Mainland Chinese companies listing in Hong Kong are still being welcomed with open arms by regulators and sponsoring banks but there are signs that investment institutions are beginning to exert some market discipline on Chinese companies in which they invest.
A recent example came in late March when the independent minority shareholders of state-owned oil and gas exploration company CNOOC voted down proposals by the board of the company to place huge sums of cash with sister company CNOOC Finance Corporation on an unsecured basis, rather than with independent commercial banks.
The proposals were part of what are referred to as ongoing connected party transactions and are commonplace in Hong Kong-listed companies, especially among Chinese state-owned enterprises that have sold minority stakes to the market but remain tightly controlled by government organs. Such transactions are normally granted waivers from independent shareholder approval for a specific time period by the Hong Kong Stock Exchange at the time of listing, after which they require a renewal authority from independent shareholders. Hitherto, such approvals have been largely routine in nature.
Against
That has now changed. After unsuccessful attempts in the past to vote down the arrangements, at CNOOC’s latest general meeting called to approve the proposals more than 52% of independent shareholders voted against the resolution. Now CNOOC Finance Corporation must repay the cash to CNOOC, not a trifling matter: according to the company, as at December 31 2006 the maximum daily outstanding balance of deposits was the equivalent of $828 million.
“We think this is a watershed for a lot of Chinese companies listed in Hong Kong,” says Dean Paatsch, vice-president, Asia Pacific markets at Institutional Shareholder Services Australia in Melbourne. “This may spell the end of these kinds of arrangements.”
Institutional Shareholder Services (ISS) analyses forthcoming company resolutions and issues voting recommendations for institutional clients. The firm has made voting against most such connected transactions a policy matter, says Paatsch.
Targets
“We’re targeting these resolutions as ones to vote down,” he says. “If there’s a compelling reason for the transaction – a key supplier agreement perhaps – then no problem. But putting your spare cash on deposit with a non-bank related company with no parent company guarantee just makes no sense.”
What makes the CNOOC result all the more significant, according to ISS, is that it wasn’t just its own clients, largely international institutional investors, that voted against the company, but also Asia-based funds.
“Local investors came under a lot of lobbying pressure from CNOOC’s bankers,” says Paatsch. “The company ran a pretty hard campaign to twist arms, so the vote is a sign that local institutions are prepared to speak up.”
Institutional ire is not restricted to unnecessary inter-group transactions, either. Of equal significance is a discernible trend among investors in Hong Kong-listed companies to refuse to continue to grant blanket mandates to directors to issue shares for cash without offering existing shareholders the chance to participate, a big cause of dilution.
Unlike in the UK, where so-called non-preemptive share issues are tightly controlled, Hong Kong’s listing regulations permit non-preemptive issues of shares up to 20% of the existing issued share capital and even allow directors to expand that amount to include share capital adjusted for repurchased shares, diluting minorities further. In the past, controlling shareholders have often used such issues as a way of raising fresh capital while maintaining strict control over the company, often by placing shares with friendly investors.
Those days might be numbered. According to Jamie Allen, secretary general of the Asian Corporate Governance Association (ACGA), UK pension funds, including, for example, Hermes and F&C Investments, are routinely voting against general mandates of Hong Kong-listed companies in which they have invested.
“It’s an issue we’ve been working on for a while now,” he says. “We’ve been taking this to our members for the past two years, recommending them to vote against mandates.”
Opposition
The efforts are now paying off. A number of Hong Kong-listed companies, surprised by the strength of voting against large general mandates, have voluntarily begun to reduce the size of mandates sought, including the Hong Kong Stock Exchange itself. For those that refuse to change, there is evidence that they can expect increasing opposition from shareholders.
One recent example is Pacific Basin Shipping. At its latest annual general meeting in April, all resolutions proposed were passed by shareholders with the single exception of the granting of the general mandate, which was comfortably defeated.
“These are all signs that investors are starting to exert market discipline on companies,” says Allen, “and that’s a good thing.”
Hong Kong-listed companies can expect more opposition ahead. ACGA is planning to lobby the Hong Kong Stock Exchange soon, says Allen, to change the limits and terms of general mandates under its listing rules. And according to ISS, there is a pipeline of mainland Chinese companies seeking renewal of controversial connected transactions. Expect more shareholder revolts ahead.
