Webb-site Reports

A circular slipped out by an HKEx subsidiary, HKSCC, will slash the effective voting window for general meetings, reducing the participation of institutional investors in important decisions such as acquisitions, connected transactions and dilutive share issues. We urge HKEx to rethink this deeply damaging move.

HKEx cuts hit corporate governance of whole market
18 April 2016

Hong Kong Securities Clearing Co Ltd (HKSCC), the lucrative monopoly clearing company owned by Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) slipped out a circular on 31-Mar-2016 containing some nasty news for investors which will undermine corporate governance by knocking 2 working days out of an already-short voting window for important meetings.

Background

HKSCC runs CCASS, the Central Clearing and Automated Settlement System. In order to trade shares on The Stock Exchange of Hong Kong Ltd, also owned by HKEx, the shares must be deposited into CCASS and placed on the share register in the name of HKSCC Nominees Limited (HKSCCN), making this HK's de facto central depository. The vast majority of publicly-owned shares (not held by controlling shareholders and directors) are held by HKSCCN on behalf of CCASS Participants comprising banks, brokers, custodians and direct "Investor Participants" like your editor.

So when the time comes to vote in an Annual General Meeting (AGM) or Extraordinary/Special General Meeting (SGM), investors who wish to vote must give instructions via HKSCC to vote the shares held by HKSCCN. Alternatively, if the investor wishes to attend the meeting, then she must instruct HKSCCN to appoint her as its "corporate representative" or proxy in respect of the number of shares it holds on her behalf.

In practice, for meetings in HK, HKSCC has normally sent a representative to the meeting to carry out the instructions of CCASS Participants, voting for and against resolutions according to the total number of shares instructed in each direction. This has the benefit that CCASS Participants can give instructions up to 4.15pm on the last working day before the meeting, either to vote the shares, or to appoint a person to attend as corporate representative.

CCASS Participants that are banks, brokers and custodians must add their own processing time and impose a deadline on clients for instructions. HK custodians often act as sub-custodians to global master custodians, who in turn must add processing time and impose a deadline on the institutional clients they serve around the world.

Of course, being the central depository means that when meetings are held simultaneously, HKSCC needs enough manpower, temporary or otherwise, to handle this load and attend the meetings.

The circular

Now, in the circular, HKSCC has announced that during what it calls "peak season" in May and June, there are so many AGMs that it will simply give up sending its own representatives to any of them, and not just to the AGMs, which handle relatively mundane business and have at least 21 calendar days' notice, but also to the SGMs, which can be called on only 14 calendar days' notice. It will therefor shorten the voting window by requiring instructions 3 business days before the meeting, so that it can submit a proxy form instead by the usual proxy deadline of 48 hours before the meeting. It says that this is:

"To ensure HKSCC have sufficient capacity and consistent approach to act on the voting instructions for all shareholders' meetings held during the peak season"

That's ridiculous, because they have a steady flow of SGMs all year round, so they should be capable of attending those at any time. These meetings handle important and often contentious business such as acquisitions, disposals, massively dilutive share issues, privatisations and connected transactions. Keep in mind that retail investor voting is already very low because the SFC does not require HK intermediaries (banks and brokers) to seek and facilitate voting instructions from their clients. So the bulk of independent votes are cast by institutional investors. These are the investors who are most likely to be impacted by a shorter voting window.

A master custodian will typically set a deadline of 3 to 5 working days before the HKSCC voting cut-off. 14 calendar days is never more than 10 working days, so that leaves 5 to 7 working days, or less if the period straddles holidays. So cutting 2 working days off this window could leave institutions with only 3 working days to read a circular and decide how to vote. Many of them rely on proxy advisory firms such as ISS and Glass Lewis, which in turn need time to produce their advice. The proxy advisors often hold standing orders to vote their clients' shares according to this advice unless the client intervenes. Such intervention becomes less likely if clients have less time to countermand the advice.

Shinbo Won, Head of Asia-Pacific (Ex-Japan) Research at ISS, told Webb-site Reports:

"assuming that custodians will reflect this change on their own cutoff dates, shareholders will be significantly impacted as it will reduce the time they have to review the agenda and make informed voting decisions. This change is not in the best interest of one of HKSCC’s key stakeholders, the investors."

HKSCC has also shortened the deadline for investors who wish to attend the meeting in person. They will no longer be appointed as corporate representatives but instead they will be appointed as proxies of HKSCCN, so the deadline for that will also be 3 business days before the meeting instead of 1 business day at present.

Incidentally, even in peak season, there is a natural limit to the number of meetings that will be held simultaneously, due to the finite supply of meeting rooms in hotels and elsewhere.

Conflict of interest

This move clearly has the effect of reducing the costs and increasing the profits of HKSCC, which otherwise has to maintain staff, or hire temporary staff, to handle the additional meetings of the peak season. It has handled the workload every year until now, so this was not a problem in the past. We suspect that this will be used as a stepping stone to complete abolition of sending HKSCC staff to shareholder meetings, and the shorter deadline will apply all year round.

HKSCC is a monopoly and the Government has exempted it (and HKEx and its other key subsidiaries) from the Competition Ordinance. The SFC's approval is needed for any tariff changes but it cannot compel HKEx and its subsidiaries to reduce tariffs. HKSCC makes an enormous profit margin partly by charging an anachronistic "scrip fee" of $1.50 on every board lot of increase in a CCASS Participant's position in a stock on successive book closure dates, despite the fact that the shares are only circulating within the computer system of CCASS, so it pays almost no scrip fees to registrars for production of physical share certificates. The HKSCC scrip fee is disproportionately expensive if the stocks you own have low-value board lots (see table here). Currently 266 stocks have a board lot worth less than HK$1000, so the scrip fee is more than 0.15% or more, and 600 stocks are below $2000.

Scrimping on staff (or even firing the surplus if they stop attending meetings all year round) will boost the HKSCC profit margin even further, but this comes at the expense of corporate governance for the whole market. We urge HKEx and HKSCC to rethink this deeply damaging move, and at the very least, to provide full coverage of all SGMs in Hong Kong and allow participants to vote or appoint representatives up to the day before the meeting as in the past.

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HKEx cuts hit corporate governance of whole market 18 April 2016