A Financial Centre for Two Empires: Hong Kong's Corporate, Securities and Tax Laws in its Transition from Britain to China [1 ed.] 1107004802, 9781107004801

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A F I NA NCI A L C E N T R E FOR T WO E M PI R E S

Th is is a case study of legal transplant, economic development, cultural adaptation and political integration. Hong Kong’s journey from British entrepôt to China’s international fi nancial centre is one of the most interesting legal stories of our time. But Hong Kong’s future is even more interesting: will this region with British-origin institutions survive full integration into China and become its permanent international fi nancial centre? Does Hong Kong have the legal infrastructure to compete effectively with Shanghai and Singapore, and even New York and London? A Financial Centre for Two Empires presents Hong Kong’s story, examines its corporate economy and securities market, assesses its corporate, securities and tax laws for doctrinal soundness and appropriate remedies, and evaluates the quality of their enforcement empirically. It closes with a view of Hong Kong from the perspective of developments in Beijing and Shanghai, including an examination of the important political dimension. DAV I D C . D O N A L D is a professor at the Faculty of Law of The Chinese University of Hong Kong. WA N G J I A N G Y U is a professor at the Faculty of Law of the National University of Singapore and a visiting professor at the Xi’an Jiaotong University Law School. J E F F E R S O N P. VA N DE RWO L K is a member of Ernst & Young’s Washington Council Ernst & Young practice.

Cambridge University Press

International Corporate Law and Financial Market Regulation Corporate law and financial market regulation matter. The Global Financial Crisis has challenged many of the fundamental concepts underlying corporate law and fi nancial regulation; but crisis and reform has long been a feature of these fields. A burgeoning and sophisticated scholarship now challenges and contextualizes the contested relationship between law, markets and companies, domestically and internationally. Th is Series informs and leads the scholarly and policy debate by publishing cutting-edge, timely and critical examinations of the most pressing and important questions in the field. Series Editors Professor Eilis Ferran, University of Cambridge. Professor Niamh Moloney, London School of Economics and Political Science. Professor Howell Jackson, Harvard Law School. Editorial Board Professor Marco Becht, Professor of Finance and Economics at Université Libre de Bruxelles and Executive Director of the European Corporate Governance Institute (ECGI). Professor Brian Cheffi ns, S.J. Berwin Professor of Corporate Law at the Faculty of Law, University of Cambridge. Professor Paul Davies, Allen & Overy Professor of Corporate Law and Professorial Fellow of Jesus College, University of Oxford. Professor Luca Enriques, Visiting Professor, Harvard Law School. Professor Guido Ferrarini, Professor of Business Law at the University of Genoa and Fellow of the European Corporate Governance Institute (ECGI). Professor Jennifer Hill, Professor of Corporate Law at Sydney Law School. Professor Klaus J. Hopt, Director (emeritus) of the Max Planck Institute for Comparative and International Private Law, Hamburg, Germany. Professor Hideki Kanda, Professor of Law at the University of Tokyo. Professor Colin Mayer, Peter Moores Professor of Management Studies at the Sa ïd Business School and Director of the Oxford Financial Research Centre. James Palmer, Partner of Herbert Smith, London. Professor Michel Tison, Professor at the Financial Law Institute of the University of Ghent, Belgium. Andrew Whittaker, Group General Counsel at Lloyds Banking Group. Professor Eddy Wymeersch, former Chairman of the Committee of European Securities Regulators (CESR); former Chairman of the IOSCO European Regional Committee, and Professor of Commercial Law, University of Ghent, Belgium.

A FI NA NCI A L CEN T R E FOR T WO E M PI R E S Hong Kong’s Corporate, Securities and Tax Laws in its Transition from Britain to China DAV I D C . DONA L D W I T H C ON T R I BU T ION S F ROM

J E FFE R SON P. VA N DE RWOL K A N D WA NG J I A NGY U

University Printing House, Cambridge CB2 8BS, United Kingdom Cambridge University Press is part of the University of Cambridge. It furthers the University’s mission by disseminating knowledge in the pursuit of education, learning and research at the highest international levels of excellence. www.cambridge.org Information on this title: www.cambridge.org/9781107004801 © David C. Donald 2014 Th is publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published 2014 Printed in the United Kingdom by Clays, St Ives plc A catalogue record for this publication is available from the British Library Library of Congress Cataloguing in Publication data Donald, David C., 1958– author. A fi nancial centre for two empires : Hong Kong’s corporate, securities and tax laws in its transition from Britain to China / David Donald ; contributions by Jiangyu Wang; contributions by Jefferson P. VanderWolk. pages cm – (International corporate law and fi nancial market regulation) Includes bibliographical references and index. ISBN 978-1-107-00480-1 (hardback) 1. Corporation law – China – Hong Kong – History – 20th century. 2. Financial institutions – Law and legislation – China – Hong Kong – History – 20th century. 3. Hong Kong (China) – History – Transfer of Sovereignty from Great Britain, 1997. 4. Hong Kong (China) – Economic conditions. I. Title. KNQ9328.D66 2014 346.5125ʹ066–dc23 2014009113 ISBN 978-1-107-00480-1 Hardback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate.

C ON T E N T S

List of figures List of tables Preface xi

ix x

1 History’s marks on Hong Kong law: from British colony, to Chinese SAR 1 A

B

C

D

Hong Kong’s historically driven component culture 1 1 The endowments of an international financial centre 1 2 Accidental haven with unintended consequences 4 Forming Hong Kong’s ‘caretaker’ government model 9 1 Cutting in the middlemen 9 2 Institutions of intermediation 15 3 Cultivating community leaders 19 Building the Hong Kong legal system 22 1 Laying the foundation 22 2 A ‘colonization kit’ of ordinances for the good order 25 3 Linking Hong Kong to the English Common Law 27 Hong Kong as an exemplary jurisdiction in China 34 1 A new role for an old port 34 2 From caretaker society to civil society? 36 3 Laissez-faire policies are essentially fading path dependence 4 Hong Kong must begin to make common law 49

2 Hong Kong’s economic structure: the corporate control context 54 A

Two salient economic characteristics 54 1 The dominance of substantial shareholders 54 2 A stock market dominated by companies formed under foreign law 57 3 Data and methodology 59

v

44

vi

Contents B

C

Hong Kong’s corporate groups 62 1 The financial services sector 62 a The Bank of East Asia 62 b The Bank of China Group 64 c HSBC Holdings 66 d Standard Chartered 68 2 The property development sector 69 a Cheung Kong Holdings 71 b New World Group 73 c The Hang Lung Group 77 d Henderson Land 79 e Sun Hung Kai 83 3 The commerce and industry sector 85 a Jardine Matheson 86 b China Mobile Limited 88 c Hutchison Whampoa Limited 90 d Swire Pacific 91 e China Resources 93 f CITIC Pacific 95 4 Governance relevant information summarized for the dominant corporate groups 97 An exchange dominated by other countries’ companies 101

3 Hong Kong corporate and securities laws in response to the Region’s role as China’s international financial centre 104 A B

C

Evaluating Hong Kong law on the basis of local risks 104 Law transplanted (only) as the need arose 111 1 Slowly evolving company law 111 2 Crisis-driven securities regulation 117 How good are the Hong Kong company and securities laws? 123 1 Does company law protect against majority shareholder abuse? 123 a Public defence of minority shareholders 127 b Applying the unfair prejudice action to listed companies 131 2 Does company law address the specific risks of corporate groups? 133 3 Does company law protect both unsophisticated and sophisticated creditors? 140 4 Does company law sufficiently serve private companies? 147

Contents

vii

5

D E

Do company and securities laws sufficiently limit risks from foreign listed companies? 152 a Recognized and acceptable jurisdictions 153 b Required provisions in articles 154 c Outreach provisions of the Companies Ordinance 155 6 Do securities laws and regulations prevent market abuse? 157 a Rules against insider dealing 159 b Rules against price manipulation 162 c Rules on short sales 163 d Requirements for investment banks sponsoring public offerings 164 Reducing the risks of algorithmic trading through taxation 165 Do Hong Kong company and securities laws measure up? 168

4 The role of Hong Kong’s tax policies A B C

D

E

171

Historical background 171 Hong Kong’s tax system today 173 Hong Kong tax seen on a global scale 176 1 Exchange of information 176 2 Hong Kong as a ‘tax haven’? 178 Taxation and the financial centre 183 1 Stamp duty on stock transfers 183 2 Exemption of offshore investment funds from profits tax Taxation and the rule of law in Hong Kong 186

185

5 Enforcement of corporate and securities law in Hong Kong 188 A

B

C

The institutional framework 188 1 Introduction 188 2 The courts 189 3 The Securities and Futures Commission (SFC) 191 4 Hong Kong Exchanges and Clearing Limited (HKEx) Private enforcement through litigation 196 1 Unfair prejudice actions 196 2 Shareholder derivative actions 201 3 Securities fraud actions 205 Public enforcement 206 1 The range of the SFC’s activity 206 2 Supervising licensed corporations 211 3 Policing the market against misconduct 213

193

viii

Contents

D

4 Direct government action: a tale of two bailouts Contractual sanctions by the HKEx 220 1 The enforcement record 220 2 Quality versus volume 221

216

6 China’s impact on Hong Kong’s position as an international financial centre: the legal and policy dimensions 223 A B C

D E

Introduction: integration, competition and erosion 223 CEPA’s direct benefits for Hong Kong’s financial sector 225 Listing Chinese companies in Hong Kong: the regulatory and legal challenges 228 1 The China factor, especially SOE listings, in Hong Kong’s stock market 228 2 The legal framework for corporatized SOEs: the law on paper 230 3 Legal-political governance of SOEs 234 a From traditional to corporatized SOEs 234 b SASAC as the de facto state shareholder 236 c Direct political control of SOEs by the party 238 4 Political and policy considerations behind the listing of SOEs in Hong Kong 240 a The good policy pursuance: financial and political reasons for listing SOEs in Hong Kong 240 b Bonding Chinese SOEs to Hong Kong’s better regulatory regime 242 c Political control of SOE listings by the PRC 246 5 SOE listing: challenges for Hong Kong’s regulatory and legal environment 249 a SOE operations: business judgement or political judgement? 249 b Challenges on cross-border enforcement of securities fraud between Hong Kong and mainland China 251 The potential rise of Shanghai as a financial centre 254 Concluding remarks 256

References 258 Index 269

L IS T OF F IGU R E S

2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 2.18 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9

BEA Group 64 BOC Group 66 The HSBC Group 68 Standard Chartered Group 70 Cheung Kong Group 74 New World Group 78 Hang Lung Group 80 Henderson Group 82 Sun Hung Kai Group 84 Jardine Matheson Group 87 China Mobile 90 Hutchison Whampoa Ltd. 92 Swire Group 94 China Resources Group 96 The CITIC Group 98 Changes in controlling shareholdings, 2003–12 100 SEHK listed companies – place of incorporation 102 SEHK Main Board, market capitalization of H-Shares (HKD mil), 1993–2013 103 Unfair prejudice actions, 1996–2012 197 Annual success rate of unfair prejudice actions 197 Derivative actions, 1996–2013 203 SFC enforcement actions by nature, quarter ended 30 June 2013 209 Aggregate annual SFC enforcement actions, 1997–2013 209 SFC enforcement claims, 2003–5 212 Violations of licensing requirements and duties to clients, 1997–2013 Policing against market misconduct, 1997–2013 217 HKEx enforcement actions, 2003–12 221

ix

214

L IS T OF TA BL E S

2.1 Shareholding types for groups examined 99 2.2 Controlling shareholder – board control overlap

x

101

PR E FAC E

his examination of Hong Kong ofers multiple points of entry into its topic, which is the transformation of a former British colony into China’s international inancial centre. My approach contains historical, doctrinal, comparative and empirical analyses. It is my hope that the sum of these various perspectives will be a complete picture of this complex phenomenon, without the gaps, simpliications and blind spots that can limit a legal study employing a single technique. A contribution from Wang Jiangyu, who lives and teaches in Singapore and mainland China, aims to provide insight beyond any home bias for Hong Kong that has crept into my analysis. A contribution from Jef Vanderwolk, who has studied, practised and taught tax law for decades, ensures that this highly specialized area is addressed with due expertise, from the inside. he result, we hope, is an accurate picture of Hong Kong’s corporate, securities and tax law as it moves from being a component of the British Empire to a Special Administrative Region of China. he irst chapter uncovers the path dependence embedded within Hong Kong’s institutional framework and developmental trajectory. Hong Kong was created as a British-managed, Chinese-inhabited entrepôt to facilitate trade between the British Empire and China; it has become a Chinese international inancial centre employing British-origin institutions to serve the growth of the Chinese economy. Hong Kong’s economy and institutions have always looked outward, towards a larger network of relationships into which the city, irst as colony and then as Special Administrative Region, it. Hong Kong is peopled by immigrants steeped in both English ideals of government and Chinese notions of family and community. hanks to this, the Region can serve as a social experiment for the larger transition of China. he second chapter examines the structure of corporate holdings in the Hong Kong equity market to better understand the risks and hazards that relationships of power pose to investors. Hong Kong is marked by two primary characteristics: controlling xi

xii

Preface

shareholders dominate its largest companies and most of its listed companies are incorporated abroad, beyond the control of Hong Kong company law. Two trends accompany these characteristics: controlling shareholdings are increasing, not dissipating, and the mainland Chinese government is replacing Hong Kong families as the controlling shareholder most present on the market. he third chapter assesses whether Hong Kong corporate and securities law adequately address the risks revealed in the second chapter. It inds that Hong Kong’s history, past and contemporary, presents challenges to this task: Hong Kong has inherited a law developed in a socio-economic context very diferent from its own, and these inherited tools must therefore be adjusted. International inancial centres are rated and assessed on the basis of standardized best practices, which might hinder Hong Kong’s eforts to adapt its transplanted tools successfully to meet local challenges. Moreover, Hong Kong is serving a shareholding client – the mainland Chinese government – whose inluence exceeds that of other shareholders in many ways. Hong Kong’s law and regulations are good, and eforts are being made to address these concerns, but the situation is very challenging. In the fourth chapter, Jef Vanderwolk examines Hong Kong’s business friendly tax laws, and evaluates the place of the Region within the context of current international eforts against tax avoidance. Here too, Hong Kong is facing challenges. he it h chapter examines the enforcement of law and regulation in Hong Kong. his chapter shows that almost all enforcement of corporate and securities law is driven by public institutions – particularly the Securities and Futures Commission. Private actions for unfair prejudice and derivative claims are increasing in pace, but still make up only a small part of Hong Kong enforcement activity, and derivative actions appear to be tailored for an economy of a diferent shape. his analysis shows Hong Kong regulatory policing to be robust, stable and steadily improving in certain areas. In the sixth chapter, Wang Jiangyu balances out the foregoing with a sceptical view of Hong Kong’s utility to the mainland Chinese economy. He shows that the so-called bonding efect of listing H-shares in Hong Kong is open to question and that Shanghai’s expansion is close on the horizon. Nevertheless, he concludes that the strong rule of law ofered by Hong Kong will remain a signiicant asset that the Region can ofer China in the future. h is study began and was completed with generous funding from the Hong Kong Research Grants Council. he research began as a Public Policy Research Project entitled ‘Anatomy of a Financial Centre: A Systemic Analysis of Hong Kong’s Legal and Regulatory Framework

Preface

xiii

for its Securities Market’ (4005-PPR-09) and could be completed thanks to further funding from a heme Based Research Project, ‘Enhancing Hong Kong’s Future as a Leading International Financial Centre’ (T31717/12-R), which allowed the complete dataset on ownership and enforcement to be compiled. his dataset, to the extent possible, will be made available on the website referenced in the second chapter. I am extremely grateful to the Research Grants Council for this valuable support. Many people have lent valuable support to this project. I thank all of my co-investigators in the initial public policy project: Jef Vanderwolk, Wang Jiangyu, Terence Grady, Annie Carver and Xi Chao. he second theme-based project that supported this work exists primarily because of the eforts of its principal coordinator, Douglas Arner, and the ideas of the project’s originator, Simon Zhao. Guo Man, Zhang Zhang and Frank Meng have worked as research assistants in one or another of the two projects to gather and organize data, and I thank them very much for this assistance. A number of students who have sought me out to volunteer their time as interns for the project deserve very special thanks: they are Calvin Chan, Adrian Fong, Ho Wingying, Jason Nung, Stephanie Poon, Roy Sim, Leslie Sin, Derek Xie and Joey Wong. he eforts of their generation will decide whether the Region of Hong Kong continues to lead among international inancial markets and retains its unique git of legal balance while fully integrating into China.

1 History’s marks on Hong Kong law: from British colony, to Chinese SAR A Hong Kong’s historically driven component culture 1 he endowments of an international inancial centre International inancial centres, like internationally active trading ports, are outward looking. heir domestic prosperity depends on the ability to attract foreign capital, goods and the deals connected to them. Although the volume of solely domestic transactions may be dwarfed by that of transactions conducted with wholly foreign legs, it is the domestic institutional environment and available skills that draw in these funds, goods and deals. Since its creation in 2007, the Global Financial Centres Index has placed four cities with very diferent economic and political positions – London, New York, Hong Kong and Singapore – in the top four slots globally.1 During this period, New York was also the domestic inancial centre for the world’s largest economy, while London served a like function for an economy with a ranking between sixth and eighth, and both Singapore and Hong Kong served domestic economies of negligible size whose GDP amounted to barely 10 per cent of the UK’s. hus, as international inancial centres, both London and New York are divided: they are both national inancial centres for their large domestic economies (of diferent sizes) and centres for activity that spans the globe without signiicant link to either the UK or the US domestic economy. Regardless of whether transactions in these cities are purely domestic, purely foreign or somewhere in between, they are drawn to the inancial centre by an economic and institutional condition that relects the institutional characteristics of the nation itself. In New York, it will be the American economy, institutions and laws, and in London, the corresponding support elements of the UK.2 he same domestic institutions and laws facilitate 1 2

Z/Yen Group, he Global Financial Centres Index, nos 1–13, 2007–13. London might be thought of as having four concentric circles in this respect, with the City of London serving irst the UK domestic economy, second the EU internal market (whose

1

2

History’s marks on Hong Kong law

both domestic and purely foreign transactions. hese respective sets of institutions and laws have developed within the larger context of the nation, received legitimacy from the power of that nation’s state, and yet gained their support for international usage from and among persons based in other countries. While performing very similar functions, Hong Kong and Singapore present a dramatically diferent origin and composition. hey inherited their legal systems from the British Empire, developed their international orientation as trade hubs of the same, and have achieved their status as leading inancial centres signiicantly free of the (lacking) dimension of their domestic economies (which themselves are composed in good part of international inancial services). Hong Kong, however, presents a geopolitical dimension not found in Singapore. Hong Kong was carved out of Chinese territory in 1841 and returned to it 156 years later, which means that Hong Kong – unlike Singapore – is hard pressed to present itself as the neutral ‘Switzerland of Asia’,3 but is very well placed to play the role of China’s ‘New York’ – integrally tied both economically and politically to one of the largest economies in the world while separate from it and primarily outward looking. Hong Kong serves the domestic economy of mainland China, yet its institutions did not spring from Chinese soil. his chapter will show how Hong Kong was built up as a colonial trading centre of the British empire, and Chapter 3 will show how, since the 1980s, it has reinvented its legal and regulatory framework to become the international inancial centre of China employing mainly British tools. Moreover, the merely factual division between domestic and international found in New York and London becomes a real political boundary in Hong Kong under the ‘one country, two systems’ model.4 We are presented with the unique phenomenon of a foreign, ofshore inancial centre operating a British-origin legal system within the Chinese state. hese characteristics endow Hong Kong with unique comparative advantages in serving as China’s international inancial centre. From its inception, Hong Kong was designed as a gateway between the local and the international and a component of a larger whole. It was built to be a gateway controlled by the British facilitating

3

4

inancial institutions can legally operate in the UK), third Commonwealth member states (whose companies populate the UK stock markets), and inally the rest of the world. Ben Steverman, ‘Cashing in on the New Gold Rush’, Bloomberg.com (12 November 2012). his is enshrined in Article 5 of the Basic Law of the Special Administrative Region of the People’s Republic of China (‘Basic Law’): ‘he socialist system and policies shall not be practised in the Hong Kong Special Administrative Region, and the previous capitalist system and way of life shall remain unchanged for 50 years.’

Hong Kong’s component culture

3

trade in goods with China and ater some modiication now serves as a gate independent from (yet controlled by)5 Beijing facilitating both investment into China, and to a lesser extent outward-bound investment transactions. Although all international inancial centres shape their laws and institutions to a certain extent as services to meet the needs of clients based outside the jurisdiction, Hong Kong has always known a government designed to be responsive to the needs of its international commercial activity.6 his characteristic is also shared by the fellow, former colony of Singapore, although Singapore’s political, cultural and geographical circumstances present a very diferent picture than Hong Kong, which clearly serves the Chinese economy. In this regard, we can see that the analogy of Singapore as the ‘Switzerland of Asia’ does have some merit, whilst Hong Kong more closely resembles New York and London in legal stature and outlook. London is a inancial centre irst to Britain, then to Europe and inally to the world; New York serves irst the United States and North America, then the rest of the world; Hong Kong is oriented irst of all to China, then the remainder of Asia and inally to the global economy. Because it was built as a trade centre, has law originating from one of the world’s most respected legal traditions, yet works within China as a Special Administrative Region, Hong Kong presents a package of structural and geopolitical factors that make it a more natural inancial centre than any of its three peers. his is quite an endowment, but what has Hong Kong done with it? hat is one of the questions this book has been written to answer.7 A good starting point in the project to understand whether Hong Kong has the measures necessary to successfully build on and address dangers from this inherited base is to understand the shape and content of the base: Hong Kong’s socio-economic and legal structure in the context of the historical path by which its natural endowment was formed. hat will be the function of this irst chapter. 5

6

7

As will be discussed in following, ‘control’ arises i rst of all from the fact that China is Hong Kong’s primary client for i nancial services, with the companies directly or indirectly controlled by the Chinese state constituting about 45 per cent of its market capitalization. Second, the Hong Kong constitution gives i nal power over its legislative enactments and judicial interpretation of its Basic Law to the Chinese ‘National People’s Congress’ (see Articles 17 and 18 of the Basic Law). As such, Hong Kong is independent, but only up to a limit. his characteristic would of course be shared by Singapore, although Singapore’s current client base is more multilateral than that of Hong Kong. As noted at the outset, this text is the outcome of a Public Policy Research Project funded by the Hong Kong Research Grants Council. he project, conducted from 2009 to 2012, was entitled ‘Anatomy of a Financial Centre: A Systemic Analysis of Hong Kong’s Legal and Regulatory Framework for its Securities Market’.

4

History’s marks on Hong Kong law

2 Accidental haven with unintended consequences he Crown Colony and later Special Administrative Region of Hong Kong has, from inception, served as a component of a larger whole, providing a portal from one culture, economy and political system to another. Like other coveted, strategically important locations, the struggle for control over Hong Kong relected the relative power of two nations – Great Britain and China – over time. Unlike most disputed territories, however, Hong Kong brought two dramatically diferent cultures into close contact, and eventually formed a deep bond of friendship between the two. While serving this function, the particular composition and governance structure of Hong Kong has amalgamated many aspects of British public administration and rule of law with Chinese culture, creating a unique form of civil society. Originally just another strategic port seized as the spoils of war, Hong Kong became a safe haven for millions of Chinese, who comprised nearly all of the British colony’s population, and this occurred during some of China’s darkest hours, times of occupation, revolution and restructuring. An imperial power of exploitation thus took on a relatively beneicent caretaker role for a large population of Chinese refugees who generally accepted – or, perhaps more accurately, did their best to ignore – British rule during the 150 years plus that it governed Hong Kong. It has been repeatedly observed that the non-democratic structure of the colonial management over the populous mirrored the various forms of paternalistic government found in China itself during the period.8 Yet although the Hong Kong Chinese found themselves in a government in which they had no say, they also experienced a form of authority that stressed law, individual rights and procedural mechanisms to protect those rights. he result was that the people of Hong Kong were presented with a general framework of government displaying extensive formal congruity with their authoritarian home in China, yet they were contemporaneously exposed to a very foreign ideology and social structure stressing rights and a proud exercise of the rule of law as standing above government authority. Seen from the perspective of what economists and legal theorists call ‘path dependence’,9 the British chose an administrative caretaker structure, resembling the existing path in the Chinese Empire for a number of 8

9

See, e.g., Tsang (2004: 198–9). For further discussion of the scholarship on this question, see Goodstadt (2007: 218–22). See North (1990: 93) for a discussion of the origins of this term.

Hong Kong’s component culture

5

reasons: it was a standard colonial format that they had employed at least since American independence, linguistic barriers made greater interaction with Chinese subjects extremely diicult, and the colonial managers consciously employed tools that could be translated quickly into the authority symbols of their subjects’ native culture.10 For similar reasons, a judicial system with high independence and expectations of competence was introduced to administer a body of law introduced mainly through a targeted collection of ordinances that set out rules for public order and the protection of private property.11 his was the English legal system adjusted for colonial administration and the only one the colonial power had at its disposal. It was introduced for this reason, not because Great Britain was preparing to school millions of Chinese in the Western legal tradition.12 As discussed below, however, the unanticipated result has been the creation of a Chinese polity with a greatly English core in public matters and an economy that sets global standards for excellence according to a wide range of Western indicators. In his text, Capitalism with Chinese Characteristics: Entrepreneurship and the State, MIT political economist Yasheng Huang has recently argued: China’s success has less to do with creating eicient institutions and more to do with permitting access to eicient institutions outside of China … China is fortunate enough to have the most laissez-faire economic system at its doorstep. Hong Kong is a safe harbour for some of the talented Chinese entrepreneurs and an alternative to China’s poorly functioning inancial and legal systems. It is only a slight exaggeration to say that [the computer manufacturer] Lenovo beneited as much from the British legacy as from the grown opportunities within China itself. China is unique in that some of its capable entrepreneurs have the option of accessing one of the most eicient inancial markets and legal institutions in the world.13

Leaving aside for the moment Huang’s judgement that China’s ‘ineficient’ institutions survive thanks to use of ‘eicient’ institutions just across the border, Huang does succinctly highlight Hong Kong’s salient 10 11 12

13

For a discussion of these eforts, see Section C.3, below. hese ordinances are discussed in Section C.1, below. h is conception of the colonization was of course raised by some at the time as moral justiication for British rule, but there is no evidence that it was ever taken seriously by the colonial administration or the Crown, particularly as the original, primary purpose of Hong Kong was to import opium into China and provide a base to allow the military to ensure that the Chinese government could not stop such imports. See the discussion in Munn (2001: 34–7). Huang (2008: 6).

6

History’s marks on Hong Kong law

characteristics: safe harbour (it is 99 per cent peopled by ‘immigrants’ into Hong Kong and their ofspring);14 on China’s doorstep (it is linked economically and infrastructurally to Shenzhen, a Chinese city of some 11 million);15 laissez-faire (ranked the world’s freest economy 20 years in a row);16 and eicient inancial market (consistently ranked a ‘global leader’ among the world’s inancial centres).17 Yet Hong Kong also earns a prominent place in books with titles like Asian Godfathers: Money and Power in Hong Kong and Southeast Asia,18 because of the economic power and prominence of a small group of families, locally called ‘the tycoons’, as the following phrasing from Hong Kong’s South China Morning Post exempliies: ‘Tycoons and their business empires pervade every corner of our city; their importance to the government in providing employment and tax revenue sometimes gives the impression that the playing ield is tilted in their favour and that their actions and behaviour are governed by a different set of rules.’19 In addition, like many international inancial centres, Hong Kong is seen as catering to the needs of multinational enterprises and foreign interests instead of the immediate needs of its own citizens.20 Yet even today, many Chinese see emigration to Hong Kong as an alternative more attractive than remaining in China,21 where prosperity may indeed be arriving, but basic civil rights and their exercise are still uncertain. hus Hong Kong is seen as orderly and eicient, a desirable haven for Chinese seeking a safer and more just society, yet accused by many of being unfairly twisted in favour of powerful interests. here is also an important temporal axis to the shape of the Hong Kong economy: its function regionally and globally has changed in adaptation 14

15

16

17 19 20 21

As discussed below, Hong Kong Island was inhabited by about 2,000 ishers and farmers when the British arrived and now has a population of about seven million. Fittingly, its very name, 香港, means ‘fragrant harbour’. h is is a igure for registered residents, as provided by the Shenzhen government on its website (http://english.sz.gov.cn/gi (accessed 15 March 2014)). As at 2013, unoicial estimates approached 16 million for all residences, registered and unregistered. he Heritage Foundation (2014: 4). Hong Kong oicially champions this laissez-faire position, although, as will be discussed in Section D.2 , history shows that the Hong Kong government does intervene to guide the market and correct market failures, and has done so increasingly in recent years. 18 Z/Yen Group (2011, 2012 , 2013). Studwell (2007). ‘Richard Li Raid Sends out an Equality Signal’, South China Morning Post (1 April 2010). See, e.g., Goodstadt (2007: 218–19). Taking advantage of a judicial interpretation of the Basic Law that gave permanent residency to children born in Hong Kong, in 2011 approximately 40,000 mainland Chinese women took the extraordinary measure of travelling to Hong Kong to give birth, with efects so severe on the public health system that the practice was eventually banned. See

Hong Kong’s component culture

7

to the activities that China was able to perform, at times serving to replace the functions of a mainland China that was closed of to the world, and at other times supplementing a China that was less than eicient, much as Huang describes above. Following an initial period of slow growth,22 Hong Kong became the southern hub of British activity in China, connecting the treaty ports of the north with Malaysia and Singapore.23 China was experiencing the decline of its Qing Empire, together with the many political and social woes that this brought,24 and was a source of products for export and customers for imports, but not a serious competitor in international trade. Hong Kong grew into a thriving trading hub for import into and export from China. here was a chance that this could have changed during the short life of the Republic of China, but this period was also rocked by political unrest and inally collapsed into Japanese invasion.25 During Japanese occupation, Hong Kong was once again under the same ruler as mainland China, but the city was stripped and looted, losing most of its population and economic activity.26 Following the four years of post-War and Civil War in China, Hong Kong then entered into a 30-year period in which it came (along with Taiwan and Japan) to i ll the void let in manufacturing and services as China retreated from the world.27 When China reopened its doors for business in the 1980s, manufacturing then migrated out of Hong Kong into neighbouring Guangdong, and Hong Kong shited its eforts towards logistics and inance. It appears that in 2013, the Port of Shenzhen overtook the Port of Hong Kong in volume processed,28 and it remains to be seen just how much of this economic activity will permanently return to the mainland in the long term. Hong Kong’s shit to inance, which is a central focus of this book, has led it to become one of the world’s leading inancial

22 23 25 26

27 28

Ella Lee, ‘Public Hospitals May Act on Mainland Mothers’, South China Morning Post (14 August 2012). his period is discussed in detail in Section B.1, below. 24 See, e.g., Tsang (2004: 57–8). See, e.g., Spence (1990: 167–91). See, e.g., Spence (1990: 267–83). See, e.g., Tsang (2004: 127–8), explaining that the population dropped from approximately 1.5 million to approximately 600,000 and that hundreds of corpses were collected weekly from the streets, having died of both starvation and violence at the hands of the occupation troops. Tsang (2004: 162–7); Goodstadt (2007: 97–103). Zhong Nan, ‘Shenzhen Set to be World’s 3rd-largest Container Port’, China Daily (22 October 2013) (‘Container low through Shenzhen reached 17.28 million 20-foot equivalent units of containers in the i rst nine months, while Hong Kong handled 16.34 million TEU of containers, according to data released at the 2013 China (Shenzhen) International Logistics and Transportation Fair’).

8

History’s marks on Hong Kong law

centres. One of the underlying questions posed in this book is whether Hong Kong is undertaking what it can to ensure that such inancial activity does not eventually migrate back to Shanghai, the historically prominent inancial centre of China. During its various manifestations as entrepôt, manufacturing hub and inancial centre, Hong Kong has received both high accolades for eiciency and criticism for inequality. What aspects of Hong Kong’s character attract such strong praise and disconcerting criticism? he key appears to lie in the colonial ‘caretaker structure’ of Hong Kong’s political and economic system and its simultaneous internalization of the British system of rights and procedural justice at the level of public discourse. he former arrangement fed directly into a laissez-faire economy in which governmental and economic leaders are free to give distant interests, whether they arise in London or in Beijing, a central place in policy making, potentially ignoring negative local impact. he latter, however, provides a fair system of public law and eicient avenues for the resolution of private disputes within this open-ended economy. Just as strategic and economic goals have been imported from afar through channels of power and inance, so too has law been brought in through statutory linkage and subsequent adjustment. hrough the century and a half of the colony’s link to the English legal system, principles of English law gradually merged into Hong Kong Chinese culture to synthesize a truly unique blend of rights-based and relationship-based dealing. Hong Kong’s judicial system has continued to operate well ater the SAR’s return to China, and receives praise from disinterested observers for the quality of its adjudication.29 Institutional quality, whether that of a colonial trading entrepôt or an international inancial centre, is judged by meeting the needs of merchants on the one hand or the international inancial community on the other, regardless of whether this function might override and neglect some needs of local citizens.30 Nevertheless, the private lives of most Hong Kong citizens would have had little interaction with these characteristics 29

30

For example, the World Justice Project (WJP) Rule of Law Index 2012–2013 ranked Hong Kong above France, Belgium and the United States for access to civil justice. WJP (2013: 27). At the level of policy making, prosperous trade or i nancial activity would theoretically bring with it jobs and increased tax revenue that help all residents. Problems can arise, however, when a zero-sum context occurs, such as the use of space to build oices for international inancial irms, which in turn makes that available for housing scarce, driving up the cost of living for average residents.

Forming the ‘caretaker’ government model

9

of colonial government because they rarely came into direct contact with its institutions.31 hey could live largely free of the colonial master while also being free of the various ills that afected life on the mainland. Public and private co-existed without signiicant demands between the two, thanks to the caretaker structure, and as will be discussed in more detail below, the ability of this caretaker structure to function throughout Hong Kong’s history has greatly depended on a partnership between government and business, in which important governmental functions were either delegated directly to, or performed in close cooperation with, leading merchants, much as guilds functioned in medieval Europe and pre-communist China. Hong Kong’s legal system both facilitated and relected this basic structure, with a core of local ordinances producing the minimum order necessary for Hong Kong to function, and the courts importing law on demand through a colonial network of courts that generated a rich corpus of case law.32 Moreover, as will also be discussed in the following, when this British system was applied to the actions of the colony’s local inhabitants, the system’s caretakers attempted to adjust it to the new environment in skilful and interesting ways.

B Forming Hong Kong’s ‘caretaker’ government model 1 Cutting in the middlemen Aside from the obvious fact of British rule over a primarily Chinese population,33 the development of Hong Kong’s socio-economic and legal systems was greatly shaped by external events that channelled immigration into the colony and encouraged these immigrants to remain in Hong Kong. his has been summed up with the dark expression that ‘trouble in China was a “god-send” for Hong Kong’.34 his was particularly true because, given the language barriers and the ratio of a few British colonial 31

32 33

34

Law Wing Sang makes the interesting argument that the missionary schools in Hong Kong provided a cultural basis through which the Chinese were able to understand and accept the British institutions. Law (2009: 31–56). he application of English Common Law in Hong Kong will be discussed in Section C.3. he European population of Hong Kong ranged from a couple of hundred in the early years to a couple of thousand in 1870. See Munn (2001: Figure 2.1). Munn (2001: 49). his characteristic is shared with another political area constituted by refugees: the United States. he United States received wave ater wave of immigrants with diferent sorts of characteristics, depending on the country they were leeing and the particular kind of trouble (religious, economic or political) that their country of origin was sufering from.

10

History’s marks on Hong Kong law

administrators to thousands of Chinese subjects, events forcing emigration from the mainland of a critical mass of inluential Chinese who were able to understand the English language and the needs of colonial oicials was a key to the colony’s survival.35 he type and extent of ‘trouble in China’ greatly determined the type and extent of emigration from China to Hong Kong, which then determined both the need for, and possibility of founding, an informal governing body of Chinese subjects in the colony. Further, the presence/absence and strength/weakness of the Chinese elite co-opted into government service had a signiicant inluence on the development of Hong Kong’s legal system as it progressed from a group of sparsely populated Guangdong ishing villages to a metropolitan area of about seven million.36 As will be explained below, the development of Hong Kong’s economy and legal system to this day generally follow the paths cut for them during Hong Kong’s irst half-century as an unruly entrepôt in which colonial administrators came to depend on a merchant elite to govern the safe haven on the edge of a decaying Chinese Empire. he setting and circumstances of Hong Kong’s founding and irst decades were unusual in many ways. Hong Kong was a strategically unimportant piece of territory that Britain seized from a very large and proudly hostile Chinese Empire through military force in retaliation for Chinese oicials coniscating 20,000 chests of illegal opium from British merchants in Guangzhou.37 he initial, legal acquisition of Hong Kong in January 1841 was through an act of insubordination directly contravening Britain’s oicial aim of acquiring trading access far to the north, near Shanghai, speciically one of the islands in the Zhoushan group.38 he British Superintendent of Trade, Captain Charles Elliot, who negotiated the Chuenpi Convention (which was never ratiied) providing for the acquisition of Hong Kong, was removed from oice.39 Because neither 35 36

37

38 39

Goodstadt (2005: 98), Munn (2001: 372), Sinn (2003: 82), Tsang (2004: 68). he estimate of 2,000 original inhabitants is endorsed by Sinn (2003: 10), although Munn is more hesitant to specify an exact igure (2001: 69). he current population is provided on an up-to-date basis by the HKSAR Census and Statistics Department at www.gov.hk . Spence (1990: 154). In part to support its colony of India, and in part because China did not want to purchase British goods and this led to undesirable outlows of silver, the British East India Company brought opium into China, sold it locally and used the proceeds to purchase items such as tea, silk and porcelain, which it then exported to Europe. Given the efects of opium on Chinese society and on its balance of payments, China outlawed the opium trade in 1838. See Spence (1990: 151–66), Munn (2001: 24–31), Ferguson (2004: 139). Tsang (2004: 11). Lovell (2011: 168–78) provides a detailed history of this question, in which she cites both Queen Victoria and Prime Minister Lord Melbourne as seeing beneits in Elliot’s

Forming the ‘caretaker’ government model

11

China nor Britain was satisied with the Chuenpi Convention, they both repudiated it; hostilities resumed, during which Britain showed China that the balance of power in this clash of civilizations was very much in its own favour.40 Britain inlicted high casualties on the Chinese while quickly seizing Zhoushan, Xiamen, Ningbo and Shanghai and then besieging Nanjing.41 he resulting Treaty of Nanjing, signed on 29 August 1842, gave Britain, among other things, ive treaty cities: Guangzhou, Fuzhou, Xiamen, Ningbo and Shanghai.42 Hong Kong was also added to the list of acquisitions, but Munn argues that this was only because a signiicant maritime settlement sprang up in the short period between January 1841 and mid 1842 under artiicial conditions, and this settlement could not be reasonably returned to China.43 Hong Kong’s situation was less than optimal: Oicial encouragement [by Charles Elliot], the role of Hong Kong as a base of war operations in 1842, the air of permanence fostered by rapid immigration, land grants, extensive public works all encouraged merchants to invest heavily in the island in the belief that it was to be the main emporium for British trade in China. As the dust began to settle … [there was] a mixed mood of tense anxiety and feverish optimism about the island’s future role. Finally, sickness, recession and crime descended on Hong Kong during the latter part of this period, and the realization grew that, with the opening of ive treaty ports, Hong Kong risked becoming superluous to British interest provoked an equally extreme disillusion with the new colony … he ‘respectable and aluent Chinese merchants’ returned to Canton. he great stone warehouses built by European irms suddenly emptied.44

Munn argues that Hong Kong’s unusual beginning as a disputed acquisition outside of British war aims in the shadow of more attractive northern treaty ports led to the colony lacking the kind of educated and permanent citizenry on which solid social orders usually depend, and inluenced the choice to impose English law in Hong Kong. he early function of the colony was ‘as a depot for two semi-monopolistic and still technically illegal enterprises: the importation of opium into China and the traic in

40

41 43

moderate position towards China, and describes how he Times managed to whip up nationalist sentiment in favour of repudiation of the Convention and further war. Also see Spence (1990: 158), Tsang (2004: 12), Munn (2001: 25). ‘In the engagements of January to March [1841], the Chinese Repository estimated, the Qing has lost more than 2,000 men; the British had sufered one dead of his wounds, and three killed by their own weapons.’ Lovell (2011: 139). 42 Spence (1990: 159), Munn (2001: 26). Spence (1990: 160–2). 44 Munn (2001: 32). Munn (2001: 33).

12

History’s marks on Hong Kong law

labourers out of China’.45 As for the growing Chinese population, Sinn observes that ‘besides outright pirates and outlaws, it is safe to speculate that the early arrivals were mostly marginal to Chinese society’.46 Law’s historical investigation yields a similar opinion.47 Colonial oicials therefore faced an economic base that tended towards criminality, a diseaseprone European community that remained very small48 and a population of uneducated, migrant Chinese labourers with very few sophisticated members to whom the colonial government could communicate its intentions and policies.49 As the immigration of Chinese labourers quickly eclipsed the small number of people inhabiting the ishing and farming villages pre-existing British rule, the colonial government came to look at the original state of Hong Kong as a ‘barren island’, mainly uninhabited, which helped justify a blanket application of English law. British colonial procedure at the time was that when an existing people were conquered, the colonial administration would try to accommodate their laws and customs, but when a barren territory was settled, the colony could be governed by English law because the settlers saw themselves as English subjects. his practice had evolved, likely under the pressure of practical necessity, from the formally correct position laid down by the Court of Common Pleas in 1608,50 whereby the royal prerogative to impose English law was absolute over people conquered by that king, a practice still used today by many jurisdictions under war powers, but did not give the Crown power to ‘alter the law governing the rights of free Englishmen’.51 To this situation was added the pressing political risk of the colony’s proximity to a very proud Middle Kingdom, in which, as Sinn puts it, there was an ‘almost universal reluctance among Chinese oicials and civilians alike to accept the fact that Hong Kong was foreign territory’.52 Moreover, nearby Portuguese Macao, in which Chinese and Portuguese law found an untidy dual application, presented exactly the kind of example that the British wanted to avoid.53 hese factors fed directly into the fundamental character of the colony’s legal system. Although Charles Elliot had declared in 45 48 50 51

52

Munn (2001: 23). 46 Sinn (2003: 10). 47 Law (2009: 15–17). Munn (2001: 59–60). 49 Tsang (2004: 50); Munn (2001: 71). See Calvin’s Case (1608) 77 ER 1308. McPherson (2007: 13–15, 15). h is traditionally solid prerogative of the conqueror ran of course contrary to practical usage, in which accommodations to conquered people and use of English law for English settlers both fed stability. hus in practice the distinction was blurred to an extent that resembled reversal. See McPherson (2007: 14–15, 36, 319) and also Munn (2001: 56, 163). 53 Sinn (2003: 5); Tsang (2004: 15). Munn (2001: 40, 168)

Forming the ‘caretaker’ government model

13

January 1841 that the local Chinese would be ‘governed according to the laws and customs of China, every description of torture excepted’,54 ater his removal and replacement, London instructed Governor Pottinger to demand ‘“unqualiied and complete” British jurisdiction’ over Hong Kong and the Chinese residing within it.55 Whilst, as explained above, this did comply with seventeenth-century case law because Hong Kong was ‘conquered’, the unusual policy for Britain in the meantime had become to apply indigenous law to a conquered population, and the reversal had much to do with Hong Kong’s unusual circumstances. Application of English law was not always something that Hong Kong could boast about. During the irst decades of the colony, its government imposed this law in an oten discriminatory and exaggeratedly harsh manner.56 his had a number of causes. he Chinese inhabitants, who, as mentioned above, tended to spring from the margins of Chinese society, found little real connection with their colonial masters, yet retained what family and social ties they previously had within China. he lack of communication, negligible common understanding and an absence of all loyalty between most of the Chinese subjects and the British meant that reciprocal mistrust was high.57 his situation led to an enduring fear of political unrest in the colony and a siege mentality among colonial oicials.58 As Governor MacDonnell expressed in an 1867 letter: Here there is but a handful of Europeans on a small Island which contains an enormous amount of wealth, and inducement for plunder, surrounded by a dense Chinese luctuating population in the proportion now of at least 60 Chinese to one European, and all placed within a few miles of the shore of a vast Empire between which and this Colony there cannot be a less interchange of population by arrivals and departures than 1,500 per day.59

Colonial oicials resorted to strong disciplinary and control methods, both out of a lack of better means and because they reasoned that such punishments were appropriate for the Chinese culture and character,60 given that, at the time, punishment in China was oten severe and 54 55 57 59

60

Sinn (2003: 8); also see Tsang (2004: 46); Munn (2001: 163). Sinn (2003: 8); also see Munn (2001: 168). 56 Tsang (2004: 47). 58 See, e.g., Sinn (2003: 10–12). Munn (2001: 327–8); Goodstadt (2005: 33). Letter of Sir Richard Graves MacDonnell to Buckingham, dated 29 October 1867, cited in Munn (2001: 342). Sinn (2003: 11); Tsang (2004: 47–50); Munn (2001: 216–18, 364); Munn refers to MacDonnell’s ‘self-preservation’ policies as ‘little less than a campaign of terror against sections of the Chinese population’ (2001: 330).

