Views on improving the integrity of global capital markets
30 October 2018

Stock Exchanges Need to Find Their Mojo

Stock exchanges in the Asia Pacific region have begun offering dual-class share IPOs as a way to stay competitive. Just how effective is their strategy?

After years of debate, both the Singapore Exchange and the Stock Exchange of Hong Kong have amended their rules to allow the listing of companies with dual-class share (DCS) structures. Their decision to do so was not made lightly and was dogged by controversy.

Much of the argument in favor of allowing DCS listings focuses on the success of DCS companies like Google and Facebook, and of course, the decision by Alibaba to list in New York rather than in Hong Kong.

A company with a DCS structure typically has two classes of shares, each carrying different voting rights. The shares with more voting rights (“super voting shares”) are usually held by the company’s founders and senior executives, allowing them a high level of control in the company with a relative low level of equity ownership. Ordinary shares, usually carrying one vote per share, are listed and sold to public investors.

New Superpowers for Some Company Founders

The recent pivot to DCS listings in Asia was made for the benefit of technology and so-called “new economy” companies (although companies in other industries may be able to take advantage of the change in some markets). Founders of these companies are said to favor such structures — a DCS structure protects them from the vagaries of market fluctuations while they implement their long-term vision, which, given new and proprietary technologies and business models, may not provide immediate, short-term benefits. By using a DCS structure, visionary entrepreneurs can focus on the long term and resist pressure to deliver short-term performance for shareholders looking for immediate financial gains.

As a byproduct, however, super voting shares give their holders almost superpower-like control over companies even though they only own a small percentage of the underlying equity. The undemocratic nature of the DCS structure is naturally making some investors and analysts nervous.

Deciding Where to List

Many exchanges see permitting DCS firms to list as a necessary step to stay relevant in a time of relentless competition in the global, cross-border IPO business. As capital becomes increasingly global, issuers are no longer limiting themselves to their domestic exchanges, but are shopping around for the best listing venue.

What does a good listing venue look like? From an issuer’s perspective, the exchange’s liquidity, financial infrastructure (e.g., speed of network), credibility and prestige, ease of future fundraising, and regulatory framework, and the availability of highly experienced, relevant professionals and the size and valuation of the issuer’s peer group on the exchange, are some of the considerations.

Another critical aspect for potential issuers is the investor and analyst community covering the issuer’s sector on that exchange. Issuers want to ensure they will get the attention they need and that their business model is thoroughly understood by investors so they can obtain the best valuation.

Of course, fees associated with the listing are also a key factor — companies desire certainty over how much it will cost them to launch their IPOs and to maintain their listings. Equally importantly, companies will look at the rules of the relevant exchange. How strongly is the market regulated? Are the rules clear? Are the rules robust and well enforced, and at the same time, business friendly?

Changing the rule book to allow DCS IPOs may appear a quick and easy way to win market share. However, it is but one of many considerations from an issuer’s perspective. In itself allowing DCS listings does not provide a sustainable competitive advantage — after all, other exchanges can easily replicate it. If all exchanges have the same rules, what makes one exchange stand out over another? What is the unique selling proposition (USP)? Are we not back to fundamentals such as liquidity, valuation, investors, analysts, the regulatory framework, and the ecosystem? If the fundamentals do not work, allowing DCS listings will not help in the competitiveness stakes. If they do, then DCS is a red herring beyond the initial IPO.

In Asia Pacific, the Australian Securities Exchange (ASX) has seen the largest number of technology company IPOs in recent years — 43 in 2016 and 2017, including companies from Israel, New Zealand, Singapore, and the United States. Notably, however, it has attracted such cross-border tech listings without allowing DCS IPOs. Instead, it focuses on its own USP — a robust legal and regulatory framework that is business friendly, an investor community that understands the tech space, and, of course, one of the largest pension fund systems in the world.

The Illusion of Choice

Many exchanges argue that allowing DCS listings would give investors more choices. Most investors already have access to equity investments worldwide via banking service providers and online brokerages. Few are limited to only investing in companies listed on their domestic exchanges. In light of the proliferation of investment opportunities, we are doubtful of the “choice” argument. What investors want are robust companies with sound investor protections and high corporate governance standards, backed by exchanges that are focused on providing a regulatory framework that balances all competing interests and are consistent with these needs.

Managing the Investment Cycle

All of this brings us back to the basics.

Ultimately, investors investing in a DCS company are taking the risk that powerful insiders could make poor decisions for minority shareholders and that minority shareholders would have no way to hold them accountable. Some investors are willing to overlook this risk when share prices are rising and the market is liquid. Since the global financial crisis, it has been by and large an issuer’s market with more money chasing fewer opportunities. But what happens when the liquidity dries up? That is when we will see a flight to quality and the outperformance of companies with strong governance.

Photo Credit: ©d3sign

About the Author(s)
Mary Leung, CFA

Mary is the Head, Standards and Advocacy, Asia Pacific. She is responsible for the development, maintenance, and promotion of capital markets policy perspectives in the APAC region. She also oversees the promotion and development of CFA Institute professional standards in the region. Mary has over 20 years of experience in the global financial industry, having worked in corporate finance, wealth management advisory, and fund management. Previously, she was with Coutts & Co, where she was director of Business Development and Management for North Asia. Prior to that she was executive director at UBS AG, where she led the Corporate Advisory Group in Hong Kong. With experience in both the buy- and sell-sides, Mary has a strong understanding of the drivers and dynamics of different investor groups, including institutional investors, corporates, family offices, asset owners, and high-net-worth individuals. Mary graduated from Peterhouse, Cambridge with a degree in Engineering. She is a CFA charterholder and speaks English, Putonghua, and Cantonese.

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