurring in Hong Kong.
18. The prevalence of penny stocks in the Hong Kong market could to a large extent be attributable to the unprecedented economic downturn in the Hong Kong economy. Another important factor could be poor market sentiment, which is beyond the control of issuers and could be unrelated to the company's fundamentals.
19. There could also be problems specific to certain sectors. For example rising energy prices for a corporation that is highly susceptible to the cost of energy, or the introduction of substitutable competing technologies or services that have undermined the corporation's long term prospects.
20. It is understood that some issuers (both from Mainland and local listing) adopt a marketing strategy to price the new issue low so as to make it more attractive, particularly to the retail investors. The chance for these companies to become 'penny stocks' is inevitably higher than others.
21. There are suggestions that the current state of affairs of corporate governance of listed companies is also a contributing factor. A low share price might have been a result of repeated dilution, right issues, consolidation and sub-division of shares by controlling shareholders in order to dilute shareholdings of minority shareholders.
22. The Council believes that if this is the case, then efforts should be made to ensure all stakeholders know the importance of corporate governance and the introduction and enforcement of effective governance regulations. The HKEx should devise measures to restrict any corporate actions that have no genuine commercial reasons and they are detrimental to the interests of the minority shareholders.
23. The HKEx proposes certain discretionary power, targeting measures to restrict these malpractices. The Council encourages the HKEx to further explore this proposal. Upgrading the standard of corporate governance in Hong Kong is another means to improve the quality of the Hong Kong market. In this regard, the Council notes the HKEx's effort to improve the standard of corporate governance through its recent consultation exercise.
24. In summary, the Council believes that in the current economic climate, a better approach than delisting would be to improve the quality of the market and boost investor confidence in the market through educating market players and listed issuers on the importance of corporate governance and the introduction and enforcement of effective corporate governance regulation.
(B) Specific Issues
25. The HKEx has requested commentators to complete a questionnaire in relation to specific issues. The Council appreciates that the use of a questionnaire can in some circumstances facilitate analysis of opinion. However, the question of de-listing is such a complex issue that there is not always a clear cut answer (i.e. Yes or No). Moreover, not all questions are relevant to the Council and the qualifications that the Council (as a consumer advocate, rather than an industry participant) would want to apply to its answers might not necessarily arise in the context of the supplementary questions posed by the HKEx in its questionnaire.
26. Accordingly, the Council has listed below those issues out of the questionnaire that it considers are relevant to it, as a commentator on consumer interests, and provides what it considers appropriate comments from its position in the community.
Minimum standards for maintaining listing
27. On the question of having, in addition to the initial listing eligibility, ongoing minimum standards for an issuer to comply, the Council considers that there should be some standards to deal with exceptional circumstances such as insufficient operation and liquidation.
28. With regard to the second question, it appears to the Council that the introduction of a clearly defined, transparent and objective standard would make delisting easy to accomplish. The Council position is that the HKEx should explore alternative measures other than delisting. Nevertheless, on the premise that de-listing measures will go ahead regardless, the Council provides comments on delisting indicators and thresholds, and alternative listing.
Minimum continuing listing standards
Threshold
29. The HKEx proposes a number of indicators and thresholds and seeks views on whether they are appropriate, e.g. "whether three years consecutive losses is an appropriate indicator and trigger?" To give an answer to question such as this is problematic. First, consecutive losses do not necessarily mean that the company does not have sufficient level of operation or tangible assets. Second, there may be external factors that may cause the continuous losses, e.g. global economic slowdown.
30. Having said that, the Council believes that if a specific measurable threshold is to be set, it should be to indicate at what point there is a concern by the HKEx that the views it formed as to the viability of the corporation, that gave rise to the HKEx listing in the first place, have been lowered and that some remedial action is required.
31. If any of the above indicators are to be adopted, the HKEx should design an investor education program explaining to the public what these indicators are and how to monitor whether the thresholds have been reached. Retail investors may not know how to find out information such as the companies' profit and market capitalization. Another example is an audit report. Quite often retail investors might not be fully aware of the importance of an audit report and where it can be found. Investors need to be informed as to the importance of, and have the ability to understand the use of audit reports, so as to properly gauge the implication of disclaimers and adverse audit opinions.
32. The Council also suggests that the HKEx should review the indicators and thresholds at a suitable time and that they be revised in light of prevailing economic conditions and market impact.
Prior warning to investors
33. The Council notes the proposed measures by the HKEx to alert investors on the trading screen against particular securities so as to give a prior warning of potential problems. Such a measure may incite different responses from investors. On the one hand, investors need information, but this information may also cause panic. The Council therefore suggests that
- investor education on these warning signals is a priority; and
- it may be worthwhile for the HKEx to explore whether a grading system of warning signals should be adopted.
34. For example, level 1, 2, 3 signals for a share if the indicators fall by 20%, 10% and 5%, before they reach the particular threshold level. This can give better advance warning so that investors can gauge the risks and take appropriate actions.
Listing standards
35. The Council considers that in deciding on specific listing standards, consideration should be given to catering for special characteristics of different economic sectors in which a listed corporation operates, and the economic variables that affect that sector. These will be different depending on each sector of the economy. The Council suggests that some segmentation on the listing standards should be considered.