14

History’s marks on Hong Kong law

arbitrary. hus English severity was arguably at least in part an educated attempt to adopt a form of government the Chinese would culturally accept. he Hong Kong solutions included loggings and beatings with bamboo rather than imprisonment or ine because, as historians of the period note, prison would have been a welcome comfort for many of the immigrants and most were too poor to ine.61 Pre-emptive monitoring was also used. First a curfew62 and then a registration system63 were set up to control the movements of the Chinese and keep track of their numbers. Later a practice of branding and banishing Chinese criminals was also used.64 he poverty of such draconian methods was well displayed in their inefectiveness, and led directly to preferred use of a method that became the salient characteristic of the Hong Kong legal system: intermediation between the government and the bulk of the population through a network of Chinese elites. his in efect led to an informal government of Chinese collaborators that provided many basic social services to the Chinese population and helped with settling all but the most intractable civil disputes, and dealt with those committing minor criminal acts and social disruption, greatly reducing necessary contact with the colonial government. A irst attempt to introduce intermediaries was use of a somewhat adjusted traditional Chinese tepo (dibao, or neighbourhood watch) scheme,65 and this showed signiicant success, but was abandoned when police commissioner Daniel Caldwell, one of the key igures in the framework, was charged with corruption and his informant network collapsed around 1860.66 his system was replaced with a much more successful and enduring network of private Chinese community police under the direction of Chinese business and social leaders in 1866.67 Munn gives Governor Hennessy credit for taking the concrete steps necessary to bind the Chinese merchant class to the colonial government in a partnership that would last for over 100 years.68 Both the composition of the Chinese segment of the merchant elite, and the fortunes of the colony generally hung from the social, political and economic health of China. No sooner did the colony set up its administration and basic infrastructure, than China entered a century of 61 63

64 65 66 68

62 Sinn (2003: 11); Tsang (2004: 48). Munn (2001: 131–2, 284–6). Munn (2001: 126–8, 286–8). See, in one of its later forms, Ordinance No. 6 of 1857, ‘Registration and Regulation of the Chinese People’. Munn (2001: 125–6, 252–3). See the Chinese Peace Oicers Regulation Ordinance No. 13 of 1844. Munn (2001: 123–5). 67 Munn (2001: 369). Munn (2001: 367–9).

Forming the ‘caretaker’ government model

15

rebellions, invasions, civil war, mismanagement and ideological cleansing69 that sent millions of Chinese to seek refuge abroad, including in the nearby Crown Colony. Fleeing Chinese business and social leaders illed the gap between the large population of relatively uneducated Chinese and the tiny expatriate community of colonial administrators. he Chinese leaders were articulate counterparties for the colonial government and respected igures for the Chinese population. he later phases of China’s political travails brought to Hong Kong many of China’s industrialists and i nanciers who were previously well established in Shanghai and other major cities,70 topping of the immigrant society that had accumulated over 100 years of colonial rule, and preparing Hong Kong to play the kind of strategic role in China’s development that Huang points out in the quotation in Section A.2. A key to establishing this relationship was for the merchant class to diferentiate themselves from the mass of migratory Chinese that the colonial government feared and avoided. his took place through two closely related developments: the creation of institutions and the increasing wealth and education of the leading Chinese. he following subsections discuss each of these in turn.

2 Institutions of intermediation Informal institutions outside of the colonial government i rst gave Chinese merchants and community leaders forums in which to discuss problems, coordinate activity and receive recognition. A formal Chinese institution, the guild, which had performed much quasi-governmental activity in China, was initially seen by the colonial government as a threat to market activities and was dampened and weakened with the same regulations applied in Britain against organized labour.71 he Chinese community’s centre thus gravitated towards less threatening institutions. he Man Mo Temple, established on Hollywood Road in 1847, was the irst such institution. Its construction was funded by people like Loo Aqui and Tam Achoy, lower-class Chinese residents who had made their fortunes by collaborating with the British.72 he temple became a centre for Hong Kong Chinese to gather, and by the 1850s its leaders were serving as a de facto governing body for the Chinese community – they ‘“acted 69

70 72

See, e.g., Spence (1990), presenting events from regional dislocation, the Taiping Rebellion and the Nain Rebellion through Japanese occupation and the Civil War, to the Great Leap Forward and the Cultural Revolution. Goodstadt (2005: 195–200). 71 Sinn (2003: 14–15). Sinn (2003: 15); Tsang (2004: 67).

16

History’s marks on Hong Kong law

as commercial arbitrators, arranged for the due reception of mandarins passing through the Colony … and formed an unoicial link between the Chinese residents of Hong Kong and the Canton Authorities”’.73 As Tsang puts it, ‘With the colonial government not keen to get too deeply involved in governing the local Chinese, the local leadership … formed the basis for de facto self-government among the Chinese’.74 As the colonial government provided infrastructure and services primarily with a view to the European community, health services for Chinese were bad, and when a shocking example of this came to the attention of the government, it worked with leading Chinese citizens to establish a hospital that would be managed and funded by Chinese, particularly successful Chinese merchants.75 he result was the Tung Wah Hospital, which was established in 1872.76 Munn gives credit to Governor John Pope Hennessy as the irst oicial successfully to transcend the racial barrier. He sought advice from and cooperation with the Chinese ‘elite’, including those directing the hospital.77 Sinn dedicates a book-length study to this institution, and the manner in which it both supplemented the colonial government and facilitated a parallel, Chinese social order operating in occasional contact with the colonial government.78 Law points out that during Hennessy’s term, ‘the inluence and the authority of the hospital reached new heights: the directorate of the hospital began to act as though it had inherited the magisterial function of the traditional petty Mandarins’.79 It was notable that, as Sinn recounts, at one point the Chinese leaders threatened to pull out of the project unless a clear statement was given that the hospital would employ Chinese, not English, methods; although this meant Governor McDonnell reprimanding his own Registrar General who had decreed otherwise, McDonnell agreed, which was a signiicant display of early Chinese power.80 hroughout its life, the hospital was known as a bastion of Chinese medicine and practices and refused European techniques (such as amputation).81 he directors forming the hospital’s committee became an informal governing mechanism for the Chinese community, assuming the functions previously performed by the Man Mo Temple, but at a higher level. Tung Wah Hospital’s directing committee had 125 members, led by a group of 12

73 74 76 77 80

E.J. Eitel (1895), Europe in China, cited by Sinn (2003: 17) and Tsang (2004: 67–8). 75 Tsang (2004: 68). Sinn (2003: 35–49). Tsang (2004: 68); Sinn (2003: 50). Munn (2001: 367–9). 78 Sinn (2003). 79 Law (2009: 23). Munn (2001: 40–2). 81 Sinn (2003: 60–5).

Forming the ‘caretaker’ government model

17

who were the most active and the largest donors to its funding, as Sinn describes them: ‘hey included the most powerful and wealthy Chinese business men of Hong Kong … he Board not only represented wealth, dynamism, and astuteness, but also knowledge and experience in managing business and community afairs.’82 From the outset until the close of the nineteenth century, the board represented six major trade guilds, thus reintroducing the Chinese private ordering system that the British had tried to squash earlier on.83 he Tung Wah’s Board even held the title of ‘gentry’ (shen) as bestowed upon them by Chinese oicials.84 Because each wealthy merchant contributing over $50 annually to the hospital was entitled to nominate one director, the functionally mercantile nature of this constituency ensured that representatives of the business community continued to dominate this important Chinese governing body in Hong Kong.85 As Sinn observes, the dominance of this ‘guild surrogate’ shows how closely Hong Kong resembled a Chinese city, ‘[b]ut the inluence of merchants was greater in Hong Kong than in China because, in the absence of a scholar-gentry class, they assumed the status and role of a local elite without competition’.86 hus Hong Kong allowed acceleration of a social change present in the West as well, as the aristocracy gave way to the bourgeoisie, but the selective nature of immigration lows accelerated this development in the colony. his demographic characteristic created an important substrate for Hong Kong’s later famous philosophy of placing business irst. However, the ‘business’ of this business community extended well beyond commerce. he Tung Wah Committee and Board managed the provision of social services to the Hong Kong Chinese and represented them in dealings both with the colonial administration and with the Chinese government. Social services included housing the poor, mentally unstable and sick, providing free burials, particularly ater a major typhoon or ire, and repatriating destitute Chinese who had been kidnapped or tricked into a captive life in Hong Kong.87 he Committee served also as a direct line of communication to convey complaints to the governor,88 formulated and proposed legislation to respond to the needs of the Chinese business community,89 heard and judged disputes among Chinese on a daily basis according to Chinese customary laws,

82 85 88

Sinn (2003: 47). Sinn (2003: 55). Sinn (2003: 91).

83 86 89

Sinn (2003: 54). Sinn (2003: 55). Sinn (2003: 93).

84 87

Sinn (2003: 87). Sinn (2003: 70–1).

18

History’s marks on Hong Kong law

such as those regarding the status and relations of family members,90 and arbitrated commercial disputes.91 he Tung Wah Committee and Board lost signiicant power at the turn of the century following a dispute with the colonial government over handling an outbreak of the bubonic plague spreading from Guangdong,92 and came under criticism from the colonial government for its relief eforts helping, and close relations with, the Chinese government in Guangdong.93 However, this was accompanied by a gradual assimilation of Chinese residents into the oicial power structures. Chinese were invited (at the request of the Tung Wah Board) to join the Legislative Council (LegCo) in 1880,94 and increasingly played a role in oicial, colonial politics. Even as those Chinese who had obtained a certain knowledge of English law and culture were incorporated into the colonial government, the informal institution of the Tung Wah, which closely tracked that of a traditional Chinese guild structure, remained. Indeed, when Tsang writes, with respect to appointing members to Hong Kong’s Basic Law Drating Committee 100 years later, that ‘he Communist Party preferred to give the business tycoons a stronger say. Ater all, it needed to secure their investments’,95 we see much the same trading of inluence and money that moved McDonnell at the creation of the Tung Wah Hospital. Seen from another perspective, it is also possible that this model of representation by the merchant gentry allowed Hong Kong’s governing of the Chinese population to approach the Confucian ideal of government.96 As such, it should not be automatically condemned as unjust and elitist. A key diference between the Confucian and democratic models is that the Confucian trades accountability based on appointment rights for an accountability based on the ethical and iduciary duties of the caretaker class.97 If, as Rawls argues, procedure is a key to Western justice,98 then civil behaviour as expressed in rites (礼) is a key to Confucian justice. As will be discussed in Section D.2 of this chapter, the problem with a Confucian system is ultimately the same that confronted the architects of the irst democratic systems – placing exterior checks on abuse of the power-wielding iduciary. 90 92 93 95 97

98

Sinn (2003: 96). 91 Sinn (2003: 97). Sinn (2003: 181); Tsang (2004: 71). 94 Sinn (2003: 141–8). Tsang (2004: 70). 96 Tsang (2004: 239). Tsang (2004: 198–9). Jacques ofers an interesting discussion of democracy in a Confucian setting in Jacques (2009: 211–20). Rawls (1971: 75).

Forming the ‘caretaker’ government model

19

3 Cultivating community leaders he Tung Wah Committee members were given gentry titles by Chinese oicials, on the one side, and formally recognized by an ordinance of the colonial government99 on the other. his status was directly connected to wealth. he merchants purchased titles from China, intervened to aid Chinese citizens and bore costs the colonial government could not (Governor McDonnell had hoped they would raise $15,000 for establishing the Tung Wah, but the merchants quickly assembled a sum of $47,000).100 In the decade during which the Tung Wah was founded, Chinese merchants began to eclipse their European competitors, and by ‘1881 they were the largest owners of real estate, contributing over 90 percent of the colony’s revenue and holding 90 percent of the note circulation’.101 With education from the UK or the United States and an incomparably better knowledge of and chance of successfully dealing with the mainland Chinese, the leaders of the Chinese community in Hong Kong increasingly outdistanced the European competition. A few examples of such community leaders are useful. Ng Choy (in Mandarin, ‘Wu Tingfang’) was a Singapore-born cofounder of the Tung Wah Hospital. He studied at University College London, was the i rst Asian admitted to the Bar in England, was appointed as a Justice of the Peace in 1878 and then served as the irst Chinese member of the Hong Kong legislative council in 1880.102 During the early years of the twentieth century, he served the Chinese Republic as a diplomat to the United States and the Americas and then was appointed to work with the ministry that drated the irst Chinese corporation law enacted in 1904.103 Wu is seen as a strong advocate of using Western law to strengthen China, and was a visionary in legal policy. In his 1914 book (which appears to be a conscious homage to De Tocqueville’s Democracy in America) expressing his observations on the United States’ culture, government and legal system, he preceded the trend that would later take shape there, asking ‘would it not be better for all the states to appoint an interstate committee to revise and codify their laws with a view to making them uniform?’104 Wu was active and prominent in every role he played in the legal system, although as his career progressed he focused more 99 100 101 104

Sinn (2003: 87). Sinn (2003: 87, purchase of titles; 43 on their contribution). Sinn (2003: 84). 102 Sinn (2003: 56, 88). 103 So and Lee (2011: 192–3). Wu (1914: Kindle location 359). h is is exactly what the United States did during the course of the twentieth century in the shape of the Uniform Commercial Code and

20

History’s marks on Hong Kong law

on mainland China and less on the colony. Another prominent Hong Kong leader was Ho Amei (in Mandarin, ‘He Xianchi’), who Sinn characterizes as ‘exceptionally dynamic and aggressive’.105 Ho was chairman of the Tung Wah Hospital in 1882.106 He was educated in Hong Kong, worked for the colonial administration and Guangdong province and was a principal in Wa Hop Telegraph Co. and secretary of On Tai Insurance Co. hus, as a corporate executive, Ho found himself active in two growing industries that would achieve central economic importance in the twentieth century: inancial investment and communications. Ho also remained in close contact with Zhang Zidong, governor of Guangdong and Guangxi and an advocate of Chinese modernization, and proudly wrote of the honours that the Chinese government bestowed upon the Tung Wah for its relief eforts.107 A third example of a prominent Hong Kong citizen was Ho Kai, who qualiied in Britain both as a lawyer and a physician, and was the irst Chinese member appointed to the Hong Kong Sanitation Board.108 He promoted the use of Western legal tools to protect the Chinese in Hong Kong,109 and thus exempliied the gradual adoption by the Hong Kong Chinese community of a British conception of how individual and state should interact. Obviously with people at this level of qualiication, the Chinese community leaders, once given a chance to operate in an organized system, displayed their capacity to excel. However, it should be noted that each of the persons referred to above was engaged with ideas and was a Chinese patriot. Indeed, Wu played important, leading roles in the early Chinese Republic. Wealthy citizens with more pragmatic visions and primary training in business might, absent a strong countervailing belief system, tend to adapt to those social circumstances that did not directly afect the results of their business activities. As Goodstadt observes, by the 1970s ‘he age was past when the colonial administration could depend on the amateur endeavours of well-meaning individuals with personal wealth to i nance welfare services’.110 Indeed, the ‘new generation taking control of the economy was more sophisticated, and its fortunes were dependent on Western markets’.111 h is appeared to be

105 107 109 111

numerous model laws. ‘Kindle locations’ will hereinater be referred to with the abbreviation ‘loc’ or ‘locs’. Sinn (2003: 58, 137). 106 Sinn (2003: 137). Sinn (2003: 137). 108 Sinn (2003: 151). Sinn (2003: 153). 110 Goodstadt (2005: 105) Goodstadt (2005: 105).

Forming the ‘caretaker’ government model

21

the kind of motivation animating the business elite when they sought to accommodate the Japanese invaders of Hong Kong to preserve their prerogatives,112 and when it appeared that once the return to China was inevitable, business leaders strongly supported the Chinese government ater the Tiananmen crackdown, as ‘the business elite no longer had the same compelling reasons of self-interest to support the colonial administration against the encroachments of the Mainland’.113 With respect to these occasions, it could be argued that at least some members of the business elite valued their personal, economic survival much more highly than a loyalty to Hong Kong society as something distinct from mainland China. An obvious moral hazard seems to be present in this ‘market leads, government facilitates’ aspect of Hong Kong government, which would be rationalized well with the laissez-faire assumption that what is good for the merchants will be good for Hong Kong. However, that only holds true if the inluential merchants’ holdings are focused in Hong Kong. Given the relative sizes of the Hong Kong and Chinese economies, substantial assets of groups owned by many wealthy Hong Kong businessmen now are found on the mainland.114 If China were to take a strong stance supporting the ascendance of Shanghai or another city as China’s leading i nancial centre, and measures could be taken to promote Hong Kong’s competitiveness to the chagrin of the Beijing plan, would the business elite of Hong Kong use their inluence in government to promote the good of Hong Kong or to serve the greater good as seen from Beijing (and their own return on assets)? It is likely, given the small size of Hong Kong, that any perceived bias and inluence along these lines would at the very least provoke heated, public debate. Although formal safeguards against mainland bias among merchant leaders do not exist, ample information, consensual decision-making processes and the closely aligned interests of Hong Kong with the economic success of mainland China greatly reduce such risk. I now turn from the socio-political framework of Hong Kong to an initial, framework analysis of its legal system.115

112 113 114

115

Goodstadt (2005: 101–2) Goodstadt (2005: 107). Also see Loh (2006: 929). he structure and holdings of Hong Kong’s major economic groups will be discussed in Chapter 2 . In particular, see the discussions of the property sector in Section B of that chapter. A more thorough analysis, focusing on company and securities law, will be provided in Chapter 3.

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C Building the Hong Kong legal system 1 Laying the foundation During the early 2000s, a debate raged about the power of common law origin legal systems to stimulate the growth of capital markets and lead to more successful economies.116 he main argument marshalled in favour of common law was that case law lexibly protects property rights in a way not possible for the ‘rigid codes’ of the civil law. According to this legal origin position, Hong Kong’s success would be largely owed to the ‘fact’ that its law sprang lexibly from the minds of savvy judges rather than from the dead letter of statutes. Mere statutes and other forms of written law not only are unable to adapt to innovation but also are sitting ducks for evasion, because they are i xed and unresponsive. he legal origin thesis has largely been discredited,117 primarily because of its failure to understand the actual composition and operation of legal systems – whether civil or common – but it has provoked a valuable debate. I will argue that while being a British colony had many advantages for Hong Kong’s legal system, the fact that some of its legal rules sprung from the indings of courts in the dominions of the British Empire was not primary among them. Acemoglu et al. have supplemented the focus on legal origin with an institutional analysis of how the structure of British colonialism led to better development than models used by competing nations.118 Because the British oten set out to transplant their own people into a colony, they chose more inhabitable locations and built up stable institutions – rather than merely extractive facilities. As a result, ‘British colonies are found to perform substantially better … in large part because Britain colonized places where settlements were possible, and this made British colonies inherit better institutions’.119 Superior military power let Great Britain ‘free to choose’ its sites for colonialization. As Klerman et al. have reminded us, British colonies might well have prospered because the British were masters of the sea throughout much of the eighteenth and all of the nineteenth century, and thus had their pick of colonial locations with high comparative advantage.120 hese authors present evidence that 116 117 118 119 120

he debate is discussed with further citations in Roe and Siegel (2009) and Roe (2006). See, e.g., Michaels (2009). Acemoglu et al. (2001: 1388, also see 1374–6). Acemoglu et al. (2001: 1388, also see 1374–6). Klerman et al. (2011: 8).

Building the Hong Kong legal system

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the development achieved by the British colonial administration was better than that of competitors regardless of legal origin (such as where the British took over a Dutch law colony).121 Certainly the loss of the North American colonies in 1781 put Great Britain on warning that it should take more care in managing its holdings,122 and by its entry into Hong Kong 60 years later, the British colonial administration was more experienced and much improved. With respect to the quality of law in the British Empire, one institution that stands out was the Judicial Committee of the Privy Council, a body serving efectively as a colonial court of appeal with judges seconded from the British House of Lords, which heard cases from imperial holdings throughout the world, recognized the demands of local conditions and shared solutions reached in one region with problems arising in another.123 he Privy Council cannot be said to be essentially a ‘common law’ institution, because civil law jurisdictions have also had their own courts of appeal hearing colonial matters.124 Rather, its activity as a colonial institution harmonized law on a global scale within the British Empire, while respecting regional heterogeneity for the sake of lowering political risk.125 he Privy Council was essentially a multijurisdictional court of appeal, and anticipated twentieth-century multijurisdictional courts like the European Court of Justice. he function of this court will be discussed in greater detail in Subsection C.3. Hong Kong, as a component of the British Empire, received the entire package of colonial solutions that Great Britain employed to manage its holdings globally. As discussed in the preceding section, a rather unusual decision was made to apply English law in Hong Kong with no provision to accommodate conlicting Chinese law,126 although provision was made for Chinese customs that did not conlict with local ordinances.127 his 121 122

123 124 125

126 127

Klerman et al. (2011: 14). Ferguson calls the 1839 report prepared by George Lambton, the Earl of Durham (the ‘Durham Report’), which advocated that Britain install a system of ‘responsible government’ in its colonies, ‘the book that saved the Empire’. Ferguson (2004: 90). For a more detailed discussion, see the following subsection C.2. See Hollander (1961: 107–13). First of all, the Privy Council was not a court, although the creation of the Judicial Committee in 1833 brought it further in that direction. Second, it contained both foreign judges and judges who were expert in foreign systems of law. hird, when colonies were captured from other European nations, the Privy Council expressly assumed functions that had been performed earlier by such bodies as the French Cour de Cassation. See Howell (1979: 9, 22, 34–44); Hollander (1961: 20–5, 107–15). Sinn (2003: 8); also see Munn (2001: 168). Sinn (2003: 9); also see Munn (2001: 169).

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decision was contrary to normal practice in the British Empire,128 and was made for a number of reasons, particularly that Hong Kong’s position was perilously close to the edge of a hostile state,129 plus the mitigating efect of Charles Elliot’s promise.130 he decision was justiied in good conscience with the theory that Hong Kong was essentially uninhabited and the Chinese who immigrated to Hong Kong did so with notice they would subject themselves to English law.131 As Tsang observes: ‘Endowed with a Crown Colony system, Hong Kong was not founded as a democracy but as an autocracy to serve British interests.’132 Munn argues that when war and diplomatic crises were not on the horizon, the purpose of the legal system vis-à-vis the bulk of the Chinese population was not primarily to meet their needs, as it would have been in a settlement, but rather ‘to make the most of the cheap labour that overlowed into the colony, while protecting the colony from the crime and other social problems that came with it’.133 he foundation of law the colonial government laid can be seen in terms of four essential elements: (1) written ordinances issued in Hong Kong, which closely paralleled existing UK law and which relected the accumulated centuries of British colonial know-how; (2) English law incorporated by statutory reference, particularly English Common Law; (3) legal institutions (primarily courts) for enforcement and administration; and (4) the culture of trust in the law that law needs to supplement its operation.134 Introducing law itself was as simple as passing ordinances. he irst Hong Kong ordinances will be discussed in the next subsection. Plugging Hong Kong into the international development of common law was somewhat more diicult and depended on both local and appellate courts. his will be the topic of the following subsection. Setting up bodies called ‘courts’ was also quite simple, although the trick was to staf them well and enable them to perform competently. Enforcement led to some behaviour by the colonial government that – although favourably compared to coeval

128 130 131 133 134

McPherson (2007: 2–4). 129 Munn (2001: 40, 168) Sinn (2003: 8); also see Tsang (2004: 46); Munn (2001: 163). Munn (2001: 56, 163). 132 Tsang (2004: 26). Munn (2001: 333); also see Tsang (2004: 67). See, generally, Milhaupt and Pistor (2008); Berkowitz et al. (2003); North (1990).

Building the Hong Kong legal system

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Chinese criminal ‘justice’ – would today be considered serious violations of human rights.135 As one might expect, the development of a culture promoting rights and justice was a much slower and more diicult process, and has ultimately led Hong Kong towards a signiicant pride in its institutions and to a large civil society movement. Given that the Hong Kong LegCo currently lacks the legitimacy universal sufrage could lend, this has created a state of political instability in Hong Kong, which will be discussed in Section D.2 of this chapter.

2 A ‘colonization kit’ of ordinances for the good order A framework of laws was introduced very quickly into Hong Kong, in the form of local ordinances. his was not technically English law but it was unquestionably inspired by English law and culture. Britain, whose experience in creating colonial settlements stretches back to the American Jamestown Settlement founded in 1607, certainly knew how to apply to its last Asian colony the experience gained through nearly a quarter millennium of controlling less developed territories. In 1844, just months ater the Treaty of Nanjing was ratiied, a virtual ‘colonization kit’ of ordinances was unpacked in Hong Kong. hese ordinances present a full institutional picture of what laws a port needs to operate smoothly. One cluster of ordinances provided rules for commercial activity, from merchant shipping and harbour regulation to weights and measures, the registration of wills and deeds, rules on slavery and a deinition of usury.136 Another group addressed the needs and discipline of sailors, such as licensing of public houses, the distillation of spirits, public gaming, rules on peace and quiet, and later, the desertion of seamen.137 Some ordinances were speciic to the kind of trade and people found in Hong Kong, particularly the licensing of opium trading and regulation of trade in China,138 as well as 135

136

137

138

See, e.g., Sinn (2003: 11); Tsang (2004: 47–50); Munn (2001: 216–18, 364) for descriptions of excessive loggings, long sentences of hard labour, branding and other harsh punishment inl icted disproportionately harder on the Chinese. See the Merchant Shipping Ordinance No. 4 or 1844, the Harbour Regulation Ordinance No. 18 of 1844, the Weights and Measures Ordinance No. 22 of 1844, the Registration of Deeds, Wills & c. Ordinance No. 3 of 1844, the Slavery Ordinance No. 1 of 1844, and the Usury Laws Ordinance No. 7 of 1844. See the Licensing Public Houses & c. Ordinance No. 11 of 1844, the Distillation of Spirits Ordinance No. 8 of 1844, the Public Gaming Ordinance No. 14 of 1844, the Good Order and Cleanliness Ordinance No. 5 of 1844, and the Desertion of Seamen Ordinance No. 4 of 1850. See the Salt, Opium Licensing & c. Ordinance No. 21 of 1844 and the Restraint of Trade in China Ordinance No. 9 of 1844.

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the registration of inhabitants, the regulation of triads and secret societies, as well as the power to use the military to keep order, if necessary.139 Others focused on the special social situation of Hong Kong. he Registry and Census Ordinance of 1844 created a system of registration targeting poor Chinese immigrants by providing exemptions for all other classes of people in Hong Kong, namely ‘persons employed in the civil, military or naval services of Her Britannic Majesty, or the Honourable East India Company, members of the learned professions, merchants, shopkeepers, householders … or persons possessing a means of livelihood amounting to the annual sum or value of not less than ive hundred dollars a year’.140 he 1845 Ordinance for the Suppression of the Triad and other Secret Societies made membership in such organizations a felony.141 A concrete case of damage sufered because of a failure to mind the gap between local custom and colonial rules is the story of Mr Too-hing. Too-hing collaborated with the British at the outset of the irst Opium War and for that service received in 1841 a signiicant land grant in Hong Kong. He moved his family to the land and settled them in a residential and commercial complex that he built with an investment exceeding $1,000.142 Following his death in 1848, his eldest son took over and began to manage the family holdings and build on them. However, he was contacted by the Register of Wills some two years later and informed that his father had failed to satisfy the applicable requirements of Hong Kong law on the registration of wills and codicils, which resulted in the estate being seized and the entire extended family being evicted.143 he last information available on the son was that he had become a vagrant opium addict.144 To the credit of the colonial administration, the relevant ordinance was later amended to avoid a repetition of this event.145 he overall picture that emerges, however, is of a regulatory framework for a commercial centre with a clear slant in favour of free commerce and strict social order, introduced quickly, in part disregarding aspects of indigenous legal principles and in part speciically seeking to control the unknown elements of the local population. his original bundle of ordinances introduced during the irst years of Hong Kong as a Crown Colony subjected the people of Hong Kong to a 139

140

141

142 144

See the Registration of Inhabitant Ordinance No. 16 of 1844, the Triad and Secret Societies Ordinance No. 12 of 1845 and the Martial Law Ordinance No. 20 of 1844. An Ordinance to Establish a Registry and Census of the Inhabitants of the Island of Hong Kong, 13th November 1844, s 2. he Ordinance for the Suppression of the Triad and other Secret Societies, 8 January 1845, s 1. Munn (2001: 74). 143 Munn (2001: 74). Munn (2001: 74). 145 See Ordinances Nos. 4 and 5 of 1856.

Building the Hong Kong legal system

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complete and systematic legal system just as quickly as if the French had moved in with their Code Napoleon. It is important to note the utility of such legislation in light of the ongoing debate regarding the amenities of common law, discussed above. he immediate introduction of this statute pack in Hong Kong presented signiicant advantages over waiting for a body of law to develop from common law decisions. hey created legal clarity quickly without having to wait for disputes arising to be addressed by the courts; they were comprehensive and based on experience gained in other colonies; they could essentially be imported from the colonial administration or from other colonies and thus did not depend upon the presence of local talent to drat them; they were, in sum, an extremely cost-efective means of governance for a commercial centre with a sparse population of legal professionals. It should be further noted, moreover, that such statutes difer primarily institutionally, not essentially, from the activity of making common law: they collect solutions drawn from experience into a document that has the force of law for persons within the jurisdiction. No statute springs from a vacuum in philosophical isolation of real events and problems. Rather, as in the formulation of a judicial decision, solutions already in force, principles already accepted and the common sense at hand are applied to a problem or problems that are seen to exist. he one essential diference between statute and case law is that in the latter instance, a concrete problem actually does exist and the persons afected seek redress, where a statute can be either reactive or proactive. In both civil law and common law systems, case law grows within the cracks between broader, more abstract statutes, with the primary diference that case law is oicially law in a common law jurisdiction, while in civil law jurisdictions it performs an ordering function more informally.

3 Linking Hong Kong to the English Common Law As mentioned above, Hong Kong was brought into the system of English Common Law, and common law needs at least two things to unfold – courts and customary principles, the latter expressed in culture, written law and in prior judicial decisions.146 hese necessary components were provided through a single ordinance: the Supreme Court Ordinance No. 15 of 1844,147 which both created the Supreme Court and ordered 146 147

See, e.g., Eisenberg (1991). he Colonial Oice disapproved of the formula for the reception of English law used in this Ordinance, and it was amended and reissued as the Supreme Court Ordinance

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the retroactive reception of English law as from 5 April 1843.148 hus Hong Kong began very early a tradition in which its statutory law was locally controlled, yet borrowed in substance from abroad, and its case law was linked to a constantly developing mass of decisions originating in England and its other colonies. In fact, as will be argued at the close of this chapter, the common law applied in Hong Kong develops primarily abroad, and very little in the common milieu of Hong Kong. he colony’s courts were plugged into England also because its highest appellate court was the Privy Council, and it was in England that common law had originated over half a millennium earlier and was still developing in a lively manner. he Privy Council heard appeals from every corner of the world, and brought them all under the English Common Law umbrella. In Hong Kong, the globalizing nature of this system was checked locally by the fact that there were high cultural and institutional barriers working against simple replication of the English legal system. Courts had to be manned, advocates trained and a culture that respected the judgement reached by these people established. he culture and socio-political environment in which English law had grown and prospered was not at all present in China, and certainly not familiar to the uneducated Chinese labourers who sought a better life in Hong Kong during its early years. With respect to the cultural problems of transplanting English law into China, the colonial government showed skill that is rarely matched even today, while also making regrettable mistakes. Transplantation of law is a very delicate task that has been much discussed in the academic literature since the 1990s. Arguments range from a belief that the best rules will prevail regardless of geographic or social context to a position that the meaning of every legal provision is context-bound and can never be carried into another culture without signiicant modiication.149 In an early formulation, Denning LJ observed the general problem from a practical perspective with an appropriate metaphor: [English Common Law] cannot be applied in a foreign land without considerable qualiication. Just as with an English oak, so with the English common law: you cannot transplant it to the African continent and expect

148 149

No. 6 of 1845. Also key to the creation of the legal infrastructure were the Civil Actions Arbitration Ordinance No. 6 of 1844, the Justices of the Peace – Summary Jurisdiction Ordinance No. 10 of 1844, the Jurors Ordinance No. 7 of 1845, and the Criminal Proceedings Ordinance No. 8 of 1845. See McPherson (2007: 325); Sinn (2003: 9); Munn (2001: 169). See, e.g., Watson (1993) and Nelken and Feest (2001).

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it to retain the tough character which it has in England. It will lourish, indeed; but it needs careful tending. So with the common law.150

Both the diiculties of such transplanting and the diligence with which the British attempted to make it work are visible in Hong Kong. Certainly, the process was signiicantly facilitated by the fact that the actual application of the common law was in practice restricted to the European population and a relatively small segment of the Chinese population, with the remainder primarily using the informal Chinese institutions already mentioned and to be discussed below in Section D. However, as Berkowitz et al. have argued, ‘for law to be efective, a demand for law must exist so that the law on the books will actually be used in practice and legal intermediaries responsible for developing the law are responsive to this demand’.151 Although the market was in fact limited to that segment of the population that came into contact with the English authorities, the quality of the intermediaries used to develop the law presented a considerable problem to increasing the demand for its use in early Hong Kong. Historians have noted two problems, in particular: irst, i lling the posts of judges, justices of the peace and barristers with the kind of people capable of carrying forward the common law in Hong Kong, and second, enabling the courts to interact efectively with the local Chinese population. Munn closely examines the judiciary and the bar in early Hong Kong and inds them severely lacking, primarily because of the short supply of qualiied personnel. When selecting its irst Chief Justice, John Walter Hulme, the Colonial Oice was forced to settle for ‘at least’ its ‘eighth choice’.152 Hulme had no judicial experience, and in addition to limited competence was suspended from the bench in 1848 for drunkenness.153 Charles Molly Campbell, Hulme’s replacement during this suspension, was described as ‘an abortion of justice, both for honesty and capacity’.154 he general problem was that the kind of educated Europeans willing to brave sickness and isolation in early Hong Kong were oten adventurers. Munn describes the career of one, Percy Caulincourt McSwyney: he served as Deputy Registrar of the Supreme Court, but was dismissed for receiving money under false pretences, then worked as an attorney in the Supreme Court, where he was caught cheating and stealing from his Chinese clients, then he dealt in opium for a while, then served as Coroner, but was dismissed when a Coroner’s inquest produced incriminating 150 151 153

Nyali Ltd v. Attorney-General [1956] 1 QB 1, 16. Berkowitz et al. (2003: 168–9). 152 Munn (2001: 210). Munn (2001: 211). 154 Munn (2001: 211).

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evidence against a policeman; ater spending some time in prison for having used his power on the court to groundlessly incarcerate a personal enemy, McSwyney became an agent in the small debts court, but was ‘ejected for having taken out summonses without authorization’.155 his example shows the importance of the high ethical standards common law countries expect and usually receive from their judges, and the decisive role such ethical comportment plays in the successful operation of a common law system. With respect to the bar, Munn explains that, ‘[b]y 1849, the colony had no barristers and, out of the six attorneys who had come to the colony, only two remained’,156 although this did improve with time as more professionals arrived from Britain. Jurors in the Supreme Court were all European until 1858, and the list of available jurors in the colony numbered just about 100 persons.157 A particularly acute Hong Kong problem was the need for court interpreters, who, according to Supreme Court policy, had to be racially European, which greatly reduced the pool of candidates; due to his unique skills set, bilingual police superintendent Daniel Caldwell oten served as interpreter in the very cases he was helping to prosecute, which cannot have given the court a great reputation of unbiased administration of justice.158 Eforts to adapt English justice to Chinese culture display the good and bad sides of the colonial government, but in any case display a colonial administration that, on the basis of its 250 years of experience, took cultural diferences very seriously. One small item that evidences the British approach is an attempt to adjust the oath administered to witnesses in court. he oath taken by a witness in an English court has a long history closely tied to the Christian religion. Indeed, early English courts would oten apply the oath alone as a sole form of proof, by, for example, requiring a defendant to swear innocence with his hand on the relic of a Christian saint, and trusting in his fear of God to ensure a truthful statement.159 Within the Hong Kong court system, uncertainty arose as to whether the best functional equivalent for administering an oath to a Chinese witness was to have him cut of a cock’s head or burn a piece of ceremonial paper, so the court turned to its principal expert on things Chinese, police superintendent Caldwell, who, as Munn recounts it, advised that cutting of a cock’s head was the form of oath ‘likely to elicit the greatest amount of truth from a Chinaman.’ he problem with this form, 155 157 159

Munn (2001: 211). 156 Munn (2001: 212). Munn (2001: 213). 158 Munn (2001: 213). Van Caenegem (1988: 66–7).

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he warned, was that since it had to be taken before the witness’s ‘patron idol’, which difered from one person to another, its efectiveness would be uneven. he Chinese did not consider ‘lying in the abstract’ to be a sin: if a prosecutor believed the defendant to be guilty he would ‘swear to any false collateral facts necessary to prove the guilt, and would not scruple to cut of a cock’s head for the purpose.’ he Chinese anyway, he added, had no dread of punishment in the world to come and had only a superstitious fear of the consequences of breaking an oath in this world … ‘he fear of immediate punishment,’ Caldwell concluded, ‘would be a much greater deterrent than the fear of future misfortune or the reproaches of conscience, the consciences of Chinese being remarkably corrupt.’160

Although laced with the kind of ofensive racist assumptions widely held in the nineteenth century, we see in Caldwell’s answer to the court an attempt to discern whether the causal link between perjury and hellire that made oaths so efective in Europe could be reconstituted in the Chinese cultural context. his type of analysis was by no means foreign to a Hong Kong government that would later have a number of expert Sinologists serving as governors. Its results may ofer still another explanation why the Hong Kong administration preferred to keep some distance between itself and the bulk of the population. Caldwell’s advice that the justice system should employ corporal punishment to create the necessary link with Chinese sensibility of the time, while perhaps accurate from an ethnological point of view, would lead to one of the darkest legacies of the Hong Kong justice system, as it imposed severe loggings, branding and imprisonment (usually transportation to another colony for hard labour) on the members of its Chinese population who were unfortunate enough to get caught in its wheels.161 Unlike in Europe, where the purpose of criminal justice had swung towards rehabilitation in the midnineteenth century, the colonial government decided it had to focus on deterrence, as given a great lack of knowledge regarding their individual backgrounds and characters, ‘“any attempt to cultivate [the] higher faculties [of the Chinese] and to improve their moral condition seems hopeless”’.162 As Munn puts it, ‘[t]he legal institutions in the colony lacked the longevity, popular acceptance, and cultural consensus that their counterparts in England depended on’.163 Although eforts were clearly being made, the evidence indicates that in early Hong Kong both the supply of 160 161 162 163

Munn (2001: 232). See, e.g., Sinn (2003: 11); Tsang (2004: 47–50); Munn (2001: 216–18, 364). 1877 Report of the Gaol Committee, cited in Munn (2001: 216). Munn (2001: 201).

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and the demand for an efective common law judiciary were lacking. his was compensated in part through the presence of a highly skilled court of appeal for the British colonies – the Judicial Committee of the Privy Council. Until 1997, the ultimate court of appeal for Hong Kong was the Privy Council, a court-like body with mixed judicial, executive and legislative capacities.164 he Privy Council is a direct descendent of the king’s council, or Curia Regis, which was the decision-making council of William the Conqueror, and which retained its jurisdiction over the Crown’s foreign holdings even ater the creation of a system of courts for national matters.165 With the expansion of the British Empire, the Privy Council heard appeals from colonies which under treaty retained Roman civil, Hindu and Islamic law legal systems.166 Ater 1881, the Judicial Committee of the Privy Council was stafed with Law Lords and judges from the highest courts of certain foreign dominions (such as Bengal, Bombay, Canada, Australia and South Africa), and its caseload increased with the size and wealth of the British Empire.167 Although the Privy Council was oten backlogged, causing signiicant delays in appeals,168 it is easy to conceive the beneit of bringing cases originating at various locations within the British Empire to a body of highly experienced judges who were familiar with problems arising and solutions applied on a global scale. Because the Judicial Committee of the Privy Council is neither a common law court nor fully judicial in nature, and because it has historically been stafed with experts on both equity and foreign systems of law, it presents a hybrid entity with multinational characteristics. As the Privy Council expressly took local conditions into account,169 the colonies of Hong Kong, Singapore and Malaysia would have both shared judicial solutions with each other – as well as with places as diverse as England, India and Canada – while each following a path that took its own local culture and needs into account. As from July 1997, Hong Kong’s Court of Final Appeal replaced the Privy Council as the ultimate judicial arbiter of claims in Hong Kong,170 164

165 167

168 169

170

Charlotte Smith, ‘An Introduction to the Judicial Committee of the Privy Council’, available on the Council’s website: www.privycouncilpapers.org (accessed 15 March 2014). 166 Howell (1979: 3–5). Howell (1979: 9–10). Smith, ‘An Introduction to the Judicial Committee of the Privy Council’, supra note 164. Howell (1979: 226–7). See the discussion by Bokhary J, in China Field Ltd v. Appeal Tribunal (Buildings) (No 2) [2009] 5 HKLRD 662. Basic Law, Art. 82.

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although the Hong Kong courts are ultimately bound by the opinion of the Standing Committee of the National People’s Congress (NPC) of the People’s Republic of China,171 and may still look to UK and Commonwealth decisions as persuasive authority. he Court of Final Appeal sits at the top of a well-articulated organization of trial and specialized courts, which have been guaranteed sole judicial power within the government under the Basic Law.172 A number of international reports on law and institutions have awarded a very high ranking to the quality of the Hong Kong judiciary.173 he Basic Law expressly guarantees that the courts ‘shall exercise judicial power independently, free from any interference’.174 Judges are nominated by a committee (including judges, barristers and other professionals) specially constituted for this purpose, appointed by the chief executive,175 and ‘may only be removed for inability to discharge his or her duties, or for misbehaviour, by the Chief Executive on the recommendation of a tribunal appointed by the Chief Justice of the Court of Final Appeal and consisting of not fewer than three local judges’.176 At the mandatory retirement age of 65, judges leave the court unless their tenure is extended for one or more i xed terms.177 In 2012, a decision on this matter led to speculation on the strength of the independence guarantee because of the treatment of a Court of Final Appeal Justice who had publicly expressed his views regarding the reference of Hong Kong ‘foreign afairs’ questions to the NPC Standing Committee. In 2012, the chief executive decided not to extend the tenure of the highly respected Justice Kermal Bokhary – who in 2011 had dissented against the Court of Final Appeal referring a question on sovereign immunity theory to the NPC Standing Committee178 – and Justice Bokhary has interpreted this as a political signal to himself and the courts.179 Given the facts that the 171 173

174 177

178

179

See the analysis in Wang (2007). 172 Basic Law, Art. 80. See, e.g., the World Justice Project (2012), which ranked Hong Kong 9th for criminal justice and 17th for civil justice (the United States was ranked 26th and 27th in these two respective categories and the United Kingdom was ranked 11th for both) and Center for Financial Stability, which ranked Hong Kong 10th globally for rule of law (including its judiciary), while ranking the United States and the United Kingdom 33rd and 25th respectively. 176 Basic Law, Art. 85. 175 Basic Law, Art. 88. Basic Law, Art. 89. See Hong Kong Court of Final Appeal Ordinance, Cap 484, s 14(2) for justices of that Court and High Court Ordinance, Cap 4, s 11A(2) for justices of the High Court (consisting of the Court of First Instance and the Court of Appeal). See Democratic Republic of the Congo v. FG Hemisphere Associates LLC (No 2) (2011) 14 HKCFAR 395, dissent by Bokhary. Ng Kang-chung, ‘Former Judge Bokhary: “I was ousted for being too liberal”’, South China Morning Post (5 November 2012).

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conceptual breadth of sovereign immunity is both a doctrine developed by common law and a principle used in international relations, there were reasons both for and against the reference to the Standing Committee.180 As such, it is too early to decide whether the referral was a normal use or part of a trend towards political abuse of the Standing Committee’s role in the Basic Law framework. he appointment and retirement of judges in every country has some political aspects, and it must remain to be seen whether Justice Bokhary’s opinion on this matter will prove correct. It is, however, a question that any serious observer of law in Hong Kong must take seriously.

D Hong Kong as an exemplary jurisdiction in China 1 A new role for an old port In June 2013, when the US National Security Agency whistleblower, Edward Snowden, had based himself in Hong Kong, declaring, ‘I am not here to hide from justice; I am here to reveal criminality’,181 the special nature and quality of the Hong Kong legal system within China had its moment of world fame.182 h is special situation came into being when the society incubated for more than 150 years under British rule had for over a decade been reinserted into the Chinese state. On 30 June 1997, through a ceremony whose signiicant geopolitical visibility was largely eclipsed by the ‘Asian Financial Crisis’ triggered two days later through a short-selling attack on the hai baht,183 Hong Kong was returned to China’s sovereign control. h is occurred for a mix of legal and political reasons. Although Britain had acquired sovereignty in perpetuity over the Island of Hong Kong and the tip of the Kowloon Peninsula, it acquired only a 99-year lease over the remainder (and geographically larger) portions of land acquired in 1898 (the ‘New Territories’) that was joined to the colony of Hong Kong.184 When, in the early 1980s, the lease 180 181

182

183

For a discussion supporting Justice Bokhary’s view of the matter, see Cheung (2011). Keith Bradsher, ‘N.S.A. Leaker Says He Will Fight Extradition in Hong Kong’, New York Times (12 June 2013), citing an interview Snowden had given the South China Morning Post. At the time, the Hong Kong legal system was discussed in varying detail by Julian Borger, ‘Edward Snowden’s Choice of Hong Kong as Haven is a High-stakes Gamble’, he Guardian (9 June 2013); Jia Lynn Yang, ‘In Hong Kong, Pressure Mounts on Government to Protect Snowden’, he Washington Post (16 June 2013); Josh Noble and Kathrin Hille, ‘Legal Experts Back Hong Kong Role in Snowden Case’, Financial Times (24 June 2013). 184 See Stiglitz (2002: 89–132). Tsang (2004: 39–41).

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was revisited by the United Kingdom and the People’s Republic of China (PRC), the roles played in 1840 were somewhat reversed. A much shrunk United Kingdom was struggling to free itself of an unsustainably large public sector and a morally questionable colonial past, while China was some four years into a process of reform that would put it on track to become the world’s largest economy.185 It was thus agreed that the entire colony of Hong Kong would be returned to China at the expiration of the lease on 1 July 1997, and that Hong Kong would become a ‘Special Administrative Region’ of the PRC, whose social, economic and political systems would enjoy a 50-year protected status under a ‘basic law’.186 he formula is known as ‘one country, two systems’, a policy originally formulated with a view towards reuniication with Taiwan.187 he 50-year period states a minimum term of protected status, not a i xed appointment with full merger into mainland China. As will be discussed below, there is no reason to believe that upon expiration of the 50-year term the PRC will decide to change or close down this special part of its national territory and lose the beneits it can gain from the HKSAR’s special institutions and status. he historical process sketched in the preceding sections was largely responsible for Hong Kong’s government, economy and society taking its current shape, one in which a population that is nearly 100 per cent Chinese feels deeply at home with a legal system that is nearly 100 per cent British (colonial).188 his is well symbolized by the fact that laws and most legal proceedings are used primarily in Chinese, but are in nearly all cases modelled on UK or Commonwealth counterparts.189 he caretaker structure, which well served the distant British interests and mediated relations with the local population through a small body of elite merchants, ater 1984 showed itself to be ambidextrous: what was done with a view westward towards London could also be done with a view northward towards Beijing. he business leaders who were a key to Hong Kong’s utility as a trade and inancial centre for the British Empire thus have also 185

186 188

189

See Tsang (2004: 211–15, 229–30) for a discussion of the negotiations leading up to the 1984 Sino-British Joint Declaration. Tsang (2004: 238–44). 187 Tsang (2004: 216–17, 236). As will be discussed later in this section, discomfort indeed exists where the system is more colonial and less British, particularly with respect to lacking legitimacy of government due to an incomplete system of suf rage. he laws of Hong Kong are available in the two oicial languages of the HKSAR, English and Chinese, at the Hong Kong Department of Justice’s Bilingual Laws Information System, www.legislation.gov.hk (accessed 15 March 2014).

