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Hong Kong Exchange Sticks to Rulebook on Alibaba IPO

Hong Kong Stock Exchange
Stock traders sit at their desks facing an electronic board on the trading floor of the Hong Kong Stock Exchange in Hong Kong. Photographer: Jerome Favre/Bloomberg

Hong Kong Exchanges & Clearing Ltd., the world’s second-largest bourse operator by market value, is making a stand for transparency in the competition for Alibaba Group Holding Ltd.’s initial public offering.

Alibaba is moving toward a U.S. listing after talks with the bourse broke down following management’s proposal for a governance structure that leaves executives in control, according to two people familiar with the matter. China’s largest e-commerce firm is leaning toward making the New York Stock Exchange its home market, said one of the people, who asked to not be named because the process is private.

Hong Kong’s exchange is under pressure from regulators and investors to uphold standards after accounting scandals involving Chinese companies from Hontex International Holdings Co. to Boshiwa International Holding Ltd. The bourse is focusing on derivatives and commodities to boost profits as IPOs dry up, buying the London Metal Exchange for 1.4 billion pounds ($2.2 billion) in December.

“The benefit of turning away people who ask for favors is that it will maintain standards and attract better quality companies,” David Webb, a former exchange director who founded local governance watchdog, said by telephone. “If you maintain standards, investors pay for the quality. If you improve them, they’ll pay more.”

IPOs Slow

Lorraine Chan, a spokeswoman for Hong Kong Exchanges, declined to comment on the IPO, citing a company policy. Shares of the bourse operator fell 1.1 percent to HK$125 in Hong Kong today, extending their 2013 decline to 5.2 percent.

Companies raised $7.8 billion through Hong Kong IPOs this year, compared with $20 billion in the same period of 2010, when the stock exchange became the world’s biggest venue for first-time offerings, according to data compiled by Bloomberg. Listing fees accounted for 11 percent of Hong Kong Exchanges’ revenue in the six months ended June 30, according to a company statement.

“They have to balance between the IPO pipeline and the rule of law,” said Dominic Chan, an analyst at BNP Paribas SA, who has Hong Kong Exchanges rated as the equivalent of sell. The bourse and the regulator “don’t really want to let go of the quality of the listing rules for just one company,” he said.

Alibaba, founded by former English teacher Jack Ma, may raise about HK$100 billion ($12.9 billion) in an initial sale, Ernst & Young LLP said on June 28. That would make it the world’s biggest IPO since Facebook Inc. raised $16 billion last year and Hong Kong’s largest since AIA Group Ltd.’s $20 billion sale in 2010, according to data compiled by Bloomberg.

Image Dented

“It is damaging from a perception point of view for the exchange, the Hong Kong market and the investor base,” Andy Maynard, global head of trading and execution at CLSA Ltd. in Hong Kong, said in an interview today. “We would have traded it; it would have been a good stock for all of the broking community.”

Allowing Alibaba’s partnership to veto board nominations would enable Ma, who owns 7.4 percent of the stock, and his management team to run the company without worrying about being pushed out by an activist investor with a different strategy, a person familiar with the matter said last month.

Hong Kong’s stock market is dominated by companies with majority shareholders, making it more important that the exchange acts in smaller investors’ interests, BNP’s Chan said.

“Every investor needs to be protected and this is something that has been working really well,” he said.

Facebook, Google

While the U.S. allows dual-share structures, Alibaba would be subject to more stringent reporting requirements and a class-action litigation system, which does not exist in Hong Kong.

Manchester United Plc decided not to list in Hong Kong in August 2011 before ultimately picking the NYSE, where it has a two-class equity ownership structure that lets insiders retain control. Both Google Inc. and Facebook, which list on a U.S. market run by Nasdaq OMX Group Inc., also have two classes of stock.

“This is not a mere profit-sharing mechanism, nor is it a vehicle of power to exert greater control over the company,” Ma said in a Sept. 10 e-mail to employees. “The partnership system, operating based on a foundation of transparency, can shield the company’s long-range development plans from the short-term profit-seeking trends of the capital market.”

Alibaba has previously asserted its desire to run without consulting investors. It spun off the Alipay online payment business to an outside entity in August 2010 without telling Yahoo! Inc., its biggest shareholder, about it until the following March.

Market Integrity

Hong Kong Exchanges shares have trailed the Hang Seng Index’s 2.1 percent advance this year. The bourse operator’s profit climbed 10 percent during the quarter that ended in June.

“It is very important for HKEx to not make exceptions and to maintain market integrity, especially in light of what has happened with Chinese companies in recent years,” said Arjan Van Veen, an analyst at Credit Suisse Group AG who has the stock rated neutral. “There are plenty of companies in Hong Kong and China that would want to do similar things, so making an exception creates a very difficult scenario.”

Hong Kong has faced several corporate governance scandals surrounding mainland Chinese companies listing in the city.

Hontex, which raised $141 million in a December 2009 IPO, in June 2012 agreed to pay shareholders $133 million to end a lawsuit. The company, which had been suspended since just three months after the IPO, was delisted this week.

Chinese Companies

Boshiwa, a maker of children’s apparel and licensee of the Harry Potter brand, said in March 2012 that Deloitte Touche Tohmatsu resigned as its auditor because of a lack of financial information. The company, which raised $321 million in a September 2010 IPO, has been suspended from trading in Hong Kong for 18 months.

Chinese companies listed in the U.S. have been plagued by governance issues. Focus Media Holding Ltd., a Hong Kong-based digital advertising company, withdrew its listing from the Nasdaq Stock Market in May after a $3.8 billion privatization deal. Short selling firm Muddy Waters LLC accused the company in November 2011 of exaggerating its ad display network, sending the shares of Focus Media down 39 percent in one day.

Of 26 analysts surveyed by Bloomberg, 11 have Hong Kong Exchanges rated as hold, 7 have buy ratings and 8 have sells. As the exchange expands into commodities, it will probably start with monthly cash-settled metals products denominated in yuan, then move into other commodities and physical settlement, Hong Kong Exchanges Chief Executive Officer Charles Li said at an LME meeting in Hong Kong on June 25.

Investor protections need to be considered objectively and not be swayed by “emotional arguments” or be distracted by “specific circumstances of any given company,” Li said in a Sept. 25 blog post on the company website.

“There’s obvious downside from what would very likely have been a fantastic IPO for HKEx and, subsequently, a huge volume driver for the market,” said Matthew Smith, an analyst at Macquarie Group Ltd., who has the stock rated at the equivalent of sell. “But it would have been difficult for them to abrogate their own rules just because it’s Alibaba.”

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