Hong Kong Loses an Independent Watchdog

The May 15 resignation of David Webb, Hong Kong’s best-known gadfly and an independent and outspoken member of the board of Hong Kong’s financial trading monopoly, HK Exchanges and Clearing, raises serious questions about its standards of governance and underlines the government’s increasing control of what ought to be an independent body.

Webb, a former investment banker and now an independent investor, was an elected non-executive director of the exchange and the only foreigner on the board of a company whose business is heavily dependent on foreign institutions. He had been a member for five years.

His resignation came in the wake of an election that saw the government use its voting power to install favorites in two vacant seats on the board. One of these, Lee Kwan-ho, has been deeply embroiled in a scandal involving a collapsed company named Ocean Grand. Lee had been a board member and chairman of the audit committee of the company until Ocean Grand was put into provisional liquidation. Its chairman is now subject to various fraud-related charges. Lee was preferred by the government to another foreigner, the managing director of a fund management company and former chairman of the Hong Kong Institute of Investment Analysts.

The Hong Kong government controls the exchange due to its statutory right to appoint six of 13 directors plus, in effect, the managing director. But it strengthened its grip further by using the Monetary Authority, which comes under the Financial Secretary, to buy a significant shareholding and thereby with it gain the ability to influence the choice of elected members. This holding was only recently revealed. Its purpose was unclear, given the government’s power of appointment, but its use of its voting power suggests that the government wants to keep independent voices off a board now dominated by its appointees and who include members of the government’s Executive Council.

In resigning, Webb made serious allegations against the exchange, which is supposed to set an example to other listed companies in terms of transparency and governance. One was that meetings were held with unnamed third parties on the express condition that the meetings not be reported to the board, raising the question of how the board can supervise management if it is denied the right to know of substantive meetings?

Webb told Asia Sentinel that he could not disclose the parties to the meeting as it was a matter for the HK Exchanges board and management. However, as he also alleged that “policy was being driven through the back door by inexperienced and inexpert officials,” analysts suggest that he was referring to the government itself.

The board did not rebut the claim directly but merely said it adhered to the Code of Corporate Governance Practices for listed companies. It also denied, without specifics, that the management refused to supply information which Webb had requested “to facilitate the performance of my duties as a director.”

At a broader level, Webb claimed that decisions were being taken on political grounds and in response to what he described as certain interests rather than to develop trading and transparency. He noted a retreat by government appointees from the recommendation of its Expert Group recommendations to provide statutory backing for listing rules. Hong Kong is unique among major exchanges in giving a listed company rather than regulatory body control over governance issues.

Although HK Exchanges has been very profitable thanks to the surge of mainland H share listings over the past two years and the buoyancy of mainland stocks, many professionals regard it as having lagged behind Singapore and other centers in developing new products, or in acting in a manner to protect entrenched interests rather than spur Hong Kong’s international role. Its second board, the GEM, was used by prominent local tycoons to exploit small investors at the time of the 2000 tech bubble and has since sunk into near irrelevance.

Most recently HK Exchanges followed the advice of a government-related think-tank to explore the idea of a “professionals only” board which would have lower standards of corporate governance than the main board. This has been seen by most professionals as an attempt to allow tycoons even more leeway, likely at the expense of institutional investors. It is certainly no way to improve Hong Kong's global standing in financial markets.

Other recent initiatives have also come in for professional criticism. Hong Kong has badly lagged other markets in attracting non-local companies to list. Indeed, there are almost none, other than the mainland-related H shares and Red Chips and a few Taiwanese companies using Hong Kong as a way of avoiding restrictions on mainland investment. Meanwhile, London has attracted dozens and Singapore several. Singapore's futures exchange has also been more successful in developing products other than local stock market derivatives.

To try to make up for lost opportunities, HK Exchanges is now proposing the listing of Depository Receipts of foreign companies. However, it is unclear what companies will want to do so, and from where they will come. Even on the New York market, there is active trading in only a limited number of American Depository Receipts, mostly in very large companies, even though many local institutions are allowed to buy them but would not be permitted to buy the actual stock on a foreign exchange.

Another initiative has been to try to attract Islamic financial instruments to trade locally. While not in itself the subject of criticism, it does raise the issue of why only now, years after London, Dubai, Singapore and Kuala Lumpur have been going for the business. It is also not a field in which Hong Kong has an obvious comparative advantage or strong traditional links with sources of Islamic funds.

The financial success of Hong Kong Exchanges has been largely due to what has happened with China listings. Trading in many of these which could well migrate back to the mainland in capital controls, both inward and outward, are further eased and as a result H and A differentials are reduced to negligible levels.

A monopoly stock exchange dominated by government appointees closely connected to Hong Kong vested interests and ultimately beholden more to political pressures than to financial market needs is unlikely to help the territory's position at a time when Shanghai and various Asian cities are on the rise. It is also a high-cost exchange thanks to a mix of HK Exchanges fees, stamp duties on transactions and the survival of some fixed commissions.

The Webb resignation is unlikely to halt the drift towards government meddling in the economy in order to protect entrenched interests rather than set a transparent and competitive playing field. The big foreign institutions that bring so much to the city complain in private but keep their mouths shut for fear of upsetting officials, whether local or mainland, which would cause them to lose lucrative issue mandates.

As for small local investors, those most hurt by poor corporate governance and high transaction costs, they never did have much of a voice. And Webb's surrogate role on their behalf will have to be conducted other than in the boardroom of the government-controlled monopoly exchange.