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led Hong Kong’s integration into the Chinese economy,190 the Chinese ‘empire’ in arrival. Goodstadt notes that when the change in power was inevitable, these elites signalled their loyalty to Beijing by voicing strong criticism of British, democratic policies.191 During the decades since 1978, Hong Kong’s business elite have in Beijing performed a mediating role that is comparable to that which their forebears once performed towards London.192 In preparation for and immediately ater the handover from the UK to China, leading igures in business served on the Committee created to drat Hong Kong’s Basic Law193 and also on the Selection Committee charged with choosing Hong Kong’s irst chief executive.194 As Loh notes, ‘the Basic Law further strengthened the position of the elites through establishing the 400-member Selection Committee to choose the candidate for the irst chief executive’.195 Currently, the functional constituencies of business and professional leaders choose 35 of the 70 members of LegCo.196

2 From caretaker society to civil society? Hong Kong existed as a colony ‘for diplomatic, commercial and military purposes’,197 and was operated autocratically to those ends, although the colony’s charter provided for the Crown-appointed governor to be assisted by both executive and legislative councils.198 Although the situation could be retrospectively gloriied, history tells us that most people

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191 193

194 196

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As McGregor puts it: ‘he communists also once despised the pre-revolutionary comprador class of Chinese businessmen, but rushed without shame into an alliance with Hong Kong tycoons when taking back the British colony in 1997.’ McGregor (2010: Kindle loc 107). At a certain point in discussing the PRC, I think it is necessary to abandon the Cold War rhetoric of referring to the country as ‘red’ or ‘communist’ even though it is oicially controlled by the Chinese Communist Party. h is is because basic communist tenets – downward redistribution of wealth to ordinary people through communal ownership – neither exist nor are advocated. he authoritarian state coupled with the massing of wealth in a largely unaccountable elite that is modern China presents a structure that long preceded communism, and can be seen currently both in the developing countries of South America and in other modern manifestations of ancient states, like Italy. Goodstadt (2005: 107) 192 Goodstadt (2005: 110, 113–15). ‘Indeed, some 70% of the membership of the Basic Law Drat ing Committee was made up of business elites’. Loh (2009: Kindle locs 955–6). Loh (2009: loc 478). 195 Loh (2009: locs 962–3). See Legislative Council of the Hong Kong Special Administrative Region of the People’s Republic of China, at www.legco.gov.hk (accessed 15 March 2014). 198 Tsang (2004: 20). McPherson (2007: 325); Tsang (2004: 18–19).

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arriving in Hong Kong were forced out of their homeland by misfortunes and mistakes in China, and certainly the British relationship with them was based on economic and political calculus, not on some larger desire to create a multicultural settlement. he intermediation between government and the general population through business leaders initially occurred through organizations that were not designed for governing purposes, such as the Man Mo Temple,199 and then later, and above all, the Tung Wah Hospital.200 A parallel development to the role of the Chinese merchant elite resulted from the regular petitions that British expatriate merchants (Hongs) made throughout the nineteenth century to the British Parliament to have a hand in governing the colony, which ultimately led to the appointment of a limited number of British and Chinese businessmen to the Executive Council (ExCo) and LegCo.201 his gradual inclusion of merchants and their representatives in the ExCo and LegCo is the path from which the Hong Kong Basic Law’s institution of ‘functional constituencies’ derives.202 However, just as the colonial administration used the merchants as a shortcut for governing the colony, so the latter also tried to use the administration to protect their commercial operations. When the Japanese briely took Hong Kong from the British, the business leaders who could, adjusted their behaviour to retain prerogatives under the new dominant class,203 and when ater the crackdown in 1989, the British began to backpedal from their agreements with Beijing and seek more protection for civil rights and democracy, the Chinese business elite knew where their long-term interests lay, and duly took issue with the British position.204 On the other side of this relationship, as Tsang and Goodstadt observe, the only times the colonial government pushed signiicantly for social justice and democracy in Hong Kong were for diplomatic purposes – in reaction to abuses in China or to use British-led Hong Kong as a foil to emphasize errors in the Chinese political system.205 Seen in this way, the caretaker model loses much of its shine.

199

200 201

202

203 205

Law explains that ‘the place later functioned not only as a religious site but also as a social center from which the Chinese exercised a certain informal self-government’. Law (2009: 21). Tsang (2004: 68); Sinn (2003). Loh (2009: locs 722–45). he role of Jardine and Matheson in Hong Kong is discussed in Chapter 2 , Section C.1. See he Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China, Annexes I and II. Goodstadt (2005: 101). 204 Goodstadt (2005: 45, 106). See Tsang (2004: 189–96, 249–53) and Goodstadt (2005: 145–6).

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Moreover, the system of elite governance has not always been efective,206 and this became much more noticeable to the residents of Hong Kong as their level of information and education rose. As we have seen, Hong Kong experienced various waves of immigration from mainland China. Similarly to the persons driven to the United States by hunger, war and persecution in Europe over centuries, the type of person driven to emigrate from the Mainland also depended greatly on the type of scourge China was currently experiencing. Initially, a failing economy, rebellions and war drove the more vulnerable poorer people from their homes to seek better economic conditions and a more secure political environment.207 Hong Kong provided that. With the coming of the twentieth century and the rise of ideologically motivated change, leading citizens like Wu Tingfang and Sun Yat-sen came to Hong Kong society to look for Western solutions to Chinese problems. Later, civil war, revolution and political purging brought the bourgeoisie, liberal intellectuals and traditionalists to Hong Kong’s safe haven.208 Recently, top secondary school students who decide to attend university in Hong Kong209 and mainland Chinese who invest in Hong Kong real estate are prominent among mainland immigrants.210 Both are attracted in part by the Hong Kong legal system and the limited powers of government. he increasing sophistication of both immigrants and residents, their attraction to civil liberties and their discomfort with the remnants of a colonial system that has structural similarities with mainland China have all contributed to an increasing movement for universal sufrage211 – a clear step back from 206

207

208 209

210

211

As Loh puts it, ‘he combination of laissez-faire economics and “consensus” government dominated by the elites led to out-of-touch policies that ended with crises in 1956 with Kuomintang fomented riots, and again in 1966 and 1967 as a result of poor social conditions in Hong Kong, as well as the overspill of the Cultural Revolution. he riots provided stark evidence that the elitist and narrow nature of the appointment system was unable to cope.’ Loh (2009: locs 851–4). See, e.g., Spence (1990: 167–91) for descriptions of triad revolts, the Taiping Uprising, the Nian Rebellion and the Muslim Revolts which let tens of millions of Chinese dead or homeless. Goodstadt (2005: 195–200). See, e.g., Yojana Sharma, ‘CHINA: Top Students Opt for Hong Kong’, University World News (21 July 2011). Residence status in Hong Kong is seen as an attractive side-beneit to investing in the Hong Kong SAR. h is is provided under the Hong Kong government’s ‘Capital Investment Entrant Scheme’. See www.immd.gov.hk, ‘Public Services’ > ‘Hong Kong Visas’ > ‘Capital Investment Entrant Scheme’ (accessed 15 March 2014). See, e.g., Emily Lau, ‘Hong Kong’s Summer of Discontent’, New York Times (30 June 2013). An interesting twist to this movement is that it contains an element of fear and

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Hong Kong’s caretaker structure. his has put pressure on the Hong Kong government model and the socio-economic arrangement that it relects. he transition of Hong Kong away from a caretaker structure toward one with a more democratic legitimacy will not be without its challenges for the people of this Special Administrative Region of China. his is not just because of any hesitancy in Beijing, but more importantly because of the way low quality public discourse interacts with a government that appears to lack conidence because of its dual deicits of legitimacy towards the people of Hong Kong and full sovereignty vis-à-vis Bejing, creating a picture very diferent from ‘the world’s most competitive inancial centre’. Take for example the case of Edward Snowden, referred to at the outset of this section. When the US whistleblower declared ‘I am not here to hide from justice; I am here to reveal criminality’, China’s Hong Kong was handed a golden opportunity to showcase its high quality system of justice to the world through long extradition hearings that would review the quality of the US justice system for signs of inhumane treatment. However, this opportunity was cast away when Snowden apparently received advice from a mysterious, informal emissary of Beijing that he should lee the territory. he embarrassing story was announced by a pro-democracy member of the Hong Kong LegCo.212 his happened ater the United States had sent Hong Kong a request for Snowden’s provisional arrest, and the Hong Kong Justice Department, which did not follow up on the US request, could salvage its legal reputation only through reference to formalistic rigour,213 because Snowden’s name was not spelled out correctly on the US request.214 he messy resolution of this matter meant that what the world had heard earlier about Hong Kong’s high quality system of justice was then overshadowed by a picture of Hong Kong as Beijing’s pawn in geopolitical manoeuvrings, with some dysfunctional, open agitation against Beijing on the side by a member of Hong Kong’s LegCo.

212

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214

resentment against the power of the mainland government and mainland immigrants in Hong Kong. One emotional chapter in this story was the (well substantiated) fear that mainland mothers seeking to give birth in Hong Kong – both because of superior medical treatment and Hong Kong residency for their ofspring – would swamp the Hong Kong hospital system, leaving insuicient care for residents. See Stuart Lau, ‘New Bid to Curb Rush to Give Birth in HK’, South China Morning Post (14 August 2012). Lana Lam, ‘Hong Kong Lawyer Albert Ho Says “Middleman” Urged Snowden to Leave’, South China Morning Post (23 June 2013). Patsy Mo, ‘US Failure to Clarify Snowden Papers Tied HK’s Hands, says Justice Chief’, South China Morning Post (26 June 2013). here was a parallel political reason which the Hong Kong government did not refer to (Snowden had provided evidence that the United States had targeted Hong Kong

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Another example of how poorly the delicate socio-political balance of Hong Kong can perform arose in a 2013 controversy regarding a duly enacted law – the Companies Ordinance 2012 – which was subject to public consultations between 2007 and 2011, and spent 18 months in the Legislative Council before adoption.215 he controversy regarded provisions introduced to protect the privacy of directors’ personal data. he Companies Ordinance attempts to reach a balance between transparency and accountability of directors and compliance with Hong Kong’s Protection of Data Privacy Ordinance.216 It contains a three-part rule: irst, directors must provide their identity card number and residential address to the company’s register of directors;217 second, a company has discretion to deny a member access to these personal details of a director;218 and third, although this personal data must be provided to the public register, the latter may not generally disclose this information in full,219 except to persons – such as a public oicer, liquidator or trustee – speciied in a regulation adopted for this purpose.220 he result of this framework is to ensure that every director provides an address for service of process and that all information would be available for any oicial purpose, but to prevent these personal details from being available generally to the public, which brought Hong Kong law into line with the company laws of other major jurisdictions.221

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217 220

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institutions for hacking strikes), but anyone familiar with Hong Kong administrative practices could attest that the formalistic reason given might well be real, as formalistic, administrative rigour is as much a part of life in Hong Kong as 90 per cent humidity. For the consultation papers on the Companies Ordinance 2012 and the history of its enactment, see information provided by the Hong Kong Financial Services and the Treasury Department at www.fstb.gov.hk, ‘Companies Ordinance Rewrite’, (accessed 15 March 2014) and by the Hong Kong Companies Registry at www.cr.gov.hk/en/home (accessed 15 March 2014). See the Hong Kong Personal Data (Privacy) Ordinance, Ordinance 81 of 1995, codiied at Chapter 486. See s 643 CO 2012. 218 See s 644 CO 2012. 219 See s 47 CO 2012. See s 51(3) CO 2012. Section 8 of the proposed ‘Companies (Residential Addresses and Identiication Numbers) Regulation’ speciied permitted disclosure to: ‘(a) a data subject; (b) a person who is authorized in writing by a data subject to obtain withheld information; (c) a member of a company; (d) a liquidator; (e) a trustee; (f) a public oicer or public body; (g) a scheduled person.’ See, e.g., the UK Companies Act 2006, sections 240–246; the Delaware General Corporation Law, section 132(d), which provides only for the disclosure of an address for an agent to receive communication with the corporation, and inclusion of information regarding directors only upon the company’s dissolution (§275(d)(4)). he German Stock Corporation Act also protects the private data of company directors.

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he delicate balance of this legislation quickly collapsed as soon as prominent international opinion coupled with local special interests put pressure on the provision. Although the purpose of company law is to provide for the creation of companies and their fair and eicient operation, the presence of residential addresses and full identity document numbers in the Companies Registry had for years provided journalists with a ready data source they employed for investigations unrelated to the operation of companies. Two US media irms (Bloomberg News and he New York Times), in particular, had gained signiicant readership in 2012 by investigating the economic activities of Chinese party oicials and their families, and they found the Hong Kong Companies Registry a good source of data to this end. In early 2013, about six months ater the adoption of the Companies Ordinance, these two irms published comments on implementing regulations that had been introduced in connection with the Ordinance,222 and were joined by the employees of a private investor in Hong Kong who operates a database on Hong Kong companies and had also used this generally available data to operate his businesses.223 Following the published accounts from the US media irms, which contained signiicant errors as to the nature of the privacy protection rule and its consequences, 1,768 Hong Kong journalists published a petition against the privacy protection provisions.224 As he New York Times put it, the privacy provisions would mean limiting access to an ‘online searchable database that is open to the public for a nominal fee’.225 For this reason, journalists had a direct interest in company law continuing to provide them with this handy source of data. he debate blithely 222

223 224

225

he i rst sentence published by Bloomberg characterized the Companies Ordinance amendments as proposed legislation to protect dishonest mainland Chinese oicials: ‘Hong Kong proposed amendments that would make tracing the personal details of company directors in the city more diicult, amid increased scrutiny of the wealth held by Hong Kong and Chinese oicials and their families.’ Natasha Khan and Simon Lee, ‘Hong Kong Proposal Makes Director Identiication Harder’, Bloomberg News (9 January 2013). he New York Times candidly admitted that its objection had nothing to do with company law: ‘As part of a broader corporate paper trail, such information was used in 2012 by he New York Times in reports on the wealth of the family of Prime Minister Wen Jiabao of China, and by Bloomberg News in a report on the wealth of the country’s presumptive next president, Xi Jinping.’ Neil Gough, ‘Hong Kong Moves to Limit Information on Executives’, he New York Times (9 January 2013). Webb-Site, ‘HKIDs and Government Secrecy’ (12 February 2013). Tom Holland, ‘Directors’ Privacy is a Direct Attack on the Public Interest’, South China Morning Post (29 January 2013). Neil Gough, ‘Hong Kong Moves to Limit Information on Executives’, he New York Times (9 January 2013).

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went forward despite (or more likely because of) the fact that it contained direct contradictions of both fact and law, which were swept aside amid allegations that the Hong Kong government was engaged in a ‘cover up’ following aggressive, investigative journalism.226 Among the assertions plainly in conlict with fact and law were: • he Companies Ordinance, which had been duly enacted in July 2012, was still only proposed legislation in 2013. • Labourers employed by a company need to know a director’s residential addresses, so that they can seek back pay from the director at home if the company does not make payment, which is, irst, untrue, because the contract would be with the company rather than with the director, and second, would promote breach of peace rather than orderly collection of debts through legal proceedings. • Directors should disclose information in return for receiving limited liability from the company form, which has no basis in law, because the director would never be liable for the debts of a company that employs her;227 even an employee of a partnership is not liable for partnership debts, even though the partners are. • he real problem is that identiication numbers have been used by private actors such as banks and phone companies as ‘authenticators’, and if this is stopped, there is no problem with releasing numbers that merely ‘identify’ a person.228 In response to the criticisms by Bloomberg News and he New York Times, and even before the Webb-Site group and the Hong Kong journalists joined 226

227

228

As he New York Times put it: ‘Ater a year in which short-sellers continued attacks on companies from China and journalists conducted in-depth investigations into the secret wealth of Chinese leaders’ families, Hong Kong is moving forward with legislation to restrict access to information about corporate directors’ (emphasis added). Neil Gough, ‘Hong Kong Moves to Limit Information on Executives’, he New York Times (9 January 2013). he argument was made as follows: ‘Statutory limitation of an individual’s personal liability for corporate debt gives directors the assurance that they would not be personally bankrupt in the event of a business failure. In return for this protection, however, directors have to disclose key information about themselves, in particular their identity and how they can be contacted.’ Gordon Jones, ‘No Good can come of New Company Director Rule’, South China Morning Post (13 February 2013). he concept of ‘limited liability’ means that a shareholder is only liable up to his contribution in the company, which is diferent from the liability a person would have if he engaged in contracting directly, rather than using a limited company as a vehicle to do so. Directors are employees of companies and are never liable for their debts. h is argument made by Webb-Site, ‘HKIDs and Government Secrecy’ (12 February 2013) is wrong for a couple of reasons. First of all, pursuant to section 2 of the Personal

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ranks, the President of the Small and Medium Enterprises Association, who represents many of the 900,000-plus companies formed in Hong Kong (and their directors), agreed that the privacy protection given to the people he represented was misguided. he reasons for his position are very telling with respect to the diicult position of Hong Kong in adopting balanced policy: ‘“Hong Kong has been so successful because of its transparency,” said Stephen Kwok Chun-pong … “If we make it so that such information is not going to be public, it may afect the business transactions, especially for international businesses in Hong Kong.”’229 Not much diferent from the complaints voiced by the Washingtonbased Heritage Foundation against Hong Kong’s attempt to protect some of its poorest residents, 230 the American media companies judge Hong Kong quickly according to their own positions and needs without thinking too much about local circumstances or, indeed, whether the United States would meet the standards they apply (even in the case of a listed company, US law provides no information regarding a director’s home residence or her social security number). Mr Kwok, when hearing the US criticism, explains that ‘Hong Kong has been so successful because of its transparency’, but does not stop to think whether this is the kind of transparency that is useful. Hong Kong provides thorough disclosure of the inancial position of companies, their outstanding liabilities, related party transactions and signiicant shareholdings.231 Unlike these items, knowledge of a director’s identiication number and residential address serves no company law purpose. he ‘transparency’ argument is thus nonsense. Nevertheless, LegCo resolved that enforcement of this aspect of the Ordinance was suspended.232 he handling of the Edward Snowden case and the failure to understand the Company Ordinance treatment of directors’ personal data has shown an Achilles heel of Hong Kong – a jurisdiction created under caretakers, where

229

230 231 232

Data (Privacy) Ordinance, ‘personal data’ (個人資料) is ‘any data (a) relating directly or indirectly to a living individual; (b) from which it is practicable for the identity of the individual to be directly or indirectly ascertained; and (c) in a form in which access to or processing of the data is practicable’ (emphasis added). Second, with regard to use of identiication numbers as authenticators being an abuse, Hong Kong has machines located on its border crossings and in its airport which read a person’s identiication number, associate it with a thumb print and allow or disallow the border crossing. he quote is provided in Lana Lam, ‘SMEs Join Chorus of Concern over Hiding of Directors’ Identity’, South China Morning Post (27 January 2013). he measure in question was a minimum wage rule. See Section D.3. he nature and quality of such provisions are discussed in Chapter 3. Danny Mok, ‘Watchdog Chief Slams Shelving of Privacy Law’, South China Morning Post (3 April 2013).

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civic participation was not practised, and where the level of debate about civic issues is now oten confused and easily manipulated. Vulnerability to manipulation is all the more because of Hong Kong’s position as only semisovereign within China and its convenience as a base for arguments against China by the West. he future ramiications of this instability are unclear – the situation could lead to internal repair and an even stronger Hong Kong, in which a highly educated populous adds its voice to the shaping of policy. A worst-case scenario is that international ‘clients’ and critics of Hong Kong will all continue to assert their own agendas, and because Hong Kong lacks quality media (at least in English)233 and cannot carry forward a coherent public discussion on the issues, the mainland government will be tempted to increase pressure to calm things down.

3 Laissez-faire policies are essentially fading path dependence Hong Kong originated in 1841 as a ‘free port’ without duties or tarifs.234 Its very existence was fruit of a war advocated by British merchants to protect their sales of opium on Chinese territory. As we have seen, the British colonial administration stayed small, and relied heavily on the private organization of leading merchants to liaise with the Chinese population and provide partial, informal governance over them. his framework meant not only that the colonial administration did not have the desire or organizational size signiicantly to impact the lives of Hong Kong residents on a regular basis, but also that the private sector had a tradition of engaging 233

234

An good example of how the South China Morning Post serves Hong Kong is a May 2013 report of how the i ndings of a study conducted by the Swiss business school IMD, which had changed its rating of Hong Kong. At the time, the World Economic Forum continued to rate Hong Kong as the most competitive inancial economy in the world. Instead of running a story that the IMD had changed its mind and giving (perhaps also arguing with) the reasons (as a proud news outlet in New York or London might), the SCMP announced in the title of the front page article: ‘Hong Kong No Longer Ranked World’s Most Competitive Economy ’, which was both factually incorrect and as sensationalist as possible. his piece by Ng Kang-chung and Stuart Lau (31 May 2013) did cite an academic referring to high property prices as being a problem, but made no mention of the international causes of these prices, which lie partly in the US inlationary monetary policy, or of measures (an anti-speculation stamp duty) that had been introduced in the same month to correct the matter. Although it is merely an anecdotal observation, over a 20-year period of daily reading I have never seen a local paper in New York, London or Frankfurt excitedly exaggerate their locale’s alleged laws in the manner embraced by Hong Kong’s only English language paper (other than he Standard, which is handed out for free on the street and contains mostly advertising). Tsang (2004: 17).

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in public services. his historical path led directly into a situation that Financial Secretary (1971–81) Philip Haddon-Cave could retrospectively describe with the phrase ‘market leads, government facilitates’,235 and this exact wording was repeated oicially as recently as 2004, appearing in the irst sentence on economic policy in the oicial Hong Kong Year Book of that year.236 his policy was noted by prominent international observers as consistent with the rising philosophy of neo-liberalism that they espoused, and praised by Nobel Laureate Milton Friedman.237 he conservative US think tank Heritage Foundation awarded Hong Kong irst place in its Economic Freedom Index for 20 consecutive years.238 However, following the close of the colonial era, historical evidence shows that the path of Hong Kong is changing and can no longer be seen as a simple case of laissez-faire economic policies in the Western mould. Leo F. Goodstadt, head of the Hong Kong Central Policy Unit from 1989 to 1997, has argued that although non-intervention was uniformly advocated during the colonial period, it was not uniformly practised: property developers in particular received protection against competition and price support intervention.239 According to Goodstadt, the laissez-faire blanket covered a more complex reality in which the government picked and chose when to succumb to industry pressure and when to keep its hands of. For example, Financial Secretary Sir John Cowperthwaite, one of the most famous proponents of non-intervention, did in fact intervene to create assistance programmes for the poorest residents and the disabled, but ‘he also helped to delay the introduction of free and compulsory education as long as possible, even at the primary level … assisting the manufacturers by ensuring the youngsters were [free for] … joining the labour force’.240 his form of ad hoc private–public partnership has decreased ater the close of the colonial era. As Goodstadt notes: Events ater the British departure illustrated how central to political credibility the principles of laissez faire and non-interventionism has become … Nevertheless, as a result of the post-1997 recessions, there was a shit in the public’s attitude towards traditional laissez faire management of the economy … ater the end of colonialism, the public had become less tolerant of the alliance between government and business interests. he partnership has been created originally by the British because the 235 236

237 239

See Latter (2007: 21). See Hong Kong Special Administrative Region, Hong Kong Year Book 2004, Chapter 3, ‘Economic Policy’. Available at: www.yearbook.gov.hk (accessed 15 March 2014). 238 Goodstadt (2011: 98). he Heritage Foundation (2014: 4). Goodstadt (2005: 128–9, 135–7). 240 Goodstadt (2005: 125).

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History’s marks on Hong Kong law rulers were alien and needed ‘respectable’ intermediaries to represent the Chinese community. Beyond 1997, the government could claim no such justiication.241

he fact that ‘laissez-faire’ can essentially mean ‘upward redistribution of wealth’ has placed contemporary Hong Kong in the diicult position of trying to respond to the needs of its residents for fairness while also simultaneously ensuring that its polity and economy will prompt ticking of the right boxes in the rating schemes its foreign observers apply. And most of these observers champion laissez-faire as Hong Kong’s award-winning trademark. While the laissez-faire policy remains oicially championed, market intervention increases. Goodstadt notes the examples of substantial government funding for the development of both a large complex of residences, oices and conference facilities called ‘Cyberport’ on the west of Hong Kong Island and a Hong Kong Disneyland on Lantau Island. 242 Tony Latter, a former deputy chief executive of the Hong Kong Monetary Authority, provides further examples of a shit away from laissez-faire policies in Hong Kong: about 200 hectares of land grants and subsidies were used to create ‘industrial estates’, 243 and the tourism industry was promoted through grants and other funding to the Hong Kong Tourist Association.244 Perhaps more telling examples can be found in the behaviour of the government during two i nancial crises. First, during the Asian Financial Crisis (1997–8), the government spent approximately US$15 billion of public reserves in open market transactions to support its equity markets against what Andrew Sheng calls a ‘double-play’ bear raid conducted by international hedge funds which hoped to crack both the Hong Kong i nancial markets and the Hong Kong dollar.245 Ideological axioms dictating non-interference in the self-correcting mechanisms of i nancial markets, which the hedge funds counted on tying government’s hands, were discarded in favour of facts regarding the dangerously manipulative nature of the raids being conducted. h is example may not appear terribly signiicant because all governments tend to provide some sort of supportive intervention during an economic crisis. However, the manner in which Hong Kong has chosen to intervene tells us something about the nature of its actual regulatory philosophy. During the Global Financial Crisis (2007–9), while the United States 241 242 243

Goodstadt (2005: 137–8). Goodstadt (2005: 138). Latter (2007) also discusses these projects at 31–5. 244 Latter (2007: 26). Latter (2007: 29). 245 See Sheng (2009: 270–1).

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was twisting the rules of contract law to bail out its largest i nancial institutions (which were not equally as generous with the many mortgagors who owned the banks money on home loans), 246 Hong Kong was twisting the arms of i nancial institutions to force their repayment to retail investors who had purchased Lehman-arranged, credit-linked notes afectionately referred to as ‘mini bonds’. hus intervention can come in many forms. In Hong Kong, formal compliance with law to the detriment of unsophisticated investors was trumped by a simple appeal to basic fairness and the bargaining power of the Hong Kong government, which was at least in part a result of public demonstrations by retail investors. h is ‘mini bond’ settlement will be discussed at more length in Chapter 5. he instances discussed above show that Hong Kong devotes energy and resources to directing its economy and safeguarding its market, and no longer advertises itself as a place where ‘market leads, government facilitates’, but such announcements have been increasingly made by others. Unlike the summary statement found in the 2004 Year Book, Hong Kong’s 2011 Year Book can refer to speciic factors presented in reports written by others: Hong Kong has a business-friendly environment with the rule of law, free trade and free low of information … a lexible labour market with a well-educated workforce and a pool of eicient and innovative entrepreneurs … prudent i scal management and a simple tax system with low tax rates. In view of these virtues, Hong Kong has been ranked by the US Heritage Foundation as the freest economy in the world for 18 consecutive years. Similarly, the Fraser Institute of Canada has also consistently ranked Hong Kong as the world’s freest economy. Hong Kong is ranked the world’s most competitive economy for the i rst time by the International Institute for Management Development (IMD) in 2011. 247

he tightrope on which Hong Kong is balancing between high ratings as a laissez-faire star and the realities of its own economy and development is not an easy one to walk. he Hong Kong political framework is criticized locally as unacceptably undemocratic,248 whilst the economy’s division 246 247

248

See Pistor (2013: 319–20). Hong Kong Special Administrative Region, Hong Kong Year Book 2011, Chapter 3, ‘he Economy’. Available at: www.yearbook.gov.hk (accessed 15 March 2014). See for example the opinion piece by the founding chairman of the Democratic Party, Martin Lee, ‘Hong Kong People Can’t Just Wait Around for Democracy; hey Must Act’, South China Morning Post (1 May 2013).

48

History’s marks on Hong Kong law

into wealthy entrepreneurs and successful professionals on the one side and those providing them inexpensive labour on the other is widely perceived as unfair.249 Given the facts that Hong Kong has a government which does not enjoy popular legitimacy and an income inequality coeficient similar to a lower income economy,250 neither argument is without merit. Yet, when Hong Kong does take a minor step towards protecting its poorest citizens, such as when it introduced a HK$28 (about US$3.60) per hour minimum wage in 2010,251 the international ratings that have for years airmed Hong Kong’s good standing for laissez-faire policies are quick to react. he Heritage Foundation included the following rebuke and veiled threat in its 2013 report on ‘economic freedom’: ‘Although Hong Kong remains number one in the Index rankings, the uniqueness of its commitment to economic freedom has eroded in recent years, and any further implementation of populist policies that empower the bureaucracy or undermine the principle of limited government could threaten its standing in the future.’252 Beyond the question of being a laissez-faire champion, this problem highlights the predicament of a i nancial centre generally. As an international inancial centre, Hong Kong has sold its policies and law to investors distant from its shores, which includes not only the Western i nancial community but also the controlling 249

250

251

252

One month into a 2013 dockworkers’ strike at a subsidiary of Hutchinson Whampoa Ltd., the general secretary of the Hong Kong Confederation of Trade Unions observed that: ‘Striking dockers are paid less now than they were in 1995. Adjusted for inlation, their hourly wage is now some 20 per cent below that of 18 years ago. Stevedores are oten asked to work three eight-hour shit s in one go, and they even have to work up to 72 hours continuously during peak seasons. Crane operators work 12-hour shit s, and sometimes 24-hour shits, in cabins 80 feet above the ground. hey are not given proper meal and toilet breaks, and have to eat and urinate in the cranes.’ Lee Cheuk-yan, ‘HIT and Hutchison Whampoa Have a Duty of Care to Contract Workers’, South China Morning Post (3 May 2013). he gini coeicient of Hong Kong, which is classiied as a ‘high income’ country by the World Bank, increased from 45 in 1981 to 54 in 2011, while during the same 30-year period the share of employment in manufacturing decreased from about 41% to 5% and that of the inancial industry increased from about 5% to 18%. Government of the Hong Kong Special Administrative Region, Hong Kong Half-Yearly Economic Report, 2012, Box 5.2. hus the Hong Kong gini coeicient was only slightly better than the 56 scored by Bolivia (a lower middle income country) and the 57.2 scored by Colombia (an upper middle income country) in 2008. he World Bank, GINI index. See the Hong Kong Minimum Wage Ordinance, Ordinance 15 of 2010, codiied at Chapter 608. Heritage Foundation (2013: 239, emphasis added). It is good for Hong Kong that it also ranks at the top of other such rankings that are less ideologically driven, such as that of the World Economic Forum and the Z/Zen Group.

Hong Kong as an exemplary jurisdiction in China

49

shareholders of major, listed issuers – in many cases that means the PRC, albeit indirectly.253 When the policies designed to serve this end bring local hardship to the people of Hong Kong and resulting social instability, these domestic matters call into question the legal framework which might have brought international standing. It cannot be ruled out that the ‘price of inequality’254 will in the future be factored into international ratings of inancial centres and economic performance, but that is not the case today. he situation in a market like that of Hong Kong is very diferent than in places with socio-economic conigurations like those of New York and London because the purely domestic economy is signiicantly smaller. he road forward between domestic fairness and international acceptance in this situation is full of delicate and diicult decisions. Nevertheless, the fact that leading inancial centres can be found in places as diferent as New York, Hong Kong and Singapore shows that a central core of inancial regulation is critically important – and comes close to being determinative – for the success of a inancial centre. Hong Kong’s legal system, especially when we understand Hong Kong as part of the PRC, is its main competitive strength, and the genesis of this system will be discussed in Chapter 3.

4 Hong Kong must begin to make common law he business elite of Hong Kong have greatly shited their investment and client base towards the Mainland,255 and may also choose to adjust the positions and projects that they are willing to support, as Hong Kong becomes increasingly integrated into the Chinese economic and social system. Albeit the growing pains discussed above are afecting its political system, the historical path of Hong Kong – a city established to serve as a component in a larger whole – has let it well adapted politically, economically and culturally to manage at least its inancial policy and regulation through a relatively small group of business and political leaders who can broker between local and distant interests. he shares of many Chinese 253

254 255

he presence of Chinese state-owned enterprises (SOEs) on the Stock Exchange of Hong Kong is discussed in more detail in Chapter 2 . he gradual assimilation of Hong Kong into mainland China might have had some impact on the shit in Hong Kong away from laissez-faire, although this appears to be more the result of events (the two i nancial crises mentioned above) and greater participation of Hong Kong residents in public debate. See, e.g., Stiglitz (2012). his is particularly apparent in some of the leading property developers. See Chapter 2 , Section C.

50

History’s marks on Hong Kong law

state-owned enterprises (SOEs) are listed on the Stock Exchange of Hong Kong because they beneit from both the Hong Kong legal system and the free convertibility of the Hong Kong dollar.256 In the passage quoted in Section A.2, above, Huang argues that Hong Kong currently serves China by supplementing its dysfunctional institutions. If this is true, a question for the future will be, if Chinese institutions become fully functional, will Hong Kong lose its utility for China and others? Perhaps the last Chinese institution we can expect to reach a par with Hong Kong is the judiciary. Whilst China cannot conceive of a branch of government independent of the CCP and the Central Committee, Hong Kong enjoys an independent judiciary. It is composed of talented, dedicated individuals whose tradition stretches back over 150 years and its coupled (previously by law, and now by tradition) to a culture of judicial lawmaking that has been found to perform reasonably well since its origin in the twelth century. Given the time necessary for mainland China to gestate a high quality judiciary with its own balance and voice in that government, it would appear that Hong Kong holds a the trump card of superior law and regulation in its hand. However, this main strength of Hong Kong could also become a source of weakness. As discussed above, Hong Kong’s legal system is a mixture of local ordinances and common law. he ordinances were originally drawn from Britain’s colonial toolbox and the drating of new ordinances also includes consulting UK or Commonwealth models where applicable. he drating and enacting of new ordinances can be used proactively to shape society if the electorate or general population (if, as in Hong Kong, suffrage does not fully determine government composition and inluence is exercised informally) sees a need for change. he common law, however, is something that clearly arises from its social and cultural environment and is not meant to shape it, but rather relect it.257 he manner in which power is organized in a jurisdiction’s economy will feed into shaping the common law of that jurisdiction because the courts may be confronted with a need to check such power if it is abused. For example, courts developed principles of tort liability for defective consumer products only ater consumer products were being manufactured and shipped on a large scale. Where Hong Kong’s socio-economic structure presents risks and dangers not found in the UK, the UK will not have created solutions for a problem it does not have, so that a dependence on the courts of the UK to generate principles of common law for Hong Kong will be inadequate. 256 257

See, e.g., De Jonge (2008), generally. Eisenberg (1991: 3, 154).

Hong Kong as an exemplary jurisdiction in China

51

An example central to the quality of Hong Kong investor protection can be found in the way that the size of the average shareholdings in an economy might be relected in the type of relief ofered to minority shareholders whose interests are prejudiced by actions of the majority shareholders. Company law provides shareholders with voting rights to control management, and these rights are exercised by majority rule. Minority rule would both be unworkable and unfair. Moreover, shareholders are generally entitled to exercise their voting rights in their own best interests. Except in relatively intimate private companies that resemble partnerships, the problem of majority shareholders abusing their power has not presented itself as pressing in the modern UK economy, probably because the blockholdings of UK shareholders were broken up as the capital markets grew ater the Second World War.258 hus courts have not been forced to fashion duties for majority owners to check unfair use of their power, except in small companies that resemble partnerships (‘quasi-partnerships’) because of their dependence on personal relationships.259 he underlying system of powerful interests is very diferent in economies where large shareholders tend to dominate companies. For example, in Germany, large shareholders are very common and thus the courts have assigned such persons iduciary duties in exercising their powers,260 quite similar to the duties assigned corporate directors. As will be set out in detail in Chapter 2, Hong Kong, which has shareholding structures more resembling those in Germany than in the UK, applies the common law developed in the UK to problems of dominant shareholders, and thus applies a law formulated over years in a completely diferent economic milieu, where the relevant problem did not arise and no solution was created. As a 2009 decision of the Hong Kong Court of Appeal made clear,261 English Common Law has not developed satisfactory solutions for some problems, such as blockholder abuse in large companies. Hong Kong must develop its own solutions if it hopes to address abuse in its own economy. he Court of First Instance took a step in this direction by extending the ‘unfair prejudice’ action to apply to a company listed on the stock exchange,262 which was upheld by the Court 258 259

260

261 262

See Chei ns (2010: 303 et seq.). For a discussion of the UK concept of ‘unfair prejudice’, see Chapter 3, Section C.1, and O’Neill v. Phillips [1999] 1 W.L.R. 1092 HL. See the translated decisions of In re Linotype and In re Girmes in Cahn and Donald (2010: 583–5, 594–8). See Re PCCW Ltd [2009] HKEC 738. See Luck Continent Ltd v. Cheng Chee Tock heodore [2012] HKEC 567, discussed in Chapter 5, Section B.1.

52

History’s marks on Hong Kong law

of Appeals.263 If this line is continued, it will provide a good basis for the kind of relief that investors need to protect their rights in the Hong Kong economic environment. As Hong Kong decouples from the British Empire and is reinserted into China, its courts should be aware of the occasional mismatch between the solutions it needs and the solutions the UK has ofered, and make adjustments. Nowhere is path dependence more tangible than in the body of judicial decisions forming common law, which project their rules and principles onto the resolution of future disputes. he growing body of homegrown cases and a clear awareness that references to authority in other Commonwealth jurisdictions is only persuasive264 assists Hong Kong in its task of formulating common law rather than implementing English Common Law. On the other hand, some may fear that if Hong Kong were to decouple its legal system from the UK and the Commonwealth, to which it looks for almost all of its extraterritorial persuasive authority, there would be a dangerous slippery slope, at the end of which could be the mainland Chinese court system and a loss of the judiciary’s core strength, judicial independence, which it draws from the common law tradition. While this fear may well be greatly exaggerated, it does show the delicate position in which Hong Kong currently inds itself. he existence of a strong and independent judiciary operating as it currently does presents only advantages and no disadvantages for Hong Kong. he prestige of the common law judge has led to a highly professional corp of dedicated justices in Hong Kong, who, regardless of the shape that the common law or statutory law of Hong Kong ultimately takes, will likely work to guarantee high quality adjudication under a rule of law. If this apparatus is consciously directed towards the customs, beliefs and principles of the people of Hong Kong, then the danger of mismatch would likely disappear in the medium term, and the danger of a slide into mainland China could be reduced. his is especially so given that immigration into Hong Kong might well have created a cross-section of people who value order highly. Although serious socio-demographic study must precede any assertion in this regard, it is possible that because most immigrants from mainland China were either leeing the chaos of war and revolution or seeking an environment where property rights and (more recently) regulatory quality could be relied upon, these people have passed these values on to their 263 264

Luck Continent Ltd v. Cheng Chee Tock heodore [2013] HKEC 1209, CA. See, e.g., the Hong Kong Court of Final Appeal’s explanation of the state of the courts following 1997, Solicitor (24/07) v. Law Society of Hong Kong [2008] HKEC 431.

Hong Kong as an exemplary jurisdiction in China

53

descendants. In this way, respect for law and order is deeply imbedded at the granular level of Hong Kong culture. From the brief historical analysis presented in this chapter, we may conclude that much of the eiciency of Hong Kong’s relationship with the mainland Chinese economy – just as its previous relationship with Great Britain – can be found in Hong Kong’s social and legal structure as formed over a century and a half. Its economy and much of its regulation is outward looking, serving the interests of those who would use Hong Kong as a port for trade or a market for trading inancial instruments and services. Knowledge of what is necessary for those purposes has come from having a relatively small number of wealthy and talented individuals directly involved in managing Hong Kong’s economic afairs and shaping much of its legislative policy. Hong Kong is very much an international (inancial) centre at its core – a component of a larger networked whole. he caretaker structure of government was useful for governing large numbers of immigrants presenting linguistic and cultural diferences. It also facilitated transition into the current governmental structure of ‘one country, two systems’. Nevertheless, it appears that the residents of Hong Kong seek more than a set of civil liberties irmly embedded in a Basic Law and an independent judiciary to administer their protection, together with the enforcement of contract and property rights. It is open to debate whether these last issues should be given much attention in a work like this, which focuses on Hong Kong as an international inancial centre. here is no deinitive theoretical framework for deciding when inequality and disenfranchisement can become political risks, although Stiglitz, for one, has recently brought signiicant attention to the question.265 However, the observations made immediately above about the development of the common law of Hong Kong are directly relevant. While arguments regarding the caretaker system’s obsolescence are mainly ethical and political, the absence of a body of case law to solve the problems actually presented in the courts of Hong Kong (as opposed to in those of the UK or Australia) is a core structural defect at the heart of Hong Kong law. Many questions will overlap and principles have been developed beautifully by British courts over the centuries, but many questions will not. If Hong Kong courts with mechanical dutifulness continue to apply ill-itting UK or Australian solutions (or lack thereof) to local problems, quality will sufer, regardless of whether they indeed achieve a tick in the box of the international rating organization. 265

Stiglitz (2012).

2 Hong Kong’s economic structure: the corporate control context

A Two salient economic characteristics 1 he dominance of substantial shareholders he history of Hong Kong discussed in Chapter 1 has cut a path of development in which private ordering by both British and Chinese merchants greatly controlled the shape of the Hong Kong economy, society and government, which let the regulatory actions and interventions of government minimal. It has also been a history of providing services outward towards foreign partners, both in trade and in inance, irst in the context of the British Empire and later within the Chinese economy. Britain and the Commonwealth were the sources for the development of much of Hong Kong’s common law, meaning that the doctrines and principles found in this body of law are not always well adapted to the local circumstances of Hong Kong. While this relationship is no longer binding post-1997, the path dependence of Hong Kong’s history is very strong in this regard. On the other hand, the relationship with China has been a constant in Hong Kong’s history that varied in shape and intensity as a factor of the state of political afairs in China. At times Hong Kong has thrived from its relationship with China and at other times it has thrived because China chose to implement policies that crippled its productive capacity and engagement in international trade, such as during the third quarter of the twentieth century when Hong Kong (together with Taiwan) briely became China’s ersatz manufacturing hub.We thus understand that the Region called Hong Kong presents a very complex phenomenon – absorbing and adapting British institutions while reacting and adjusting itself in relation to China’s, Asia’s and indeed global developments. In this political-economic climate, and particularly during times when its domestic market was largely disconnected from mainland China, Hong Kong business leaders spun out webs of control in corporate groups that came to dominate the relatively isolated local economy in many areas and 54

Two salient economic characteristics

55

serve as bases for larger regional and global business expansion. No sector of activity has displayed this more than that of property development. he investment of leading local companies in mainland China has both accelerated the economic integration of the two areas and increased the size of some local corporate groups. he result of this developmental path has been to create both a salient characteristic of the Hong Kong economy (analysed on the basis of the data presented in this chapter) and a resulting type of legal risk: in the relatively small local economy within Hong Kong, important sectors are dominated by a few corporate groups controlled by dominant owners, oten founding families. he minority shareholders investing in these listed companies that remain dominated by controlling families or, indeed, the PRC government must be adequately protected. Corporate governance solutions devised in the United States and the UK to protect dispersed shareholders against the domination of professional managers, as famously championed in the work of Berle and Means,1 are not suicient and are in many cases unnecessary in the Hong Kong economy. It is important to keep in mind just how far away from the ‘Berle and Means’ corporation the norm in Hong Kong stands, so that Hong Kong policy makers can select appropriate governance mechanisms. he presence of dominant shareholders in Asian companies, including those of Hong Kong, has been well documented. Claessens et al. found that as at 1996, 84 per cent of Hong Kong’s listed company assets were controlled by the top 15 families,2 and 72.5 per cent of Hong Kong’s largest companies were family owned,3 and this displayed higher percentages of family control than all the other countries studied.4 However, relative to most other jurisdictions in the analysis, these authors also found low use of pyramid structures and dual class share structures, techniques that can be employed unfairly to achieve greater control than the shareholding in question might otherwise lend its owner.5 In fact, as will be discussed in more detail below, use of dual classes of shares with diferent voting rights is prohibited on the 1 3 4

5

2 See Berle and Means (1968). Claessens et al. (2000: 108). Claessens et al. (2000: 106). he other countries were Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan and hailand. Claessens et al. (2000: 92, 99). If a subsidiary owns the shares of a second tier subsidiary, the subsidiary’s board will vote those shares. hus the ability to control the subsidiary’s board will be enough to force the minority shareholders in the second tier subsidiary to bear the cost of the sub-holding without being able to control it, and this principle applies to the third, fourth and other tiers of the group, which lowers the cost of ultimate control of the entire corporate group for the lead company at the top of the pyramid.

