Regulation of Listed Issuers

Paul M Y Chow

Chief Executive, HKEx 25 November 2003

Presentation to the Hong Kong Institute of Directors

Agenda



Current Issuer Regulatory System



Checks and Balances of HKEx’s Listing Function



Five questions

1.

Is the regulation of listed issuers effective in HK?

2.

Is the quality of listed issuers deteriorating?

3.

Does HKEx have a conflict of interest?

4.

Is the Listing Unit effective?

5.

What is expected of the Listing Committee?



Conclusion

2

Listed companies in Hong Kong are governed by a three tier regulatory system

Roles Checks & balances Government

 Sets overall policy direction  Initiates legislation  Executive Council  Legislative Council

SFC HKEx

 Statutory regulator  Market watchdog  Administers the Codes on Takeovers and Merger and Share Buybacks  Regulates HKEx  Licenses advisers and IFAs  Process Review Panel  Securities and Futures Appeals Panel & Tribunal  Other independent committees  Judicial review  Frontline regulator  Public organisation  Business entity  Administers the listing rules  Oversight by SFC (via SFO and various MOUs)  Balanced board structure  Independent Listing Committee and Listing Appeals Committee  Other independent committees  Judicial review 3

Safeguard measures ensure checks and balances in HKEx’s Listing function

Safeguard measures Description SFO

      HKEx shall give precedence to the public interest over its own interests Appointment of HKEx Chairman (elected by HKEx Board) requires approval of CE of SAR Appointment of HKEx CE (appointed by HKEx Board) requires approval of SFC All HKEx’s fees and charges relating to listing activities and new and amendments to listing rules require approval of SFC SFC has power to give directions to HKEx if it deems appropriate (SFC needs to consult with FS in cases of issuing restriction notices and suspension notices ) SFC can introduce and make amendments to any listing rules after consulting FS and HKEx   Listing application materials submitted to SEHK are also filed with the SFC The SFC has the power to make comments on and object to a listing application

Dual filing

4

Safeguard measures ensure checks and balances in HKEx’s Listing function (cont’d)

Safeguard measures Description MOU on Listing Matters

    SEHK has delegated all its listing decision making powers to the Listing Committee (

“LC”

) assisted by the Listing Unit (

“LU”

) LC approves new listing applications, new and amendments to policies and the cancellation of any listing Independence of LC is secured by the Listing Nomination Committee, on which HKEx and SFC are equally represented Continuous oversight by SFC of HKEx’s performance of its listing responsibilities, including monthly reporting, monthly liaison meetings and periodic audits

MOU for the Listing of HKEx

  A Conflict Committee is established to review any situation where concerns are raised that HKEx may have a conflict of interest HKEx as a listed company is regulated by SFC, not by SEHK

Balanced Board

  All board members (except HKEx CE) are INEDs (as confirmed by SFC) Government appoints 6 Public Interest Directors and shareholders elect 6 Directors 5

There are also checks and balances in the listing process …

Independent of HKEx

Applicant Listing Unit (LU)

 Receives listing application  Rejects application or recommends application for LC’s consideration Recommends or rejects

Listing Committee (LC)

Approves or rejects Rejects (and applicant appeals the decision) Approves or rejects

SFC

 Under dual filing, receives application from LU  Provides feedback to applicant via LU

Listing Appeals Committee (LAC)

 Reviews appeal by applicant 6

… And in the disciplinary process

Independent of HKEx

Listing Unit (LU)

 If a potential breach is suspected, recommends to LC how its disciplinary power should be exercised Reports a potential breach

Listing Committee (LC) Listing Appeals Committee (LAC) First hearing by LC

Announces decision Issuer seeks a review Issuer seeks a review

Review hearing by LC

Announces decision

Final review hearing by LAC

Announces decision 7

Five questions on the regulation of listed issuers in Hong Kong

Question 1 : Is the regulation of listed issuers effective in HK?

Question 2 : Is the quality of listed issuers deteriorating?

Question 3 : Does HKEx have a conflict of interest?

Question 4 : Is the Listing Unit effective?

Question 5 : What is expected of the Listing Committee?

