Across the board

Gary Mead looks at the differences between corporate governances codes in the East and West

When Alibaba, the giant Chinese e-commerce company, decided in 2013 to float on the New York Stock Exchange rather than in Hong Kong, it was widely trumpeted as a victory for American savvy banking.

Wow! New York steals the biggest-ever IPO from under the noses of the leading Asian stock market!

Hong Kong’s bankers wept into their Tsingtaos as they counted the losses in advisory fees – around $300 million. The total cost to Hong Kong was incalculable: unquantifiable losses in trading volumes and embarrassing humiliation for the trading community.

But for those interested in long-term corporate stability and transparency, this was actually a clear victory for Hong Kong’s market regulators. Far from loss of face, it could be argued that they deserved a massive pat on the back.

According to Philip Armstrong, Senior Advisor on Corporate Governance at the International Finance Corporation, in Washington D.C.: “Hong Kong remains highly regarded for good corporate governance because it declined to list Alibaba.” The Asian regulators took a long hard look at Alibaba’s pre-IPO structure and decided they didn’t much like what they saw.

Hong Kong was desperate to host Alibaba – but the local regulators nobly refused to bend their rules. For the structure proposed by Alibaba’s founders, Jack Ma and Joseph Tsai, ensured that they would retain control of the company, despite holding a relatively insignificant percentage of shares.Big shareholders of the floated Alibaba will find themselves unable to influence the company’s direction.

They may be happy about that – for now.

This kind of corporate control – a cosy arrangement that suits a company’s founders rather than necessarily benefitting the shareholders – is not permitted in Hong Kong.

More cautious finance minds might consider that the looser rules in New York are indicative of greed getting the better of corporate probity. The Alibaba event was a triumph of power without responsibility, a watershed moment for those who want to see improved standards of corporate governance. It demonstrated that, when it comes to finger-wagging, the ‘developed’ West cannot necessarily feel superior to the supposedly undeveloped East.

Hong Kong was right to say no to Alibaba, even though it paid dearly for it.

Why should we worry about the standards of corporate life? Armstrong, who was closely involved with developing the King Reports on Corporate Governance in South Africa, held to be some of the most advanced principles on corporate governance in emerging markets, is clear: “Because poor management leads to corruption and the inappropriate use of assets.

You need to have governments to ensure that boards fulfil their duties, that they are good stewards of the company on behalf of investors and shareholders.

So the government needs to create credibility for company reports, and to recognise good practice to encourage boards behave responsibly.” As is so often the case, globalisation has heightened awareness of and the need for corporate standards.

Just as investors have seen a doubling in their choice of markets in almost 30 years – the leading emerging markets’ index, MSCI, today identifies 23 emerging markets, against just 10 countries almost three decades ago – the trading volumes on those markets have exploded.

Back in 1988 those original 10 countries represented just one per cent of the total value of shares available to private investors; today, the 23 represent 11 per cent. Since 2003 emerging markets have moved from 24 per cent to 43 per cent of global GDP.

It’s also two-way traffic.

Just as investors can make a mint from emerging markets, those markets also benefit from being classified as such. In 2013 HSBC estimated that the inclusion in MSCI’s Emerging Market Index of Qatar and the UAE – nudging up from the higher-risk category ‘frontier market’ status – could attract $800 million of new inflows into the two countries.

George Dallas, now Policy Director at the International Corporate Governance Network and former Director of Corporate Governance at F & C Investments, points out that there is a definitional problem about what constitutes an emerging market: “There’s no clear definition of what an emerging market is.
Is Italy an emerging market, for instance?” There is also a certain fluidity about the relevant list of indicators concerning good or bad corporate governance.

As Dallas puts it: “You really are trying to quantitatively capture issues that are essentially qualitative in nature. But we have to be aspirational, as well as pragmatic, and endeavour to systematically factor governance into investment analytics. The World Bank has developed a toolkit that lets you juxtapose different markets, but drilling down into specific companies and being confident about their disclosures is even more challenging.” The danger of cronyism creeping in is ever-present, even in markets and companies that are supposedly well-developed.

Are there specific emerging markets that are doing better than others when it comes to good corporate governance? Both Armstrong and Dallas point to South Africa as a good reference point, as well as Brazil’s Novo Mercado (New Market), a listing segment of BM&F Bovespa.

If a company wants to be listed on Novo Mercado it must comply with a tough set of regulations that far exceed those required by law, for example that the capital of the company is composed only of common shares.

All shareholders are to be treated equally, and a company’s Board of Directors is to have a minimum of five members, with the requirement that they stand for re-election after two years. At least 20 per cent of board members should be independent directors.

Strict quarterly reporting standards of financial information are needed. For Armstrong, a concern is that a jurisdiction might develop good corporate governance codes in theory – such as India’s highly ambitious new company law – but may fail to implement them in practice.

He says: “The issue, as emerging markets look to grow – and the benefit of that is the development of the economy overall, and at a corporate level private enterprise often needs external financing – is that inevitably you can only rely on reports received and the integrity of disclosure and transparency, furnishing or providing additional information.

If you have a board that is behaving badly then no amount of rules can alter that.” Dallas says: “Good corporate governance at a systemic level can make all boats float higher

But if you don’t have good governance standards then even the good boats are in danger of sinking.
The whole point about improving corporate governance in emerging markets is that it should hopefully result in a virtuous circle.

If you have good standards – strong regulatory quality ensuring equal shareholder rights, the rule of law holding sway, corruption being controlled and dealt with, vested interests not allowed to determine company policy – then this can be tremendously beneficial to the overall economy, even if is very difficult to achieve.

It can lower the cost of capital and help to attract capital.” It was always likely that Alibaba would end up with a New York listing. The US permits multiple-tier stock structures that allow a small number of people to control a company’s fate. In Hong Kong it’s ‘one share, one vote’, and the Hong Kong Securities and Futures Commission stuck strictly by the rules.

Who’s to say which is right? Which system will bring the greater benefit to shareholders? New York believes that the combined forces of public disclosure and tendency towards fierce litigation will keep its listed companies honest.

It’s just rather odd that, when it comes to corporate governance, Hong Kong insists on a much more democratic style than the US.

As the world shrinks, corporate governance issues are going to become increasingly topical.