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Hong Kong’s economic structure

SEHK. Cheung et al. examined the relationship between executive compensation and large shareholdings in Hong Kong for the period 1995–8, inding ‘a positive relationship between the cash emoluments received by the CEO and the Chairman and their respective shareholdings for levels of ownership of up to 35% in small irms and for up to 10% in large irms’.6 As will be discussed below, in spite of this correlation between shareholding and higher pay, executive compensation in Hong Kong remains low by international comparison. On the basis of the member companies of the Hang Seng Index (HSI) for which pre-tax information on chief executive oicers (CEOs) is available, the average annual CEO pay for 2011 was just over US$2.9 million, a sum that would make the average CEO of Hong Kong’s largest listed companies roughly the 420th most highly paid US CEO according to Forbes 2012 rankings.7 Another aspect of corporate groups that has been studied is the incidence of legal but proitable trading by insiders in the shares of Hong Kong companies that they own and manage. Zhu et al. ind that ‘mean abnormal returns earned by insiders who purchase their own irms’ shares in Hong Kong [reach] … more than one billion HK$ annually at the expense of the outsiders with whom they trade’.8 hey determined this igure using the disclosure that directors must make of dealings in the company’s shares under the Securities and Futures Ordinance (SFO), and thus the trading is not a sign of abuse (under the rules then in force), but demonstrates the plain economic reality connected with owner-managers in listed companies. In fact, as will be discussed below, the general trend of family held companies in Hong Kong is towards an increase in concentrated holdings, rather than a decrease. As Forbes reported in 2013, during 2012 Dr Lee Shau Kee ‘boosted his stake [in Henderson Land Development Co. Ltd.] by 6.8 percentage points, to 62.6%, and then watched the company’s stock climb 42% last year, helping to boost his net worth by $3 billion, to $20 billion’.9 Internal risks of abuse within a company run by owner-mangers will therefore not be identical to those within a company run by professional managers for dispersed shareholders. he real economic relationships found within Hong Kong companies must be taken into account when assessing the quality of its regulation, for regulation is only useful if it 6 7

8 9

Cheung et al. (2005: 512). Forbes, ‘America’s Highest Paid Chief Executives’, available at: www.forbes.com/ lists/2012/12/ceo-compensation-12_rank.html (accessed 15 March 2014). Zhu et al. (2002: 22). Russell Flannery, ‘Pumped-Up Property Prices Lit he Fortunes Of Hong Kong’s Richest’, Forbes Asia (9 January 2013).

Two salient economic characteristics

57

addresses problems and risks that actually occur. It is true that an international inancial centre must ‘signal’ to the international investment community that it meets best practice standards as set in other centres of like status – such as New York and London – and for this reason a number of rules may languish on the books without a real purpose. An example is the requirement for a US style remuneration committee10 on the board although executive compensation in Hong Kong is relatively low and Hong Kong companies generally require shareholder approval of such compensation.11 Nevertheless, if the real risks present in an economy are not addressed, scandals and market breaks will eventually catch up with even the most cosmetically fashion-conscious system of regulation. In the areas of company and securities law, real risks are determined by the character of the economic relationships: dispersed shareholdings or concentrated shareholdings, primarily local activity or primarily international activity. he economic structure sketched in this chapter deines the risks that regulation in Hong Kong should be designed to meet. If the Hong Kong company and securities laws are to be efective, they must take the risks of abuse arising from this economic structure into account when providing restrictions and remedies. Following this analysis of the Hong Kong economy, Chapter 3 then examines the speciic aspects of Hong Kong law for their robustness in relation to the actual shape of the economy – rather than in relation to an ideal of good governance formed in New York or London on the basis of a diverging coniguration of risks.

2 A stock market dominated by companies formed under foreign law A second type of legal risk arises from Hong Kong’s character as an international inancial centre for mainland China. As China rekindled its economic activity, its expanding economy required signiicant funding, yet its markets were young, illiquid, volatile and poorly regulated. he Renminbi (RMB) was not freely convertible. Hong Kong, as a Region of China with a freely exchangeable currency and solid rule of law, ofered a window to international inance. Mainland Chinese private and stateowned companies have entered Hong Kong to use its stock exchange as a source of external inancing. Companies owned directly or indirectly by the PRC, state-owned enterprises (SOEs), have since 1993 listed 10

11

See SFC, Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, ss 17.1–17.15. Model Articles of Association, Art. 26(1).

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Hong Kong’s economic structure

‘H-shares’ in Hong Kong while maintaining another listing in Shanghai or New York.12 In addition, many private companies whose operations are in mainland China have incorporated in Bermuda, the British Virgin Islands or the Cayman Islands and listed on the SEHK. he cause for this circuitous and legally expensive boomerang structure is not fully understood, but appears to be a combination of tax beneits, asset sheltering from political risk and PRC restrictions on the number and quality of Chinese incorporated companies permitted to list. If we take 1990 as the year when ‘the China dimension’13 of the SEHK began in earnest, we see that the market capitalization of the SEHK has increased 33-fold, from HK$650 billion to HK$21.87 trillion in 2012.14 his has been the core of Hong Kong’s birth as an international inancial centre. A result of this international expansion is that, at the close of 2012, only about 15 per cent of the companies listed on the SEHK were incorporated in Hong Kong.15 he law where a company is incorporated governs the basic structure of its governance, including the distribution of powers between shareholders and directors, and the duties to which each of these groups are subject. Securities law add provisions on mandatory disclosure and prohibit certain kinds of activities (insider dealing and market manipulation), while exchange listing rules can create contractual duties of disclosure and board composition. he markets in New York and London might be considered as ‘normal’ examples of securities exchanges. here, the company law of a US or EU state (the latter infused with EU law) would govern the company’s internal afairs while the securities law of the United States or UK would apply to disclosure and market conduct and listing rules would ill in the rest. A relatively minor percentage of the companies would be incorporated under completely foreign law. he current national distribution of listings on the SEHK, however, means that the protections aforded investors under Hong Kong company law would not be available for about 85 per cent of the listed companies if Hong Kong did not take measures to correct this. he national distribution therefore presents a very diferent picture than that found in the exchanges of New York or London, and throws out a signiicant regulatory challenge for the securities law and the listing rules of Hong Kong. his is particularly true because the PRC SOEs that comprise about 11 per cent of the listed companies and over 20 per cent of the SEHK market 12 13 14 15

See Meng (2011). See www.hkex.com.hk, ‘listing matters’ > ‘China dimension’ (accessed 15 March 2014). HKEx (2013: 27). his will be discussed in greater detail in Section C.

Two salient economic characteristics

59

capitalization are not only incorporated under PRC law, but are also generally dominated indirectly by the state through a majority shareholding. hey are very large companies with very powerful controlling shareholders. At the close of 2012, four of the top ive companies by market capitalization listed on the SEHK were SOEs.16 Hong Kong must be in a position to discipline companies whose internal afairs do not fall under the control of its company law. As such, it is necessary to create suicient ‘outreach’ mechanisms to adjust and improve the governance mechanisms in many foreign companies. he law and rules designed to achieve this will be discussed in Chapter 3.

3 Data and methodology I have examined 15 corporate groups that are all component companies of the Hang Seng Index and are distributed evenly throughout each of three major sectors of the HSI sub-indices: inancial services, property development, and commerce and industry (which includes logistics and transportation),17 as well as major Chinese SOEs listed on the SEHK through H-shares. Unlike earlier studies that rely on commercial databases, the data used here is taken directly from the published annual reports of the listed companies in each group and from shareholding declarations iled with the SEHK.18 his analysis does not posit an a priori deinition of what will be considered as ‘ownership’ (say, cash low or ownership rights), but rather states the nature of the holding as declared for each company pursuant to law. In most cases this will be a percentage of nominal capital, as required by the Hong Kong SFO, which requires disclosure of holdings reaching 5 per cent of nominal capital.19 Given the prohibition of dual 16

17

18

19

hey are China Mobile Ltd., China Construction Bank Corporation, CNOOC Ltd., and Industrial and Commercial Bank of China Ltd. HKEx (2013: 28). he four companies of the last sub-index sector, ‘utilities’, are power companies that together comprise less than 1 per cent of the HSI. One of them (Power Assets Holdings Ltd.) is a second tier subsidiary of Hutchison Whampoa Ltd., and the other (China Resources Power Hldgs) is a member of the China Resources Group, both of which are analysed in the commerce and industry section. he data used in this chapter was assembled by Mr Guo Man and Dr Zhang Zhang, whose research was funded by the Hong Kong Research Grants Council. he former’s research was funded by the heme-Based Research Project, ‘Enhancing the Future of Hong Kong as an International Financial Centre’ and the latter’s research was funded by the Public Policy Research Project, ‘Anatomy of a Financial Centre’. Notiication must be made to both the listed company and the exchange. See s 310, 324 SFO.

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Hong Kong’s economic structure

class share structures referred to below, nominal capital will correspond to voting rights. Attribution rules are wide-reaching, which makes it very diicult for a major equity stake to be hidden through indirect holdings (in fact, because of this, the groups studied normally show two or more shareholders to whom the same holding is attributed). With the 5 per cent disclosure threshold and the attribution rules, we can assume that beyond the holdings declared in the listed company, no other shareholders reaching 5 per cent exist at the cut-of date for the annual report declaration. hese 21 corporate groups have been chosen because they include the top companies by assets in each of the ive sub-indicies of the HSI. Each of these groups is examined for ultimate owner, for concentration of ownership and – when data is available20 – for the trend in such concentration over a ten-year period. Given the absence of market share analyses for most major sectors of the Hong Kong economy, I have used share of total assets in the relevant HSI sub-index as a rough proxy for market power. his chapter presents ownership information for the listed companies in each group as declared in their annual reports, and in a database linked to references in this chapter, I have placed information on all group subsidiaries, jointly controlled entities and associates listed in the consolidated inancial statements of each group as at 31 December 2011. he distinction between ‘subsidiaries’ and ‘associates’ is that presented in the companies’ inancial statements, and derives from Hong Kong Financial Reporting Standards (HKFRSs).21 he distinction is whether the parent can exercise control over the other entity, which is deemed to occur when the relevant shareholding reaches 50 per cent.22 Entities over which control is so exercised are ‘subsidiaries’ for accounting purposes. Other entities in which the parent holds shares are ‘associates’ if the shareholding exceeds 20 per cent but does not reach 50 per cent.23 he groups are examined by the HSI sub-index within which they fall, beginning with inancial services. In the listed companies examined, it is no surprise that there are neither multiple classes of shares nor restrictions on the voting power of any class of shares examined.24 Although Hong Kong company law places no 20

21

22 24

Available data for Jardine Matheson does not allow trend of controlling shareholding to be discerned. Hong Kong Financial Reporting Standards include Hong Kong Accounting Standards (HKASs) and Interpretations issued by the Hong Kong Institute of Certiied Public Accountants (HKICPA). HKAS no. 27. 23 HKAS no. 28. he only existing exception to this on the SEHK is Swire, whose two classes of shares preexisted the SEHK prohibition and contain two diferent levels of dividend rights, rather than voting rights. See Subsection 3.d.

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restrictions on the classes of shares a company may issue, or the nature of their rights, the SEHK does not permit the listing of new shares if ‘voting power does not bear a reasonable relationship to the equity interest of such shares’.25 For the companies examined, the ‘pyramid’ (or partial ownership) aspect is strongest when the subsidiary is listed, which requires in most instances at least a 25 per cent public loat, and unlisted subsidiaries are in most instances wholly owned directly or indirectly.26 his appears to indicate that the lead companies of the groups we examine are not systematically exploiting the pyramid structure, but rather bringing in outside capital to a limited extent, in response to the listing requirements. his would be consistent with use of a Hong Kong listing as a signalling action by Chinese SOEs and with the general preference for internal inancing expressed in much corporate inance literature.27 he low incidence of pyramid structures in Hong Kong also accords with the earlier i ndings of Claessens et al.28 Nevertheless, minority shareholders are present in every listed component company of the groups examined in this chapter. With only minor exceptions, 29 there is no evidence of cross holdings among the major companies of the groups examined. Under Hong Kong law, if a subsidiary owns shares in its parent, it may not exercise the voting rights from those shares.30 All of the family controlled irms examined use trust structures to concentrate shares in the ultimate parent company while providing for generational estate planning, and elect a family member to the position of board chair, and in many cases also as ‘managing director’, which under Hong Kong law is the rough equivalent of a chief executive oicer, although potentially more powerful.31

25 26

27

28 29 30 31

SEHK Listing Rules, Rule 8.11. Information on all disclosed subsidiaries of the groups examined is available at: https:// sites.google.com/site/davidcdonald/ (author’s personal website). Myers (1984: 581–5), discussed recently from a more legal point of view in Ferran (2008: 64–5). Claessens et al. (2000: 93). See the discussion of Henderson Land in Subsection 2.d. CO 2012, s 113(9). Hong Kong’s ‘Model Articles of Association for Public Companies’ provide that: ‘A director appointed to the oice of managing director is not, while holding the oice, subject to retirement by rotation’ (Art. 33(2)) and ‘he directors may entrust to and confer on a managing director any of the powers exercisable by them on terms and conditions and with restrictions they think it, either collaterally with or to the exclusion of their own powers’ (Art. 34(1), emphasis added).

62

Hong Kong’s economic structure

B Hong Kong’s corporate groups 1 he inancial services sector his section examines and maps out the ownership structure for the inancial services groups headed by Bank of East Asia Limited (BEA), Bank of China Limited (BOC), HSBC Holdings plc, and Standard Chartered plc. BEA is a good example of a family institution in transformation, BOC displays the Hong Kong economy’s strong connection to the SOEs of China, HSBC is probably the leading example of a fully local Hong Kong enterprise becoming a globally engaged institution, and Standard Chartered provides an image of the important commercial ties that have survived the formal demise of the British Empire. hese four inancial groups represent 39.7 per cent of the total assets encompassed within the HSI inancial services sub-index, and about 55.4 per cent of the inancial activity in Hong Kong during the irst half year of 2013.32 hey include all of the note-issuing clearing banks in Hong Kong, and also include some of the most signiicant brokerages and investment banks. Under Hong Kong banking and securities law, the same entity could be licensed by the Hong Kong Monetary Authority (HKMA) as an ‘authorized institution’ to conduct banking services and as a ‘registered institution’ with the SFC to perform one of a number of regulated activities in the area of securities dealing and providing advice on such trading,33 although in the case of the entities discussed here, diferent companies within the group will provide diferent services and be licensed accordingly. Unlike the property sector, none of these banks have a controlling family shareholder. he one family owned bank in this group, the Bank of East Asia, is now under the control of institutional investors, although the Li family remains in executive management. he only group with a clearly dominant shareholder is the Bank of China, which is controlled by the government of the PRC through its sovereign investment arm.

a he Bank of East Asia he Bank of East Asia was established in 1918 by the ancestors of the bank’s current Chairman and CEO, Sir David K.P. Li. BEA was listed on the Hong Kong Stock Exchange (a predecessor of the SEHK) in 1930, is currently listed on the SEHK as a component bank in the HSI, and is 32 33

Hong Kong Economic Report (16 August 2013: 16). See Donald (2012: 89–91).

Hong Kong’s corporate groups

63

Hong Kong’s largest independent bank,34 although considerably smaller than the other banks discussed in this section. BEA well represents the development of Hong Kong and its economy. Upon formation, BEA almost immediately expanded into mainland China, opening a branch in Shanghai in 1920 (which – although BEA does not provide information in this regard – likely became dormant or was expropriated post-1949), and since the mainland’s opening in the 1980s has both opened more branches and acquired the United Chinese Bank Limited, giving it an extensive branch network in mainland China.35 Sir David Li clearly represents the kind of leading businessman discussed in Chapter 1: although primarily a banker, Li served as a member of LegCo from 2004 to 2012, representing the Finance functional constituency,36 and still held the oice of Pro-Vice Chancellor of Hong Kong University in 2013.37 In 2007, Li was awarded the Grand Bauhinia Medal to recognize his extraordinary service to Hong Kong.38 His cousin, Mr Justice Andrew Li, served as Chief Justice of the Court of Final Appeal.39 BEA has been a component of the HSI since 198440 and was a founding member of the Hong Kong Securities Clearing Company Limited, which clears and settles all trades on the SEHK. BEA also provides an example of the risks involved for an economy led by a merchant elite. In 2008, because of allegations that through a directorship he held in Dow Jones Corporation, Sir David was involved in insider trading, he paid a substantial sum in settlement to the US Securities and Exchange Commission (SEC),41 and resigned his seat on the Hong Kong Executive Council. At the close of 2011, BEA controlled 35 subsidiaries and seven associated companies. Its total assets comprise 0.7 per cent of the HSI inancial sector sub-index, and it is unusual among the companies studied in this chapter because it has relatively dispersed shareholdings. Its largest shareholders are a Spanish bank, CaixaBank S.A. and a Singaporean investment company, Davos Investment Holdings Private Limited, which 34 35 36

37 38

39 40 41

See www.hkbea.com, ‘Milestones’ (accessed 15 March 2014). See www.hkbea.com, ‘Milestones’ (accessed 15 March 2014). See Legislative Council of the Hong Kong SAR, ‘Precedence Lists of LegCo Members’, 2nd and 3rd Councils, at www.legco.gov.hk (accessed 15 March 2014). See www.hku.hk, at ‘Oicers of the University’ (accessed 15 March 2014). See ‘Recipients of Hong Kong Special Administrative Region Honours and Awards Grand Bauhinia Medal (G.B.M.)’, at www.info.gov.hk (accessed 15 March 2014). Robin Kwong, ‘A Man with Connections’, Financial Times (20 July 2007). See www.hsi.com.hk, ‘Historical Changes of Constituents’ (accessed 15 March 2014). Francesco Guerrera et al., ‘Consummate Networker who Faces Regulator’s Might’, Financial Times (28 January 2008).

64

Hong Kong’s economic structure Bank of East Asia Ltd. Finance Incorporated in HK Owner

Code: 23 % held by owner

CaixaBank S.A.*

16.88

Cuoco Group Limited*

14.34

Sumitomo Mitsui Banking Corporation

9.50

Others

59.28

35 Subsidiaries

7 Associates

Figure 2.1 BEA Group *Note: CaixaBank S.A. is controlled by Caja de Ahorros y Pensiones de Barcelona and Cuoco Group Limited is contolled by a string of companies with Hong Leong Company (Malaysia) Berhad at the top.

through a chain of holdings controls Cuoco Group Limited, the beneicial owner of about 14 per cent of capital. Over the period from 2007 to 2012, the percentage of BEA’s capital held by CaixaBank S.A. increased by 7.05 per cent. Another of BEA’s substantial institutional shareholders is Sumitomo Mitsui Banking Corporation, with about 10 per cent of the shares. Sir David Li owns 2.58 per cent of the shares, although it cannot be excluded that his indirect holdings exceed that amount.42 BEA’s subsidiaries serve the function both of diversifying into related areas, such as insurance and oice support services, and expanding operations into foreign markets. Figure 2.1 summarizes the ownership relationship of BEA. Detailed information on its subsidiaries is provided in my online database.43

b he Bank of China Group he government-owned Bank of China Limited is both a very powerful SOE and gives good evidence of the historical relationship between 42

43

BEA Annual Report 2012, p. 104. he declaration made in accordance with SFO s 352, which – under s 345(5) – requires shares to be included in a declaration if a person can control the right. he chain of holding leading to Cuoco Group Ltd. is long and obscured by the fact that it runs through the company laws of various countries, particularly of Malaysia and Singapore. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website).

Hong Kong’s corporate groups

65

Hong Kong and the mainland. BOC opened its irst branch in Hong Kong in 1917, and increased its activity during a period of close economic ties between Hong Kong and mainland China prior to the Japanese invasion, but political developments ater 1949 led to a signiicant slowdown in its activity.44 During the Cold War, as the United States placed an economic embargo on China, Hong Kong became a channel for mainland exports of raw materials to support the colony, and BOC became a channel for purchasing Sterling in exchange for the HK dollars received from these export sales, helping the PRC to function under the strain of the American-led embargo.45 he history of BOC thus teaches us that Hong Kong presents a much more complex picture than a simple West–East standof during the Cold War. Ater this period, from the 1980s on, commercial connections resumed their pre-war intensity and greatly multiplied in volume and complexity. In 2001, BOC Hong Kong (Holdings) Limited (BOCHK Holdings) was incorporated to consolidate holdings in 13 separate entities, including its principal subsidiary, Bank of China (Hong Kong) Limited (BOCHK), which is one of the three banknote issuing banks in Hong Kong, and is the oicial clearing house for all RMB transactions in Hong Kong.46 Both the BOC and BOCHK Holdings are listed on the SEHK, with the mainland Chinese company listing H-shares. BOCHK Holdings is a component company of the HSI, inancial sector sub-index. At the close of 2011, BOCHK Holdings controlled 50 subsidiaries, led by its wholly owned subsidiary BOCHK and including companies active in the sectors of insurance, payment systems, and i nancial administration technology.47 BOCHK is very signiicant in Hong Kong’s RMB activities, and constitutes 15.9 per cent of the total inancial sector sub-index by assets. BOCHK Holdings is ultimately controlled the State Council of the PRC government through a wholly owned subsidiary of the China Investment Corporation(CIC), Central Huijin Investment Ltd., with an equity stake of about 68 per cent of its shares.48 his holding remained stable over the period 2002–12. BOCHK Holdings reports that the remainder of its share capital is held by the public, with about 32 per cent of this held by institutions in Asia, Europe, North America and Australia.49 Figure 2.2 summarizes the relationship among the companies that own 44 46 47

48 49

45 See Goodstadt (2007: 6–7, 39). See Goodstadt (2007: 90–3). BOCHK Holdings, Annual Report 2012, p. 1. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). BOCHK Holdings, Annual Report 2012, p. 55. BOCHK Holdings, Annual Report 2012, p. 82.

66

Hong Kong’s economic structure State-owned Assets Supervision and Administration Committee

BOC Limited Finance Incorporated in PRC Owner Central Huijin Limited HKSCC Nominees Limited Others

Code: 3988 % held by the owner 67.73 29.25 3.02 *50 subsidiaries

100% BOC Hong Kong (Group) Limited (HK) 100%

BOC Hong Kong (BVI) Limited (BVI) 66.06% BOC Hong Kong (Holdings) Limited (HK) Finance Incorporated in HK Ultimate Owner Central Huijin Others

Code: 2388 % held by the owner 66.06 33.94

50 Subsidiaries, including BOC Hong Kong Limited

Figure 2.2 BOC Group

and are controlled by BOCHK Holdings. Detailed information on its subsidiaries is provided in my online database.50

c HSBC Holdings he Hong Kong Shanghai Banking Corporation Limited (HSBC) has been one of the most powerful organizations in the history of Hong Kong. It was founded in Hong Kong in 1865, opened up an oice in Shanghai one month later, and set up oices in most major Asian ports during the next 20 years.51 At the pre-war height of the economic link between 50

51

See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). HSBC (2012: 4–6).

Hong Kong’s corporate groups

67

Hong Kong and Shanghai, HSBC served as the most important inancial conduit in China.52 Goodstadt observes that one reason Hong Kong did not provide London with suicient data on its economy before 1959 was that ‘HSBC, for example, was afraid that its true inancial position might be deduced from published statistics’.53 hat may well have been an accurate judgement, given the portion of Hong Kong’s banking market controlled by HSBC. During the Cold War, Hong Kong was the only member of the Sterling Area that was able to force London to promise no future devaluations of the Sterling. As Goodstadt explains: in 1968, ‘Hong Kong accounted for around 15 per cent of the Sterling Area’s total balances in London. A signiicant share … belonged to HSBC … [which] warned that these funds would be transferred to New York – which would bring down sterling – unless the UK ofered guarantees against further devaluations.’54 In 1965, HSBC was able to take over the Heng Seng Bank, which only one year earlier had founded the Hang Seng Index and had been the largest bank in Hong Kong save HSBC, but was then badly damaged in a bank run, in part due to the colony’s poor banking regulation.55 HSBC’s dominance consolidated, and it then became instrumental in creating the generation that now dominates the Hong Kong economy. In 1975, HSBC helped Li Ka-shing gain his international foothold by assisting him (rather than Jardine Matheson) to acquire control of Hutchison Whampoa,56 which had been damaged by ‘disastrous currency speculation’.57 HSBC issued 60 per cent by value of the Hong Kong dollar banknotes in circulation as of 2012.58 In recent decades, HSBC expanded beyond Hong Kong and Asia. hrough a 1991 scheme of arrangement, the shares of HSBC were transferred to HSBC Holdings plc in return for shares of the latter company, which resulted in HSBC becoming a wholly owned subsidiary of a UK company with headquarters in London.59 Unlike most leading Hong Kong groups, the shares of HSBC Holdings are widely held, with its largest investors being JPMorgan Chase and BlackRock, Inc., and over the period from 2003 to 2012, the percentage of its capital in the hands of 52

53 55 57 59

As Goodstadt observes, ‘HSBC was the only British company to enjoy the formal support of the British Foreign Oice … When British priorities in China switched … to command of its i nancial system, HSBC became even more useful to London.’ Goodstadt (2007: 210). Goodstadt (2007: 23). 54 Goodstadt (2007: 205). 56 Goodstadt (2007: 115). Goodstadt (2005: 184–5). Goodstadt (2005: 160). 58 HSBC (2012: 88). See the court approval of the transaction in Re he Hongkong and Shanghai Corporation Ltd. [1991] 2 HKLR 111.

68

Hong Kong’s economic structure HSBC Holdings plc

Banking, Financial Services

Incorporated in England

Code: 5

Owner

% held by the owner

JPMorgan Chase & Co.

6.79

BlackRock, Inc.

6.05

The others

87.16

*28 subsidiaries, 7 associates, 4 jointly controlled entities

62.14% Hang Seng Bank

Banking

Incorporated in HK

Code: 11

Owner

% held by the owner

The Hongkong and Shanghai Banking Corporation Limited

62.14

Others

37.86

*17 subsidiaries, 3 associates

Figure 2.3 he HSBC Group

its largest shareholder remained substantially the same. HSBC seen historically has therefore been one of the most important companies in the Hong Kong economy, but at the current time it no longer exhibits the traits of other major corporate enterprises created in Hong Kong. At the close of 2011, HSBC Holdings controlled 59 other entities, including Hang Seng Bank. It is listed on the SEHK and a component of the HSI inancial sector sub-index, constituting (including Hang Seng Bank) over 23 per cent of the total assets represented in the index; if banks based in mainland China are excluded from the calculation, HSBC’s share of the sub-index increases to 53 per cent, which perhaps better represents its power locally. Figure 2.3 summarizes the ownership relationship of HSBC Holdings. Detailed information on its subsidiaries is provided in my online database.60

d Standard Chartered Standard Chartered plc is the result of a 1969 combination of the Chartered Bank of India, Australia and China, established in 1853, and 60

See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website).

Hong Kong’s corporate groups

69

the Standard Bank of British South Africa, established 1862.61 Chartered Bank was a British bank with interests throughout Asia that came to make Hong Kong one of its central markets,62 and was commissioned by the Crown to issue banknotes in Hong Kong from 1862.63 It still performs this task through Standard Chartered Bank (Hong Kong) Ltd., a wholly owned subsidiary.64 Standard Chartered plc does not have a single, dominant shareholder, but its largest shareholder with over 18 per cent is a sovereign wealth fund of the government of Singapore, Temasek Holdings (Private) Limited. For Hong Kong, Standard Chartered’s most important subsidiary is Standard Chartered Bank (Hong Kong) Limited, which is a major retail bank in the Region. From this we can see that the three, oicial note-issuing banks of Hong Kong are signiicant in their own right and very diferent from each other: HSBC is the home-grown bank of Hong Kong merchants evolved into a global player, much like Hong Kong itself; BOCHK provides a signiicant link to the government of mainland China, and this link has grown with the reintegration of Hong Kong into China; Standard Chartered is a British bank that grew up under the colonial network, and while keeping this network as its backbone, has made the transition to an Asian and developing country player, with its largest shareholder being the government of Singapore. Figure 2.4 summarizes the ownership relationship of Standard Chartered plc. Detailed information on its subsidiaries is provided in my online database.65

2 he property development sector Given the limited geographical size of the Hong Kong SAR at just over 1,000 square kilometres (much of it unusable mountain slopes), and its growth to a leading business and inancial centre of about seven million residents, the control and development of property was a key to commercial power during the last quarter of the twentieth century. Between 1971 and 2011, the population of Hong Kong increased from 3.94 to 7.07 million, an increase of about 80 per cent.66 During the period between 1985 61 62 63 64 65

66

For historical information see www.standardchartered.com (accessed 15 March 2014). See Tsang (2004: 60). For historical information see www.standardchartered.com (accessed 15 March 2014). See Hong Kong Monetary Authority: www.hkma.hk.gov (accessed 15 March 2014). See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). See Hong Kong SAR Census and Statistics Department, www.censtatd.gov.hk/home/ (accessed 15 March 2014) ‘Hong Kong statistics’ > ‘population’.

70

Hong Kong’s economic structure Standard Chartered plc Banking Incorporated in England

Code: 2888

Owner

% held by the owner

Temasek Holdings (Private) Limited

18.17

Aberdeen Asset Management plc

7.7

BlackRock, Inc.

6.4

Others

67.73

100% Standard Chartered Bank (Hong Kong) Ltd.

11 Other Subsidiaries

1 Jointly Controlled Entities

3 Associates

Figure 2.4 Standard Chartered Group

and 1994, the price of residential housing increased at an annual rate of 23 per cent, while inlation was at about 8 per cent and per capita earnings increased by about 13 per cent.67 Under these conditions, property developers could rest assured of a substantial proit, given the demand and price increase between the time that a project was planned and that at which the lats were sold to the public. As discussed in Chapter 1, Goodstadt argues that property was an area where the Hong Kong government played its ‘laissez-faire’ role speciically to adjust the market for the beneit of the leading developers. He points out irst, that although from 1987, Hong Kong’s property market was in the hands of less than ten developers and prices were rising at unacceptable rates, the colonial government closed its Housing Branch, which was the only central agency designed to deal with such problems,68 and second, in 1997, when the new SAR government took steps to ofer afordable housing to its poorer citizens, when prices did fall, it quickly reversed course under criticism from 67

Goodstadt (2005: 128).

68

Goodstadt (2005: 128–9).

Hong Kong’s corporate groups

71

the developers that such action was ‘anti-capitalist’, ultimately pledging that ‘public housing’s role would be curtailed in order to avoid “unfairly” crowding out the private sector’.69 In recent decades, wealth in Hong Kong has thus been associated with property development and – more than other segments of the economy – property development has been concentrated into companies owned by Hong Kong individuals and families that became the Region’s wealthiest: Li Ka-shing (the wealthiest person in Hong Kong and in Asia70 in 2012), Lee Shau Kee (second wealthiest in Hong Kong in 2012), homas and Raymond Kwok (third wealthiest in Hong Kong in 2012), Cheng Yu-tung (fourth wealthiest in Hong Kong in 2012), and Ronnie and Gerald Chan (fourteenth wealthiest in Hong Kong in 2012).71 hese men are controlling shareholders of ive leading Hong Kong property development groups: Cheung Kong, Henderson Land, Sun Hung Kai Properties, New World Development and Hang Lung Properties, respectively. hese ive companies, which will be examined in detail in the following subsections, are all components of the HSI, and at the close of 2012, their aggregate share of this sub-index’s total represented assets was 63.7 per cent, broken down as follows: • • • • •

Cheung Kong (15.6%) New World (11.9%) Henderson (10.8%) Hang Lung (6.4%) Sun Hung Kai (19%).

Other corporate groups, such as that headed by Swire Paciic Limited, are also important participants in the property development market, but will be addressed primarily as members of the commerce and industry subindex in the next section of this chapter. In the analysis presented here, the only company that will be examined in both the property and the commerce sections is Cheung Kong, as its subsidiary, Hutchison Whampoa, is an important member of the commerce and industry group.

a Cheung Kong Holdings Cheung Kong (Holdings) Limited is the vehicle of Li Ka-shing, who Goodstadt describes as ‘the outstanding Hong Kong entrepreneur of the 69 70 71

Goodstadt (2005: 136–7). See Naazneen Karmali, ‘Asia’s 20 Richest 2012’, Forbes (7 March 2013). Rankings for Hong Kong are taken from Forbes, ‘Hong Kong’s 50 Richest’, www.forbes. com/hong-kong-billionaires/ (accessed 15 March 2014).

72

Hong Kong’s economic structure

twentieth century’.72 Tsang points out that Li’s bold purchases as the property market collapsed in 1967 launched him into leadership in Hong Kong, and was emblematic of a changing of the guard, as Chinese entrepreneurs came to outweigh British in Hong Kong.73 As mentioned above, his entrance as a stakeholder in Hutchison Whampoa with the help of HSBC is seen as a turning point in Hong Kong business history. His expansion was very impressive, to say the least. Forbes in 2012 asserted that ‘Li’s companies have built one in every seven residences’ in Hong Kong.74 Li was a member of the committee that drated Hong Kong’s Basic Law,75 and has donated generously to all universities and many charitable institutions in Hong Kong. In 2001, Li was awarded the Grand Bauhinia Medal to recognize his extraordinary service to Hong Kong.76 hus Li is another good example of the leading Hong Kong merchants who once functioned as caretakers of the people of Hong Kong. A long strike in 2013 against his dock enterprises (discussed in Chapter 1) provides an example of how this social structure design is currently under pressure for change. he 1997 retreat from public housing mentioned above presents an interesting juxtaposition of diferent policies at a 30-year distance from the rise of Li Ka-shing: when property prices collapsed in 1967, new fortunes were made and the guard of leading developers changed, but when intervention on the public’s behalf threatened such collapse 30 years later, it is reported that the government quickly acted to stabilize prices, lest it be seen as ‘anti-capitalist’. he impression that the public can receive from diferent treatments of similar circumstances could well feed the increasingly general public sentiment that change is needed. Cheung Kong (Holdings) Limited was incorporated in Hong Kong in 1971, and at the close of 2012 Li Ka-shing controlled about 43 per cent of its voting rights through a family trust for which he is the trustee and a corporation which he wholly owns.77 JPMorgan Chase & Co, as a combination of custodian, ‘approved lending agent’ and holder of options, was reported in the same year to control about 9 per cent of Cheung Kong’s voting rights.78 he remaining interests are undisclosed. Li Ka-shing 72 74 75 76

77 78

Goodstadt (2005: 185). 73 Tsang (2004: 173). Russell Flannery, ‘Asia’s Richest Man’, Forbes (14 March 2012). See the list provided at www.webb-site.com (accessed 15 March 2014). See ‘Recipients of Hong Kong Special Administrative Region Honours and Awards Grand Bauhinia Medal (G.B.M.)’, at www.info.gov.hk/cml/eng/miscell/index2.htm (accessed 15 March 2014). See Cheung Kong (Holdings) Annual Report 2012, p. 40. See Cheung Kong (Holdings) Annual Report 2012, pp. 50–1.

Hong Kong’s corporate groups

73

has chaired Cheung Kong since 1971, and his son Victor Li has been its managing director since 1999, when he replaced his father.79 In 2011, Cheung Kong Holdings reported having 66 subsidiaries, seven associated entities, and 34 joint controlled entities. he most prominent subsidiaries are Hutchison Whampoa Limited, which will be discussed in its own right in the following section, and CK Life Sciences Int’l. (Holdings) Inc. Figure 2.5 summarizes the ownership relationship of Cheung Kong (Holdings) Limited and its two main subsidiaries. Detailed information on subsidiaries is provided in my online database.80

b New World Group Like Cheung Kong, New World Development Co. Limited (New World Development) was established following the market turmoil of 1967, in this case the company was formed in May 1970.81 Seed money for the investments in property could have come from Cheng Yu-tung’s wife’s family business, the Chow Tai Fook Jewellery Company.82 New World Development and the other companies in the New World Group are now controlled by the Chow Tai Fook family, led by Cheng Yu-tung. Cheng Yu-tung’s son, Henry Cheng, is the chairman and managing director of New World Development, and his brother, two children and nephew all are board members.83 he family owns New World Development Company Limited through a relatively complex chain of ownership, consisting of two family holding companies,84 which wholly own a capital investment company,85 which owns further two tiers of holding companies, the last of which ultimately own the shares of New World Development.86 It is characteristic for Hong Kong corporate groups to contain one listed company with multiple subsidiaries and have the listed company controlled by a private investment company and a family trust, usually stacked with the latter on top. his limits obligatory disclosure to one link in the chain 79 80

81 82 83 84

85

86

See Cheung Kong (Holdings) Annual Report 2012, p. 26. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). Memorandum and Articles of Association of New World Development Co. Limited. See Studwell (2007: 55). New World Development Co. Ltd. Annual Report 2012, pp. 94–100. hese are Cheng Yu Tung Family (Holdings) Limited and Cheng Yu Tung Family (Holdings II) Limited. See New World Development Annual Report 2012, p. 109. his company is Chow Tai Fook Capital Limited, and it has a 74.07 per cent direct interest in Chow Tai Fook (Holding) Limited, which wholly owns Chow Tai Fook Enterprises Limited, which is the registered shareholder. See New World Development Annual Report 2012, p. 109.

Downloaded from https://www.cambridge.org/core. University of Groningen, on 01 Dec 2019 at 17:09:09, subject to the Cambridge Co of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/CBO9780511791918.003

Li Ka-shing Family Trust Cheung Kong (Holdings) Limited Property Conglomerate Incorporated in HK Code: 1 Owner % held by owner Li Ka-shing 40.43 Others 59.57 *66 subsidiaries, 7 associates, 34 joint controlled entities 49.97% 45.32% Hutchison Whampoa Limited CK Life Sciences Int’l., (Holdings) Inc. Conglomerate Medical Equipment & Devices Incorporated in HK Code: 13 Incorporated in Cayman Code: 775 Islands Owner % held by owner Owner % held by owner Cheung Kong (Holdings) Ltd. 49.97 Gold Rainbow Int’l Ltd. 45.32 Others 50.03 Trueway Int’l Ltd. 22.05 *122 subsidiaries, 4 associates, 46 joint controlled Triluck Assets Ltd. 7.45 12.2% Others 25.18 Tom Group Limited *32 subsidiaries, 1 associates Advertising Incorporated in Cayman Code: 2383 Islands % held by the owner Owner 24.47 Eastehouse Limited Others 75.53 *44 subsidiaries

Figure 2.5 Cheung Kong Group

Hong Kong’s corporate groups

75

of companies, although the consolidated accounts do give a broader perspective. Uncharacteristically, the New World Group contains four companies beyond New World Development that are all listed on the SEHK: NWS Holdings Ltd., New World Department Store China Ltd., New World China Land Ltd. and Lifestyle International Holding Ltd. hus, in spite of the opacity of multiple layers clouding ultimate ownership of New World Development, its three subsidiaries all make annual and regular disclosure pursuant to law and the Listing Rules, including with respect to substantial shareholders. A diferent view of this use of public companies comes from Studwell, who argues that a division has been made between choice private and less attractive public revenues. He asserts that in the mid 2000s Cheng’s minority holdings in gambling casinos earned him more cash low than the New World Group, while he illed his listed companies in which the public had invested with unproitable projects.87 his does not present any unfairness if the division of businesses exists at the time of an Initial public ofering (IPO). However, if a proitable business were to be spun of into a private company, that would be unfair to minority shareholders who, in essence, would have lost a business opportunity to the controlling shareholder. In judicial activity policing controlling shareholders against behaviour abusive of the minority, such spin-ofs are a classic technique.88 Currently it is unlikely that Hong Kong law would present a remedy for such transfer of assets unless it entailed a breach of the SEHK listing rules. Cheng Yu-tung also plays a prominent public role in Hong Kong society. He has entered into numerous arrangements with governmental and quasi-governmental institutions for the public beneit, evidence of which is that buildings housing the Chinese University of Hong Kong Business School and the Hong Kong University Law Faculty both bear his name. Like Sir David Li and Li Ka-shing, Cheng was awarded the Grand Bauhinia Medal to recognize his extraordinary service to Hong Kong.89 An example 87

88

89

Studwell (2007: 65–6, 119–20), referring to Cheng’s holdings in Shun Tak Holdings and the Sociedade de Turismo e Diversoes de Macau, controlled by Stanley Ho, as well as the manner in which he and homas Lau purchased the Hong Kong operations of the Sogo Department Store. See, e.g., in Delaware, Weinberger v. UOP, Inc. 457 A 2d 701 (1983), and in California, Jones v. H.F Ahmanson & Co, 1 Cal.3d 93, 112. In Germany, the courts have also developed a principle of iduciary duty (Treuplicht) for controlling shareholders. See In Re Linotype, Doc. No. II ZR 75/87, BGHZ 103, 184 (1988), reprinted in translation in Cahn and Donald (2010: 585). See ‘Recipients of Hong Kong Special Administrative Region Honours and Awards Grand Bauhinia Medal (G.B.M.)’, at www.info.gov.hk/cml/eng/miscell/index2.htm (accessed 15 March 2014).

76

Hong Kong’s economic structure

of mainland China-oriented civic engagement is the strategic alliance ‘New World Liberty China Ventures’ that New World formed with the Asian Development Bank and the US Liberty Mutual Group to stimulate the mainland Chinese economy by injecting about US$150 million of venture capital into SMEs.90 hanks will always mix with suspicion in speculation about the true intentions of even the most socially engaged super rich, but as long as economically powerful people also have inluence in government – and Hong Kong is certainly not the only example of this91 – special attention must be given to protection against potential abuse. he speciic scenario of diverting proitable activity from a listed into a private company owned by the controlling shareholder of the listed company – which did not appear to occur in New World – requires an efective unfair prejudice remedy or a iduciary duty of the controlling shareholder, neither of which yet fully exist in workable form under Hong Kong law for such a scenario. he New World Group also displays another characteristic of the wealthy merchants who have led Hong Kong: when China economically opened in 1978, New World began a programme of investment into the enormous potential of the grossly undeveloped mainland market as a source of steady and predictable revenue. he 2012 Annual Report of New World Development notes that its major divisions of property development,92 property investment,93 service94 and infrastructure95 have all 90 91

92

93

94

95

Datamonitor, ‘Company Proi le of New World Development Co Ltd’, 7 March 2012. For example, Johnson and Kwak assert with sadly convincing evidence that in the United States an oligarchy of power has been formed around the inancial industry. See Johnson and Kwak (2010: 189–222). ‘he inclusion of Central Park-view, a high-end residential project in Pearl River New Town, Guangzhou, and commercial properties with higher average price and gross proit in the property sales portfolio of NWCL, coupled with the diferent levels of increase in average selling price of residential projects in general during the year, overall gross proit margin also increased signiicantly by 17 percentage points year-on-year to 50%.’ New World Development Annual Report 2012, p. 40. ‘In FY2012, property investment contributed HK$2,016.9 million, up 14.5% from FY2011’s HK$1,761.5 million mainly due to the contribution from the projects in Mainland China.’ New World Development Annual Report 2012, p. 40. ‘During the year under review, service segment contributed HK$1,907.2 million, up 17.7%. he key contributor of service segment was the Free Duty business. Strong patronage of aluent travellers from Mainland China contributed to the signiicant growth of Free Duty’s tobacco and liquor retail business at various cross-boundary transportation terminals in Hong Kong.’ New World Development Annual Report 2012, p. 40. ‘In FY2012, the contribution from infrastructure segment was HK$2,343.7 million, up 25.2%. Ater the completion of the fourth stage of acquisition of HZRR [Hangzhou Ring Road] in January 2012, NWSH owns 95% efective interest in the project. his 103.4 km long expressway boasted a daily traic volume of over 100,000 vehicles and contributed signiicantly to the road business in FY2012. Meanwhile, average daily traic

Hong Kong’s corporate groups

77

grown substantially on the back of the mainland economy. In this way, as for most of the companies listed on the SEHK, Hong Kong remains a headquarters and inancial centre, but increasingly cedes the centre of operations to mainland China. his is reminiscent of New York, where bankers now own ‘lot’ apartments that once housed production facilities in a powerful garment industry. Figure 2.6 summarizes the ownership relationship of the New World Group. Further information on the group’s 300-plus subsidiaries is provided in my online database.96

c he Hang Lung Group he Hang Lung Group was founded by Mr Chan Tseng-His in 1960. he group’s lead company is Hang Lung Group Limited, a company listed on the SEHK and a component of the HSI property sub-index. At the close of 2012, a controlling 36.93 per cent interest was held by a discretionary trust over which Mr Chan’s surviving wife, Chan Tan Ching Fen, had power of discretion.97 Mr Chan’s oldest son, Ronnie Chan, has chaired the company for over two decades. His younger son, Gerald Chan, was at 2012 a nonexecutive director. Hang Lung Group Limited’s major subsidiary, Hang Lung Properties Limited, is also listed on the SEHK and is also chaired by Ronnie Chan. he Hang Lung Group displays the salient characteristics found in many of the enterprises examined in this chapter: control remains with the family, the family is civically engaged in Hong Kong society, and the company is expanding aggressively outward into the mainland Chinese market. he civic engagement of the Chan family takes place mainly through the family’s Morningside Group, which is a venture capital investor that also engages in civic action, such as by founding and endowing a college at the Chinese University of Hong Kong bearing the group’s name, and creating a ‘China Heritage Fund’ to preserve buildings of historical importance in mainland China.98 With respect to expansion on the mainland, the Hang Lung Group highlights this as a key business policy: We made our irst investment on the Mainland in early 1990s as the foremost step in our future business expansion … our portfolio of investment

96

97 98

low of Guangzhou City Northern Ring Road grew by 13%, as beneited from the repairs and maintenance being undertaken by a competing road during FY2012.’ New World Development Annual Report 2012, p. 41. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). See Hang Lung Group Limited Annual Report 2012, p. 134. See www.morningside.com (accessed 15 March 2014) for more information about the Chans’ Morningside Group.

Chow Tai Fook Family (Holdings) Limited, and II

41.77%

32.44%

New World Development Co. Ltd.

Lifestyle International Holding Limited

Property Conglomerates

General Trading & Retailing Incorporated in Cayman Islands Code: 1212 Owner % held by owner

Incorporated in HK

Code: 17

Owner

% held by owner

Chow Tai Fook Family (Holdings) Ltd.

41.77

Others

58.23

Chow Tai Fook Family (Holdings) Ltd. United Goal Resources Others *28 subsidiaries

*224 subsidiaries, 16 associates, 48 joint controlled entities 58.05% 72.29% NWS Holdings Ltd. Conglomerate Incorporated in Bermuda Code: 659 Owner % held by owner New World Development Co. Ltd. 58.05 Others 41.95 *74 subsidiaries, 11 associates, 38 joint controlled

65.91%

32.43 35.14

New World Department Store China Ltd. General Trading & Retailing Incorporated in Cayman Islands Code: 825 Owner % held by owner New World Development Co. Ltd. 72.29 Others 27.71 *28 subsidiaries New World China Land Ltd.