Objectives :

 Set out the facts  Clarify any misperceptions  Provide further details on current arrangements  Propose possible enhancements 8

Question 1 : Is the regulation of listed issuers effective in Hong Kong?

Facts Perceptions Current arrangements Possible enhancements

 Less than 1/5 of listed issuers are incorporated in HK (many Bermuda / Cayman Islands incorporated companies)  Many family-owned businesses have concentrated ownership  Majority of listed issuers comply with the listing rules  “Regulation of listed issuers lacks teeth to address serious misconduct?”  “The range of sanctions and penalties that can be imposed on listed issuers may not provide meaningful deterrence effect?”  Statutory regulation rests mainly on Companies Ordinance Applicable mainly to HK companies  Regulation mainly falls on non-statutory Listing Rules  Under SFO, criminal liability is attached to intentional disclosure of false/misleading information However, SFO does not deal with non disclosure of material information  Listing rules related to market operations & practices should remain non-statutory  Embody key requirements in statute  Improve investor remedies and protection  Foster closer working relationships between HKEx, SFC and other relevant authorities on regulatory enforcement 9

Question 2 : Is the quality of listed issuers deteriorating?

Facts Perceptions

 Post-IPO market performance of selected listed issuers is considered unsatisfactory in the eyes of investors  There are numerous small and illiquid companies listed on HKEx  There have been some high-profile corporate scandals in the past few years  “HKEx approves too many listing applications?”

Current arrangements Possible enhancements

 LU takes a firm stand in assessing whether the applicant meets the requirements  Strengthen gate-keeping and disclosure-based regulatory regime: Enhance regulation of sponsors and IFAs  Independent LC approves listing applications Enhance initial listing & continued listing criteria  Under dual-filing arrangement, SFC has power to object to any application  Hong Kong operates a predominantly disclosure-based regime  Introduce an effective delisting regime Strengthen corporate governance Improve director’s understanding of Listing Rules and regulatory requirements  Improve investor education 10

Question 3 : Does HKEx have a conflict of interest?

Facts

 HKEx is a profit making company  Some HKEx executives are granted stock options  Reputation is critical to HKEx’s success

Perceptions Current arrangements Possible enhancements

 “HKEx does not have incentive to : Allocate sufficient resources to regulatory activities?

Suspend a company from trading in case of misconduct?”  “HKEx executives with stock options have incentive to focus on short-term financial results?”  Safeguard measures were built in to ensure HKEx does not have a conflict of interest

(as mentioned earlier)

 Maintaining investor confidence will create an attractive market which will help HKEx’s growth and return in short and long term  Quality assurance is part of HKEx’s branding  Further enhance transparency of HKEx’s Listing function  Independent assessment of whether HKEx has allocated sufficient resources to regulatory activities 11

Question 3 : Does HKEx have a conflict of interest? (cont’d)

Facts

 HKEx is a listed company

Perceptions Current arrangements Possible enhancements

 “As a listed company, HKEx is subject to its own listing rules and has low incentive to tighten rules?”  “Only HKEx can initiate rule changes?”  HKEx is regulated by SFC as a listed company  SFC can introduce and make amendments to any listing rules after consulting FS and HKEx  SFC provides extensive policy input  Government provides directions in some policy areas  Strengthen communication between SFC, HKEx and others relevant parties to identify policy initiatives and develop rule amendments 12

Question 4 : Is the Listing Unit effective?

Facts

 LU administers the listing process and makes recommendations to LC  LU supervises the ongoing compliance by issuers with the listing rules  LU develops proposals for rule amendments

Perceptions Current arrangements Possible enhancements

 “Listing process is long and inefficient?”  “LU overly focuses on detailed technical requirements?”  “Decision making in rule amendments is slow?”  LU is in the process of reorganising into 4 functional divisions to improve its operational efficiency: Enforcement IPO Transactions Compliance & Monitoring Legal & Policy  Continue to streamline listing application process  Further improve staff quality  Further promote service culture  Establish metrics to measure performance of LU  New listing application vetting initiatives have been implemented  Independent assessment of the adequacy of LU performance 13

Question 5 : What is expected of the Listing Committee?

