By Ian Fraser
In refusing to bend its own rules for Chinese internet giant Alibaba, the Hong Kong stock exchange (HKEx) has put principles over profits. China's eighth-richest person, Jack Ma, wanted to list Alibaba, the sprawling e-commerce sourcing and social media empire he founded in 1999, on Hong Kong Exchanges & Clearing (HKEx). But, after the bourse refused to relax its listing rules in order to suit his needs earlier this week, he confirmed Alibaba will float in New York instead.
Alibaba dominates Chinese e-commerce, with a circa 80 percent market share. Two of its main arms had annual sales of $170bn in 2012 - more than those of Amazon and eBay combined. The company's planned initial public offering (IPO), which is expected to value Alibaba at $100bn, is set to be one of the financial events of the decade, rivaling those of US-based technology giants like Facebook (NASDAQ:FB), Twitter (NYSE:TWTR) and LinkedIn (NYSE:LNKD).
The IPO can be expected to generate underwriting fees of some $400m for investment banks, dramatically boost trading volumes, and bring a degree of prestige to whichever stock exchange ends up hosting it. The IPO is clearly impossible in China, partly because of the sheer size of the float - at $15bn it will be the biggest since Facebook in 2012 - and partly because of some serious teething troubles in China's domestic equity, and the fraud and misconduct among financial intermediaries, which prompted the Chinese government to ban IPOs from September 2012. They have yet to be fully reinstated.
So, any self-respecting financial center would want to secure the Alibaba IPO, wouldn't it? Well not, it seems, Hong Kong - which, after several months of debate, has effectively told Ma and Alibaba to shove their IPO. The entrepreneur is thought to have really wanted to be able to list Alibaba's shares on HKEx, with all the associated benefits this would bring. The trouble, however, was that he was only willing to do so in a structure that contravened the exchange's rules, and indeed, the basic principles of shareholder democracy - "one share, one vote." He wanted the exchange to allow him and 28 of Alibaba's most senior executives and founders to nominate and control the board - even though they would hold only around 13% of Alibaba's equity.
But Hong Kong refused to buckle. A key principle of the former British colony's cherished listing rules is that dual-class share structures are banned, as are other schemes that give controlling shareholders or managers disproportionate voting rights. Such structures can bring stability, but they are also open to abuse, causing a lack of accountability at the top. Reuters columnist James Saft wrote:
"Without the right to appoint board members or exert other forms of control, investors can only vote with their feet. That leaves executives free to pursue self-serving policies, be they for reasons of self-enrichment, self-aggrandizement or caprice."
In September 2013, HKEx chairman, Charles Li outlined his thinking on the matter. Writing of a bizarre dream that he had had the previous night, Li described how he had been harangued by garrulous characters, including Mr. Righteous, Mr. Innovation, Ms. Future, Mr. Disclosure, Mr. Solution, Mr. and Mrs. Investor (big and small) and Mrs. Practical. Each had their own views on whether the HKEx should accede to Alibaba's demands. At the end of the hallucinogenic dialogue, Li concluded:
"In the end, we should take responsibility for doing what is right and best for Hong Kong, not just what is safe and easy."
Speaking on Monday, 17 March (one day after Alibaba confirmed its intention to list its shares in the US), Li insisted that Hong Kong had been right to stick to its principles. He said:
"We would not bend our existing rules just for one applicant. We feel proud of Hong Kong as we ensure that our rule of law and investor protection remain intact."
However, Li (whose views on the future of Hong Kong as a financial center I wrote about in January) conceded that Hong Kong and its financial regulator, the Securities and Futures Commission of Hong Kong (SFC), are willing to reconsider its position by launching a thorough review. They don't want to completely close the door to a host of other Chinese technology firms whose owners have a penchant for dual-share structures.
In an op-ed published in Finance Asia, Jamie Allen and Michael Cheng welcomed the decision. They wrote:
"We applaud the SFC on standing firm and their logic is very simple. Allowing the listing of Alibaba on its own terms would undermine the Hong Kong Stock Exchange's reputation and likely create innumerable problems: if Alibaba can list with special rights, why not other IPO applicants? And will existing issuers seek comparable terms?"
"The stock exchange's listing committee cannot make a principled differentiation for exemption based on industry sector. This is not a persuasive argument and leads to a slippery slope of future exemptions."
So now there are only two contenders in the race to secure the Alibaba IPO, which is likely to be the largest of the next five years - NYSE Euronext and the Nasdaq OMX Group. Neither has any qualms about allowing the company's founder and senior management team to control the make-up of its board; nor do Alibaba's biggest shareholders, Softbank, with 37%, and Yahoo (NASDAQ:YHOO), with 24% (it is worth pointing out that dual listings have been allowed in the US since 1988, when the New York Stock Exchange relaxed its ban for fear of losing business. Today, they are favored by media companies including News Corporation (NASDAQ:NWS) (NASDAQ:NWSA), insurance firm Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and a host of technology firms, including Google (NASDAQ:GOOG), Facebook (FB), LinkedIn and Zynga (NASDAQ:ZNGA)). Now Citigroup (NYSE:C), Credit Suisse (NYSE:CS), Deutsche Bank (NYSE:DB), Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM) and Morgan Stanley (NYSE:MS) are fighting out to see which can become the lead underwriter on the Alibaba IPO bonanza.
There could, of course, be darkness in Alibaba's cave, even with a US listing. Not least of these is that, in the United States, there is a much greater risk of class action lawsuits if management tramples over the rights of other shareholders, misrepresents financial performance or screws up in other ways. So, at least Mr. Ma will not be wholly unaccountable.