China Property Incorporated in Cayman Islands Code: 917 Owner % held by owner New World Development Co. Ltd. 65.91 Others 34.09 *59 subsidiaries, 2 associates, 19 joint controlled entities

Figure 2.6 New World Group

32.43

Hong Kong’s corporate groups

79

properties currently comprises two large scale developments in Shanghai … Coupling with our prime landmark complexes … in Jinan, as well … in Shenyang, we are vigorously building on our successes to develop similar properties in major cities including Wuxi, Tianjin, Dalian, Kunming and Wuhan.99

Figure 2.7 summarizes the ownership relationship of the Hang Lung Group. Information on the nearly 200 subsidiaries controlled by the group is provided in my online database.100

d Henderson Land he Henderson Land Group is dominated by the family of Dr Lee Shau Kee. Lee began his career in property development in 1956 by founding Sun Hung Kai Properties (discussed below) with the Kwok family, but let that company in the early 1970s to found the lead company of his own group, Henderson Land Development Company Limited (HLD Co.), which was listed on the SEHK in 1981 and is a component of the HSI property subindex.101 At the close of 2012, Lee controlled 62.69 per cent of HLD Co.’s ordinary shares, primarily through his control of a number of discretionary trusts and the private company Henderson Land Development.102 Contrary to the trend towards public holding that one might think in the case of a family founded business that goes public, the current holding is up from about 53 per cent in 2008. An interesting feature of the shareholding structure used in the Henderson Group is the keiretsu type practice of cross shareholdings between associated companies within the group: the Hong Kong and China Gas Company Limited, in which HLD Co. has a 39.88 per cent stake, indirectly owns 5,602,600 shares of HLD Co., and the Hong Kong Ferry (Holdings) Company Limited, in which HLD Co. has a 31.36 per cent interest, indirectly owns 940,211 shares of HLD Co.103 Control of these shares is ultimately attributable to Lee through the trusts mentioned above.104 If these companies were subsidiaries of HLD Co., the shares could not be voted, but the Company Ordinance does not extend that rule to ‘associated’ entities,105 where the holding is signiicant, but not numerically controlling. 99 100

101 102 103 104 105

Hang Lung Group Limited Annual Report 2012, p. 3. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). See HLD Co. Annual Report 2012, p. 2. See HLD Co. Annual Report 2012, p. 136. HLD Co. Annual Report 2012, p. 140, Note 1. HLD Co. Annual Report 2012, p. 140, Note 1. Companies Ordinance 2012, s 113(9).

Chan Family Trust

Hang Lung Group Ltd

Property management, car-parking, dry cleaning

Code: 10 Incorporated in HK % held by owner Owner 36.93 Chan Tan Ching Fen 15.14 Aberdeen Asset Management 47.93 Others *120 subsidiaries, 9 joint controlled entities

51.28% including shares of Hang Lung Group

50.65%

Hang Lung Properties Limited

Property development Code: 101 Incorporated in HK % held by owner Owner 50.65 Hang Lung Group Limited 49.35 Others *73 subsidiaries, 3 joint controlled entities

Figure 2.7 Hang Lung Group

Hong Kong’s corporate groups

81

he Henderson Group thus represents a very compact family company, and control extends into the management level. Not only is Dr Lee Shau Kee the controlling shareholder, but he is also chairman of the board and managing director, a position more powerful than CEO.106 Dr Lee’s two sons, Lee Ka Kit and Lee Ka-shing, as vice chairmen, together with Mr Lee’s daughter, Lee Pui Ling, and son-in-law, Li Ning, and two brothers, Lee Tat Man and Fung Lee Woon King, all sit on the HLD Co. board.107 his tightly controlled family unit is also active in Hong Kong as a socially engaged agent. HLD Co. more than any other developer has historically focused on the creation of afordable housing in the less aluent New Territories area of Hong Kong, and recently Dr Lee has announced his intention to donate land on which up to 10,000 new lats for low and medium income purchasers could be built.108 Dr Lee was a member of the Hong Kong SAR Prepatory Committee and has been a member of the Region’s Election Committee; in 2007 he was awarded the Grand Bauhinia Medal to recognize his extraordinary service to Hong Kong.109 Dr Lee donates generously to Hong Kong universities, and the building housing the Law Faculty of the Chinese University of Hong Kong bears his name. HLD Co. has won numerous awards for promoting environmental conservation and energy eicient design.110 hus again, we see a leading merchant who is closely involved in Hong Kong government. It is signiicant, however, that like Li Ka-shing, Dr Lee is an octogenarian, and the younger generation of his family does not play as distinctively political a public role as the founding elder. Figure 2.8 summarizes the ownership relationship of the Henderson Land Group. Detailed information on the group member’s subsidiaries is provided in my online database.111

106

107 108

109

110 111

HLD Co. Annual Report 2012, pp. 123, 254. Under the articles of association used in companies limited by shares in Hong Kong, it is possible to delegate the entire power of the board of directors to a managing director alone. h is has been provided for in the articles of association of HLD Co. See Art. 111, Memorandum and Articles of Association of Henderson Land Development Company Limited, available at: www.hld. com/en/pdf/corporate/c2.pdf (accessed 15 March 2014). HLD Co. Annual Report 2012, pp. 123, 150–1. Peggy Sito, ‘Tycoon Lee Shau-kee in Talks to Donate Land for Cheap Flats for Young’, South China Morning Post (4 June 2012). See ‘Recipients of Hong Kong Special Administrative Region Honours and Awards Grand Bauhinia Medal (G.B.M.)’, at www.info.gov.hk/cml/eng/miscell/index2.htm (accessed 15 March 2014). HLD Co. Annual Report 2012, p. 5. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website).

Lee Shau Kee 68.13% Hong Kong Ferry (Holdings) Co. Ltd.

Henderson Land Development Co. Ltd. Property Conglomerate Incorporated in HK Code: 12 Owner % held by the owner Lee Shau Kee 68.13

31.36%

Others 31.87 *99 subsidiaries, 4 associates, 5 joint controlled entities

Henderson Investment Ltd. Management, Investment and Leasing of the Properties Incorporated in HK Code: 97 Owner % held by owner HLD Co. Ltd. 67.94 Others 32.06 *13 subsidiaries

associated entities

67.94%

39.88%

Ferry Service Incorporated in HK Owner HLD Co. Ltd.

Code: 50 % held by owner 31.36 68.64 Others *20 subsidiaries, 3 associates, 2 joint controlled entities

44.21% Miramar Hotel & Investment Co. Ltd. Hotel Operation and Management Incorporated in HK Code: 71 Owner % held by owner HLD Co. Ltd. 44.21 Chong Wing Cheong 9.98 Others 45.81 *30 subsidiaries, 9 associates

associated entities The Hong Kong and China Gas Co. Ltd. Gas Utility Incorporated in HK Code: 3 Owner % held by owner HLD Co. Ltd. 39.88 Others 60.12 *97 subsidiaries, 15 associates, 22 joint controlled entities

Figure 2.8 Henderson Group

Towngas China Co. Ltd. 66.18%

Gas Utility Incorporated in Cayman Islands Code: 1083 Owner % held by owner The Hong Kong and China Gas Co. Ltd. 66.18 Enerchina Holding Limited 7.18 Others 26.64 *63 subsidiaries, 7 associates, 8 joint controlled entities

Hong Kong’s corporate groups

83

e Sun Hung Kai he Sun Hung Kai Group, which has built Hong Kong’s tallest landmark buildings, was the largest property developer by assets in the HSI in 2012. he company could also be in its last period as a family controlled and dominated business. It is unique as the only major Hong Kong irm that has become famous for the seeming implosion of its controlling family. he lead company, Sun Hung Kai Properties Limited (SHK Properties), was founded in 1963 by Kwok Tak Seng, Fung King Hey and Lee Shau Kee, was listed on the Hong Kong Stock Exchange (predecessor of the SEHK) in 1972, and is a component of the HSI property sub-index, where in 2012 it made up whopping 19 per cent of the sub-index’s total market capitalization. As mentioned above, Lee Shau Kee let the business to found the Henderson Group in 1976, although he still serves as a non-executive director on SHK Properties’ board of directors. A discretionary trust over which Kwok Tak Seng’s wife, Kwong Siu-hing, has control owns a 42.87 per cent interest in SHK Properties, and her two sons, Raymond and homas, are both joint beneiciaries of this trust and joint chairmen of SHK Properties.112 he oldest son, Walter, was chairman of SHK Properties in 2008 when his mother forced him of the board because of behaviour she found allegedly instigated by his ‘mistress’, Ida Tong.113 His mother took Walter’s place as Chair, and then in 2011 inserted the two younger brothers homas and Raymond as co-Chairs.114 hen, in 2012, homas and Raymond were charged by Hong Kong’s Independent Commission Against Corruption (ICAC) with bribery and conspiracy to commit misconduct in public oice, because of an alleged HK$28 million in bribes passed to former government chief secretary Rafael Hui Si-yan in exchange for preferential treatment in land development. When homas and Raymond were arrested, SHK Properties immediately inserted the two men’s 29- and 30-year-old sons Adam and Edward to take their places, which triggered signiicant criticism,115 and led the Financial Times to speculate that ‘Sun Hung Kai faces prospect of non-Kwok helm’.116 Nevertheless, as they await their trial scheduled for 2014, the SHK Properties annual report for 2012 112 113

114 115

116

See SHK Properties Annual Report 2012, pp. 107, 136. Sandy Li, Ambrose Leung and Peggy Sito, ‘Kwok Family Matriarch takes the Reins’, South China Morning Post (19 July 2008). SHK Properties Annual Report 2012, p. 107. See, e.g., Alex Lo, ‘SHKP Shareholders Deserve Better’, South China Morning Post (15 August 2012). Enid Tsui, ‘Sun Hung Kai Faces Prospect of Non-Kwok Helm’, Financial Times (16 July 2012).

Kwong Siu-hing for Family

42.87% Sun Hung Kai Properties Limited Property Conglomerate Incorporated in HK Code: 16 Owner % held by the owner Kwong Siu-hing 42.87 Others 57.13 *168 subsidiaries, 5 associates, 28 joint controlled entities 33.28%

74.04% 66.51% SUNeVision Holdings Ltd. E-Commerce & Internet Services Cayman Islands

Code: 8008

Owner

% held by owner

SHKP Ltd

74.04

Others 25.96 *16 subsidiaries

SmarTone Telecommunications Holdings Ltd. Telecommunications Bermuda Code: 315 Owner

Public Transportation Bermuda Code: 62 Owner

% held by owner

SHKP Ltd 66.51 Others 33.49 *6 subsidiaries, 1 associate

Transport Int’l Holdings Ltd.

% held by owner

SHKP Ltd 33.28 Others 66.72 *20 subsidiaries, 2 associates 73.01% Road Show Holdings Limited

Multimedia Service Bermuda Code: 888 Owner % held by owner KMB Resources Limited 73.01 Others 26.99 *25 subsidiaries, 1 associate

Figure 2.9 Sun Hung Kai Group

Hong Kong’s corporate groups

85

reports that homas and Raymond Kwok continue as co-chairmen of the Board and managing directors of the company.117 he report makes no mention of the charges as a potential risk factor for investors. At the end of 2012, the SHK Properties board did not have a large presence of Kwok family members.118 If the two co-Chairs were to be disqualiied because convicted of the conspiracy charges, and were ultimately not replaced by their sons, the company will have made the transition to professional management augured by the Financial Times. his would be a irst among the major property developers. Figure 2.9 summarizes the ownership relationship of the Sun Hung Kai Group. More information on the group’s 200-plus member companies is provided in my online database.119

3 he commerce and industry sector Like other parts of the Hong Kong economy, the commerce and industry sector has changed in relation to changes in China. When China was largely closed of to the world because of its own policies and an American-led embargo, Hong Kong picked up the slack in supply and became a vibrant manufacturing centre in Asia. When China reopened for business under Deng Xiaoping, Hong Kong companies moved their manufacturing inland to the Pearl River Delta. Since then, commerce has increasingly focused on Hong Kong’s historically core activity of trade and transport. As at 2012, the Hong Kong commerce and industry irms engaged mainly in services connected to the transfer of goods through harbour logistic services, the transfer of people by air and sea, and the transfer of data for the residents of Hong Kong. he leading component companies of the HSI commerce and industry sub-sector examined here are thus active in logistics and port services, air and ferry transport services, and telecommunications. he irst group discussed is Jardine Matheson, a company that was instrumental in founding the colony of Hong Kong,120 and also an initial component of the HSI in 1964, but one that was removed from the HSI in 1994 when Jardine moved its listings 117 118

119

120

SHK Properties Annual Report 2012, p. 107. Other than the newly appointed Adam and Edward, who serve as their fathers’ alternates, family members on the SHK Properties board are limited to homas, Raymond and their uncle, Kwong Chun (Walter Kwok is listed as a nonexecutive director, but there is no indication that he is active in that position). See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). Tsang (2004: 17).

86

Hong Kong’s economic structure

to the London and Singapore stock exchanges.121 Because the London stock exchange provides disclosure of major holdings comparable to that under the SFO, information on current shareholding data is still available through the lead company’s annual report. Next, the three largest Hong Kong companies in the sub-index are examined: China Mobile Limited, Hutchison Whampoa Limited and Swire Paciic Limited. Lastly, two large SOEs with limited Hong Kong activity are also examined – both as important components of the sub-index and more importantly as examples of what one might expect as the future leaders in the Hong Kong economy. hese are China Resources and CITIC Paciic, which entered Hong Kong in recent decades and have become signiicant global players in minerals and heavy industries. Measured by total assets, these ive companies represent 26.7 per cent of the 25-company commerce and industry sub-index, and that igure increases to over 56 per cent when the other mainland SOEs are excluded from the calculation. he components of the commerce and industry sector relect two signiicant trends in the development of Hong Kong: irst, the absence of manufacturing companies evidences how the Chinese Region of Hong Kong has adjusted its activity in symbiosis with the economy of mainland China, and second, the declining local presence of Jardine Matheson relects the declining local importance of colonial ties, while the entry of China Resources and CITIC Paciic relects the increasing integration of the Hong Kong economy into that of mainland China, as well as the importance of the PRC as a controlling shareholder in Hong Kong. hus, an important corporate governance aspect of this trend is that dominant physical person shareholders are being replaced by dominant state-controlled shareholders. Protection against abuse by controlling shareholders remains a high priority, and ministerial ties may replace family ties as an institutional ordering network running parallel to (and potentially conlicting with) duties of oice under company law. It goes beyond this – and indeed any study that is not expressly political economic – to speculate on the inluence that Beijing could potentially place on Hong Kong courts and regulatory authorities in connection with local attempts to discipline such large SOEs.

a Jardine Matheson he relationship between Jardine Matheson and Hong Kong pre-dates the founding of the British colony. When in 1839 Guangdong Commissioner Lin Zexu destroyed 20,000 chests of opium, it was William Jardine who 121

See www.jardines.com, History, ‘Redei ning the Group (1980–1999)’ (accessed 15 March 2014).

Keswick Family 9.2% of holding declared held by Keswick Family directors

Jardine Matheson Holdings Limited Diversified Conglomerate Incorporated in Bermuda Listed on LSE Owner % held by owner Jardine Strategic Hldgs 55.53 The 1947 Trust 5.36 *39 subsidiaries, 1 associate

Jardine Strategic Holdings Limited 82%

Hong Kong Land Holdings Limited Properties Incorporated in Bermuda Listed on LSE Owner % held by owner Jardine Strategic Hldgs 50.1 *48 subsidiaries, 15 associates

Retail & Food Incorporated in Bermuda Listed on LSE Owner % held by owner Jardine Matheson Hldgs 82.2 Others 17.8 *6 subsidiaries, 1 associate

56%

73% 50%

Automotive Incorporated in Singapore Listed on SGX Owner % held by owner Jardine Strategic Hldgs 72.32 *14 subsidiaries, 5 associates

Dairy Farm International Holdings Limited Retail & Food Incorporated in Bermuda Listed on LSE Owner % held by owner Jardine Strategic Hldgs 77.64 *16 subsidiaries, 3 associates Jardine Pacific Holdings Limited

100%

Holding for unlisted group companies No corporate data available Unlisted Owner % held by owner Jardine Matheson Hldgs 100 Parent lists holdings in 10 unlisted companies in Asia

Figure 2.10 Jardine Matheson Group

Jardine Cycle & Carriage Limited

78% 50% PT Astra International Tbk Auto Parts Incorporated in Indonesia Listed on IDX Owner % held by owner Jardine Cycle & Carriage 50.11 *26 subsidiaries, 19 associates

88

Hong Kong’s economic structure

the other British opium merchants sent to London with $20,000 in funding to lobby the British Parliament for military intervention,122 and a few years later, it was Jardine and Matheson who accelerated the growth of Hong Kong by investing £50,000 in warehousing facilities.123 Tsang tells us that about 100 years later when the Japanese military attacked Hong Kong, a John Patterson – who was both chairman of Jardine Matheson and a member of LegCo – was among the few who stood their ground to defend the island.124 During its long history, Jardine Matheson has supplied Hong Kong and the Region with shipping, logistics, engineering, manufacture of textiles, property development, luxury hotels, grocers, distribution of luxury automobiles, insurance and investment banking.125 In the 1970s, it started to lose its dominant position. Goodstadt argues that under control of the Keswick family during the second half of the twentieth century, Jardine and Matheson failed to integrate with the changing position of the Chinese in Hong Kong, erroneously sought favours and protection from the colonial government, and vainly tried to regain its China market in the north instead of focusing on Hong Kong.126 he Keswicks were afraid that as mainland Chinese inluence in Hong Kong grew, they would be subject to a hostile takeover. When Governor Chris Patten refused to reverse what Jardines allegedly called the SFC’s ‘“pettifogging and vindictive decisions”’ to apply the Takeover Code without a waiver to protect against possible takeover of Jardines by a Chinese business,127 the shareholders of Jardine Matheson voted to transfer the company’s listings to London and Singapore. he most recent shareholding igure publically disclosed shows substantial cross listings between the two lead companies of the Jardine Group and the Keswick family with a signiicant holding in Jardine Matheson Holdings Limited. his igure and the information presented in Figure 2.10 is taken from disclosure made under the UK Disclosure and Transparency Rules. More information on the group’s 200-plus member companies is provided in my online database.128

b China Mobile Limited he predecessor of China Mobile Limited was incorporated in Hong Kong in 1997 to receive assets related to wireless services from China 122 125

126 128

Spence (1990: 156). 123 Munn (2001: 35). 124 Tsang (2004: 122). See Jardines, ‘175 Years of Looking to the Future’, available at: www.jardines.com (accessed 15 March 2014). Goodstadt (2005: 170–3). 127 Goodstadt (2005: 172). See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website).

Hong Kong’s corporate groups

89

Telecom, and listed one month later on the New York and Hong Kong stock exchanges. China Mobile is the largest provider of wireless services in China (and the world), with about 710 million customers,129 a member of the HSI since 1998 and the largest member of the HSI by market capitalization at the end of 2012.130 China Mobile Limited, which is incorporated in Hong Kong, is the most prominent representative of the ‘red chip’ category of blue chip irms whose operations are primarily in mainland China, but are not incorporated under PRC law, and are listed on the SEHK. As Figure 2.11 shows, China Mobile Ltd. is controlled by a 74.08 per cent stake in its capital indirectly held by China Mobile Communications Corp. (CMCC), which is owned by the Chinese central government’s State-owned Assets Supervision and Administration Committee (SASAC).131 China Mobile’s Chairman, Xi Guahua, is also the chair of CMCC and is a former Deputy Minister of the Ministry of Industry and Information Technology.132 his holding not only allows the controlling shareholder alone to adopt ordinary resolutions at the general meeting, but also – when either not all the capital is present at a meeting or 0.92 per cent of the capital joins forces with it – also undertake extraordinary changes to the rules by which the company is governed through amending the articles of association. For this reason, China Mobile provides a strong example of the new type of controlling shareholder in the Hong Kong market. As the dominance of the family controlled businesses wanes, the presence of corporate groups controlled by the Chinese state increases. Protection against prejudicial action by majority shareholders remains an essential for Hong Kong company law, and ministerial ties might come to replace family loyalty as the secondary form of bonding used between shareholder and management. A possible risk that might arise in Hong Kong is pressure by the Chinese central government on the authorities of the Special Administrative Region in connection with the compliance of Chinese SOEs with Hong Kong law and listing rules. Such pressure is, of course, much more obvious and can be applied much easier in Shanghai – where the exchange, the regulator and the courts all are held in one hand – but it could potentially be applied in Hong Kong as well. 129 130

131 132

China Mobile Ltd Annual Report 2012, p. 4. HKEx (2013: 28). China Mobile’s market capitalization was about HK$1.8 trillion. HSBC was second with about HK$1.5 trillion. Together they constitute about 15 per cent of the SEHK’s Main Board market capitalization. See the list of SASAC holdings at: www.sasac.gov.cn (accessed 15 March 2014). China Mobile Ltd Annual Report 2012, p. 6.

90

Hong Kong’s economic structure State-owned Assets Supervision and Administration Committee

China Mobile Communications Corp.

> S* * The annual disclosure only indicates that the holding exceeds the 1/3 threshold.

China Mobile (HK) Group Limited

> S* China Mobile HK(BVI) Limited

74.08% China Mobile Limited Communications

Incorporated in Hong Kong

Code: 941

Owner

% held by the owner

China Mobile Communications Corp.

74.08

Others

25.92

*49 Subsidiaries

*3 Associates

*1 Jointly controlled entity

Figure 2.11 China Mobile

Figure 2.11 summarizes the ownership relationship of the China Mobile Group. More information on the group’s subsidiaries is provided in my online database.133

c Hutchison Whampoa Limited Hutchison Whampoa Limited is a subsidiary of Cheung Kong, discussed above in the section on the property sector, and is ultimately controlled by Li Ka-shing, who has also chaired the company since 1981.134 he Financial Times ranked this subsidiary as the 180th largest company in the world by market capitalization in 2013.135 Its activities include the operation of 52 ports and their related logistics services, the development and operation of real estate and hotels, major transport, water and energy infrastructure, telecommunications providers and retailers in Hong Kong, Asia and Europe. he reader can have an idea of the pervasiveness of Hutchison 133

134 135

See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). Hutchinson Whampoa Ltd Annual Report 2012, p. 96. ‘FT Global 500’, www.t.com (accessed 15 March 2014).

Hong Kong’s corporate groups

91

Whampoa in Hong Kong by knowing that an average resident could spend her life living and working in a couple of its investment properties, buying groceries at Hutchison’s many ‘Park ‘n Shop’ stores, satisfying all needs for consumer electronics from refrigerators to smartphones at Hutchison’s ‘Fortress’, obtaining all toiletries, prescription drugs and wine from Hutchison’s ‘Watsons’ and ‘Watsons’ Wine’, and conducting all communications and data transfer through Hutchison’s ‘3’ network. hrough his control of Hutchison Whampoa, Li Ka-shing also controls its four listed subsidiaries: Hutchison Telecommunications Hong Kong Holdings Limited, Hutchison Harbour Ring Limited, Cheung Kong Infrastructure Holdings Limited, and the latter’s subsidiary Power Assets Holdings Limited. he interests through which these are held are set forth in Figure 2.12. Information on further subsidiaries is available in my online database.136

d Swire Paciic Swire Paciic Limited is a subsidiary of the private UK company John Swire & Sons Limited, which was founded in Liverpool in 1816 and which still has a 68.5 per cent holding in the equity of Swire Paciic Limited. Swire opened its irst Chinese oice in Shanghai (1866) and then in Hong Kong (1870).137 hroughout its history, the company’s Chinese operations have expanded from trading to include sugar and chemicals, distribution of bottled drinks, property development and now perhaps most prominently cargo and passenger aviation. Goodstadt praises Swire Paciic for avoiding the mistakes that the Keswicks made in Jardines. He argues that they ‘managed to look less colonial’, ‘were less mesmerized by dreams of regaining their lost China markets’ and ‘accepted the commercial case for setting aside the racial prejudices of the age’.138 One might add that it was a good idea for Swire to bet on aviation in the 1950s and Coca-Cola in the 1960s, two areas which now account for about 82 per cent of the group’s employees, as well as to choose to develop oice space in central Hong Kong, a segment that generated about 32 per cent of the group’s proits in 2012.139 Unlike the other companies discussed in this chapter, Swire Paciic Limited has two classes of shares listed on the SEHK, with difering 136

137

138 139

See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). Historical information taken from the website, www.swirepaciic.com, ‘About Swire Paciic’ > ‘Company History’ (accessed 15 March 2014). Goodstadt (2005: 173). Swire Paciic Ltd Annual Report 2012, pp. 4, 8.

Hutchison Whampoa Limited Conglomerate Code: 13 Incorporated in HK Owner % held by owner 49.97 Cheung Kong (Holdings) Ltd. Others 50.03 *122 subsidiaries, 4 associates, 46 joint controlled

65.01% Hutchison Telecommunications Hong Kong Holdings Limited Telecommunications Code: 215 Incorporated in Cayman Islands Owner % held by owner 65.01 Hutchison Whampoa Ltd. Others 34.99 *15 subsidiaries 76.39%

Cheung Kong Infrastructure Holdings Limited Infrastructure Code: 1038 Incorporated in Bermuda Owner % held by the owner 76.39 Hutchison Whampoa Ltd. Others 23.61 *10 subsidiaries, 9 associates

38.87% Power Assets Holdings Limited Public Utility Code: 6 Incorporated in HK Owner % held by the owner Cheung Kong Infrastructure 38.87 Holdings Ltd. Others 61.13 *32 subsidiaries, 11 associates, 2 joint controlled entities

Figure 2.12 Hutchison Whampoa Ltd.

71.36% Hutchison Harbour Ring Limited Manufacturing Code: 715 Incorporated in Bermuda Owner % held by the owner 71.36 Hutchison Whampoa Ltd. Others 28.64 *5 subsidiaries

24.47 % Tom Group Limited Advertising Code: 2383 Incorporated in Cayman Islands Owner % held by the owner 24.47 Hutchison Whampoa Others 75.53 *44 subsidiaries

Hong Kong’s corporate groups

93

dividend rights but – complying with the SEHK listing rules – the same voting rights. Although the company’s annual report goes to some length to discuss its various sub-committees of independent directors, it does not explain the distinction between the two classes, and the only mention of a distinction between the class ‘A’ and ‘B’ shares is at the back of the document in a note to the accounts.140 As will be discussed further in Chapter 5, the lack of attention applied to diferential power between shareholders is a problem found in the law and rules surrounding the Hong Kong securities market. he legal framework goes to great lengths to match the ‘best practice’ requirements originating in New York or London (protecting against director abuse), even though such requirements might be unnecessary in Hong Kong (with a 68.5 per cent controlling shareholder, no director will slip from shareholder control), whilst overlooking the real source of governance risk: controlling shareholders and the power they wield directly and indirectly, including through the possible use of ‘grandfathered’ dual class share structures.141 Figure 2.13 summarizes the ownership relationship of the Swire Paciic Group. Information on the more than 200 other subsidiaries controlled by the group is provided in my online database.142

e China Resources he China Resources Group is a diversiied, state-owned concern led by China Resources National Corp., an unlisted PRC company that controls ive subsidiaries that are all listed on the SEHK and operate in the sectors of coal, wind and hydro power (China Resources Power Holdings Co. Ltd.), natural gas distribution (China Resources Gas Group Ltd.), retail outlets and beverages (China Resources Enterprise Ltd.), property development (China Resources Land Ltd.) and the production of cement (China Resources Cement Holdings Ltd.). All of these subsidiary companies are listed on the SEHK as their primary listing, and China Resources Enterprise Ltd. is a constituent of the HSI commerce and industry subindex. he ultimate owner of the group is SASAC,143 but the biographies 140

141

142

143

‘Except for voting rights, which are equal, the entitlements of “A” and “B” shareholders are in the proportion ive to one.’ Swire Paciic Ltd Annual Report 2012, p. 189. SEHK Listing Rules, Rule 8.11(2) provides an express exception to its prohibition of ‘new applicants’ and ‘new issues’ of dual class share structures with diferential voting rights, ‘in the case of those listed companies which already have B Shares in issue’. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). See the list of SASAC holdings at: www.sasac.gov.cn (accessed 15 March 2014).

Swire Pacific Ltd. Property, aviation, beverages, marine services and trading & industrial Incorporated in HK Code: 19 Owner % held by the owner John Swire & Sons Limited 68.49 Aberdeen Asset Management plc 12.4 Others 19.11 *170 subsidiaries

75%

74.99%

Hong Kong Aircraft Engineering Co. Ltd.

Cathay Pacific Airways Ltd. Operating scheduled airline services, airline catering, aircraft handling and engineering Incorporated in HK Code: 293 Owner % held by the owner Swire Pacific Limited 74.99 Others 25.01 *20 subsidiaries, 7 associates

Commercial aircraft overhaul, modification and maintenance Incorporated in HK Code: 44 Owner % held by the owner Swire Pacific Limited 75 Others 25 *5 subsidiaries, 8 joint controlled entities

19.5% Air China Ltd. Providing air passenger, air cargo and airline related services Code: 753 Incorporated in PRC Owner % held by the owner Cathay Pacific Airways Ltd. 55.3 Others 44.7 *17 subsidiaries, 12 associates, 6 joint controlled entities

Figure 2.13 Swire Group

82%

Swire Properties Limited Property Incorporated in HK Code: 1972 Owner % held by the owner Swire Pacific Limited 82 Others 18

Hong Kong’s corporate groups

95

provided for the directors of the ive listed companies do not give evidence of direct ministerial involvement in management. here are no overlapping chairmen or managing directors, and an obvious and useful overlap on all ive boards are the auditors, Mssrs. Du WenMin and Wei Bin, who serve as a nonexecutive directors.144 Figure 2.14 summarizes the ownership relationship of the China Resources Group. More information on the more than 200 other subsidiaries controlled by the group is provided in my online database.145

f CITIC Paciic Another state-controlled company, a subsidiary of which is a component of the HSI, is CITIC Group Ltd., the current lead company of a group created in 1979 under the auspices of Deng Xiaoping to carry forward China’s economic reforms.146 he group is active in minerals (coal, oil, aluminium and manganese, among others) through its Bermuda incorporated subsidiary, CITIC Resources Holdings Ltd., it produces specialty steel products and mines iron ore through CITIC Paciic Ltd. (a Hong Kong company), and conducts commercial and investment banking services through CITIC Bank Corporate Group (also incorporated in Hong Kong). CITIC Group has a Bermuda associated company, CITIC 21 CN Co. Ltd., which is engaged in consumer product quality control and communications. hese four companies are all listed on the SEHK, and CITIC Paciic Ltd. is a component of the HSI commerce and industry subindex, comprising 3 per cent of the total aggregate assets of the sub-index (6 per cent if H-shares are excluded). CITIC Paciic has two subsidiaries listed on the SEHK, CITIC Telecom International Holdings Ltd. and Dah Chong Hong Holdings Ltd., both also incorporated in Hong Kong. he group is engaged in a number of international joint ventures, and Banco Bilbao Vizcaya Argentaria S.A. (BBVA) holds 15 per cent of CITIC Bank Corporate Group. 144 145

146

China Resources Power Holdings Co. Ltd. Annual Report 2012, pp. 15–16. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website). As CITIC Bank explains: ‘CITIC Group is China’s leading state-owned multinational conglomerate, focusing its investment in i nancial services, information technology, energy and heavy industries, with business operations in Hong Kong, US, Canada and Australia. Initiated by Mr. Deng Xiaoping, Chief Architect of China’s reform and opening-up, and approved by the State Council, CITIC Group was established in October 1979 by Mr. Rong Yiren, former Vice President of China, as the irst window corporation in China for reform and opening up. Its registered address and place of business are both in Beijing.’ CITIC Bank Corporate Group Annual Report 2012, p. 109.

State-owned Assets Supervision and Administration Committee

China Resources National Corp. (CRNC)

63.51%

67.99%

51.33%

China Resources Power Hldgs

China Resources Enterprise Ltd.

China Resources Land Ltd.

Retailing Hong Kong Code: 291

Properties

Electric Utilities

Hong Kong Owner

Code: 836 % held by owner

Owner

CRNC

51.33

CRNC

63.51

Others

48.67

Others

36.49

*28 subsidiaries, 2 associates, 10 jointly controlled entities

*46 subsidiaries, 11 associates

Code: 1109

Owner

% held by owner

CRNC

67.99

Others

32.01

*146 subsidiaries, 3 associates

63.95%

73.34%

China Resources Gas Group Ltd. Gas Utility

Bermuda

Code: 1193

Owner

% held by owner

CRNC

63.95

Others 36.05 *15 subsidiaries

Figure 2.14 China Resources Group

Cayman Islands

% held by owner

China Resources Cement Holdings Ltd. Cement Code: 1313 Cayman Islands Owner % held by owner

CRNC

73.34

Others 26.66 *96 subsidiaries, 4 associates

Hong Kong’s corporate groups

97

Each of the six listed companies of the CITIC Group complies with the listing requirements on the SEHK, and there are no obvious ministerial connections on these companies’ boards. However, despite the currently robust appearance of its corporate governance, CITIC Paciic was victim of rogue currency trading (through leveraged FX forward contracts) and insider trading scandals in 2008.147 hese problems evidenced a breakdown in board monitoring (with regard to the currency forwards) and a failure promptly to disclose information to investors (which created opportunity for insider trading).148 hese scandals showed both the readiness of the SFC to act, as it immediately launched an investigation,149 and of the PRC state-owned controlling shareholder to inject (HK$1.5 billion) capital into CITIC Paciic to prop up its share price.150 A related insider trading violation occurred from Morgan Stanley’s position of advisor to CITIC Resources, and led to the criminal conviction of a Morgan Stanley managing director, Du Jun.151 It is notable that in the context of these cases Hong Kong regulators were vigorous (following a relatively docile period leading up to the Global Financial Crisis (GFC)) and the PRC government entered with rescue funding, but not with (any visible) pressure on either the Hong Kong regulators or courts. Although these events occurred during the rareied atmosphere of the GFC, the SFC has continued to supervise more aggressively and we must assume that the position of the mainland government has remained unchanged with respect to Hong Kong regulatory autonomy. Figure 2.15 summarizes the ownership relationship of the CITIC Group. More information on the roughly 200 other subsidiaries controlled by CITIC Group Corp. is provided in my online database.152

4 Governance relevant information summarized for the dominant corporate groups he foregoing analysis of 15 major corporate groups with companies listed on the SEHK has revealed three types of ownership patterns: 147

148

149

150

151 152

See, e.g., Carol Chan, ‘SFC Investigates Entire Board of CITIC Paciic’, South China Morning Post (4 April 2012). SFC, ‘Former CITIC Paciic Senior Executive Jailed for Insider Dealing’ (27 November 2012), available at: www.sfc.hk (accessed 15 March 2014). See ‘Investigation Commenced on CITIC Paciic Limited’ (22 October 2008), available at: www.sfc.hk (accessed 15 March 2014). Tom Mitchell, ‘CITIC Pays Price for HK Arm’s Forex Gamble’, Financial Times (12 November 2008). See the Court of Appeal decision, HKSAR v. Du Jun [2012] HKEC 1280. See the data available at: https://sites.google.com/site/davidcdonald/ (author’s personal website).

The People’s Republic of China

CITIC Group Corp.

61.85%

57.51%

CITIC Bank Corporation Ltd.

CITIC Pacific Ltd.

Finance Incorporated in Code: 998 PRC (H shares) % held by owner Owner

Steel, property, iron ore mining Code: 267 Incorporated in HK % held by the owner Owner 57.51 CITIC Group Corp. 42.49 Others

61.85 (A) CITIC Group Corp. 34.22 (H) BBVA 65.78 (H) Others *5 subsidiaries, 2 associates

*70 subsidiaries, 15 associates, 25 joint controlled entities

60.64% CITIC Telecom Int’l Hldgs Ltd. Telecommunications Code: 1883 Incorporated in HK % held by owner Owner 60.64 CITIC Pacific Ltd. 39.36 Others *25 subsidiaries

CITIC Resources Holdings Ltd. Natural resources Incorporated in Bermuda Code: 1205 % held by owner Owner 59.43 CITIC Group Corp. 40.57 Others

55.68%

Dah Chong Hong Holdings Ltd.

Automotive Code: 1828 Incorporated in HK % held by owner Owner 55.68 CITIC Pacific Ltd. 44.32 Others *41 subsidiaries

Figure 2.15 he CITIC Group

59.43%

21.73%

CITIC 21 CN Co. Ltd. Software, IT consulting Incorporated in Bermuda Code: 241

Owner CITIC Group Others

% held by owner 21.73 73.27

*28 subsidiaries

Hong Kong’s corporate groups

99

Table 2.1 Shareholding types for groups examined Shareholding structure

Financial sector

Controlling family (over 30%)

Property sector Cheung Kong Hang Lung Henderson New World Sun Hung Kai

State control (over 30%)

BOC Standard Chartered (18%)

Dispersed (all under 10%)

HSBC BEA

Commerce and industry Hutchison Jardine Matheson Swire China Mobile China Resources CITIC Group

companies with controlling family shareholders, such as Cheung Kong, companies whose controlling shareholder is the government of China, such as China Mobile, and as the exception, widely held companies such as HSBC. As Table 2.1 makes clear, classic ‘Berle and Means’ corporations are restricted to the inancial sector, and government control is heavily concentrated in the commerce and industry sector, with the 18 per cent holding of Temasek as the non-Chinese exception. Following the traditional line of thinking on economic development, we would expect that family companies and state-held companies would evolve towards the higher, more American, form of a company with widely dispersed shareholdings and professional managers. However, when we examine the information available for the lead listed company in the groups discussed, we see a trend towards concentration of holdings rather than towards dispersal. Figure 2.16 shows the concentration trend in shareholding for the major corporate groups analysed in this chapter over the decade from 2002 to 2013. Only Hang Lung shows a slight downward trend in the holding of its controlling members. his could be a result of controlling shareholder repurchases following the GFC, when outside investors began to lose conidence and reinforcing a controlling position was cheap, or it may indicate that the Berle and Means corporation will not be the goal of listed companies in Hong Kong, which is an important fact to consider when building up the Hong Kong regulatory

100

Hong Kong’s economic structure

Holding (per cent) 80

China Mobile

BOC

70

HSBC 60

Henderson

Hang Lung

50

China Resources

Hutchison

40

Sun Hung Kai 30

New World

Cheung Kong

20

CITIC

Standard Chartered

10

BEA 0

Swire 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Figure 2.16 Changes in controlling shareholdings, 2003–12 Notes: Majority share changes of listed irms from 2003–12 *he data on which this igure is based is taken from the annual inancial statements of the companies plotted.

framework with American style protections against strong management. Rather than import such measures, Hong Kong should concentrate on increasing the public loat of listed companies, perhaps by increasing the current 25 per cent threshold,153 and strengthening the protections ofered against the abusive acts of controlling shareholders. Company law establishes a division of labour between shareholders and directors, with the latter setting policy and approving ordinary management, and the former becoming involved only annually to elect directors and approve accounts, or occasionally to approve an extraordinary transaction. his is not designed as a system of checks and balances except to the extent that shareholders can check the power of management, including by refusing to re-elect them, removing them from oice and suing them for a breach of iduciary duties. When the board of directors is chaired and led by a controlling shareholder or a close family member thereof, the risks to minority shareholders can multiply, given both the concentration of power and the information instantly available to the majority. In a listed company, exit is always a viable option, but this is not something an international inancial centre should encourage, as it thrives by attracting such shareholders from the entire global market. hus, controlling 153

SEHK Listing Rules, Rule 8.08(1)(a).

An exchange dominated by other countries

101

Table 2.2 Controlling shareholder – board control overlap Shareholding structure Shareholder or related party is chairperson

Shareholder or related party is CEO Shareholder or related party is executive director

Family holding Cheung Kong Hang Lung Henderson Hutchison Sun Hung Kai Jardine Cheung Kong Henderson Sun Hung Kai Jardine Cheung Kong Hang Lung Hutchison Henderson Sun Hung Kai New World Jardine

Government holding

Widely held

China Mobile (ministerial connection)

BEA (minority, founding shareholder)

China Mobile (ministerial connection)

BEA (minority, founding shareholder)

China Mobile (ministerial connection)

BEA (minority, founding shareholder)

shareholder domination of the board is not something that is oten desirable. Table 2.2 shows that based on the 2012 annual reports for the 15 corporate groups examined, the overlap between controlling shareholders and board control existed primarily in the family operated property development concerns, and in Jardine and Matheson. Going forward, it may be advisable for rules on the information to be provided about directors to better bring out collateral ties (such as ministerial or administrative agency ties) for the board members of an SOE.

C An exchange dominated by other countries’ companies An important characteristic of the SEHK that presents a serious challenge for governance of listed companies in Hong Kong is the fact that, by introducing rules into its company law, it would directly afect the behaviour of only about 13 per cent of the companies listed on the exchange, as only this percentage are incorporated under Hong Kong law. his is a very diferent state of afairs than that found on the New York Stock Exchange (NYSE), where the portion of companies not incorporated under the law of a US

102

Hong Kong’s economic structure

Cayman Islands 41.69%

Bermuda 31.73% Hong Kong 13.25%

PRC 11.18%

The others 2.15%

Figure 2.17 SEHK listed companies – place of incorporation

state was only about 25 per cent in 2007,154 the most recent year for which publicly available data could be located. Moreover, it is extremely rare for a foreign company to list its ‘foreign’ shares directly on the NYSE through a so-called global share.155 Most listings of foreign companies take place only indirectly, with their shares being deposited in a pool of such securities held by a US bank and the latter issuing ‘depository receipts’ (‘American Depository Receipts’, or ADRs) giving the holder rights against such securities. In Hong Kong, the company law shaping the governance and shareholder rights for the largest portion of companies on the SEHK (about 42 per cent) is not Hong Kong, but that of the Cayman Islands, with the law of Bermuda (about 32 per cent) coming next, followed in fourth place by that of the PRC (about 11 per cent), with the remaining 13.25 per cent constituted by Hong Kong companies and another roughly 2 per cent made up of the companies governed by the laws of the British Virgin Islands, Jersey and non-UK origin jurisdictions such as Italy and Japan. Moreover, these shares are directly listed, without the prophylactic intervention of a trust bank issuing depository receipts. Figure 2.17 displays the breakdown. Changes in statutory company law can afect the manner in which directors are elected, the composition of the board of directors, the powers of the shareholders over decisions such as calling meetings, declaring dividends, approving reorganizations of the company and removing directors. Moreover, company law (whether statutory or case law) also deines the iduciary duties and duties of care of the directors and the power of shareholders to bring action against (1) misconduct of directors and (2) mismanagement of the company, particularly through abusive behaviour of the controlling shareholders. he ‘incorporation principle’ conlict of laws rule that applies to company law in nearly all jurisdictions 154 155

See www.nyse.com, at ‘international’ > ‘nonuslisted’ (accessed 15 March 2014). Gruson (2001).

An exchange dominated by other countries

103

HKD mil 6,000,000.00 5,000,000.00 4,000,000.00 3,000,000.00 2,000,000.00 1,000,000.00

19 9 19 3 9 19 4 95 19 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 01 20 0 20 2 0 20 3 0 20 4 05 20 0 20 6 0 20 7 0 20 8 09 20 1 20 0 11 20 1 20 2 13

0.00 Year

Figure 2.18 SEHK Main Board, market capitalization of H-Shares (HKD mil), 1993–2013

provides that the company law of the country of incorporation applies to all such matters of governance. hus, under normal circumstances, the Hong Kong market would be subjected to the desires of the jurisdictions scattered around the world that govern 86 per cent of its listed companies. One country of origin – the PRC – has had a massive impact on the size of the SEHK, and thus presents a signiicant risk for corporate control. he H-share companies incorporated under PRC law are in most cases the heavyweights of the SEHK. Figure 2.18 presents the rising presence of H-share companies (by market capitalization) on the SEHK since 1994. As discussed in Chapter 3, Section C.5, Hong Kong has addressed these risks in a number of ways. First, a requirement for listing on the SEHK is that each foreign company comply with the same listing rules as Hong Kong companies. Second, where this is deemed necessary, these companies must amend their articles of association to provide for protections comparable to those found in Hong Kong law, such as the power to remove a director with an ordinary resolution of the shareholders. hird, the Companies Ordinance contains an outreach provision for the sections providing shareholder rights to ile derivative and unfair prejudice actions. As will be discussed in the next chapter, these provisions apply to companies with a ‘place of business’ in Hong Kong, which includes a listing on the SEHK. In this way, much of Hong Kong company law extends its protection to the shareholders of companies incorporated anywhere in the world, if they are listed on the SEHK.

3 Hong Kong corporate and securities laws in response to the Region’s role as China’s international inancial centre A Evaluating Hong Kong law on the basis of local risks As we have seen in Chapter 1, Hong Kong is fascinating from the points of view of comparative law and socio-economic development. It combined the peculiar characteristics of a colony enduring on the territory of an unconquered, albeit weakened, China that served as a refuge for subjects leeing China during various periods of economic, political and social woes, and was then transferred back to China as this country’s economy skyrocketed towards global economic leadership, destined to serve a crucial role as booming China’s (preliminary?) international inancial centre. Britain kept Hong Kong, like any other colony, only because it served commercial and strategic purposes, but unlike almost all colonies, Hong Kong developed into a unique, cultural sub-unit of the nation from which it was carved out, with a large, homogeneous majority of Chinese ‘voluntarily’1 accepting (ultimate) rule (outside of their local, private ordering) by a tiny minority of British oicials. he arrangement was accepted ‘voluntarily’ because the colonial government usually presented a better political and economic milieu than did mainland China during the colony’s 156 years of existence. he core of Hong Kong’s early legal system was a collection of ordinances designed to meet colonial needs, coupled with a link to the common law as it developed in Britain and its empire. he larger outer circle of social ordering in Hong Kong more oten consisted 1

As explained in Chapter 1, although Hong Kong was oicially ceded to Great Britain as a booty of the i rst Opium War, a number of factors indicate that this arrangement was attractive to the Chinese people who populated the area: (1) Hong Kong and the Kowloon Peninsula were largely uninhabited, but this changed ater the British turned Hong Kong Harbour into its southern Chinese port, (2) available records show this inlowing population was always well over 90 per cent Chinese, and (3) histories document a constant low of Chinese subjects moving luidly between Guangdong and Hong Kong, but – in a time of numerous rebellions and uprisings – no serious attempt to expel the British from the Island.