Responsibilities of Listing Committee Facts

 All LC members (except HKEx CE) are market practitioners and users and part-time volunteers: Cannot take up full time workload

Perceptions Current arrangements Possible enhancements

 “Mismatch of expectations on : The type of issues that the LU should submit to LC for approval?

Whether LC should play a reactive and consultative role or a pro-active and decision-making role?”  As set out in Chapter 2A/B of Listing Rules, LC can :  Revise Chapter 2A/B of Listing Rules to: Approve or reject a new listing application Impose disciplinary sanctions Streamline the decision making process Establish a separate Listing Review Committee to alleviate LC’s workload Decide listing-related policy matters  LC meets once a week to discuss general listing matters  Clearer delineation of roles and responsibilities of LC and LU  LC meets quarterly to decide on matters of policy and principle 14

Question 5 : What is expected of the Listing Committee? (cont’d)

Relationship between Listing Committee and Listing Unit Facts

 LC does not control the budget and management operation (e.g. hiring and firing of staff) of LU

Perceptions Current arrangements Possible enhancements

 “LC should be responsible for the operation of LU?”  “LC cannot effectively carry out its delegated responsibility in relation to listing matters without controlling the operation of LU?”  HKEx Board is responsible for the budget and operation of LU  Members of LC can request specific support from LU  Not having the LC controlling the budget and management operation of LU is in effect a check and balance measure  Independent assessment of whether LC receives adequate support from LU  Independent review and approval of LU’s budget and proposal of remuneration structure of LU to the Remuneration Committee 15

Question 5 : What is expected of the Listing Committee? (cont’d)

Agenda of Listing Committee Facts

 The agenda for LC meetings reflects the decisions that the LC members are invited to make

Perceptions Current arrangements Possible enhancements

 “LU controls the agenda of LC meeting and as such LC can only respond to matters that are tabled by LU?”  Agenda of LC is prepared by the Secretary of LC  Members of LC can raise meeting agenda items  Establish formal process for LC members, particularly LC’s Chairman and Vice-Chairman, to set the Committee’s own agenda 16

Question 5 : What is expected of the Listing Committee? (cont’d)

Composition of Listing Committee Facts Perceptions

 LC comprises experienced market practitioners  Heavy sell-side weighting of LC  “LC protects the interests of listed issuers only?”

Current arrangements Possible enhancements

 Composition of LC is decided by the Listing Nomination Committee, which has equal representation from HKEx and SFC  Listing Rules define the composition of LC  There are conflict procedures to ensure independence of decision making  Commercial experience of LC members is leveraged to maintain market quality  Increase representation of investors  Maintain proper balance of the composition of LC 17

Summary of possible enhancements

1. Introduce effective statutory regulation built on the strengths of the current system

 Listing rules relating to market operations & practices should remain non-statutory  Embody key disclosure requirements in statute  Improve investor remedies and protection  Foster closer working relationships between HKEx and relevant authorities on regulatory enforcement

2. Improve quality of listed issuers

 Strengthen gate-keeping and disclosure-based regulatory regime  Strengthen corporate governance  Improve investor education

3. Further strengthen checks and balances in HKEx’s Listing function

 Further enhance transparency of HKEx’s Listing function  Independent assessment of HKEx’s listing function  Strengthen communication between SFC, HKEx and others to identify policy initiatives and to develop rule amendments 18

Summary of possible enhancements (cont’d)

4. Further upgrade performance of LU

 Continue to streamline listing application process  Further improve staff quality  Further promote service culture  Establish metrics to measure performance of LU

5. Further enhance effectiveness of LC

 Revise Chapter 2A/B of Listing Rules  Clearer delineation of roles and responsibilities of LC and LU  Establish formal process for LC members, particularly LC’s Chairman and Vice-Chairman, to set the Committee’s own agenda  Increase representation of investors in LC  Maintain proper balance of the composition of LC 19

Conclusion

 The three-tier regulatory system in Hong Kong has many checks and balances features and has worked well since its introduction  Building on the current practice, potential enhancements can be made to strengthen Hong Kong as a financial centre meeting international standards  HKEx is dedicated to co-operating with all parties to implement these enhancements 20