Relisting of shares
36. If specific predetermined indicators are used for delisting stocks, the Council suggests that the HKEx should, by the same token, devise specific predetermined indicators for a delisted corporation to be relisted if it resumes a state that is satisfactory for listing. For example, if a company is delisted because its market capitalization is less than $50 million, the HKEx should devise a mechanism so that it can re-list if its market capitalization increases to a certain level, instead of treating it as a new listing application.
Preventing delisting
37. The HKEx also seeks views as to whether it should have discretionary power to object to any de-listing if the sole purpose of the delisting is for the controlling shareholders to take advantage of delisting procedures as an pretext to privatization to the detriment of minority interests. The Council supports the position that the HKEx should have such discretionary power to safeguard minority interests against abuse of delisting procedures, provided there is transparency in exercising this discretion. The Council urges the HKEx to clearly define, as far as practicable, all the circumstances under which it will exercise the power.
Investor education
38. The Council believes that extensive investor education on the new delisting procedures and the above measures are a must and crucial for successful reform.
Alternative treatments of securities delisted from the Main Board
Compulsory privatization & winding up
39. The Council considers that compulsory privatization or buy-back by controlling shareholders and compulsory winding up, are some options the HKEx should further explore as it can provide an exit and perhaps some relief to minority shareholders. The HKEx can exercise its discretionary power, if conferred on, to deal with circumstances where there is a suggestion that controlling shareholders are engaging in "privatization on the cheap".
Alternative board for listing
40. With regard to alternative listing, the difficult question is what sort of alternative rules should apply to those that apply with primary listing. The administrative costs in setting up and running a third board is another important consideration.
41. Taking the view that due diligence should have been exercised in allowing listing in the first place, the requirements, insofar as financial reporting and corporate disclosure are concerned, should be set with a view to imposing a higher discipline on the corporation than would apply if the share price is above the benchmark. If lower reporting requirements were imposed, then this would only seem to exacerbate the eventual decline of the share price. Moreover, the creation of an alternative listing on this lower reporting basis could give the impression that corporations on that list have been abandoned.
Market for trading unlisted securities
42. The Council believes that if there is any market for trading in unlisted securities, it has to be regulated and preferably operated by the HKEx. Otherwise, retail investor confidence would be doubtful. HKEx should explore the possibility of setting up a unit within HKEx, and invite a potential market maker (e.g. SFC registered brokers/dealers) for the delisted shares. As it is believed that the liquidity of the delisted shares would not be high, market maker system should be adopted.
Consolidation of shares
43. Consolidation of shares would provide a short term relief for investors. The higher the threshold for consolidation, the better the result for investors because the higher share price might reflect more favorable trading spread terms. However, consolidation would not seem to provide a long term resolution of the problems the corporation is facing that led to the fall in share price. Another factor that should be borne in mind is that investors may also need to pay extra share registration fees if these stocks are to be consolidated.
Low-priced securities
Corporate governance related matters
44. The Council considers that if low-priced securities are a result of corporate governance malpractice, then there should be measures to upgrade corporate governance standards through education and effective enforcement.
45. If the price of low-priced securities is more volatile and they are easily prone to market manipulation, then the relevant authorities should vigilantly enforce rules against market manipulation through the market manipulation tribunal and other means.
46. The Council considers as a matter of principle that there is no need for action such as delisting simply because they are low-priced. However, the Council considers if the price of such securities falls below a certain benchmark and they cannot be traded through the Automatic Matching System (AMS), the shares should be consolidated to allow them to trade in AMS.
47. With respect to the restriction in undertaking share consolidation and sub-division, the Council considers that it should be either subject to the HKEx's discretionary power or subject to a certain percentage of independent shareholders' approval. The circumstances should be where the corporate actions have no genuine commercial reasons and the circumstances suggest that the main reason is to dilute controlling shareholders interests and is detrimental to interests of minority shareholders.
48. Whether it is necessary for the HKEx to intervene by prohibiting any rights issue, the Council suggests that the HKEx should examine the reasons why, notwithstanding the existing safeguards, repeated rights issues are still a major corporate governance malpractice. Retail investors often complain controlling shareholders use repeated rights issues to dilute their shareholding and cause prices to drop which is detrimental to the interests of minority interests, whether or not they opt for taking up the rights issue.
Fair and orderly market related issues
49. The Council understands that retail investors may have a perception that low-priced securities are "cheap" and "worth-buying". The Council is not in a position to comment on whether such perception is right or wrong, but what is crucial is that retail investors should understand the risk involved in investing in "cheap" stock. Investors education programs should be designed to address this concern.
50. In summary, low-priced securities could be a result of a number of factors. For example, the economic downturn or corporate governance malpractice. Having low-priced securities trading on the Main Board should not in itself be a concern.
51. Notwithstanding the fact that investors are informed as to the risks involved in investing on the stock market, and this is still important, there is a legitimate expectation that the listing of a corporation has a reasonable expectation of commercial return.
52. HKEx should take the necessary steps to ensure the listing procedures do not allow stocks that are inherently problematic from being listed in the first place; and that appropriate standards as to the governance of listed corporations are enforced.