104

Evaluating Hong Kong law

105

of arrangements under Chinese customary law and practice, and we have seen in Chapter 1 that the colonial government openly recognized this. Following a century and a half of incubation during which these English and Chinese ordering arrangements interacted with each other, the community of about seven million Chinese with an Anglicized legal system, public administration and sense of justice rejoined their mother country as a ‘Special Administrative Region’. Hong Kong had lipped from being a mainly Chinese component serving British foreign commerce to an Anglicized unit serving Chinese international inance. Only history will tell us what impact this small bit of leaven will eventually have on the massive Chinese loaf.2 he evidence displayed in this chapter’s examination of company and securities law, however, shows that Hong Kong’s return to China in 1997 is correlated with – or even the cause of – the colony’s commercial infrastructure exiting the conservative holding pattern it navigated during most of the post-war period, and launching into a vigorous programme of renovation in competition with other Asian inancial centres, particularly Shanghai and Singapore. Fiteen years ater its return to China, Hong Kong’s company and securities laws generally meet international standards as to content, but they must also be examined to ascertain whether they meet the particular risks that Hong Kong – with the unique socio-economic constellation outlined in Chapter 2 – presents. Both company and securities laws are designed to ensure eicient and fair commercial activity. Each of these systems of law enables the creation of entities the law endows with special characteristics like companies limited by shares and licensed broker-dealers, but each also seeks to limit risks arising in connection with the use of such entities. he speciic balance of ‘fairness’ that these systems of law attempt to ensure can only be judged in relation to the actual, local context and the forces at work that could provoke unfairness. In company law, fairness is oten concerned with balancing the legitimate expectations of the various constituencies of the company (e.g. directors, majority shareholders, minority shareholders and creditors) and is generally achieved by overcoming the risk that a person to whom the law delegates power will use such power for personal beneit and to the detriment of another constituency in the company. Since the 1970s, these problems of delegated power have been referred to 2

By focusing on corporate, securities and tax laws, this study brackets out to a certain extent the central contribution that Hong Kong might make to mainland China, which is ‘rule of law’ in all its manifestations, particularly in the areas of human rights, environmental regulation and regulatory monitoring of foodstufs, cosmetics and pharmaceuticals for safety.

106

Hong Kong corporate and securities laws

as ‘agency problems’,3 even though no constituency in a company acts in a strict legal sense as an agent for another. hese problems arise because the use of a corporate entity almost always entails a delegation of power, whether to a professional manager from the company’s owners or to a resolving majority of shareholders from those shareholders who i nd themselves in the minority on a given resolution’s vote. Such delegation is inherent to the company structure. For this reason, company law contains a number of mechanisms designed to allow shareholders to control the actions of management and seek redress against management abuse, as well as to protect minority shareholders against any unfairly prejudicial actions of the majority. Another problem that arises in connection with the corporate form is that both shareholders and the managers they appoint, neither of whom have any liability for the company’s debts, control funds lent to the company by creditors. hus company law also ofers tools for creditor protection. As Armour et al. very well explain, each of these three relationships present an instance of agency problems – between shareholders and management, between majority and minority shareholders, and between shareholders and creditors – for which company law has developed countervailing strategies.4 Securities regulation, on the other hand, as Langevoort observes, ‘has two main subject areas: the regulation of the securities markets and the securities industry, and the regulation of corporate issuers and information about issuers’.5 Company law connects with securities regulation because companies issue securities, which are sold to the public and traded on the stock market. Securities regulation attempts to give every investor the opportunity to make an informed decision and ensure that the price at which securities are sold is not distorted. Risks include that investors receive false, misleading or incomplete information about issuers or their securities, that the intermediaries executing trades or holding securities disappear – taking the investor’s securities with them – because of dishonesty or bankruptcy, and that some traders exploit information that has not been disclosed to ordinary investors or place unsupported pressure on the price at which ordinary investors buy or sell securities. hus, securities regulation focuses on requiring issuers to disclose information to investors,6 licensing and supervising market 3

4 6

On the concept of ‘agency problem’ and ‘agency costs’, see Jensen and Meckling (1976: 309). 5 Armour et al. (2009: 35). Langevoort (2009: 1027). See the discussion in Paredes (2003: 417–30).

Evaluating Hong Kong law

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participants,7 and policing against the abuse of market integrity through insider dealing or market manipulation.8 he intensity of each of the risks referred to above can vary depending on the socio-economic and institutional context in which companies are operating or securities are being traded. he gravity of each agency problem in a given company will depend on the real shape of the company in question, which is a factor not only of legal institutions, but also of the ownership patterns in similar companies in the economy where it is incorporated.9 For example, where shareholdings are widely dispersed among a number of poorly organized investors, collective action problems will augment the risk of management abusing the rights of shareholders, but where only a few, well-organized shareholders own a company, it will be relatively simple for them to monitor and control management. he risk that, absent regulatory requirements, an issuer will not release true and complete information to investors will depend on the governance regime to which the issuer is subject, the nature of the instruments sold, and the sophistication of the investors, as well as market expectations. he risk that absent regulation traders will abscond with securities, operate with insuicient capital, trade on inside information or manipulate market price will vary as a factor of market size and customs, as well as in relation to the real impact of reputational sanctions on a given trader’s proits. he company law and securities laws in a speciic socio-economic setting should provide countervailing strategies against those agency problems, risks and abuses that are most likely to occur in that setting. When regulatory tools are transplanted or borrowed from another jurisdiction, however, it is possible that the regulation implemented, while efective in the setting from which it is borrowed, will not address the real dangers 7

8

9

See IOSCO (2010: 11): ‘here should be initial and ongoing capital and other prudential requirements for market intermediaries that relect the risks that the intermediaries undertake. Market intermediaries should be required to establish an internal function that delivers compliance with standards for internal organization and operational conduct, with the aim of protecting the interests of clients and their assets and ensuring proper management of risk, through which management of the intermediary accepts primary responsibility for these matters. here should be procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.’ See IOSCO (2010: 12): ‘Regulation should promote transparency of trading. Regulation should be designed to detect and deter manipulation and other unfair trading practices.’ For a discussion of the varying risks associated with ‘block’ or ‘dispersed’ shareholding, see Chei ns (2010); Barca and Becht (2001); Cofee (2001).

108

Hong Kong corporate and securities laws

presented locally.10 For example, at least since 2000, it has oten been the case that an image of the ‘Berle and Means’ corporation11 dominates discussion on corporate governance, so that a jurisdiction might be expected only to introduce American-style remedies (designed for typical US agency problems) to boost its corporate governance rating, even if the jurisdiction’s economic and shareholding structure is very diferent from that in the United States.12 Such a cosmetic i x can leave pressing local agency problems unaddressed, and in the case of a former colony like Hong Kong, the probability is high that measures could be imported (from the UK or a Commonwealth country) whether or not they it local conditions. he analysis in Chapter 2 of the Hong Kong economy with a focus on the corporate groups that dominate it lagged some trouble spots that should attract legislative and regulatory attention. We have also seen that various business sectors have direct representation on the Legislative Council, that the banking sector has been historically strong and active, that block shareholders oten dominate large, listed companies, and that corporate groups conduct coordinated activity in broad sectors of the economy. To this must be added that the vast majority of the companies listed on the SEHK are not incorporated in Hong Kong, and that nearly all Hong Kong incorporated companies are private companies.13 he presence of these characteristics in the Hong Kong economy tell us much about the entities 10

11

12

13

his is a well-known danger of transplanting law from one jurisdiction to another. As law develops within a speciic socio-economic framework it is natural that it address its original context’s problems. However, the country receiving the transplant will have diferent needs and capabilities, particularly thanks to a diferent set of institutions and cultural attitudes towards the regulated area. Without adjustment, local problems can remain unaddressed, while organs serving important functions in the ‘donor’ country remain useless in the new environment. See Berkowitz et al. (2003). As mentioned in Chapter 2 , this is a reference to he Modern Corporation and Private Property, published by Adolf Berle and Gardiner Means in 1932, which i rst formulated the problem of separating ownership and control where shares are widely dispersed. As Roe explains, ‘As the number of stockholders increases, the capacity of each to express opinions is extremely limited. As a result, corporate wealth is held by shareholders as a “passive” investment while managers control the corporation.’ Roe (1994: 6). See Clarke (2006: 205–16) for an analysis of why the transplanted US institution of ‘independent’ nonexecutive director into Chinese companies is not an efective corporate governance measure. Another example is under pressure from Anglo-American oriented institutional investors, the German code of corporate governance recommends inserting the US institution of an ‘audit committee’ into the Aufsichtsrat, or supervisory board, a body made up of nonexecutive directors exactly for the purpose of appointing and supervising the managing directors, including their preparation of the accounts. See the discussion in Cahn and Donald (2010: 450–1). See Subsections C.4 and C.5 of this chapter.

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using the legal system and how they are controlled, and what risks the law should at least consider addressing. For purposes of the analysis in this Chapter, I formulate these structurally determined risks as follows: • he power of business and professional associations through direct legislative representation as functional constituencies may have been employed to stymie company and securities law reform or shape the content of such laws to an extent not acceptable from the perspective of a representative government. • Strong majority shareholders may abuse their companies and the rights of minority shareholders. • Subsidiaries could be subjected to detrimental decisions beneiting other group companies. • Creditor protection may tend to favour well-organized, sophisticated creditors like banks, to the detriment of unsophisticated creditors. • he limited power held by small, private companies could lead to company law legislation failing to recognize the exigencies of SMEs. • Persons investing in the stock market could be damaged by governance abuses in the management of issuers incorporated under foreign company law. • Hong Kong is a geographically small area, with a relatively tight community and set of business leaders who know each other, which could lead to abuse of inside information and market manipulation. Section B will look at the irst of these questions through an examination of how Hong Kong company and securities law has developed over the years. Although law reform in Hong Kong has oten been glacially slow, there is no clear correlation between the interests of speciic functional constituencies and the speed at which company and securities law were enacted or updated in Hong Kong. he remaining questions listed above will be examined in Section C of this chapter on the basis of the law as it now stands, with particular focus on the written law. Enforcement in Hong Kong will be examined in Chapter 5. With respect to company law and the presence of large shareholders in Hong Kong, it will be seen that Hong Kong has insuicient protection for minority shareholders against majority action, although the judiciary has taken a strong stand in favour of investor protection on a number of occasions,14 and has repeatedly 14

See, e.g., Re PCCW Ltd [2009] HKEC 738, CA (attempted circumvention of minority head count vote invalidated); Luck Continent Ltd v. Cheng Chee Tock heodore [2012] HKEC 567 (extension of unfair prejudice action to a listed company). hese cases are discussed in Sections C.1.b and C.2 , below.

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underlined the importance of protecting investors.15 he rules available for the governance of corporate groups are rudimentary, but on the whole above average among common law jurisdictions.16 he inluence of banks and the legal profession, both of which are formally represented in the LegCo and beneit from the use of complex security arrangements in Hong Kong law likely contributed to the retention of company law charges, and path dependence might have worked against the introduction of a stronger capital maintenance regime for unsecured creditors. As a result, Hong Kong law contains strong tools for the protection of sophisticated creditors and few safeguards for other types. he rules for private companies have been repeatedly amended in recent years, showing a local legislation that is responsive to the needs of small business, which constitute the primary users of the Hong Kong company form. As explained in Chapter 2, about 75 per cent of companies listed on the SEHK, the exchange capable of boasting the best regulatory standards in China, are incorporated neither in Hong Kong nor in China, but in the Cayman Islands or Bermuda, although their centre of business operations is mainly in China. It is doubtful that any defect in Hong Kong company law has driven companies to incorporate in such jurisdictions before listing on the SEHK, and the popularity of such law likely instead relects a combination of political fears in connection with the return to Chinese sovereignty and embedded ineiciencies within the Chinese corporate and securities laws. In the alternative route of incorporating and listing in China, incorporation would be expensive, listing would be bureaucratically diicult and any funds received from foreign investors as well as dividends to such investors would be subject to numerous controls on investment and exchange.17 As for market integrity, Hong Kong’s 15

16

17

For example, in response to an Australian court’s restrictive interpretation on how a shareholder right to information should be applied, Harris J of the Hong Kong Court of First Instance observed regarding an identical provision: ‘By enacting section 152FA, the legislature provided an important new procedure for the protection of shareholder rights and interests and the community’s more general interest in the maintenance of good corporate governance. Section 152FA should therefore be interpreted and applied in a manner consistent with these legislative objectives. h is can be achieved through taking a generous approach to the interpretation of what constitutes an interest “reasonably related” or “germane” to the applicant’s status as a shareholder.’ Wong Kar Gee Mimi v. Hung Kin Sang Raymond [2011] HKEC 1164. As will be discussed below, the options range from a specialized framework of statutory provisions, as is used in Germany, to a general reliance on court made equitable duties, as are employed in Delaware. See Cahn and Donald (2010: 677–89). On incorporation and listing, see Wang (2014: chapters 4 and 9), on round-trip investment, Wei (2010: 123–35).

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law and regulations meet international standards, and as discussed in Chapter 5, the steady low of enforcement actions, taken together with an absence of large insider trading or market manipulation scandals being uncovered, tend to indicate that the existing risks are being addressed efectively. Moreover, perhaps for the same reasons that small countries tend to have less corruption,18 it appears that the reputation impact within the small inancial community of Hong Kong has made both formal and informal reputational sanctions on issuers, broker-dealers and gatekeepers (auditors, lawyers, listing sponsors)19 a strong enough deterrent to ensure a high level of legal compliance without ‘heavy-handed’20 regulation. Before turning to these questions, Section B will examine the development of Hong Kong company and securities law and the reasons behind stagnation or reform.

B Law transplanted (only) as the need arose 1 Slowly evolving company law Loh argues that the allocation of separate votes to general and functional constituency representatives for the passage of bills that are introduced into the Legislative Council by persons other than the government is ‘designed to thwart legislative initiative’.21 It is generally thought that the Competition Bill, which sufered neglect and languished in the LegCo for over ten years, was an example of such ability to thwart legislative change.22 As will be explained below, company law in Hong Kong has evolved at a pace that – although it never sank to that of the Competition Bill – would clearly have been unsatisfactory for a leading inancial centre. From the evidence available in connection with amendments proposed and adopted, however, the stagnation of the statutory company law in Hong Kong seems more a case of negligence than of vested interests bent on impeding reform. Its accelerated development in recent years correlates with Hong Kong’s handover to China and its growth as an international inancial centre. Hong Kong received its company law and securities law, as well as the shape and philosophy of its inancial regulation, through the colonial 18 19

20

21

See Amin (2011). On the diference in quality between Hong Kong and mainland Chinese gatekeepers, see Meng (2013). As will be discussed in Section C , much of Hong Kong regulation is expressed in the form of guidelines issued by the SFC and listing rules issued by the SEHK, neither of which have directly enforceable civil or criminal penalties. Loh (2009: Kindle location 447). 22 Loh (2009: Kindle location 446).

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administration as transplants from Great Britain – either directly or in forms that had already been adjusted for use in other colonies. Its tax law harks back to the colony’s founding as a free port.23 As discussed in Chapter 1, the basic commercial framework for the colony’s operation was laid down with a set of ordinances in 1843–4, including linking decision-making in the colonial courts to British common law. Hong Kong’s irst Companies Ordinance (CO) was enacted in 1865,24 and was modelled on the English Companies Act 1862.25 Providing the core of a standard companies act, the 161 section CO 1865 provided for the creation of companies limited by shares, by guarantee and without limit on liability,26 their management27 and their winding up.28 he required constitutional documents were the memorandum and articles of association (a feature of Hong Kong law until 2014),29 and just as was done until 2014, a model articles was appended to the Ordinance as Table A of Schedule 1. he Ordinance also provided for annual general meetings30 and a vote by proxy unless denied in the articles,31 as well as for the creation of a Companies Register,32 to which constitutional documents33 and copies of resolutions must be submitted.34 he 1865 Ordinance was then replaced by the Companies Ordinance 1911 (following the UK Companies Act 1908), which brought in more detailed rules on capital, such as for the issue of warrants,35 greater speciication and binding duties for the keeping of accounts36 and statutory rules on prospectuses for the public sale of shares.37 he 1911 Ordinance was replaced by the more detailed Companies Ordinance 1932 (following the UK Companies Act 1928), which remained the basic framework of company law in Hong Kong for the next 80 years, until the Companies Ordinance 2012 replaced it. Given that the details of management under the UK model are speciied in the articles of association, which can be privately adapted to changing circumstances, and common law decisions from both the UK and the (now) Commonwealth 23

24 25

26 28 30 33 36

An Ordinance for the Incorporation, Regulation, and Winding-up of Trading Companies and other Associations, No. 1, 4 March 1865. Halsbury’s Law of Hong Kong, S.95.002. Although the size of the Ordinance more closely resembles the CA 1856, the fact that the Ordinance included treatment of insurance companies, a feature not found in the CA 1856, Chei ns (2010: 166, Table II), indicates that the CA 1862 rather than the earlier law was the draters’ point of reference. 27 CO 1865, ss 8, 9, and 10. CO 1865, Part III. 29 CO 1865, Part IV. CO 1865, s 15. 31 CO 1865, s 49. CO 1865, s 51. 32 CO 1865, s 160. 34 CO 1865, s 160. CO 1865, s 53. 35 CO 1911, s 38. 37 CO 1911, s 77. CO 1911, s 82–86.

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countries continued to evolve and feed into the Hong Kong courts, company law cannot be said to have stood still during this 80-year period.38 For example, in a 1976 action, shareholders of the property management company Chinese Estates Ltd. sought to have the company wound up for lack of a ‘substratum’, i.e. that it was no longer pursuing its object following sale of its property holdings, but the Hong Kong court referred to recent decisions of UK39 and Commonwealth courts to reach a holding that was much less formalistic than earlier doctrine: the company should survive given its substantial assets and the possibility that it can continue business.40 he company, which survived, eventually through acquisition and reorganization became the holding company of a diversiied investment group.41 A 1978 action42 gives a good example of how the company law of Hong Kong has evolved in courts until today. he High Court was faced with the question whether to approve a request that the Financial Secretary investigate the afairs of a company under an open-ended provision of the Ordinance.43 Finding no guidance in Hong Kong or the UK, the Court surveyed decisions across the Commonwealth, inding guidance in South Africa, New Zealand and British Columbia from which it formulated a principle for deciding the Hong Kong question of law.44 hus, despite antiquated statutory provisions, much of Hong Kong company law remained modern through the activity of the courts, which were free to seek and adopt solutions that had been formulated in the courts of other jurisdictions whose law harked back to a UK companies act. However, it does not speak well for Hong Kong as a business centre that the colonial administration let the CO 1932 largely unchanged for over 50 years. he irst signiicant push for renovation of the company law came, interestingly, in the same year as the Sino-British Joint Declaration, when in 1984 Hong Kong company law took what some call the ‘great leap forward to 1948’,45 incorporating for the irst time many of the changes that were introduced in the UK Companies Act of that year.46 his historical correlation of dates marking improved law and milestones in Hong 38 39 40 41

42 43 44 46

Examples of company law applied by Hong Kong courts will be discussed in Section C.5.c. Particularly Re Kitson and Co Ltd. [1964] 1 All ER 435. Re Chinese Estates Ltd. [1976] HKCU 36. See the website of Chinese Estates Group at www.chineseestates.com, group proi le > group structure (last accessed 31 July 2012). Re San Imperial Corporation Ltd. [1978] HKCU 34. In question was CO s 143. he section was later amended in 1984. San Imperial [1978] HKCU 34, at 3–6. 45 Bates (1985: 167). In 1962, a Companies Law Revision Committee was appointed to consider and make recommendations on Hong Kong’s company law. In ten years, the Committee published

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Kong’s entry to China might also include causation, as it is reasonable to assume that both the Hong Kong government and leading igures in business knew the role a well-developed commercial infrastructure could play in the rebirth of the mainland Chinese economy.47 Indeed, in 1994, the government instructed a consultant to review the Hong Kong Companies Ordinance, with a report due in 1997,48 the year of the colony’s return to China. Although the Hong Kong Companies Ordinance was not completely revised until 2012, from 1984 – when a Standing Committee on Company Law Reform was established together with the ‘great leap’ revision – the Ordinance was amended regularly. hese amendments have been primarily designed to bring in bits and pieces of newer UK and even US law (indirectly through Australia),49 and a number of the changes exemplify an increased focus on shareholder protection: • loosening of the rules on i nancial assistance for listed and private companies;50 • allowing the SFC or oicial receiver to petition the court for disqualiication and removal of company directors;51 • elimination of the common law ultra vires doctrine;52 • relief from share premium reserve requirements in the case of 90 per cent acquisitions of a company with shares or reorganizations of owned groups;53

47

48 49

50 51 52 53

two reports: the Protection of Investor Report and the Company Law Report. he Company Law Report was based on the Cohen Committee Report of 1945 and the Jenkins Committee Report of 1962 in the UK, supplemented by consideration of local conditions in Hong Kong and developments in other Commonwealth jurisdictions. he 1973 recommendations of the Committee in the Company Law Report mainly endorsed the proposals contained in the reports of its English counterparts. See Bates (1985: 167–8) and Kwan (2012: 2.1.2). In a managed economic environment, it is not unusual for steps such as these to be planned in advance. For historical background of the political background to the choice of Hong Kong as a form for listing Chinese state operated enterprises, see Meng (2011: 257–9). Halsbury (2007: 95.0002). An example of such transplantation was a provision introduced in 2004 to give shareholders a right to request access to company books and records for a ‘proper purpose’, now s 152FA of the Hong Kong Companies Ordinance (s 740 of CO 2012) and s 220 of the Delaware General Corporation Law. Introduced by the Companies (Amendment) Ordinance 1991. Introduced by the Companies (Amendment) Ordinance 1994. Introduced by the Companies (Amendment) Ordinance 1997. Introduced by the Companies (Amendment) Ordinance 1999.

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• introduction of written resolutions in lieu of general meetings;54 and • introduction of the right under statute to bring a derivative action against directors on behalf of the company.55 Particularly the increased availability of derivative actions and the use of written resolutions present advantages for minority shareholders, and do not support the thesis of majority shareholder power thwarting amendment of Hong Kong company law. he statutory derivative action allows remedy against management for misconduct if the court grants leave for the petition to go forward,56 and shareholder petitions have found good reception in the courts.57 his piecemeal approach of annual amendments could have been the result of Hong Kong’s long-standing policy of conservative, minimum interference in the market interacting with knowledge of its growing role as China’s gateway to foreign inance in competition with Shanghai and Shenzhen, and compounded by the global ‘corporate governance movement’ that perhaps reached its climax with the US Sarbanes-Oxley Act of 2002.58 he result of adding piecemeal amendments to a statute from 1932 was a law that might generally be assessed as complete, albeit poorly organized, sometimes with antiquated wording, and at places internally repetitious or even conlicting.59 If the piecemeal 54 55 56

57

58 59

Introduced by the Companies (Amendment) Ordinance 2000. Introduced by the Companies (Amendment) Ordinance 2004. An innovation of the statutory derivative action was the adoption of the concept of ‘speciied corporation’, which was dei ned as ‘a company or a non-Hong Kong company’ (former CO s 2), and although the 2012 Ordinance eliminates this concept, it expressly applies statutory derivative actions to non-Hong Kong companies (CO 2012, s 722). Under the former Ordinance, actions could be brought for ‘misfeasance’, which was deined as meaning ‘fraud, negligence, and default in compliance with any enactment or rule of law or breach of duty’ (former CO s 168BB(2)). his concept remains, although the word ‘misfeasance’ has been changed to the more readily understandable ‘misconduct’ (CO 2012, s 731). Under s 168BC(3) of the statutory derivative action as introduced in 2004, leave to bring an action would be granted upon satisfaction of four preconditions: (1) it appears to be prima facie in the interests of the company to grant leave, (2) there is a serious question to be tried, (3) that the company itself has not brought proceedings or if it has, it has not ‘diligently continued, discontinued, or defended those proceedings’, and, that at least 14 days before i ling with the court, the applicant has served written notice on the company, setting out his intention to apply to the court and the reasons for his intention. Hong Kong courts have found the preconditions for a grant of leave present a low threshold for the plaintif shareholder, so that the action may not be lightly dismissed. For recent treatment, see Li Chung Shing Tong (Holdings) Ltd [2011] HKEC 1192 (Court of First Instance) and Waddington Ltd v. Chan Chun Hoo & Others (2008) 11 HKCFAR 370 (Court of Final Appeal). he Sarbanes-Oxley Act of 2002, Pub. L. No. 107–204, 116 Stat. 745. he law contained two diferent, partially inconsistent rules on the sale of shares at a discount, sections 46 and 57, only one of which survived in the new bill introduced to the

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evolution had been carried on annually with changes corresponding to recent developments in belief about best practices, the activity would resemble that of the US state of Delaware, where since 1967 the bar and business communities have fed suggestions to the state legislature on a regular basis, but the legislature never revisits fundamental structural properties of its law, as there is a tacit understanding that businesses rely on Delaware not to modify radically the framework around which they have planned and built.60 hus, a failure to follow the UK in its regular issue of newly renovated companies acts, such as those enacted in 1985 and 2006 – which largely implement EU directives – would not, in itself, be a symptom of uncompetitive regulatory activity in Hong Kong. he open question of whether speciic groups exercise unfair inluence in the formulation of Hong Kong company law, particularly through the functional constituencies, arose during the last days before the Companies Ordinance 2012 was enacted. he Companies Bill contained a provision holding auditors criminally liable if they either ‘knowingly’ or ‘recklessly cause a statement required to be contained in an auditor’s report … to be omitted from the report’.61 he chairman of the committee charged with preparing the Bill for a vote by the Legislative Council, the Honourable Paul Chan, represented the accountancy functional constituency.62 With the argument that the accounting industry can discipline itself, the Hong Kong Institute for Chartered Public Accountants, Hong Kong’s primary auditors association, proposed that the clause be removed.63 he Committee responded to this by noting that the provision had ‘support from SFC, and deputations including Federation of Hong Kong Industries … [and] he Hong Kong Electronic Industries Association’, as well as a secondary accounting association, ‘he Institute of Certiied Management Accountants’, because of the clause’s ‘beneit in enhancing the accountability of

60

61 62 63

LegCo in 2011. Rules on inancial assistance were in provisions provisionally numbered from 47 to 47G, and statutory derivative actions were in sections with auxiliary section numbers running from 168B to 168BK. Article 98 in Table A of the Ordinance in force as of 2013 (Chap 32) still conlicted with s 157B of the Ordinance, despite the latter’s express provision that an article in conl ict would have no efect. With respect to the evolution of the Delaware General Corporation Law, see Romano (1985); Roe (2003, 2009, 2009a); Armour et al. (2012). See s 399 Companies Bill 2011. See www.legco.gov.hk, members’ biographies (accessed 15 March 2014). Report of the Bills Committee on Companies Bill, LC Paper No. CB(1)2221/11–12, para. 106. Available at www.legco.gov.hk, bills committees > bills committee on companies bill (accessed 15 March 2014).

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auditors and integrity of the i nancial reporting system’.64 he clause remained in the Bill, 65 albeit with assurances that under interpretative guidance to be provided by the Companies Registrar, ‘junior accountants will not face criminal liability’ as a result of the provision.66 Another hotly debated provision might say even more about the fairness of lawmaking in Hong Kong, given that it is designed to protect minority shareholders in the context of corporate reorganizations. As explained in Chapter 2 , block-holding majority shareholders constitute the greatest threat to balanced corporate governance in Hong Kong, and a recent, high-proi le case discussed in Section C.2 of this chapter brought the machinating skills of majority shareholders to the attention of the media. he result was an amendment that could be called balanced, given that it appears both reasonably designed to address ineiciencies in the minority protection mechanism and did not reduce protection for those persons who may seek to block a selfserving transaction initiated by a majority shareholder.67 hus, as the discussion of the substance of Hong Kong company law in Section C will evidence, although Hong Kong company law does leave room for improvement in substance, its shape and the (slow) pace of its evolution do not seem to have been prejudiced by the direct representation of business interests in Hong Kong lawmaking. However, the extensive use of foreign incorporation means that a great deal of the regulatory burden for good governance has been shited from the company law to securities laws and listing rules in the Hong Kong market.

2 Crisis-driven securities regulation he Hong Kong laws regulating the sale of and dealing in securities compete well with those of other i nancial centres, both formally and, as will be discussed in Chapter 5, in terms of enforcement. Unlike the regulatory competition for corporate charters oten discussed in the US or EU context, the competition in which Hong Kong engages is inancial: foreign companies enter Hong Kong to access its capital market and seek funds at costs that beneit from Hong Kong’s regulatory framework. he round64

65 66

67

Report of the Bills Committee on Companies Bill, LC Paper No. CB(1)2221/11–12, para. 107. See s 408 CO 2012. Enoch Yiu, ‘Auditors will be Liable under Law Change’, South China Morning Post (15 August 2012). For a discussion of the so-called ‘head count rule’, see Section C.2.

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trip model of companies with China-focused operations that incorporate in a Caribbean jurisdiction and list on the SEHK places signiicant strain on this regulatory framework. he foreign investment, capital account and mutual recognition regimes between mainland China and Hong Kong do not yet allow Hong Kong to compete with the mainland for corporate charters – in spite of signiicant progress made by the Closer Economic Partnership Arrangement (CEPA). A Hong Kong incorporated company cannot simply start doing business in China the way a Delaware company might do business in California or a UK company might do business in France. Although the nine phases of the CEPA completed by 2012 made steady progress in liberalizing cross-border inancial activity and trade, no provision is made for free corporate mobility between China and Hong Kong.68 he ield of battle between Hong Kong and other jurisdictions in regulatory competition is clearly corporate inance: the SEHK and HKFE, supported by the framework of the SFO, the quality of market participants like brokers and banks, the infrastructure supporting funds transfers, clearing and settlement, and the regulatory authorities that license, supervise and discipline market participants – the SFC and HKMA. he importance of the Hong Kong dollar in this context must also be highlighted, given that from the beginning of mainland China’s economic transformation it has provided a solid currency whose exchange is both full and free.69 Lastly, a strong community of professional advisors acting as ‘gatekeepers’ provide what is hoped to be efective supervision and enforcement in the inancial sector.70 Although Hong Kong market 68

69

70

he speciic commitment expressed in the inancial services subsector of CEPA IX provides for continued use of local companies on each side of the mainland–Hong Kong border, as the liberalization measures are designed: ‘To allow Hong Kong securities companies which satisfy the qualiication requirements as foreign shareholders of foreigninvested securities companies, and Mainland securities companies which satisfy the requirements for establishing subsidiaries, to set up equity joint venture securities investment advisory companies in the Mainland. he equity joint venture securities investment advisory company shall be a subsidiary of the Mainland securities company, the scope of business of which shall focus speciically on carrying on securities investment advisory businesses. he percentage of shareholding of the Hong Kong securities company could, at a maximum, reach 49% of the total shareholding of such joint venture securities investment advisory company.’ CEPA. Annex, Supplements and Amendments IX to the Mainland’s Speciic Commitments on Liberalization of Trade in Services for Hong Kong, s 7. Financial Services (emphasis added). On the maintenance of the Hong Kong dollar’s stability through two inancial crises, see Sheng (2009: chapters 10, 15). Meng (2013).

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institutions have been developing for over 100 years, the laws and regulations governing this area of ‘securities regulation’ were slow to come to Hong Kong. In the 40 years since their irst introduction, these laws and regulations have come to meet or surpass international best practices. Unlike the development of company law, securities regulation in Hong Kong – as is generally true in the rest of the world71 – has been established, expanded or improved in the wake of inancial crises. Although securities trading in Hong Kong dates back at least to the mid-nineteenth century,72 and an Association of Stockbrokers was established in 1891,73 which could provide private controls on securities trading, particularly ater its reorganization into the Hong Kong Stock Exchange in 1914,74 statutory rules for exchanges, broker-dealers and market conduct were not introduced until 1973.75 Stimulated in part by the ideological redeinition and subsequent isolation of China following 1949,76 Hong Kong’s inancial sector strengthened throughout the 1950s and 1960s, so that Colony’s Financial Secretary could remark that Hong Kong was ‘“attracting capital from outside … to what could be an embarrassing degree”’.77 In light of that increasing activity, the colonial government asked its Companies Review Committee to look at market regulation, and in 1971 the Committee recommended ‘the appointment of a Commissioner for Securities to assume the registration and monitoring process’ for broker-dealers, supported by ‘an advisory committee composed of men knowledgeable in the securities industry’.78 However, no concrete steps towards the creation of such a body were taken at that time. Even as equity trading overlowed the Hong Kong Stock Exchange and fed the creation of three new exchanges formed in 1969, 1971 and 1972 – the ‘Far East Exchange’, the ‘Kam Ngan Stock Exchange’ and the ‘Kowloon Stock Exchange’, respectively79 – no speciic, secondary market rules were put in place. Only a Stock Exchange Control Ordinance, enacted in early 1973, was drated to prevent further fragmentation of the 71

72 75

76 77 78

From the UK ‘Bubble Act’ of 1720 to the US Dodd-Frank Act of 2010, regulation of the inancial markets has followed public choice, which tends to demand change only when losses have been sufered by market failure of one kind or another. See, e.g., Banner (1998) and Cofee (2012). HKEx (1999: 1). 73 HKEx (1999). 74 HKEx (1999). Material used in this section is drawn in part from he Hong Kong Stock and Futures Exchanges: Law and Microstructure (Donald 2012). I thank the publisher for the right to use such material. See Goodstadt (2007: 90–4). Goodstadt (2007: 164), quoting a statement of J.J. Cowperthwaite made in 1967. 79 Fell (1992: 41). Fell (1992: 38–9).

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market through the opening of more new stock exchanges.80 However, when, ater reaching a peak of 1,775 points in March 1973, the Hang Seng Index dropped about 70 per cent to 433 points at year’s end,81 the colonial government decided to act. In March 1974, at a time when the Hang Seng Index had bottomed out around 400 points, the government adopted a ‘Securities Ordinance’82 and a ‘Protection of Investors Ordinance’.83 he Securities Ordinance imposed licensing and prudential requirements on irms engaging in securities dealing, whilst the Investor Protection Ordinance policed market integrity. he Securities Ordinance imposed initial and continuing licensing requirements on both securities exchanges and broker-dealers,84 created an informally stafed commission to supervise the securities market and a compensation fund for investors damaged by brokers,85 and outlawed short selling, market manipulation and fraud in connection with the purchase or sale of a security, generally.86 In 1978, a prohibition against insider dealing was added to this Ordinance,87 and an Insider Dealing Tribunal was created.88 Although these eforts may appear late compared to the US creation of insider trading rules in 1942,89 it is useful to remember that even the 1978 Ordinance preceded EU eforts in this area by over ten years.90 he Investor Protection Ordinance was a slim, nine-section statute that focused solely on punishing reckless or intentional misrepresentation or advertisement in connection with inducement to purchase securities.91 he penalty imposed for inducing anyone fraudulently or recklessly to 80

81 82 83 84 85 86 87 88 89 90

91

HKEx (1999: 2). Although today such lawmaking might be understood as an ai rmative measure of securities regulation taken to maximize the network efects (liquidity) of securities trading, increase transparency and thus improve market quality, in the context of 1970s Hong Kong, a control on the number of exchanges might better be seen simply as further evidence of a long-standing government stance according to which, in Goodstadt’s words, ‘[r]estrictive practices proliferated … in any area of business that did not face direct competition from abroad’. Goodstadt (2005: 5). See HKEx (1999: 2); Fell (1992: 42); McGuinness (1999: 30). he Securities Ordinance, Chapter 333, 1 March 2974. he Protection of Investors Ordinance, Chapter 335, 29 March 1974. Securities Ordinance (1989 edition), ss 20–97. Securities Ordinance (1989 edition), s 109. Securities Ordinance (1989 edition), ss 80, 135–136, respectively. Securities Ordinance (1989 edition), ss 141A-141F. Securities Ordinance (1989 edition), ss 141G-141L. See 17 CFR § 240.10b–5. he i rst European Economic Community (as it then was) legislation against insider dealing was Council Directive 89/592/EEC of 13 November 1989 coordinating regulations on insider dealing, Oicial Journal, L 334, 18 November 1989, p. 30. Protection of Investors Ordinance, ss 3–6.

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invest in securities was imprisonment of up to seven years and a ine of up to HK$1 million.92 A Commodities Trading Ordinance93 was added to this inchoate regulatory system in 1976, to license and supervise commodities exchanges94 and dealers95 under the auspices of an informally stafed commission, as well as to establish a compensation fund to reduce the risk for investors of defaulting broker-dealers.96 Following the 1986 entrance into force of a 1981 Stock Exchange Uniication Ordinance,97 the four existing stock exchanges were merged into the Stock Exchange of Hong Kong (SEHK) in 1986, and in the same year the popular Hang Seng Index Futures were introduced on the Hong Kong Futures Exchange (HKFE).98 he next signiicant crisis pushing the development of Hong Kong securities regulation forward was a market failure afecting both the stock and the futures exchanges. In 1987, the HSI lost about 52 per cent of its value, falling from 3,968.70 points to about 1,917 during the month of October.99 As prices rose, the HKFE had neglected to raise margin requirements for futures traders or to increase the capital of its guarantee fund, so that when the crash came and investors betting long on the HSI found themselves with unmanageable liabilities, this brought the futures market to the point of insolvency.100 As it would during the 1997–8 Asian Financial Crisis when its currency was under attack,101 and again during the 2008–9 global inancial crisis when faced with widespread losses from Lehman credit-linked notes,102 the Hong Kong government deviated from its announced laissez-faire principles and stepped into the matter directly. In 1987, the government bypassed the Securities Commissioner and arranged a ‘rescue loan’ of HK$2 billion for the HKFE guarantee fund.103 he next step it took was in November 1987 to commission a study of its regulatory framework, and it established a Securities Review Committee, chaired by Ian Hay Davison, ‘to review the constitution, powers, management and operation 92 93 94 95 96 97

98 99 101 103

Protection of Investors Ordinance, ss 3. he Commodities Trading Ordinance, Chapter 250, 1 September 1976. Commodities Trading Ordinance (1989 edition), ss 13–25. Commodities Trading Ordinance (1989 edition), ss 26–65. Commodities Trading Ordinance (1989 edition), ss 76–98. he Stock Exchanges Uniication Ordinance, Chapter 361, 1 February 1981. Pursuant to section 27, commencement date of the Ordinance was 2 April 1986. Fell (1992: 71); HKEx (1999: 3). 100 HKEx (2009: 4); Fell (1992: 194–5). Fell (1992: 196). 102 See Sheng (2009: 263–73). See Chapter 5, Section C.5. Fell (1992: 198). h is consisted of HK$1 billion from the government’s Exchange Fund and HK$1 billion contributed in equal parts by HSBC, Standard Chartered Bank and the Bank of China. SFC (2002: 31–2).

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of the Stock and Futures Exchanges and their regulatory bodies’.104 he subsequent ‘Davison Report’105 recommended, inter alia, ‘replacing the two [existing, lay] Commissions … with a single independent statutory body outside the Civil Service … headed and stafed by full-time regulators … charged with ensuring the integrity of markets and the protection of investors … [having] extensive reserve powers to intervene if [the exchanges] fall down on the job [of primary supervision]’.106 To implement this recommendation, the Securities and Futures Commission Ordinance was enacted in 1989,107 which created a new regulatory agency, the Securities and Futures Commission (SFC). Compared to the Securities Commission of seconded market participants previously used, the SFC is given signiicantly more independence from the market, a clearer mandate in licensing broker-dealers and investment advisors, enhanced powers of investigation, and authority to launch actions for injunctions, removal of directors and criminal prosecution.108 he last steps in creating the main framework of the regulatory infrastructure used in Hong Kong today took place in 2000 and 2002. he irst was to demutualize the SEHK and the HKFE, and place them and their clearing houses under a holding company, the Hong Kong Exchanges and Clearing Ltd. (HKEx), in which the government has a signiicant shareholding and power in the appointment of management. he Financial Secretary has the right under the SFO to appoint up to eight members of a recognized exchange company’s board of directors,109 and the HKEx’s articles of association state that the appointment of its chairperson must be approved by the chief executive of the HKSAR,110 and that the SFC may veto any planned appointment to the post of chief executive or chief operating oicer of the HKEx.111 he second step was to codify the existing securities laws in a single ordinance, the Securities and Futures 104 105

106 107 108

109 111

SFC (2002: 25). he formal title was ‘he Operation and Regulation of the Hong Kong Securities Industry’. See Securities Review Committee (1988) and SFC (2002: 25). SFC (2002: 37). he Securities and Futures Commission Ordinance, Chapter 24, 1 May 1989. For a general discussion of the SFC’s structure, independence and powers, see Donald (2012: 2.3.2). Section 213 SFO allows the SFC to seek injunctions against broker-dealers and listed companies, and s 214 SFO allows the SFC to take action against management irregularities. For questions of market integrity, the SFC can take both civil and criminal action against violation of rules against market manipulation and insider dealing. See SFO s 388. hese enforcement powers will be discussed in greater detail in Chapter 5.A.3. 110 SFO s 77(1), (5). HKEx Articles of Association, Art. 111(2). he HKEx Articles of Association, Art. 111(3)(b).

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Ordinance, which in addition to creating a new Market Misconduct Tribunal (MMT)112 into which the Insider Dealing Tribunal was merged, reorganized and combined the pre-existing pieces of legislation that, as discussed above, had been enacted in response to crises during the previous quarter century, including: • • • • • • • •

the Securities Ordinance (1974) the Protection of Investors Ordinance (1974) Commodities Trading Ordinance (1976) Stock Exchange Uniication Ordinance (1981) Securities (Disclosure of Interests) Ordinance (1988) the Securities and Futures Commission Ordinance (1989) Securities (Insider Dealing) Ordinance (1991) the Exchanges and Clearing Houses (Merger) Ordinance (1999).

As will be discussed below in Section C , the SFO has recently been amended to include stronger rules on the disclosure of price-sensitive information and will soon be amended to incorporate a regime for information on, and the clearing and settlement of, over-the-counter derivative products. In the following, the Hong Kong corporate and securities framework is examined for an ability to meet, not expectations deriving from rules considered leading because formulated in the United States and Europe, but the needs and risks arising in the speciic socio-economic environment which is Hong Kong in the early twentyirst century.

C How good are the Hong Kong company and securities laws? 1 Does company law protect against majority shareholder abuse? As in other systems of company law, Hong Kong companies limited by shares make decisions through ordinary or special shareholder resolutions,113 reached by either the simple majority or three-quarters of the votes cast, respectively. Majority voting as the highest forum for company decisions presents a compromise position under which not every member will have his or her way within the company he or she owns in part. Such decision-making is used in companies because a unanimity requirement for decision-making could paralyse a corporation, prejudicing investment and thus render the corporate form very unattractive. 112

Part XIV.

113

See CO 2012, ss 563–564.

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As a result of majority voting, persons holding nearly 50 per cent of the voting power may be forced to accept decisions of the majority on ordinary matters (such as allotting shares)114 and persons holding up to 25 per cent of the voting power may be so forced on special matters (such as amending the articles of association).115 To address the risk of majority abuse, company law has developed a number of strategies that allow minorities to have a proportionately stronger voice and to seek redress when necessary. A stronger voice can be achieved by mandating that a higher majority be required for a decision, such as that for a special resolution, by giving a separate class or disinterested shareholders a separate vote, such as for variation of class rights,116 by allowing a shareholder to ‘accumulate’ all her votes on a single person for election when votes are cast for board members,117 or by granting multiple voting rights to shares in certain circumstances, such as giving preference shares multiple votes regarding the declaration of dividends the year following a decision by the ordinary shareholders not to make distributions.118 Redress can be built into the law by giving a minority reaching a certain percentage of the vote a right to challenge a majority decision,119 giving even a single shareholder the right to bring an alleged breach of the law to the court, or empowering a public supervisory authority to act in this regard. his study focuses on the latter two techniques. To challenge the behaviour of a majority shareholder, company law ofers one of two causes of action: that the majority acted in an unfairly prejudicial manner, as provided for in UK law and systems of law deriving from it, including Hong Kong,120 or that the majority breached a duty of 114 116 117

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115 See CO 2012, s 141. See CO 2012, s 88. his is provided for in HK CO 2012, s 180(3). Hong Kong law does not provide for cumulative voting. he Company Law of the People’s Republic of China, which allows cumulative voting if provided for in the company’s articles, dei nes it as follows: ‘a cumulative voting system shall mean, in the election of directors or supervisors by the general board of shareholders, the number of voting rights granted under each share is the same as the number of directors or supervisors to be elected, and the shareholders may use all of their voting rights for a single candidate.’ PRC Company Law, Art. 106. his would be provided by contract, such as the terms of issue of preference shares. For example, Hong Kong law gives a minority constituting 10 per cent of a company’s voting rights the power to veto a resolution to merge or reorganize the company. See CO 2012, s 674(2)(a)(ii). he HK Companies Ordinance has provided a statutory unfair prejudicial remedy since 2004. Under ss 723–725 (previously 168A) of the Ordinance, a member of the company can apply to the court for an order on the ground that the afairs of the company are being or have been conducted in a manner which is unfairly prejudicial to the interests

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loyalty to the whole of the company and the minority, as is provided for in, inter alia, the law of Delaware and that of Germany.121 Both approaches seek to redress the unfairness of actions that are technically legal, but normally entail an element of bad faith. he majority shareholder has the legal right to undertake every act that the percentage of its holding allows it to resolve on, but if such actions are prejudicially unfair to the minority, each of these two causes of action, in principle, allow redress. he UK ‘unfair prejudice’ approach and the ‘duty of loyalty’ approach found in the United States and Germany diverge greatly as applied in courts, with the former usually being limited to ‘quasi-partnership’ situations. he origins of the UK unfair prejudice remedy, which is the main cause of action ofered minority shareholders by Hong Kong company law, is understood as an extension of iduciary principles from partnership law, as Lord Hofman explains: company law has developed seamlessly from the law of partnership, which was treated by equity, like the Roman societas, as a contract of good faith. One of the traditional roles of equity, as a separate jurisdiction, was to restrain the exercise of strict legal rights in certain relationships in which it considered that this would be contrary to good faith. hese principles have, with appropriate modiication, been carries [sic] over into company law.122

For this reason, a court hearing an unfair prejudice claim seeks to understand whether the majority shareholder has breached the ‘terms of the association’ which are ‘contained in the articles of association and sometimes in collateral agreements between the shareholders’.123 Because an of the members generally or of some part of the members. he Ordinance further sets out six types of relief which may be granted by the court as sees it: (1) require the company to refrain from doing or do an act which the petitioner has complained it has omitted to do; (2) authorize civil proceedings to be brought on behalf of the company; (3) appoint a receiver or manager; (4) regulate the conduct of company’s afairs in the future; (5) order share purchases; (6) award damages and interest.

