Non-Preemptive Share Issues in Asia: Reforming Rules to Protect Investors
If you own stock in a listed company, the value of your investment is not only the monetary value of these shares but also your share of control in the company. This technically gives you the right to either approve or oppose certain management actions. And as a shareowner, you typically have the right to buy any new shares that the company may issue — referred to as “preemptive rights.” But many Asian companies seek approval for a shareowners’ mandate at annual general meetings (AGMs) to issue shares without these preemptive rights. Such mandates give management the right to issue shares to hand-picked investors, and usually at a discount to market price.
In an effort to shed light on this important issue, CFA Institute recently released a research report, Non-Preemptive Share Issues in Asia: Role of Regulation in Investor Protection. The objective of this report is to help create greater awareness of the rights, roles, and responsibilities of various stakeholders, including investors, regulators, company management, and board members as well as controlling and minority shareowners within an organization.
How Do Regulations in Asia Compare to the UK Model?
We look at the regulations governing non-preemptive share issuance based on general mandates across four jurisdictions in Asia: Hong Kong, Singapore, Malaysia, and Thailand. We then compare these market practices with the UK regulations of preemption and highlight the differences between jurisdictions. This is important because some of the Asian markets featured in the report derive their regulatory framework from the UK system. Key findings:
- Special resolution versus ordinary resolution: In the UK, a general mandate must be approved by at least 75% of shareowners. Among the Asian companies we studied, only Thailand has the same stipulation. The remaining three jurisdictions require only a simple majority or an ordinary resolution — that is, 50% approval to pass a general mandate.
- Percentage of share capital: The UK also limits non-preemptive share issuance to no more than 5% of a company’s issued share capital. In addition, there is a cumulative cap of no more than 7.5% over a three-year period. In contrast, limits in Asia range from 10 –20% of the issued share capital. What’s even more alarming is that no market in Asia has a cumulative cap on the amount of shares that can be issued without preemptive rights, as a percentage of the total existing share capital.
- Percentage of discount: The UK also limits the discount of such issues to no more than 5% to market price. In Asia, the practice is for discounts to range from 0–10%, and as high as 20%.
The stark differences in the complex, labyrinth-like regulations governing non-preemptive share issues in Asia led us to ask two critical questions: Is the spirit of the law adhered to in practice? And are minority shareowners’ interests being unduly diluted?
We looked at four years’ worth of data from the Hong Kong market to analyse the actual discounts at which placements are made; the cumulative dilutive effect of multiple placements; whether adequate disclosure of placees and utilization of proceeds are made available to minority shareowners; and whether poll results indicate minority shareowners’ voices are being heard at AGMs.
We conclude that while companies need this financial flexibility, minority shareowners probably grant these mandates without fully understanding the consequences of their actions. These mandates can become a problem in two ways. First, companies can resort to non-preemptive share issues as a routine affair without making adequate disclosures to shareowners. Secondly, the ease and extent to which minority shareowners’ interests can become diluted is problematic.
To further enhance investor protection, CFA Institute recommends the following measures:
- Cumulative caps over a three-year rolling period. CFA Institute recommends a maximum limit over a three-year rolling period, implemented through regulations (i.e., stock exchange listing rules or the Companies Act mandating a total cap over a three-year rolling period).
- Transparency and Disclosure:
- Adequate disclosure of placees and discount details of prior share issuance. Where companies have placed shares based on general mandates in the immediately preceding three years, we recommend that management clearly disclose the number and percentage of shares issued in those earlier placings, the discount at which the shares were issued, and details of the actual placees (including criteria for selecting these placees) in the proxy materials at the next AGM for shareowner information.
- Adequate disclosure of utilisation of share issuance proceeds. CFA Institute recommends that companies avoid generic reasoning, such as future working capital or future investment opportunities. As a best practice, they should articulate clearly the intended uses for the funds to be raised through the general mandates. For companies that have raised capital in the immediately preceding three years through earlier mandates, we further recommend that the actual utilisation of proceeds raised earlier be included in the proxy materials at the next AGM for shareowner information.
- Shareowner approval. CFA Institute recommends that share mandates require more than a simple majority approval; a three-fourths majority requirement would provide more equitable protection of minority shareowners in most Asian markets. Our study of Hong Kong showed that at a 75% approval level, 15% of the general mandate requests would have been rejected in 2012; 17% in 2011; 10% in 2010; and 14% in 2009.
To summarize, each of us has a role to play:
- Companies need to be more transparent and to provide a higher level of detail in disclosures when they seek mandates to waive pre-emptive rights.
- Regulators in Asia can consider tightening rules to better protect the interests of minority shareowners.
- And finally, investors, too, have a role to play. Attend AGMs. Ask questions. Vote on resolutions. Let your voice be heard. You can make a difference.
All of this will help to create a stronger corporate governance framework in Asia.
Photo credit: iStockphoto.com/Elenathewise