Equity: Stock Connect bourses agree on dual-class shares

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By:
Jonathan Breen
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The Hong Kong Stock Exchange and its counterparts in Shanghai and Shenzhen will include companies with dual-class shares on the southbound trading of Stock Connect, after reaching a deal.

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Stock Connect’s bourses are working to put together a set of rules governing dual-class share trading, which they expect to implement by mid 2019, according to an announcement from the Hong Kong Stock Exchange in early December 2018.

“The Shanghai Stock Exchange, Shenzhen Stock Exchange and [HKEx] jointly announce that they have reached a consensus on the detailed arrangement for the inclusion of companies with weighted voting rights in southbound trading of Stock Connect,” says the announcement. “The three exchanges will promptly work on formulating relevant rules, and will announce them to the market after completing the necessary procedures.”

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Charles Li, HKEx

The Hong Kong exchange, under Charles Li, only amended its regulations to allow the listing of shares with weighted voting rights (WVRs) in April 2018. 

WVRs enable control of a company by a small number of shareholders. The structure is popular with tech firms, where the founders often want to retain control over their long-term vision rather than be tied to short-term concerns. 

The introduction of WVRs followed a four-year effort by Hong Kong to become a listing hub for Chinese new economy companies, which was sparked by the city’s loss of Alibaba Group Holding’s $25 billion IPO to New York in 2014.

Xiaomi Corp ushered in the new era for Hong Kong by debuting the city’s first dual-class share listing in June this year. It floated through a HK$37.1 billion ($4.7 billion) IPO. The company was set to join the Hang Seng Composite Index, which would make its shares eligible for trading through the Shanghai and Shenzhen Stock Connects.

However, barely one week after the landmark listing, the Chinese bourses wrecked the party with a surprise announcement that WVR stocks would not be admissible for southbound trading. The news caught both investors and HKEx off guard. 

The Hong Kong exchange suggested making an announcement earlier in the year to manage market expectations as well as make sure investors were well prepared for the dual-class share structure. Because that the inclusion concerns southbound trading, responsibility fell to the SSE and SZSE to forewarn the market, but by the time Xiaomi kicked-off its IPO neither had said anything. 

As a result, the onshore exchanges said mainland investors still did not have sufficient understanding of WVRs to trade them. 

Stock Connect 101

The Stock Connect scheme, launched in November 2014, is Chinese investors’ only direct means of trading offshore stock in Hong Kong. It also gives international investors access to China’s A-share market. As of December 2018, the scheme included more than 2,000 stocks.

The bourses on both sides of the border have the power to exclude certain index stocks from trading under special circumstances. That means the legality of the onshore exchanges’ move to exclude WVR companies was not in dispute, but it was out of the ordinary.

All three of the bourses had previously agreed to exclude foreign company shares and stapled securities from southbound trading. But they clashed on the topic of WVR shares.

At the time, the HKEx pointed out that mainland investors should not be deprived of the chance to participate in China’s new economy through Stock Connect. And among the reasons that it believes WVR companies should be eligible for southbound trading are its extraordinary investor protections, such as that it only accepts WVR listings from issuers with an expected market capitalization of HK$40 billion and that it requires them to establish a corporate governance committee made up of entirely independent non-executive directors.

To keep the problem from snowballing, the HKEx quickly came to an agreement with its mainland partners after their announcement in July to work on an inclusion plan. One course of action agreed upon was to have an initial special stability trading period (SSTP) for Hong Kong-listed WVR companies, after which they could be included in southbound trading. The duration of the SSTP is still unclear.

HKEx said at the time: “The meeting acknowledged that as mainland investors are not yet familiar with [WVR] companies, there is a need to consider the maturity and regulatory practices of the two markets when including WVR companies in the list of eligible securities for southbound trading.”

Apart from Xiaomi, only Meituan Dianping has floated in Hong Kong using the dual-class share structure. Meituan nabbed HK$33.1 billion from its listing, which left its three co-founders in control.