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CO s 168A(2)(a). Although the court has wide discretion to make such an order, the most commonly sought and granted remedy is a buy-out of the petitioner’s shares. h is is a strong reason for not allowing unfair prejudice actions in the context of listed companies, given that shareholders may easily sell their shareholding on the market. See Cahn and Donald (2010: 574–81). O’Neill and Another v. Phillips and Others [1999] 1 W.L.R. 1092, 1098. O’Neill and Another v. Phillips and Others [1999] 1 W.L.R. 1092, 1098.

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otherwise valid exercise of a legal right will only be deemed unfair where there is a ‘collateral agreement’ between the shareholders, UK law has traditionally restricted such actions to shareholders of private companies.124 Lord Hof man, quoting the decision of Parker J in Re Astec (BSR) plc,125 observes: ‘in order to give rise to an equitable constraint based on “legitimate expectation” what is required is a personal relationship or personal dealings of some kind between the party seeking to exercise the legal right and the party seeking to restrain such exercise, such as will afect the conscience of the former.’ … I have no diiculty with this formulation. But I think that one useful cross-check in a case like this is to ask whether the exercise of the power in question would be contrary to what the parties, by words or conduct, have actually agreed. Would it conl ict with the promises which they appear to have exchanged?126

It is not likely that retail, or even most institutional, investors in a corporate group dominated by a founding shareholder would informally ‘exchange promises’ with the majority shareholder, making application of the unfair prejudice remedy to listed companies highly unlikely according to this theory127 Yet the primary majority/minority problem in Hong Kong is that existing when founding shareholders from the Hong Kong economy or an administration of the Chinese state bring a company to the market and sell a portion of its shares to investors. Nearly all of the 15 major corporate groups examined in Chapter 2 have a shareholding structure of this type. hus the UK unfair prejudice remedy as classically understood is not helpful for addressing the primary agency problem facing company law in Hong Kong. he response has over time taken shape in two steps, each discussed below. First,

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Another useful example is: ‘Although fairness is a notion which can be applied to all kinds of activities its content will depend upon the context in which it is being used. Conduct which is perfectly fair between competing businessmen may not be fair between members of a family. In some sports it may require, at best, observance of the rules, in others (“it’s not cricket”) it may be unfair in some circumstances to take advantage of them. All is said to be fair in love and war. So the context and background are very important.’ O’Neill and Another v. Phillips and Others [1999] 1 W.L.R. 1092, 1098. Re Astec (B.S.R.) Plc. [1998] 2 B.C.L.C. 556, 588. With respect to the general unavailability of an unfair prejudice action against the impersonal circumstance found in a listed company, also see Re Blue Arrow plc [1987] BCLC 585, Re Posgate and Denby (Agencies) Ltd [1987] BCLC 8, and Re Saul D Harrison & Sons plc [1995] BCLC 14. O’Neill [1999] 1 W.L.R. at 1101. See Re Blue Arrow plc [1987] BCLC 585.

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Hong Kong took128 the novel step of creating a parallel public avenue of redress by giving its securities regulator, the SFC, a statutory right to petition courts to take action on a number of theories, among which is unfair prejudice. Second, Hong Kong courts have taken the remedy of ‘unfair prejudice’ forward for application to listed companies in a seemly straightforward extrapolation of existing common law rules. Whether the decision ultimately conforms to common law as understood in the UK will not, however, be an issue because – as discussed in Chapter 1 – ater 30 June 1997 Hong Kong courts are no longer bound by UK precedent,129 and the Privy Council no longer hears Hong Kong appeals. Beyond this, compliance with the minimum public loat requirement for listing on the SEHK130 is monitored continuously, and a failure to meet it can lead to suspension.131 he combination of these elements, if continued and (preferably) extended, would present a solid framework for the protection of minority shareholder rights.

a Public defence of minority shareholders When a company is listed on a stock exchange, its shares are liquid and there is small incentive for a retail investor to take judicial action against an abusive majority shareholder rather than simply selling her shares on the market. As such, even when an efective remedy for breach of minority rights is available, shareholders faced with prejudicial behaviour from dominating shareholders may exit the company rather than choosing to incur the expense of seeking redress from a court. h is can lead to a situation in which both misbehaviour of a dominant shareholder goes unchecked and the percentage of an issuer’s public loat trading among outside shareholders remains small or even shrinks, the latter problem being addressed by monitoring and sanction. A possible solution to this mismatch of interests and costs and its undesirable efects on enforcement is to empower a supervisory authority – somehow generally funded, such as by tax revenue, a regulatory levy on exchange trading or i nes paid by ofenders – to act for the beneit of the 128

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In its current form, the pertinent section 214 has been in the SFO since it came into force in 2003. h is is a self-evident aspect of the handover to China, but is discussed and airmed by the HK Court of Final Appeal in Solicitor (24/07) v. Law Society of Hong Kong [2008] HKEC 431, 586. SEHK Listing Rules, Rule 8.08(1)(a). At 25 per cent of total issued share capital, this is a rather low requirement. SEHK Listing Rules, Rule 6.01(2).

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minority. Hong Kong law has provided such a ‘public defender’ route to the control of dominating shareholders through unfair prejudice since 1994.132 he SFO expressly empowers the SFC to ask the Court of First Instance (CFI) to take action against a listed company if it i nds that the company’s business or afairs have been conducted in a manner: (a) oppressive to any of its members; (b) involving thet, fraud, or misfeasance towards any members; (c) withholding reasonably expected business information from any members; or (d) unfairly prejudicial to any members.133 he relief available includes the removal of a director or other oicer from all management, a cease and desist order, an order to the management of the corporation to itself bring suit, placing the company under a receiver, or ‘any other order it considers appropriate’.134 his tool has been particularly useful for policing management in the foreign (‘overseas’) companies that dominate listings on the SEHK. With only one exception, the companies in connection with which the action has been applied were incorporated in Bermuda or the Cayman Islands,135 and normally fall into the ‘red-chip’ category: i.e. companies operating in and controlled by persons from mainland China, but incorporated in a foreign jurisdiction and listed in Hong Kong. Although the SFC has had this powerful tool at its disposal for nearly two decades, it has been used only 14 times, with 11 of those occurring from late 2008,136 and the companies against which, or against whose directors, the SFC sought orders had in most cases already been suspended from trading and were mired in various other

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Originally Securities and Futures Commission Ordinance, s 37A, since 2003, SFO, s 214. With respect to the date s 37A was inserted into the now repealed SFCO, see Securities and Futures Commission v. Mandarin Resources Corp. Ltd & Another [1997] HKLY 192. h is provision also allows the SFC to seek redress for the kinds of management misbehaviour normally challenged in shareholders’ derivative suits. SFO, s 214(1). 134 SFO, s 214(2). Styland Holdings Ltd., Pearl Oriental Innovation Ltd., GP NanoTechnology Group Ltd., and Wah Sang Gas Holdings Ltd. were incorporated under the law of Bermuda, while Warderly International Holdings Ltd. and Rontex International Holdings Ltd. were incorporated under the law of the Cayman Islands. Mandarin Resources Corp. Ltd. was incorporated in Hong Kong. h is information is provided in the decisions discussed below in this subsection. A search of WestLaw and Lexis databases, conducted on 1 August 2012, with the broad search parameters ‘(37A or 214) & Securities & Commission’, revealed only 12 companies that had been challenged under the provision.

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legal problems.137 As such, the SFC has employed the action more as a tool for mopping up a messy market, particularly disqualifying directors who had driven their company into the ground, than protecting market integrity before the company runs completely of the track. he 2012 case of Re Styland Holdings Ltd (No 2)138 is representative of both the advantages and disadvantages of SFC actions under section 214. In this case, a company founder and his spouse built and served on the various boards of a multinational corporate group, with the parent company, Styland Holdings Ltd., incorporated under Bermudan law and listed on the SEHK. hese controlling shareholders caused Styland’s various subsidiaries to enter into a number of transactions that were both damaging to the respective subsidiaries and beneicial to themselves or family members, such as loans to and support for the company of a nephew of the founder’s co-director/wife.139 An advantage of the SFC taking these actions forward is its team of forensic accountants and lawyers with good regulatory experience, investigative powers, and its interagency network based on numerous Memoranda of Understanding (MoUs), all of which allow the SFC to produce detailed analyses of multinational corporate organizations and the lows of money through their various accounts, oten, as in the Styland case, returning to the dominant shareholder-directors. For example, one of the various instances in which the SFC demonstrated that funds lowed back to the Styland founder showed that in connection with a purchase of a shareholding, a company unrelated to Styland paid a sum to a Styland subsidiary, which transferred funds to a second Styland subsidiary, which made a transfer to another company unrelated to Styland (whose sole director was, however, an employee of the Styland group), which made payment to another unrelated company (which was directed by the founder couple’s nephew who also was a director of other Styland companies), which then for no clear reason transferred funds to a company 100 per cent owned beneicially by Styland’s founder.140 his resulted 137

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h is was the case with Mandarin Resources Corporation Limited (see Securities and Futures Commission v. Mandarin Resources Corp. Ltd & Another [1999] HKEC 1055 CA), Styland Holdings Ltd. (see Styland Holdings Ltd (No 2) [2012] 2 HKLRD 325 CFI), Warderly International Limited (see Securities and Futures Commission v. Yeung Kui Wong [2010] HKEC 1637) and Wah Sang Gas Holdings Limited (see Wah Sang Gas Holdings Ltd [2009] HKEC 892). [2012] 2 HKLRD 325. See the discussion of Iwana Company Ltd.’s purchase of shares issued by Inworld Holdings Ltd., the option granted by the latter to Mr Keven Ngai (nephew of Yvonne Yeung), and loan by Iwana Company Ltd. to Mr Ngai. Re Styland Holdings [2012] 2 HKLRD 325, at paragraphs 24–55. Re Styland Holdings [2012] 2 HKLRD 325, at para. 80.

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in a inding of breach of directors’ iduciary duty by that founder-director, and contributed to an order disqualifying him from current and future director positions. On the other hand, by the time the SFC brought proceedings against the directors and founding member of Styland Holdings Ltd., the SEHK had already delisted the company over four years earlier, the strongest sanction available to the exchange, so that the SFC was primarily ensuring that the directors involved in Styland’s abuses were not able to regroup into another corporate scheme for a number of years. A recent action iled by the SFC may indicate, however, that it is seeking to police existing listed companies more aggressively. In November 2012 it iled an action against three directors of Hong Kong listed company First China Financial Network Holdings Ltd., seeking disqualiication of directors who arranged a related-party transaction beneiting a subsidiary in which one of them had a signiicant holding.141 his occurred at a time when, although First China Financial was sufering signiicant losses,142 it was still in good standing on the Growth Enterprise Market (GEM) board of the SEHK. Nevertheless, the action focused on directors, and as we have seen in Chapter 2, dominant shareholders – not self-interested professional directors143 – present the greatest threat to balanced corporate governance in the Hong Kong economy, a threat which should be addressed with adequate tools. 141

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See ‘SFC Seeks Court Orders against Former and Current Directors of First China Financial Network Holdings Ltd’, SFC Enforcement News, 12 November 2012, available at: www.sfc.hk, home > news & announcements > enforcement news (accessed 15 March 2014). See First China Financial Network Holdings Ltd., h ird Quarterly Report 2012, available at: www.hkexnews.hk, Listed Company Information (accessed 15 March 2014). Hong Kong law contains the standard measures used to limit the risks of director power, even if such risks are low, given the great power of the shareholders that elect them to oice. As we have seen, individual members may bring derivative actions against directors for misconduct and a majority of the members voting at one time may remove a director without cause. In addition, the boards of listed companies must contain at least three (constituting at least one-third) independent, nonexecutive directors (INEDs). Hong Kong followed international trends in gradually increasing its use of independent directors. he SEHK introduced a provision in its Listing Rules in 1993, requiring listed companies to have at least two INEDs on their boards of directors. Ho (1997: 507). In 2004, the SEHK increased the minimum number to three (Listing Rules, Rule 3.10(1)), and required that the board contain at least one INED with ‘appropriate professional qualiications or accounting or related i nancial management expertise (APQs)’ (Rule 3.10(2)). As from 2013, INEDs must constitute at least one-third of the board of a listed company (Rule 3.10A). he Listing Rules also provide that listed companies must establish an audit committee (Rule 3.21) and a remuneration committee (Rule 3.25) comprised solely of nonexecutive directors (NEDs).

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b Applying the unfair prejudice action to listed companies he Hong Kong Companies Ordinance provides shareholders with an action to seek relief in the case that ‘the company’s afairs are being or have been conducted in a manner unfairly prejudicial to the interests of the members generally or of one or more member’.144 Available relief includes an order to purchase the plaintif ’s shares, desist from taking an action, take a speciic action, commence a derivative action against any person, and appointment of a receiver.145 As discussed above, this action was transplanted from the UK Companies Act, and in the UK it has traditionally been available in private companies where a ‘quasi-partnership’ relationship creates expectations of certain kinds of behaviour that would justify equitable intervention when breached.146 Hong Kong courts have applied the unfair prejudice rules consistently with their UK colleagues in spite of the prominent mismatch between the agency risks present in the two economies. Although – as Barma J observed in Luck Continent – such application did not legally restrict unfair prejudice actions to companies in which a personal relationship among the members had been established (i.e. private companies), the reported decisions awarding relief147 had addressed this sort of small company in which tacit agreements or expectations can be understood to exist. he prejudicial breaching of such tacit agreements or expectations by the majority shareholder is then seen as unfair. In a 2012 judgment on an unfair prejudice action, the Hong Kong Court of First Instance broke this mould for the irst time, albeit on the basis of very unusual facts, and granted relief to one shareholder of a listed company challenging the behaviour of another shareholder in the voting of company shares as unfairly prejudicial.148 he decision was subsequently airmed on appeal.149 Given the strong presence of controlling shareholders on the Hong Kong market and – as discussed also with reference to Re PCCW Ltd, below – the eforts of Hong Kong courts to protect unsophisticated minority shareholders, this opening of the unfair prejudice action to such companies was meaningful for Hong Kong. As discussed in more detail in Chapter 5, the application of the unfair 144 146 147

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CO 2012, s 724(1)(a). 145 CO 2012, s 725. he leading case is O’Neill and Another v. Phillips and Others [1999] 1 W.L.R. 1092. Re Shun Tak Holdings Ltd [2009] 5 HKLRD 743 examined an application on unfair prejudice against major shareholders and directors of Shun Tak Holdings Ltd., a company listed on the SEHK, but the court rejected the petition, holding that the action was actually derivative in nature against directors for misconduct. Luck Continent Ltd v. Cheng Chee Tock heodore [2012] HKEC 567. Luck Continent Ltd v. Cheng Chee Tock heodore [2013] HKEC 1209.

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prejudice remedy as airmed in Luck Continent means that any breach of the SEHK listing rules serious enough to result in a suspension from trading and tolerated by majority shareholders could allow a shareholder action for unfair prejudice. If Hong Kong courts continue along this line, and allow minority shareholders of large companies to seek redress when the majority uses its power to cause the company to take actions unfairly detrimental to the minority, this would bring it in line with non-UK legal systems like Germany, Delaware and California, which require majority shareholders to use their powers of control over the company fairly. Germany’s High Federal Court150 has explained that the majority shareholder has a iduciary duty because it is ‘able to inluence the company’s management to the prejudice of the interests of their fellow shareholders in the company, thus requiring introduction of a counter-balancing duty to take such interests into consideration’.151 he Delaware Supreme Court has also concluded, despite lacking statutory requirement, that ‘[a] parent does indeed owe a iduciary duty to its subsidiary … Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary.’152 he California Supreme Court has stated that a ‘comprehensive rule of good faith and inherent fairness to the minority in any transaction where control of the corporation is material properly governs controlling shareholders’.153 Each of the cases in which this duty was expressed concerned the exercise of a shareholder vote resulting in a transfer of value from the minority to the majority shareholders: in the Linotype154 and Ahmanson155 cases, the majority voted to transfer the most productive assets of the company into an entity they alone controlled, and in Sinclair156 the parent chose not to cause a subsidiary (with minority shareholders) to take action against another (wholly owned) subsidiary for breach of contract. he Delaware court has also 150

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he Bundesgerichtshof. In this ‘civil law’ jurisdiction, the high court itself has taken the initiative to crat an equitable iduciary duty because the overall framework of the statute demands balance and fairness, but did not provide a speciic solution for such abuse. In Re Linotype, Doc. No. II ZR 75/87, BGHZ 103, 184 (1988), reprinted in translation in Cahn and Donald (2010: 585). Sinclair Oil Corporation v. Francis S. Levien, 280 A 2d 717, 720 (1971). Jones v. H.F Ahmanson & Co, 1 Cal.3d 93, 112 (1969). See Cahn and Donald (2010: 583–4). See Ahmanson, 1 Cal.3d 93, at 102–5. See Sinclair, 280 A 2d 717, at 722–3.

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applied this iduciary standard of fairness in circumstances where a parent company sought to force through a merger between a subsidiary with minority shareholders and another, wholly owned subsidiary.157 he iduciary duty of majority shareholders resembles that imposed on directors, given that company law gives both company organs (board and general meeting) power over the entire company, and it is implicit that this power must be used for a proper purpose, not for advantageous self-dealing. Although use of the unfair prejudice action in Hong Kong company law meets international standards under the UK company law model, neither the UK nor major Commonwealth countries like Australia, Canada or New Zealand have an economy in which large, controlling shareholders play such a dominant role as they do in Hong Kong. For this reason, introduction of a iduciary duty or duty of loyalty for controlling shareholders would create an excellent tool for checking moral hazard in Hong Kong even if not doctrinally appropriate in the context of British and Commonwealth common law. Such a duty would greatly beneit minority shareholders, particularly in the context of the corporate groups, and strengthen Hong Kong’s position as a i nancial centre where retail and institutional investors can purchase minority stakes with low legal risk. Application of actions for unfair prejudice beyond intimate, quasi-partnership arrangements, such as happened in Luck Continent, is a good step in the right direction. he next section focuses more closely on the treatment of corporate groups under Hong Kong company law.

2 Does company law address the speciic risks of corporate groups? As Chapter 2 shows, corporate groups are prevalent in the Hong Kong economy. Some are the results of British merchants’ activity in Hong Kong in coordination with other holdings. Others started as family concerns locally, and grew into multinationals headed by listed companies.158 Still others are multinational concerns owned by the Chinese state. In 2007, the Hong Kong Society of Accountants reported that nine out of ten listed companies in Hong Kong had one family group holding 25 per cent or more of the issued shares.159 In 2000, Claessens et al. found that around 65 per cent of listed companies on the SEHK were 157

158 159

See, e.g., Weinberger v. UOP, Inc. 457 A 2d 701 (1983); Kahn v. Lynch Communication System, Inc. 638 A 2d 1110 (1994). Wong (1985). Also see Lawton (2007). Hong Kong Society of Accountants (2007).

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family owned enterprises (FOEs).160 While the listing of large, Chinese state-owned enterprises (SOEs) has signiicantly changed the balance of SEHK market capitalization away from the FOEs, it has reinforced the strong presence of corporate groups with dominant shareholders on the Hong Kong securities market. With a market structure characterized by the dominance of families or the Chinese government as shareholders of major enterprises, the Hong Kong legal and regulatory framework should show particular focus, strength and competence in regulating corporate groups. Relationships in corporate groups are troublesome because of the fundamental conlict between each member of the group being an independent body corporate with, as a matter of law, its own interests and internal decision-making process, and the fact that a subsidiary company will, as a matter of business strategy, only exist at all if this beneits the overall interests of the holding company. Economic unity collides with company law separateness. Many aspects of a company’s operations provide opportunity for controlling shareholders to extract value from the irms they control (oten referred to as ‘tunnelling’) in various ways. As Atanasov et al. observe, seen generally, ‘there is both cash-low tunneling (diversion of on-going cash low) and “equity tunneling” (extraction of value via inancial transactions that afect ownership claims, rather than the irm’s operations)’.161 Beyond tunnelling by extracting funds from a subsidiary to the latter’s detriment or causing a subsidiary to transact to its own detriment while beneiting the parent or another group company, and unfairly diluting the holding of minority shareholders through majority-driven changes in the capital structure, a parent can also abuse the group form by placing risks in a group company despite the fact that it would not have the means available to cover the potential, resulting liabilities. In tunnelling, the interests of a subsidiary’s minority shareholders will be damaged disproportionately, given that the majority shareholder will beneit from the transfer of funds to itself or another company it controls, or through a transaction that is unfavourable for the subsidiary company in question while beneiting the parent or another of its subsidiaries. In the case of undercapitalization, creditors of the individual group company are placed at risk of receiving partial or no payment on a claim, despite the fact that the company’s activity is inseparable from the economic operations of the group as a whole.

160

Claessens et al. (2000).

161

Atanasov et al. (2010: 156).

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Against the prejudicial extraction of rents by controlling shareholders, the tool kit of available solutions range from a full blown statute on parent–subsidiary relationships (as is done in Germany)162 to a judicially crated remedy for unfair prejudice to the minority (as is done in the UK and Hong Kong) and has been already discussed above, and also includes a rule on related party transactions.163 Against the parking of risk in undercapitalized subsidiaries, solutions range from mandatory minimum capital requirements (as is done in Germany and other EU countries),164 to statutory presumptions that the corporate entity should in certain circumstances be disregarded (as is done in China),165 to judicially crated equitable standards on when the corporate entity of the subsidiary should be disregarded (piercing the corporate veil).166 In dealing with groups, Hong Kong law provides less-than-efective protections for minority shareholders and average protection for creditors. Creditor protection will be addressed in the following section. 162

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his is provided for in the German Stock Corporation Act (Aktiengesetz) at §§291–338, which actually permits many forms of tunnelling, provided that necessary approvals are obtained and – in most cases – compensation is provided to the minority shareholders. h is is done by creating a special category of ‘enterprise agreements’ (Unternehmensverträge). As explained in Cahn and Donald (2010: 683–4) (citations omitted): ‘Enterprise agreements may subject a subsidiary company to the instructions of its parent (Beherrschungsvertrag) or divert all or part of the proit of the subsidiary into the cofers of the parent (Gewinnabf ührungsvertrag). Enterprise agreements must be approved by a 75 percent majority of the votes cast by the dominated or proit-transferring company’s shareholders and, if the parent corporation is an AG, by 75 percent of the votes cast by its own shareholders. Prior to the shareholder vote, the Vorstand must prepare a report on the contents of the agreement, focusing particularly, in the case of a proit transfer agreement, on the amount of compensation to be given for proits diverted. Unless the subsidiary is wholly owned, enterprise agreements must be examined by auditors. Like charter documents and shareholder resolutions, an enterprise agreement does not take efect until it is entered into the commercial register for the seat of the subsidiary. A domination agreement (Beherrschungsvertrag) directly overrides §76 of the Aktiengesetz by subjecting the Vorstand of the subsidiary to the instructions of the parent. he range of such instructions is quite open-ended, and could include orders to relinquish corporate opportunities, make discount deliveries, transfer proprietary information, and perform services without compensation. Another possible efect of a domination agreement is that, when the parent is not subject to co-determination and the subsidiary is, the efects of co-determination on the subsidiary are essentially sidestepped.’ See Section C.1.b. Under EU law, all public companies must have a minimum capital of 25,000 euro under art 6(1) Second Company Law Directive, but this is not required for private companies, so that capital requirements for the latter difer from jurisdiction to jurisdiction. See Davies (2010: 14–16). See Company Law of the People’s Republic of China, Art. 64. See hompson (2005); Huang (2012).

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Beyond the action for unfair prejudice, Hong Kong law ofers few statutory protections for minority shareholders of subsidiaries outside of the context of major corporate transactions. Although, similarly to EU law, Hong Kong puts the control of share capital in the hands of the members167 (rather than delegating this power to the board as is done in Delaware168), unlike in the EU169 Hong Kong company law does not ofer existing shareholders pre-emptive rights.170 Giving majority shareholders power over the allocation of shares does not solve the problem of majority abuse, although it may be seen as making such transactions more visible and giving minority shareholders an opportunity to voice their concerns. Generally, this arrangement of rights and powers is in line with what might be expected from a public choice perspective to arise in a society, like that of Hong Kong, where large shareholders are common and the power of small shareholders has only recently been advocated. For the consummation of major transactions that would alter the position of minority shareholders, such as reorganizations of the outstanding shares, takeovers and share buy-backs, Hong Kong statutory provisions and the courts that administer them are somewhat more robust in their protection of minorities. A reorganization of the shares of a company through consolidation or division will require approval of both 75 per cent of the votes cast at a meeting to approve it and a majority in number of the members voting at such meeting,171 plus court sanction.172 As will be discussed below, the requirement of approval by a majority of members (a ‘head count’) led to a high proile judicial intervention in 2009, and the result of ensuing controversy was that the Companies Ordinance 2012 now allows the court to dispense with that test.173 For a reorganization of the shareholding structure that takes the form of a takeover or buy-back, the court does not have this power to disregard the position taken by the minority shareholders, which in such cases is structured not as an approval, but as a right to veto the transaction by vote of 10 per cent of the shareholders not participating in or ai liated with the ofer (‘disinterested shares’).174 167 169 170 171 173

174

168 See CO 2012, s 141. See DGCL s 152. See Second Company Law Directive, Art. 29. hese could be created in the company’s articles. CO 2012, s 674(1)(c). 172 CO 2012, s 673. CO 2012, s 674(1)(c)(ii) (‘the members agree to the arrangement … if … unless the Court orders otherwise, a majority in number of the members present and voting … agree to the arrangement’), emphasis added. CO 2012, s 674(2). ‘Disinterested shares’ are generally shares other than those held (1) by the oferor or its nominee or agent, or (2) by an associated person or company of the oferor. CO 2012, s 674(3).

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his requirement of 10 per cent of the minority shareholders disinterested in the transaction was newly introduced in the 2012 Ordinance and would plainly be easier to meet than the head count rule. In the case of a takeover175 or share buy-back176 that reaches 90 per cent of the company’s share capital, the remaining minority shareholders also have a right to be bought out at the original ofer price within three months ater the closing of the ofer. Under the current company law, it is unclear when courts might decide to disregard a minority vote on a scheme to reorganize the shareholding structure of a company. Such intervention would of course tip the balance against the minority shareholders and thus be very important for the quality of minority protection in Hong Kong. A 2009 decision under the previous Companies Ordinance has, however, shown something of how the Hong Kong courts view the position of dispersed, minority shareholders in corporate groups. he case involved a utility, Hong Kong Telecommunications Limited, the shares of which retail investors had purchased as a source of retirement income due to their low risk and the steady stream of dividends expected.177 In 2000, in the context of the telecommunications industry’s move into data and wireless, a reorganization of shareholdings resulted in Hong Kong Telephone becoming a wholly owned subsidiary of Paciic Century CyberWorks Limited (PCCW Ltd.), which was listed on the SEHK. In late 2008, at the height of the global inancial crisis, the controlling shareholders of PCCW Ltd. proposed a reorganization that would roll up the company through a delisting and a buyout of the dispersed shareholders, who constituted a numerical majority in this case, at a price slightly above market, which was at a historical low for PCCW shares at that time. he majority controlling shareholders were PCCW’s Chairman, Richard Li Tzar Kai (son of Li Ka-shing), who through various companies owned about 28 per cent of the stock, and an SOE, China United Network Communications Group Company Limited (Unicom), which held about 20 per cent.178 he reorganization, through which about 52 per cent of the shares, which were held by smaller shareholders including retail investors, would be cancelled and their holders 175

176

177 178

See CO 2012, s 700. However, the majority will have a corresponding right to squeeze these minority shareholders out. See CO 2012, s 693–696. See CO 2012, s 718. Also in this case, the majority will have a corresponding right to squeeze these minority shareholders out. See CO 2012, s 712–714. Re PCCW Ltd [2009] HKEC 738, CA at para 4. See circular issued by PCCW, ‘Proposed Privatization of PCCW by Joint Offerors’, 6 December 2008, 53–5, available at www.hkexnews.hk (accessed 15 March 2014).

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cashed out at a historically low price, required (1) approval of 75 per cent of the company’s capital, (2) a majority of the company’s shareholders counted per head, and (3) sanction of the court.179 Although it was very likely that Richard Li and Unicom would obtain 75 per cent of the capital by value in favour of the transaction, they apparently did not want to leave the ‘head count’ portion of the approval to chance. he controlling shareholders’ vehicle that was being used to purchase the shares of PCCW had until recently owned an insurance company, which it sold to the Fortis Group, where the former chairman stayed on as deputy chairman.180 Although the court did not have to reach a inding of fact on this point, it appears that the controlling shareholders agreed with Fortis that the latter would distribute bonuses in the form of PCCW shares to agents, employees, friends and family, arrange to register these shares individually in the name of each person (rather than in the name of the clearing house’s nominee, as is usually the case), and pre-complete proxy forms so the recipients need only tick ‘yes’ for the transaction to turn their PCCW shares into cash.181 his created a sizeable army of small shareholders, registered in their own name, who were pre-disposed to approve the transaction and cash out of the company. he result was that the transaction to buy out the minority shareholders at a record low price was approved both by 75 per cent of the capital and by a majority of the individual shareholders. As the CFI explained: ‘Of the 859 Independent Shareholders who voted against the Scheme, 829 (96.5%) were registered as shareholders prior to 30 October 2008, prior to the announcement of the privatisation proposal. Of the 1404 Independent Shareholders who voted for the Scheme, 1,288 (91.7%) were registered as shareholders ater the Scheme was announced.’182 he controlling shareholders were in this way able to conjure up and marshal a ‘clone army’ of retail investors on very short notice. In its examination of this arrangement in the context of exercising its duty to sanction or disapprove of the transaction so supported by twin majorities, ater hearing additional evidence from the SFC on how the majority shareholder had packed the ballot box for the head count portion of the vote, the CFI concluded through Kwan J that: ‘here is no discernible public policy in Hong Kong regarding share splitting in the 179 180 181 182

See former Companies Ordinance (in force until 2014), s 166(2). Re PCCW Ltd [2009] HKEC 738, CA at para 16. Re PCCW Ltd [2009] HKEC 738, CA at paras 42–65. Re PCCW Ltd [2009] HKEC 553, CFI at para 61.

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context of a scheme for privatisation of a company.’183 As such the Court sanctioned the squeeze out of the retail shareholders. he Court of Appeal unanimously reversed the CFI’s decision. Hong Kong law did not ofer the Court any particular principle, such as a iduciary duty of controlling shareholders, to apply to the creation of the extra votes through such deliberate distribution of packets, but nonetheless the Court found that what the controlling shareholders and Fortis had done was ‘vote manipulation’. Rogers V-P, in his opinion for the Court of Appeal, disagreed that the creation of such votes was an acceptable practice: Frankly, the arguments that amounted to little more than that there was nothing wrong with vote manipulation are, on analysis, extraordinary. I do not consider that any right thinking member of society could condone a situation where the law required that a vote should be taken so as to balance the fairness between the holders of shares in diferent proportions and deliberate steps had been taken to distort that vote; in this case, it may be said, at minimal cost to those responsible. Vote manipulation is nothing less than a form of dishonesty. he court cannot sanction dishonesty. It is also a form of coercion where the wishes of the minority in number of shares are overridden by those who hold the majority of the shares; that is the very thing that … the court should see should not be allowed to happen.184

With reference to what a ‘right thinking’ Hong Kong ‘society’ would make of the practice, Justice Rogers was formulating new common law in Hong Kong, turning commonly held standards of correct behaviour into law through judicial decision185 just as common law courts have done for over 800 years, and the decision was indeed popular in the Hong Kong press.186 Lam J, ater agreeing with Rogers’ decision, reinforced it by stressing that the burden of proof rested on the persons promoting the reorganization to satisfy the court that the vote had ‘come to a decision representative of the class in question’.187 Especially in light of the fact that the decision at irst instance was written by a leading company law 183 184 185

186

187

Re PCCW Ltd [2009] HKEC 553, CFI at para 151. Re PCCW Ltd [2009] HKEC 738, CA at para 71. On the nature of common law’s justiication in generally accepted principles of justice see Eisenberg (1991: 150). Since the appellate decision was handed down in 2009, I have discussed the matter with hundreds of Hong Kong law students and i nd nearly universal approval of the court’s view of ‘right thinking’. Re PCCW Ltd [2009] HKEC 738, CA at para 122. Barma J also agreed, stating: ‘I agree that this appeal should be allowed on the basis that the court cannot be satisied that the majority by number of the shareholders of PCCW who voted in favour of the scheme at the adjourned scheme shareholders meeting held on 4 February 2009 fairly represented the class of scheme shareholders as a whole.’ At para 167.

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jurist in Hong Kong, the Court of Appeal position shows a clear interest of the Hong Kong judiciary to protect retail investors caught up in the schemes of controlling shareholders. As we have seen, the LegCo has since amended the Companies Ordinance to empower a court to disregard both approval and disapproval of a scheme, which amendment followed arguments of a tyranny of the minority in Hong Kong companies, and as such, it is uncertain how the courts will interpret this provision in the future. Nevertheless, the PCCW decision, the willingness of the courts to extend the unfair prejudice action (as seen in Luck Continent, discussed in Subsection C.1.b, above) and the statutory provisions discussed in this section that tend to privilege use of individual small companies over use of groups with many small companies, appear to indicate an awareness among Hong Kong lawmakers of the risks presented by groups and a willingness to take action. Supplementing this is a good system of shareholder disclosure. he SFO mandates and the SEHK has implemented a good system for the disclosure of substantial shareholders as well as transactions between the company and the same.188

3 Does company law protect both unsophisticated and sophisticated creditors? Beyond the agency problems between management and members, and that between majority and minority members, another important agency problem that increases the risks inherent to the company form is that between the company and its creditors.189 Creditors of a company can range from the most sophisticated contractual creditors, such as banks, to the least prepared and unwilling victim of a tort. When a debt is payable on a given future due date, the company can be thought to hold funds to cover the debt, essentially as an agent of the creditor. Limited liability, which means the debts of the company are payable exclusively by the company, regardless of how little resources it may have and how abundant the resources of the members may be, is at the core of this problem. It can tempt members to behave opportunistically towards creditors by increasing their company’s liabilities while extracting its capital through payment of dividends, imprudent loans or other distributions for which the company receives no tangible asset in return. Such behaviour can be particularly common in corporate groups, where risk management may 188 189

See Part XV, SFO and SEHK Listing Rules, Chapter 14A. Armour et al. (2009: 35).

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advise partitioning potential liability from assets in diferent components of the company group. Traditional techniques of creditor protection include a system of robust security interests, requirements that a company hold minimum capital, restrictions on the distribution of assets to members, the possibility of disregarding the corporate entity (piercing the corporate veil) to hold members liable for a company’s debts, and disclosure of the company’s inancial position to potential creditors. he creditor protection regime under Hong Kong company law might be thought of as average among highly developed legal frameworks, although it tends to provide much better protection for sophisticated than for unsophisticated creditors. he most prominent creditor protection mechanisms under Hong Kong law as seen in international comparison are a traditional array of i xed and loating charges and an above-average framework of mandatory disclosure. Both of these tools would more beneit sophisticated, contracting creditors like the leading banks examined in Chapter 2. Such institutions have the time and skills necessary to examine a company’s inancial disclosures and enter into a security arrangement with it before lending. Beyond these protections, Hong Kong law also provides modest requirements for capital maintenance, albeit without any form of required minimum capital, and a moderately strong doctrine of veil piercing. Security interests for sophisticated creditors. Recently, Hong Kong had an opportunity to remove charges from its company law, as have Canada, Australia and New Zealand,190 but chose to retain this specialized security interest ofered exclusively to companies. he opportunity arose during the process of amending its Companies Ordinance from 2009 to 2012, when the drating team looked to Australia and New Zealand oten, and frequently adopted solutions employed in those common law jurisdictions. When it came to charges, however, they chose not to follow those 190

For Canada, see Personal Property Security Act [RSBC 1996] Chapter 359; for New Zealand, see Personal Property Securities Act 1999, Public Act 1999 no. 126; for Australia, see Personal Property Securities Act 2009. he basic framework for a general system of registered securities is found in Article 9 of the US Uniform Commercial Code (UCC), which is a model law that has been adopted with slight variations in all 50 US states. As the secretary for the initial drat of UCC Article 9 has explained, ‘[t] he organizing concept which underlies Article 9 is that security transactions should be diferentiated with reference to the status of the person whose property secures the debt and the kind of property put up as collateral – thus: consumer goods; farm products; and property used in business enterprises, which is subdivided according to whether it is intended for use in the business (equipment) or for sale (inventory) or represents the proceeds of the sale of inventory (“accounts receivable,” “chattel paper,” etc.).’ Gilmore (1951: 27). For further history of Article 9, see White and Summers (2000: 1–7).

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other former UK colonies by hiving of company law charges into an American-style system of security interests. As a result, Hong Kong company law continues to include a system of secured lending that is available exclusively to companies and whose use depends upon relatively sophisticated legal documentation and advice. he priority of charges depends on intricate judicial doctrine developed over a century of litigation, and the registration system for charges does not include all information necessary to subsequent lenders, making register notice incomplete. Register notice is a key to the efect of security interests against competing creditors, as it provides a presumption that the entire world has knowledge of what is entered in the register. he ‘crystallization’ of a loating charge into – for most purposes – a i xed charge is an extremely important event, yet one that the register is incapable of notifying to the lending community. Moreover, lenders have for many decades attempted to improve the bite of loating charges (which by nature allow disposal of the charged asset, including by the grant of a i xed charge) through inserting ‘restrictive’ or ‘negative’ pledge clauses into loating charges, which oten act contractually (i.e. only between the parties to the debenture) to crystallize the loating charge if the chargor attempts to grant a subsequent, superior charge, such as a i xed charge. Such clauses also receive no constructive notice through the register, but depend on private notice directly given in order to be efective.191 To use this form of protection, a creditor must have time and bargaining power to negotiate the terms of the debenture creating a charge, as well as the legal expertise and know-how to navigate through the legal technicalities and techniques entailed in the use of i xed and loating charges to secure a debt, plus a suitable network to provide actual notice of crystallization and restrictive clauses. he continued use of the charge system clearly beneits sophisticated creditors to the detriment of their less well-equipped competitors. Disclosure by unlisted companies. Regular disclosure requirements for companies listed on the SEHK are essentially identical to those of other major exchanges.192 For unlisted companies, the considerable amount of information a Hong Kong public company must gather and provide its shareholders on an annual basis sets Hong Kong far apart from other leading jurisdictions and greatly facilitates the negotiation of both secured and unsecured credit with such companies. Unlike other major jurisdictions, 191

192

See the discussion in ABN Amro Bank v. Chiyu Banking Corp Ltd [2001] 2 HKLRD 175. It is possible, although by no means certain, that s 338 of CO 2012 will be interpreted as providing notice of such clauses. See SEHK Listing Rules, Chapters 12, 14, 14A, 16.

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such as the United States (Delaware) or the UK, Hong Kong requires unlisted public companies and large private companies to provide detailed annual inancial statements and a report on business operations signed by directors.193 Exemptions from such requirements are available for wholly owned subsidiaries (included in the holding company’s reporting) and ‘small private companies’, which are – roughly speaking – companies with no more than 50 members, whose shares are not freely transferrable, whose total revenue and total assets each do not exceed HK$100 million, and which do not employ more than 100 persons.194 Other companies must annually prepare inancial statements or summary inancial statements that conform to applicable accounting standards and in any case ‘give a true and fair view of the inancial position of the company’,195 and lay them before the annual meeting.196 hese inancial statements must be accompanied by a signed directors’ report that sets forth, inter alia: • the principal activities of the company during the year past;197 • particulars of any matter material for the members’ appreciation of the company or whose disclosure would not harm the company’s business;198 • principal risks facing the company and important events that have afected the company in the past year;199 • an indication of the company’s future development,200 and to the extent necessary to understand the business’ development and performance, • an analysis of the key performance indicators;201 • the company’s environmental policies and compliance with law;202 and • key relationships with employees, customers and suppliers.203 he directors’ report and inancial statements, together with an auditor’s report on the inancial statements, must be iled each year with the Companies Registry in an ‘annual return’, which must also contain ‘particulars of the total amount of the indebtedness of the company’, and ‘particulars relating to members and share capital of the company’.204 In this way, not only members of a company, but also creditors and potential 193 194

195 197 199 201

202 204

See CO 2012, s 429. CO 2012, s 361 and Schedule 3, s (1). If the company meets two out of three of the assets, revenue and employees requirements, it can qualify for a reporting exemption. 196 CO 2012, s 380. CO 2012, s 429. 198 CO 2012, s 390(1)(b). CO 2012, s 390(2). 200 CO 2012, Schedule 5, s 1. CO 2012, Schedule 5, s 1. CO 2012, Schedule 5, s 2. A detailed Companies (Directors’ Report) Regulation requires additional disclosures, of particular note among which is statements on any i nancial dealings between the company and directors. 203 CO 2012, Schedule 5, s 2. CO 2012, Schedule 5, s 2. CO 2012, s 662 in connection with Schedule 6.

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lenders have access to detailed information regarding the shareholding structures, business operations, inances and indebtedness of all but the smallest private company in Hong Kong. Capital maintenance for unsecured creditors. he capital maintenance provisions found in Hong Kong company law are moderate and are linked to annual disclosure, in that they protect a ‘share capital’ that is an arbitrary igure i xed by the members, but disclosed to the public. his aspect of Hong Kong law more resembles the US Model Business Corporation Act, which never employed minimum capital and made the concept of par value optional in 1986,205 than it does the UK Companies Act (whether 1985 or 2006),206 which incorporates minimum capital requirements for public companies in compliance the EU Second Company Law Directive. In 2012, Hong Kong abandoned the measure of par value to determine appropriate share capital (arbitrary par x number of issued shares = share capital) and replaced it with a combination of a declared amount and a solvency test. Now, upon forming a company, the incorporators must state some amount of ‘share capital’,207 and this capital may not be distributed to members.208 Beyond this, for any distribution that would lead to a reduction of the declared share capital directors must inspect the state of the company’s inances and issue a ‘solvency statement’,209 which is a technique resembling provisions in the UK Companies Act 2006.210 his system of capital maintenance works together with the disclosure requirements discussed above, in that any creditor who has had opportunity to inspect the company’s annual disclosures will know the amount of share capital,211 although they would not have access to information on liabilities incurred in the current year, which might have already exhausted such amount during the current accounting period. he solvency statement is a declaration signed by each director making the declaration that ‘immediately ater the transaction there will be no ground on which the company could be found to be unable to pay its debts’, and that this condition will remain during the next 12 months.212 he use of declared share capital and dependence on directors to verify solvency for the protection 205 206 207

208 210 211

212

See Model Business Corporation Act, §§ 2.02(b)(2)(iv) and 6.40(c). See Companies Act 2006, ss 761, 763. See CO 2012, s 68(2) and Sch 2, s 8(1)(b). Another possible interpretation is that all proceeds from share allotments will automatically be share capital, but it is unlikely that such dramatic change in the law would be introduced without express mention. CO 2012, s 297(1). 209 See CO 2012, ss 206, 259. See Companies Act 2006, s 643. he ‘annual return’ i led for public view in the Companies Registry must state ‘particulars relating to … share capital’. See CO 2012 s 664(3)(a) and Schedule 6, s 1(f)(i). CO 2012, ss 205–206.

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of creditors follows a dominant thread used in US corporate law, where the quality of corporate action in many areas ultimately hangs on the ability of the court to enforce the duties of directors to act with due care, skill and diligence and in the interest of the company.213 For a reduction of capital, Hong Kong retains the favoured UK element of introducing court supervision, and in 2012 set up an approval process that closely tracks the procedure laid out in Companies Act 2006.214 As a result, the procedure for a reduction of capital employs the three diferent safeguards of directors’ duties when deciding on solvency, supermajority approval and court review. First, if the directors propose a reduction they must accompany their proposal by a solvency statement, which, second, the shareholders must approve by a supermajority of 75 per cent of the votes cast (special resolution).215 hird, before the resolution can become efective, notice of the decision must be published and sent directly to creditors, giving them ive weeks to ask the court to cancel the resolution,216 and the court may conirm or cancel the resolution on ‘any terms and conditions it thinks it’.217 In this way, although no speciic amount of capital must be present in order to form a company, the amount that creditors rely on from earlier disclosures cannot be changed without court approval if the creditors ind the change objectionable. his system will of course beneit only contracting creditors, and will ofer no comfort to the unwilling tort victim creditors of a Hong Kong company. Veil piercing under Hong Kong law. As in many other jurisdictions, the doctrine used to decide whether legal personality should be disregarded and payment for a company’s debt may be demanded of the company’s members has been crated in case law. Unlike the United States, where veil piercing principals are phrased in an unruly jumble of tautological metaphors, 218 and the UK rule, according to which limited liability is 213

214 215 218

See Model Business Corporation Act, §6.40(d) (directors’ determination of solvency for distributions to shareholders); Delaware General Corporation Law, §§152, 154 (directors’ determination of what consideration may be contributed for shares and the value of such consideration is binding in the absence of ‘actual fraud in the transaction’, and directors determine what portion of such consideration will be capital for purposes of capital maintenance); Zapata Corp. v. Maldonado, 430 A2d 779 (1981) (the determination of a board of directors whether a derivative action should go forward will be given great weight absent conl icts of interest); Moran v. Household International Inc., 500 A.2d 1346 (1985) (a board has discretion to impede a takeover ofer it inds unattractive, provided that it does not completely preclude the takeover). See Companies Act 2006, ss 641–649. 216 217 CO 2012, s 216. CO 2012, s 218. CO 2012, s 222. With reference to veil piercing under US company law, Easterbrook and Fischel (1985: 89) have observed that: ‘“Piercing” seems to happen freakishly. Like lightning it is rare, severe, and unprincipled.’

