Hong Kong needs to raise its corporate governance standards and beef up co-operation with the mainland if it is to maintain its advantage as a financial centre, a senior regulator has warned. Securities and Futures Commission executive director Ashley Alder said mainland firms already accounted for half of Hong Kong's initial public offerings. The China Securities Regulatory Commission was making serious efforts to address problems in the mainland's stock markets so Hong Kong could not rest on its laurels if it wished to remain an attractive place to list. 'To remain credible with the mainland and with overseas institutional investors we must be seen to be serious about corporate governance,' Mr Alder told the Chinese University's third Symposium on Corporate Governance and Disclosure yesterday. Mr Alder called for increased liaison with Chinese authorities on corporate governance issues. 'The mainland challenge is something we need to get to grips with pretty quickly. We need to work out what Hong Kong really is,' he said. 'Investors should know this is a quality market and companies have to adhere to [these standards], and that if they don't we will do something about it.' Quality assurance was a large part of the reason mainland companies were encouraged to list in Hong Kong. 'If quality is not delivered, Hong Kong's markets will suffer.' The SAR had a fantastic natural advantage in terms of its legal system, rule of law and certainty of contract, Mr Alder said. However, he highlighted a string of weaknesses in the regulatory system. The most important of these, he said, was pyramid corporate structures, which enabled ultimate controlling shareholders to extract value from listed companies through inter-company transactions. Pyramid structures are favoured by many family-controlled firms, which dominate the Hong Kong stock market. Mr Alder cited an unfinished Chinese University study which showed the SAR had the highest proportion of family-controlled listed companies in the world. 'This shows you what sort of challenge we have from a corporate governance perspective,' he said. Connected transactions are subject to special disclosure and shareholder approval provisions under Hong Kong listing rules. However, 'it is relatively easy to evade the rules or fix minority voting at meetings', he said. Hong Kong Exchanges and Clearing has proposed tightening the rules on connected transactions in a consultation paper on amendments to the listing rules issued last week. The Standing Committee on Company Law Reform issued similar recommendations for changes to Hong Kong's corporate law last year. Mr Alder said pyramid structures often had arisen because a successful family business had decided to move into a new business and wanted to invite outside shareholders to share the risk. 'That is a perfectly legitimate motive for setting up listed companies and with good disclosure there is no problem with it.' The issue arose when there were transfers of assets between the more closely held family companies and those lower in the pyramid. If an overvalued asset was sold to a company lower in the pyramid, that would benefit the controlling family at the expense of other shareholders. Other weaknesses included: Independent directors. The independence of non-executive directors was 'seen to be compromised' because they were appointed by controlling shareholders. The clearing system. Minority shareholders were starved of information and had no voice because most shares were held under the name of the clearing system's nominee company. Lack of shareholder activism. Hong Kong accounted for a minimal amount of fund managers' portfolios, and most benchmarked their performance to indices, so they had little incentive to seek to raise overall returns by campaigning for better governance.