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never taken from a public company regardless of perceived abuse, 219 Hong Kong’s courts have formulated a rule that is fair and relatively unproblematic to apply. his is another area (like that of unfair prejudice actions) where Hong Kong courts are adopting inherited doctrine freely to meet local needs. he leading case on this point is Mitrans Shipping,220 where Bokhary JA formulated the rule as follows: ‘Using a corporate structure to evade legal obligations is objectionable. he courts’ power to lit the corporate veil may be exercised to overcome such evasion so as to preserve legal obligations. But using a corporate structure to avoid the incurring of any legal obligation in the irst place is not objectionable.’221 he line is therefore drawn between incorporation in advance of a liability and incorporation (or transfer of debt to a company) that changes the state of afairs in which a liability is incurred, with the former fair play and the latter grounds for piercing the corporate veil. As a result, Hong Kong courts seem to have taken hompson’s advice that they ‘ought to recognize the widespread acceptance of risk-shiting through … corporate planning … [and] keep in mind the irst mover advantage accorded private ordering in such a setting to establish the separate corporate entity’, and that the dealings between the parties might include ‘implicit or explicit pricing relected in that planning’.222 Fraud, changing the arrangement of liability ater an obligation exists, is another matter, and grounds for disregarding the corporate veil.223 he Mitrans rule is complementary to Hong Kong’s extensive array of disclosure requirements, discussed above, which allow contractual creditors to understand exactly what form of private ordering has been set up to limit liability, and survey the inancial condition of their contractual counterparty. If the balance of liability is changed ater inspection and contracting by introducing a new entity or shiting assets among entities, it is equitable for the court to intervene, but if the corporate structure and inancial condition were visible beforehand and the arrangement of liability remains unchanged, there is no reason for judicial intervention. 219

220 221 222 223

Since Salomon v. A Salomon & Co Ltd [1897] AC 22, UK courts have shown a strong tendency to respect the limited liability of company members in public companies regardless of the circumstances. Recent examples are found in Adams v. Cape Industries plc [1990] 1 Ch 433 and Re Polly Peck International plc (in administration) [1996] 2 All ER 433. China Ocean Shipping Co v. Mitrans Shipping Co Ltd [1995] 3 HKC 123. Mitrans Shipping [1995] 3 HKC at 127. hompson (2005: 635). hompson’s theory for the application of veil piercing in common law also agrees on this point. hompson (2005: 628–9).

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his arrangement does not, however, address the dilemma of a tort victim who is unfortunate enough to be damaged by a corporate vehicle for which shareholders have carefully under capitalized to reduce the liability that would arise on exactly such an occasion. For tort creditors, the Hong Kong rule on veil piercing appears harsh. Addressing this situation, Hansmann and Kraakman conceive the planning activity of a business that arranges its corporate structure in the face of a known liability that could arise for a certain kind of tortuous action it may engage in as ‘evasion’.224 Seen from this perspective, the owners or management clearly perceive the liability that can arise from a planned activity even though a claim has not yet arisen, and take action to evade it. Although there is no indication that a Hong Kong court would interpret the avoid/evade distinction diferently in contract and tort situations, the distinction ofered by Hansmann and Kraakman, if brought into the Mitrans test, could allow Hong Kong courts to pierce or let stand the corporate veil according to a speciic rule that is fair and predictable for obligations arising in either contract or tort.

4 Does company law suiciently serve private companies? Another question in this evaluation of Hong Kong company law goes to the balance of equities in lawmaking, rather than agency risks in the company form. At the close of 2011, nearly 99 per cent of companies registered in Hong Kong were ‘private companies’, a percentage that has remained relatively stable in recent years: 2008 (98.6 per cent), 2009 (98.7 per cent) and 2010 (98.8 per cent).225 Like the distinction in US law between a corporation and a close corporation, and exactly the same as the UK public company/private company distinction, a Hong Kong private company is incorporated and operates under the same statutory framework as a public company with certain special provisions made for its smaller size. he Companies Ordinance deines ‘private company’ as one having no more than 50 members (excluding employee members) and whose shares are subject to a restriction on transfer and may not be freely ofered to the public.226 here is no restriction on the activities private companies may perform or the dimension of the assets they may hold. A private company 224 225

226

Hansmann and Kraakman (1991: 1881). he igures for 2011 were 945,464 private companies out of a total of 956,392 registered. See www.cr.gov.hk, statistics > local companies on register (accessed 15 March 2014). See CO 2012, s 11.

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may be incorporated by an individual founding member227 without any speciic amount of capital,228 and for a modest fee. Moreover, following the UK model, election of directors and management of the company are provided for almost solely in the articles of association, which can be drated in ways to, for example, place all the power of the board in a single person and eliminate elections of this or other directors altogether. As such, the private company form is well suited to the start-up enterprises and small businesses that are common in the Hong Kong economy. As discussed in Chapter 2, investigation of the leading corporate groups in Hong Kong has not shown the private company form to be popular as a vehicle for ultimately holding shares at the top of a corporate pyramid (for family ownership, that is the trust, and for PRC government ownership, a PRC company), although it did appear to show that this form is a common vehicle for subsidiary members of the corporate groups studied. Among the 15 groups examined in Chapter 2, there are about 1,000 private Hong Kong companies.229 hus, if the rules on the private company form have been crated for a particular use to suit the needs of persons employing the private company form, such use would be both as a subsidiary unit in a corporate group and a vehicle for smaller businesses. he accommodations accorded this form in the Companies Ordinance appear commensurate with such uses, although they also seem designed to discourage the unnecessary fragmentation of economic activity into complex groups. As discussed in the previous subsection, when assessed in comparison with the company law of other major jurisdictions, Hong Kong company law presents an extraordinarily extensive disclosure regime for companies that are not listed. It operates on three levels: the directors of a company must maintain registers, which are open to the general public, prepare and disseminate information to members on an annual basis, 227 229

228 See CO 2012, s 67(1). See CO 2012, s 68(2) and Schedule 2, s 8. h is is an estimate based on the 2011 annual reports of the listed companies in each group. he igure of 1,034 is based on those Hong Kong companies within the group that are not listed, and are held by their parent with at least a 50 per cent shareholding. he breakdown, using the groups as dei ned in Chapter 2 , is as follows: Cheung Kong (99), Hang Lung (164), Henderson (148), New World (183), Sun Hung Kai (145), Bank of East Asia (11), Bank of China (44), HSBC (16), Standard Chartered (2), China Mobile (2), China Resources (25), CITIC (57), Swire (80), Hutchison (38) and Jardine (20). Given the holding of the parent company, it is unlikely that these companies would have over 50 members, excluding employee shareholders. A dei nitive answer on this question would require accessing the Companies Registry entry for all of the Hong Kong and Hong Kong registered subsidiary and associated companies within the major corporate groups studied.

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which information is also i led together with an ‘annual return’ at the Companies Registry, and disclose information to members when they so request for a ‘proper purpose’. he Companies Ordinance provides that a company must keep an updated register of its members, 230 of any debentures issued231 and also of i xed and loating charges.232 Annual disclosure takes the form of a directors’ report to be presented to the members at each annual general meeting, together with the annual inancial statements (prepared according to the appropriate version of Hong Kong Financial Reporting Standards), 233 the notes to which must disclose emoluments, retirement beneits, severance payments and any credit paid to directors.234 he directors’ report as discussed above is a detailed presentation of the company, its inancial position, business activities, any resignation or indemnity of directors, and all signiicant transactions involving related parties.235 It compares to disclosure required from listed companies under common provisions of securities law or listing rules. Beyond keeping speciied registers and making annual disclosure, companies must provide access to documents if either (1) ive or more members or (2) members constituting at least 2.5 per cent of voting rights so request in ‘good faith’ and for a ‘proper purpose’, and the court decides that the request should be granted.236 From the above, it is easy to understand that the costs for providing the level of annual disclosure required in Hong Kong can be signiicant. he Companies Ordinance exempts qualifying private companies237 from 230

231

232

233 235

236 237

CO 2012, s 627. h is register must be kept in either English or Chinese, stating the members’ names and addresses, shares and amount paid in by each member, the date at which each person was entered in the register, and the date at which any person ceased to be a member. A company with more than 50 members must also create an ‘index’ of members with the same information. CO 2012, s 630. CO 2012, s 308. his register must be maintained for any debentures that are not transferred by simple delivery (i.e. registered instruments) and must be kept in either English or Chinese, stating the holders’ names and addresses, amount held by each holder, the date at which each person was entered in the register, and the date at which any person ceased to be a holder. CO 2012, s 352. h is register must include the following information on every charge afecting the company’s property: the amount secured by the charge, the property providing the security, and the charge of the particular charge. S.122(1). 234 CO 2012, s 383. See CO 2012, s 388 and Schedule 5, as well as the Companies (Directors’ Report) Regulation. CO 2012, s 740. See CO 2012, s 359. his category does not include any entity licensed for inancial services such as banking, brokerage or insurance. Qualiications focus on limits which total assets and revenues may not exceed. See CO 2012, Sch 3, s 1.

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preparing a directors’ report on the annual activities of the company,238 and from most accounting disclosure except that regarding inancial assistance given in the context of employee share schemes,239 and information regarding parent and subsidiary companies (which would of course not apply in the case of a small enterprise operating independently).240 As a wholly owned subsidiary enjoys a blanket exclusion from preparing inancial statements, the reporting duty would in such cases be passed up to the holding company,241 which would not have to include the exempted company in its consolidated accounts.242 Such accommodations, like those allowing one-person companies with streamlined governance and inancial rules, are by no means new, and are standard policy measures to stimulate the activity of small and medium enterprises (SMEs). What is unusual, yet also structurally predictable in Hong Kong, are provisions expressly extending allowances such as limited disclosure to groups of private companies. Nevertheless, as many cases in Hong Kong raising allegations of management or controlling shareholders violating company law entail abuse of multi-entity groups, it is sound regulatory policy that the set of accommodations is structured to favour use of individual, small companies rather than groups of small companies. A holding company of a corporate group that does not include a company licensed to perform any form of inancial service will be exempt from most disclosure, provided that it qualiies as a group of ‘small private companies’ or a group of ‘eligible companies’.243 Aside from the requirement that it not include a inancial services company, the other main determinants in meeting this qualiication are the deinitions of ‘small’ and ‘eligible’ as they apply to corporate groups. A group of small private companies is one in which two of the following three apply: neither total revenue nor total assets of the group exceed HK$100 million, nor does the group employ more than 100 persons.244 For a group of eligible private companies, the inancial ceilings are doubled. It is one in which two of the following three apply: neither total revenue nor total assets of the group exceed HK$200 million nor does the group employ more than 100 persons.245 he inancial requirements 238 239 240 242 244

245

See CO 2012, s 388(3)(a). See CO 2012, Sch 4 s 1 in connection with ss 280, 281. See CO 2012, Sch 4 ss 2 and 3. 241 See CO 2012, s 379(2). See CO 2012, s 382(3). 243 See CO 2012, s 359(2)(b). CO 2012, s 364 and Schedule 3, ss (1)(7), (1)(8). Speciied conditions apply to application of the rubric ‘small’ during periods in which a company in existence either begins to meet these criteria or later ceases to meet the criteria. CO 2012, s 365 and Schedule 3, ss (1)(10), (1)(11). As with a group of small companies, speciied conditions apply to application of the rubric ‘eligible’ during periods in which

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for both of these categories are the same whether applied to classifying an individual company as ‘small’ or ‘eligible’ or so classifying the homonymous group, which – if reduction of costs through exemption from disclosure requirements is an aim – provides a clear disincentive to multiply the number of companies a single holding company operates. A similar pattern of exemptions is found in the rules on loans or other forms of credit between a company and its directors or their controlled companies.246 As applied to private companies, these rules are much more lexible than those applicable to public companies, for they only restrict the making of loans, but not the extension of other forms of credit from a company to its directors or the directors of a holding company.247 his changes if the company is a subsidiary in a corporate group that includes a listed company as its parent, and in this latter case, all restrictions applicable to public companies also apply to the private company.248 By making provision for minimal and streamlined management structures, reduced disclosure and lexibility in related party transactions, Hong Kong company law provides the normal set of beneits and exemptions for companies used in SMEs. Moreover, by extending some such beneits to groups of small companies while clearly favouring stand alone small companies through limits on total revenue and assets, Hong Kong law appears to recognize both the presence and the dangers of complex corporate groups in its economy. As such, it seems that the legislative process did aim to serve the majority of its corporate constituents, even if the overall balance of disclosure requirements under Hong Kong company law falls clearly on the side of investors and lenders, rather than entrepreneurs. h is speaks strongly for the fairness of the Hong Kong legislative process. As discussed in Chapter 1, Section D.2, with respect to the public debate on disclosure of directors’ personal data, the lead organization representing SME interests found the arguments of the international press that they required easy access to the personal data of directors more compelling than the privacy interests of the directors of

246 247

248

a company in existence either begins to meet these criteria or later ceases to meet the criteria. See CO 2012, Part 11, Division 2, Subdivision 2. CO 2012, Part 11, Division 2, Subdivision 2 prohibits a private company making loans to directors without the approval of disinterested shareholders, but does not impose a like prohibition for indirect loans triangularly structured (referred to as ‘quasi-loans’) or credit transactions, although these latter prohibitions apply to public companies and private companies in a group with a listed company. CO 2012, s 491(1), dei nition of ‘speciied company’, (b).

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the companies it represents, which indicates either that businesses using the small company form in Hong Kong are not represented well, or are represented by a group that chooses not to aggressively promote their own interests above their general understanding of the public good.

5 Do company and securities laws suiciently limit risks from foreign listed companies? As discussed in Chapter 2, at the close of 2012, there were a total of 1,547 companies listed on the Main Board and GEM of the SEHK. Of these, only 205 (13.25 per cent) of them were incorporated in Hong Kong, 645 (41.69 per cent) of them were incorporated in the Cayman Islands, 491 (31.73 per cent) were incorporated in Bermuda, 173 (11.18 per cent) were incorporated in the PRC, and 33 (2.13 per cent) were incorporated elsewhere, including in the British Virgin Islands, the UK, Canada, Brazil, Japan, Jersey, Luxemburg, Singapore and a US state, such as Delaware or California. hus, about 87 per cent of companies listed on the SEHK are incorporated under a system of company law other than Hong Kong law, which means the government of Hong Kong has no direct control over the nature of the rules governing their internal afairs, such as board structure and shareholder rights. With the Hong Kong market playing host to a vast smorgasbord of corporate governance and inance regimes, Hong Kong’s attractiveness as an international inancial centre can be maintained only if it is able to control the agency risks to which investors are subject in this heterogeneous mass of legal systems that it brings together as issuers of the securities traded on the matching engine of the SEHK. Hong Kong company law has established three mechanisms to deal with this problem. First, HKEx examines the law of a jurisdiction before allowing its companies to list on the SEHK, so that a certain level of quality – whether it takes the shape found in Germany or Bermuda – is a prerequisite for listing. Second, the SEHK requires that companies adjust their internal governance before and during listing through commitments made in the listed company’s articles of incorporation (certiicate, by-laws, statut, or Satzung). hird, an outreach section of the Hong Kong Companies Ordinance applies a package of ‘shareholder protection’ mechanisms (including derivative and unfair prejudice actions, and right to inspect records) to companies listed on the SEHK, regardless of where they are incorporated. hese three techniques are discussed in following.

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a Recognized and acceptable jurisdictions By international comparison, the SEHK is an extremely open market, in which the shares of companies incorporated abroad are listed directly on the exchange in diferent currencies. By contrast, in almost all cases, foreign shares would never be listed on the NYSE or Nasdaq. Instead, the shares would be deposited in an American bank and highly standardized certiicates issued by that bank incorporating a claim against the rights in the shares would then be listed. hese American Depository Receipts (ADRs) are denominated in US dollars and standardized in every way to plug neatly into the US listing and trading routine. Given that the characteristics of the US securities market generally set standards for what other securities markets are considered to need, the HKEx has also created ‘Hong Kong Depository Receipts’, but this solution has been used by a mere three issuers of the 1,368 companies listed on the SEHK Main Board at the end of 2012. Hong Kong, like the NYSE, Nasdaq and other exchanges, examines the company laws of jurisdictions in which potential listed companies are incorporated, but in contrast to most other exchanges, the HKEx assesses whether they are ‘acceptable as an issuer’s place of incorporation’,249 for direct, primary listing in Hong Kong. he HKEx can list these companies directly without the prophylactic protections of depositary receipts because it applies its entire listing rules to the foreign companies who will have their primary listing in Hong Kong,250 requiring introduction of governance measures shaping the issuer’s board and shareholder rights.251 Issuers incorporated in such jurisdictions are referred to as ‘overseas’ issuers, not ‘foreign’ issuers. In a 2007 statement on this practice issued jointly with the SFC, the HKEx explained that it attempts to ensure that such jurisdictions have ‘appropriate standards of shareholder protection that are at least equivalent to those required under Hong Kong law’.252 249

250 251

252

www.hkex.com.hk, Rules & Regulations > Rules and Guidance on Listing Matters > Special Topics > Listing of Overseas Companies > List of Acceptable Overseas Jurisdictions (accessed 15 March 2014). SEHK Listing Rules, Rule 19.01. In addition to annual and current disclosure obligations, and obligations to disclose connected party transactions, these requirements include that the board contain a required number of independent directors, an audit committee and a remuneration committee, and that any allotment of shares receive shareholder approval. See SEHK Listing Rules, Chapters 19, 13 and 3. SFC and HKEx, ‘Joint Policy Statement Regarding the Listing of Overseas Companies’, 7 March 2007, p. 2.

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Beyond requirements as to board structure, disclosures and voting rights, an important prerequisite for overseas companies is that they maintain ‘a register of holders’ for the transfer of shares in Hong Kong,253 which will constitute a ‘place of business’ in Hong Kong under the CO,254 triggering jurisdiction of the Hong Kong courts to hear derivative and unfair prejudice actions regarding all such ‘non-Hong Kong’ companies, 255 as discussed in Subsection c, below. At the end of 2012, there were 21 ‘acceptable jurisdictions’ from which issuers could list on the SEHK as overseas listed companies.256 hree of these jurisdictions, the PRC, the Cayman Islands and Bermuda – which together constitute nearly 85 per cent of the companies listed on the SEHK – are singled out for application of speciic governance provisions that must be incorporated in their articles of association. hese are discussed in following.

b Required provisions in articles Caribbean red chip and H-share companies dominate the SEHK by both numbers and market capitalization, and are also formed in jurisdictions whose laws are not held up as examples of exceptional corporate governance. As such, the HKEx has set out speciic provisions that these companies must include and maintain in their articles of association in order to be listed,257 in addition to those governance measures required of all listed companies, such as that one-third of each board be nonexecutive independent directors,258 and that the board include an audit committee259 and a remuneration committee.260 he additional required provisions for Cayman Island and Bermudian companies are, however, rather minimal, requiring suicient notice for shareholder meetings, the keeping and laying down of accounts, and the right to remove directors with a simple majority of the votes, 261 with additional requirements for the Cayman Islands that directors declare conlicts of interest and loans to directors are strictly regulated.262 As beits the bonding service that Hong Kong has ofered mainland Chinese issuers, the HKEx spends much more time on requirements for PRC issuers. he Listing Rules Chapter dedicated to them explains that ‘the Exchange Listing Rules apply as much to 253 254 257 258 260 261 262

SEHK Listing Rules, Rule 19.05(3)(a). CO 2012, s 774(1). 255 See CO 2012, s 722(1). 256 HKEx (2013: 4). See SEHK Listing Rules, Chapter 19A, Appendices 13A and 13B. SEHK Listing Rules, Rule 3.10(A). 259 SEHK Listing Rules, Rule 3.21. SEHK Listing Rules, Rule 3.25. See SEHK Listing Rules, Appendices 13A and 13B. SEHK Listing Rules, Appendix 13B(5).

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PRC issuers as they do to Hong Kong and overseas issuers, subject to the additional requirements, modiications and exceptions set out or referred to in this Chapter’.263 hese additional requirements go to inserting qualiied professionals into advisory roles with the PRC issuer and ensuring that these people actually do their job according to standards set by the HKEx. he professionals are the lead manager investment bank (sponsor), a compliance oicer and the issuer’s accounting irm.264 Beyond the standard requirements that the board contain independent directors, the Rules provide that ‘the independent non-executive directors of a PRC issuer must also be able to demonstrate an acceptable standard of competence and adequate commercial or professional experience to ensure that the interests of the general body of shareholders will be adequately represented’.265 Beyond this, a mandatory provision in their articles must provide that the supervisory board members will make decisions by a vote of three-quarters of its members.266 Constituting about half of the SEHK’s market capitalization, the H-shares are very important for the HKEx, which justiies the custom-made rules applying to speciic, perceived weaknesses in mainland Chinese law. Nevertheless, the extent to which the HKEx analyses diferent jurisdictions and writes custom-made rules for them sets it apart from the kind of prophylactic standardization one sees on the US exchanges, in particular.

c Outreach provisions of the Companies Ordinance As mentioned above, the Hong Kong Companies Ordinance applies its shareholder protection mechanisms to any company incorporated outside of Hong Kong which establishes a ‘place of business’ in Hong Kong, with these entities being referred to as ‘non-Hong Kong companies’.267 hese companies must register with the Hong Kong Companies Register and provide certain regular disclosure,268 but will nevertheless still come under the Ordinance even if they never register. As at August 2013, there were 9,102 non-Hong Kong companies so registered,269 not considerably less than the total number of Hong Kong incorporated public companies (11,882) in existence.270 Although for companies not listed in Hong Kong, 263 264 265 266 267 269 270

SEHK Listing Rules, Rule 19A.01(3). SEHK Listing Rules, Chapter 19A, parts 3A and 4A. SEHK Listing Rules, Rule 19A.18(1). SEHK Listing Rules, Appendix 13D, s 1(d). CO 2012, s 2, ‘non-Hong Kong company’. 268 CO 2012, s 776. See www.cr.gov.hk, statistics > non-Hong Kong companies (accessed 15 March 2014). See www.cr.gov.hk, statistics > number of local companies on register in 2013 (accessed 15 March 2014).

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the exact circumstances under which a ‘place of business’ is found to exist will be open to debate,271 the Ordinance expressly includes a share transfer or share registration oice,272 which overseas companies listed on the SEHK must maintain in Hong Kong,273 within the deinition of that term. Beyond registration of an agent for service of process and i ling information on directors,274 the Companies Ordinance also requires that each non-Hong Kong company annually publish a return with information on its organization and activities, as well as accounts if required by the rules of another jurisdiction or a securities exchange,275 and provides that Hong Kong courts may entertain members’ actions of the following types against such companies, their members and their directors:276 • actions for unfair prejudice afecting the interests of some or all members;277 • actions against conduct causing the company to breach the CO;278 • shareholder derivative actions against management misconduct;279 and • actions to allow members constituting 2.5 per cent of voting rights (or ive members collectively) to inspect company records.280 he SEHK Rules expressly apply Hong Kong standards for the duty of care and iduciary duty apply to the directors of listed companies, 281 271

272 273

274 276 278 280 281

CO 2012, s 774. he factual circumstances constituting establishment of a ‘place of business’ were discussed in he Artemis (Cargo Owners) v. Artemis Transportation Corp [1983] HKLR 364, where the Court of Appeal held that to prove the existence of a ‘place of business’, it is necessary to consider three matters: (1) the acts relied on to show that an agent is carrying on business must have continued for a suiciently substantial period of time, (2) the acts should have been done at some i xed place of business, and (3) the agent must be here in the form of a person carrying on business for the company in Hong Kong, it is not enough to show simply that the company has an agent here. he Court of First Instance recently considered the question in Yung Kee Holdings Ltd [2012] HKEC 1480, where in denying jurisdiction for an unfair prejudice action against the British Virgin Islands holding company of a well-established Hong Kong company, it held that ‘if a foreign holding company, carrying out a business internationally through subsidiaries some of which operate in Hong Kong, decides to hold some of its regular board meetings in Hong Kong that does not of itself mean that it has established a place of business here even if some of its subsidiaries clearly have done so’. Para. 38. CO 2012, s 774. SEHK Listing Rules, Rule 19.05(3)(a), (4). For a separate discussion of SEHK listed companies as non-Hong Kong companies subject to registration, see Yung Kee Holdings Ltd [2012] HKEC 1480, para. 42. 275 See CO 2012, ss 786 and 802. CO 2012, s 789. 277 See CO 2012, s 722. CO 2012, s 724. 279 CO 2012, s 728. CO 2012, s 732. CO 2012, s 740. See SEHK Listing Rules, Rule 3.08.

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which greatly reduces the risk of a local court inding that – in hearing a derivative or unfair prejudice action – it had to apply a listed company’s home law, perhaps containing less rigorous standards, to such actions. his ensures a signiicant amount of company law monitoring (beyond the application of listing rules and securities law) over the internal governance of the 85 per cent of Hong Kong listed companies whose afairs would otherwise be governed solely by foreign law. As discussed above in Section C.1, regarding Luck Continent Ltd v. Cheng Chee Tock heodore, the reason the Bermudan company could be sued in a Hong Kong unfair prejudice action is because the Hong Kong Companies Ordinance speciically pulls such non-Hong Kong companies within its ambit. As also explained in Section C.1 regarding Re Styland Holdings Ltd (another Bermudan company), the SFC has power to take judicial action against such companies on theories such as a breach of the duty of care or iduciary duty, or action by management or controlling shareholders that unfairly prejudices the interests of some or all of the members. he expressly applicable Hong Kong standards have been applied to non-Hong Kong companies under these provisions.282 In this way, the Companies Ordinance outreach provisions and the SEHK Listing Rules discussed above adapt foreign law to local standards by inserting local rules into the foreign company’s constitutional documents and ensuring that such company can be brought into Hong Kong court on a local shareholder protection theory. his aggregate of substantive measures introduced via the Listing Rules and the jurisdiction given to the Hong Kong courts for a number of corporate actions – whether commenced by a shareholder or the SFC – ties the foreign companies into Hong Kong law so as to reduce substantially the risks of them importing poor governance rules into Hong Kong through their listing on the SEHK. As securities laws apply to activity on a given market rather than according to the state in which an actor entity is incorporated, Hong Kong’s securities laws and regulations – discussed immediately below – apply to all persons engaged in relevant activity in Hong Kong.

6 Do securities laws and regulations prevent market abuse? Even if Hong Kong company law extends into the listed companies incorporated in many foreign jurisdictions, and as also discussed above, SEHK rules supplement and standardize the governance structure of non-Hong 282

See, e.g., GP Nanotechnology Group Ltd [2009] HKEC 1677, para. 42.

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Kong companies, the entity-centred nature of such company law rules means that they can only go so far in policing dealings on the market. Securities laws, regulations and rules, including listing rules, must i ll the remaining gap. hey must address risks arising from the two signiicant factors regarding listed companies in Hong Kong. First, as seen in Chapter 2, controlling, insider shareholders abound in Hong Kong. Second, as discussed above, the vast majority of the companies listed on the SEHK are based in jurisdictions that are not known for especially high quality corporate governance, such as the PRC, the Cayman Islands and Bermuda. he measure of Hong Kong securities law must be taken in relation to the risks posed by these market characteristics rather than merely as a measure of the extent to which they also include US or European best practices. he SFC has recently sought to bolster gatekeeper impact in Hong Kong by introducing rules to ensure that the investment banks which act as managers in the public oferings of these companies fuli l their roles as gatekeepers.283 hese rules are similar to those discussed above for the sponsors of PRC companies, although they are much more generalized and detailed. To protect the integrity of the prices of listed securities discovered in secondary market trading, efective protection against insider dealing and manipulated prices are of great importance. Given the number of sophisticated, controlling shareholders in the small Hong Kong market, trading by insiders is common and constitutes a signiicant part of exchange turnover.284 Although neither regulatory authorities nor the media have uncovered any cases of insider dealing that indicated a hidden pattern of previously undetected abuse, older studies of price movements in connection with earnings announcements and share repurchases concluded that inside information was being abused on the Hong Kong market.285 Currently, Hong Kong has a framework of laws, regulations and enforcement against market abuse that meets or exceeds international standards, although the more pertinent question is whether this framework i lls the needs of an environment in which controlling shareholders are regularly privy to information regarding 283

284

285

See SFC, Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, ss 17.1–17.15. Chapter 2 has shown the predominance of controlling shareholders in Hong Kong companies. In 1998, 541 out of the 680 i rms listed on the SEHK Main Board registered sales or purchases of their shares by insiders. Cheuk et al. (2006: 76). Also see Zhu et al. (2002). See Cheng and Leung (2008: 435); Jaggi and Tsui (2007: 218).

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the inner workings of their companies and market participants remain in very close contact. Chapter 5 gives some data on enforcement, but further empirical analysis of prices in connection with the release of market sensitive information would be useful for a more robust evaluation. It could be useful for such data to be recorded and published continuously, such as in SFC annual reports. In the following, four sets of rules for market regulation are singled out for examination: rules on insider dealing, market manipulation, and the gatekeeping duties of investment banks sponsoring IPOs.

a Rules against insider dealing Hong Kong’s framework of rules against insider dealing contain the standard, three-part mix: insider dealing is prohibited, transactions by insiders are recorded, and inside information is subject to rapid disclosure requirements. he irst of these prohibitions is the oldest and the last has only recently been introduced, while the recording of directors’ and substantial shareholders’ ownership and transactions is required both by the SFO (according to speciied thresholds) and by listing rules (without thresholds). he Region’s irst legislative prohibition of insider dealing is comparatively old, coming in 1973,286 a full 20 years before a comparable law in – to take one example for illustration – Germany.287 Over a period of three decades this legislation was adjusted, amended, reformulated and inally codiied in the SFO in 2003.288 In 2012 an enhanced rule on the prompt disclosure of inside information was adopted for incorporation in the SFO.289 he tribunal where most civil290 insider dealing cases are heard has also changed from an ‘Insider Trading Tribunal’291 to a ‘Market Misconduct Tribunal’ (MMT)292 – a move which paralleled the European Union’s coterminous broadening from a directive on insider 286

287

288 289

290 291 292

See Annotated Ordinances of Hong Kong, Securities (Insider Dealing) Ordinance, Chapter 395, Introduction, LexisNexis. See he Securities Trading Act (Gesetz über den Wertpapierhandel – WpHG), i rst enacted 26 July 1994. See SFO ss 270–273. Now SFO, Part XIVA, added by the Securities and Futures (Amendment) Ordinance, no. 9 of 2012. Hong Kong provides for both civil and criminal prosecution of insider dealing. See Securities Ordinance 1973, Chapter 333, s 141G (now repealed). See SFO, ss 251–265. One reason for the creation of the MMT was that the sophisticated market practices and techniques used to manipulate market prices make it very diicult to prove the criminal standard of ‘beyond a reasonable doubt’ to convict for market manipulation. SFC (2000a: Para. 20).

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dealing to one that also included other forms of market abuse, 293 such as price manipulation. he MMT is discussed in more detail in Chapter 5. As seen in following, the rules and enforcement protecting market integrity in Hong Kong do provide some elements to counter the serious risks posed by large shareholders in the small Hong Kong corporate and i nancial community. However, as mentioned above, it would be possible to focus more attention on detecting insider dealing by substantial shareholders. he prohibition of insider dealing is expressed in sec 270 SFO, and attaches civil, 294 criminal295 and disqualiication of oice sanctions to persons ‘connected with’ a listed company who have ‘inside information’ about the company and (1) deal in the company’s listed securities, (2) ‘counsel or procure’ another person to so deal, or (3) give the information to another ‘having reasonable cause to believe that the other person will’ do (1) or (2).296 A dedicated provision speciies that contemplation of a takeover bid is inside information which triggers these provisions.297 Importantly for Hong Kong, the deinition of ‘connected with’ the company expressly includes a ‘substantial’ shareholder of the company, which is deined as any shareholding exceeding 5 per cent of share capital,298 as well as persons holding oice in a ‘related’ company,299 which means in the company’s holding company, a subsidiary or a subsidiary of the holding company of the company whose shares are traded.300 As discussed in Chapter 5, in 2012, the Hong Kong Court of Final Appeal handed down a decision, Securities and Futures Commission v. Tiger Asia Management LLC, which assured that the SFC will have lexibility in acting against breaches of the SFO. he transactions of insiders are monitored and recorded according to two sets of rules. First, all shareholdings or options to acquire the same in listed companies reaching 5 per cent of share capital and any 0.5 per cent change thereater301 must be notiied to the company and the exchange within three business days ater it arises.302 his information is publicly 293

294 296 298 300 301

See Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003 on insider dealing and market manipulation (market abuse), 2003 O.J. (L 96) 16, replacing Council Directive 89/592/EEC of 13 November 1989 coordinating regulations on insider dealing. 295 See SFO, 281. See SFO, 291. SFO, s 270(1)(a), (c). 297 SFO, s 270(1)(b). 299 See SFO ss 247(1)(b), (3). See SFO ss 247(1)(c), (ii). SFO Sch 1, s 1(3), ‘references to related corporation’. 302 See SFO ss 310(1), 313(1), 313(7), 315(1). SFO ss 324–325.

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available in electronic form.303 A like duty applies to short positions, 304 although the newer reporting rules discussed below create transparency at a lower threshold. Second, directors must report their dealings in the company’s shares pursuant to a ‘Model Code for Securities Transactions by Directors of Listed Issuers’,305 which however applies only on a ‘comply or explain’ basis.306 Pursuant to this Code, directors of a company listed on the SEHK may not buy, sell or mortgage shares in the company during a 60-day period preceding publication of the annual results and during a 30-day period preceding the publication of the quarterly or semi-annual results,307 and must request prior clearance for such sales, purchases or mortgages from the board chair or a director speciied for this purpose,308 and the company must retain a written record of such transactions.309 Any short positions held by directors in their company’s shares must be entered in a register that is available for inspection by all directors and members.310 One obvious avenue to strengthening this regime would be to apply a blackout period to substantial shareholders of the company as well as to directors, but the impact of such a measure on liquidity might well be more dangerous than the ill it seeks to combat. Another would be to place the directors’ reporting requirements on a statutory basis with the record being available to both the exchange and the SFC for inspection. Such disclosure could also apply to substantial shareholders beyond that already available when the speciied 0.5 per cent threshold is crossed. Statutory backing was, instead, recently given to the duty to disclose inside information to the public as rapidly and fairly as practicable. Pursuant to this new rule, a listed company must ‘as soon as reasonably practicable’ disclose to the public any inside information that ‘has come to its knowledge’,311 unless the information is a trade secret or concerns ongoing negotiations and the conidentiality of the information is preserved.312 In the context of this new statutory requirement, the SFC has provided an extensive comment on the nature of ‘inside information’ and the likelihood that a given item of information would trigger 303 304 306 307 308 309 311 312

See www.hkexnews.hk, ‘shareholding disclosures’ (accessed 15 March 2014). 305 SFO s 310(4). SEHK Listing Rules, Appendix 10. SEHK Listing Rules, Appendix 14, s H, and Appendix 10, s D. Directors’ Dealings Code, s A3. Directors’ Dealings Code, s A8. 310 Directors’ Dealings Code, s A9. SFO s 352. SFO s 307B(1). SFO s 307D(2). Similar exceptions apply to the receipt of liquidity from the government Exchange Fund and cases where the SFC has waived the requirement because disclosure would violate local or foreign law. SFO s 307E.

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a requirement to disclose in a given set of circumstances, basing its analysis on a roughly 20-year series of decisions regarding the prohibition of insider dealing,313 which should substantially reduce the risk of unwittingly violating the law. he disclosure must be efected in a matter that provides ‘equal, timely and efective access by the public’.314 he SFC may bring action against a company, its directors and oicers for a failure to disclose, in the context of which the MMT is authorized to order the disqualiication of directors and levy ines of up to HK$8 million against directors and CEOs.315 As Chapter 5 explains, while the prosecution of insider trading in Hong Kong has not been particularly aggressive or high-proi le, a steady stream of cases, including targeting employees of leading institutions, has provided a credible deterrent to the market.

b Rules against price manipulation he other major type of market abuse to which Hong Kong law addresses its attention is market manipulation. Market manipulation has been prohibited since 1974, and the SFO currently provides an articulated network of prohibitions for various types of distorting practices, while a combination of SFC and SEHK rules provide a framework for regulating and monitoring short selling, and the SFC operates an ongoing process of electronic surveillance to detect trade-based price manipulation.316 he types of market manipulation codiied in the SFO are the following: • ‘false trading’, which is understood to include trading that intentionally or recklessly creates the misleading impression of an active market or creates or maintains an ‘artiicial’ price, and expressly includes wash sales;317 • ‘price rigging’, deined as including wash sales and ictitious transactions that have the efect of stabilizing or maintaining a given price, unless a contrary purpose is demonstrated;318 • ‘disclosure of information about prohibited transactions’, which is an attempt to multiply the efects of transactions otherwise constituting market misconduct by making the transactions themselves known to others;319 313 314 316

317 318 319

SFC (2012: paras 13–37). SFO s 307C(1). 315 SFO ss 307I, 307N. h is system is designed by SMARTS, a monitoring tool which analyzes the nexus between combinations of trades and share price impact, created by Michael Aitken. SFO s 274; for the criminal ofence, s 295. SFO s 275; for the criminal ofence, s 296. SFO s 276; for the criminal ofence, s 297.

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• ‘disclosure of false or misleading information inducing transactions’, if the actor knows or acts recklessly overlooking that a statement or omission is misleading as to a material fact;320 and • ‘stock market manipulation’, technically deined as entering into two or more transactions intended to move price and then beneit from another trader’s action or inaction.321 As in the case of insider dealing, these diferent acts constituting market misconduct may be prosecuted along a civil route in the MMT or a criminal route by referring them to a court. As will be discussed in Chapter 5, all existing actions against market manipulation have been initiated by the SFC, the Financial Secretary or the Department of Justice, and many of these have been initiated against licensed intermediaries.

c Rules on short sales Short selling can be a powerful component of sequenced trading strategies designed to inject unsupported price pressure into the market, and as such, the discipline of short selling should be considered in any treatment of the market’s efective regulation against market abuse.322 he discipline of short selling in Hong Kong is imposed from a number of angles. First, the SFO prohibits naked short sales – that is, sales of a security which the seller neither owns, has an option to nor has borrowed – altogether,323 and imposes a potential penalty for violation of up to two years’ imprisonment.324 Every person who sells short through a broker or other agent must provide the latter with documented proof of compliance with this requirement,325 and the exchange participant entering the trade must earmark it for the matching system as a short sale.326 In this way, the SEHK and the SFC gather data on short selling market impact. Second, although the SEHK allows permitted short selling in a speciic list of designated securities for which liquidity is deemed suicient,327 it requires that for most of these securities, a short sale may not be entered for lower than the current, lowest ask price.328 hird, the SFC has issued further 320 321 322 323

324 326 327

SFO s 277; for the criminal ofence, s 298. SFO s 278; for the criminal ofence, s 299. For further discussion of this point, see Donald (2011). SFO s 170(1), which states that the seller must have ‘a presently exercisable and unconditional right to vest the securities in the purchaser of them’. 325 SFO s 170(4). SFO s 171(1). SFO s 171 in connection with SEHK Rules, Sch 11(5)(b). SEHK Rules, Rule 563D(1). 328 SEHK Rules, Sch 11(15).

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reporting rules on short positions in listed securities, which require that any short position exceeding 0.02 per cent of the class of securities by value or HK$30 million be notiied to the SFC at the close of each week.329 his information is then published on the SFC website.330

d Requirements for investment banks sponsoring public oferings Eforts have also been made to guarantee the quality of gatekeeping professionals in Hong Kong. As discussed above, this was already in the SEHK Listing Rules for special application to PRC companies. In 2012, the SFC recommended, and ultimately concluded, that the SFO be amended expressly to provide that investment banks advising on and underwriting public sales of securities in connection with a public listing of securities (sponsors) be considered liable together with the issuer and its directors for material misstatements or omissions in prospectuses.331 he SFC also announced amendments to its Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission to introduce rules that in essence turn the existing best practices of sponsors into irm, regulatory standards.332 he provisions of the Code do not have the force of a regulation, but function as authoritative interpretations of the meaning of requirements set out in the SFO, particularly what is necessary for a market participant to be considered ‘it and proper’ to retain its licence under the SFO.333 he provisions regulating sponsors are a new section 17 of the Code of Conduct, and apply to all aspects of a sponsor’s activity, requiring, inter alia, that the sponsor thoroughly understand and provide good advice to its client on compliance with applicable law,334 undertake a rigorous and responsible investigation of the issuer to identify and correct or disclose any material issues,335 have reasonable grounds to believe that all statements made in a prospectus, whether the character of the statements is non-expert or expert, are suicient to avoid misunderstanding, true, accurate and complete,336 collaborate with the relevant exchange 329 330

331

332 333 335

Securities and Futures (Short Position Reporting) Rules, ss 3(2), 4. See www.sfc.hk, > Regulatory functions > Market infrastructure & trading > Short position reporting > Aggregated reportable short positions of speciied shares (accessed 15 March 2014). SFC (2012b: para 39). ‘Sponsors’ are persons who are licensed to engage in an activity deined in Schedule 5 of the SFO as ‘Type 6: advising on corporate inance’, which are in business terms called underwriters or managers. See SFC (2012b: Appendix A). 334 See Code of Conduct, s 1.5. Code of Conduct, ss 17.3, 17.6. 336 Code of Conduct, s 17.4. Code of Conduct, s 17.5, 17.7.

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and the SFC, bringing to its attention any failure of the issuer to comply with law or applicable rules, 337 and ‘maintain adequate records so as to demonstrate to the SFC its compliance with the Code’.338 his encapsulation of best practice in a Code, compliance with which will airm the underwriter’s or manager’s eligibility to remain licensed to perform the functions of a sponsor, aims expressly to reinforce Hong Kong’s role as a provider of quality regulation in connection with inancial services. As the SFC observed, ‘[i]nitial public oferings … have been an important feature in the growth of Hong Kong’s … overall development as a leading international inancial centre. In order to help Hong Kong maintain its position as a leading venue for fund-raising it is vital that the IPO regulatory regime enables market participants to invest and raise new funds with conidence.’339 As will be discussed in Chapter 5, the introduction of these rules followed a historically signiicant disciplinary action against a licensed sponsor.

D Reducing the risks of algorithmic trading through taxation Hong Kong tax law will be considered by Jef Vanderwolk in Chapter 4. Here, however, it is useful briely to note the efect that Hong Kong’s tax on the transfer of shares has had on market quality. he Hong Kong stamp duty was irst introduced in 1866.340 he current Stamp Duty Ordinance applies to legal documents conveying or certiicating interests in: immovable property located in Hong Kong, shares of ‘stock the transfer of which is required to be registered in Hong Kong’, bearer instruments issued in Hong Kong or regarding shares of Hong Kong companies, and duplicates and counterparts of such documents.341 he Ordinance exempts from duty certain transactions in derivatives entered into by market participants and transfers of stock efected by options market makers for hedging purposes.342 As a result, for every sale not exempted (such as most sales of shares) a stamp duty 0.1 per cent of transaction value must be paid by both buyer and seller (efective 0.2 per cent), and a transfer deed stamp duty of HK$5.00 must be paid by the seller.343 Together with fees levied by the HKEx (which include a transaction levy at 0.003 per 337 339 341 342

343

Code of Conduct, s 17.9. 338 Code of Conduct, s 17.10. 340 SFC (2012b: para 8). Stamp Ordinance, No. 12 of 1866. Stamp Duty Ordinance, Chapter 117, s 4 and Schedule 1. Stamp Duty Ordinance, s 19(1D), Schedule 4, and Schedule 1 together with the Stamp Duty (Jobbing Business) (Options Market Makers) Regulation, Chapter 117A, s 3. Stamp Duty Ordinance, Schedule 1, ‘Hong Kong Stock’.

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cent of transaction value, paid by each side, a trading fee at 0.005 per cent of transaction value, paid by each side, a trading tarif at HK$0.50 on every transaction, and a transfer fee of HK$2.50 per share certiicate paid by the buyer for each new certiicate issued),344 Hong Kong is a very expensive market in which to make trades.345 his state of afairs, John Kay argues, is a good one to support liquidity, because counterparties will have funds available to engage in necessary trades, and the availability of funds is a true measure of liquidity, not the raw number of trades executed.346 High Frequency Trading (HFT), as its name suggests, is a broker-dealer market model in which trades are entered into with frequency far beyond the capacity of human traders through computers guided by algorithms, and the number of trades per minute could aim to approach the current upper limit processing capacity of the SEHK Automatic Order Matching and Execution System (AMS), which can handle between 30,000 and 100,000 orders per second.347 Although the dangers and possible beneits of HFT for an equity market are still being debated, various studies and post-mortem analyses of incidents have found that HFT can create feedback loops that drive extreme short-term volatility, lead to small order size and low execution rates that drive larger trades into specialized ‘dark pool’ venues, thus fragmenting the market, and create unacceptable imbalances in markets between those who have massive computing power and those who do not, dramatically afecting fairness and market 344

345

346

347

HKEx (2010a) he investor compensation levy (0.002 per cent of the consideration of a transaction, charged to both sides) was suspended because the value of the fund exceeded $1.4 billion. Material in this section is borrowed from he Hong Kong Stock and Futures Exchanges: Law and Microstructure (Donald 2012). I am grateful to Sweet and Maxwell for permission to use this material. Some regard ‘the volume of trading as a measure of liquidity; but this led to the circular argument that trading was good because it encouraged trading … If the volume of trade in electricity increased and the margin of spare capacity did not, or even declined, then the instance of blackouts would rise. Higher trading volumes thus reduce, rather than increase, efective liquidity. And high-frequency traders cannot, by the nature of their activities, provide liquidity in a relevant sense because they provide no capital: they close their books at the end of the day … So the best measure of market liquidity is the degree of customers’ conidence that their requirements will be met’. John Kay, ‘A Fixation on Liquidity is not Healthy for Financial Markets’, Financial Times (18 September 2013). Also see Kay (2012: 4.13): ‘One important misalignment arises from the bias towards action which is found at almost every point in the equity investment chain.’ HKEx (2010: 2). he variable igure relects the plan to upgrade the automated matching system on a continuous basis, with 100,000 providing the top target.

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integrity.348 he advent of HFT algorithmic trading essentially means the end of securities markets as we have known and regulated them – as venues in which good information about issuers allow skilful traders to allocate capital eiciently to its most productive use. One way to slow down HFT is to make trades more expensive. he European Commission on 14 February 2013 approved a proposed Directive that would allow cooperation among 11 EU member states to impose a minimum 0.1 per cent tax on transactions in securities and 0.01 per cent on derivatives transactions.349 One stated purpose of the proposed Directive is to create ‘appropriate disincentives for transactions that do not enhance the eiciency of inancial markets’.350 Although the Hong Kong stamp duty was certainly not created to that end, but is perhaps evidence of an era in which the inancial sector had less inluence on iscal policy, it serves the same purpose as the proposed European measure. he presence of HFT in Hong Kong has remained negligible, and the Hong Kong market has hitherto remained a source of capital for new growing enterprises – particularly those in mainland China – rather than a venue for sophisticated gaming. It is diicult to say whether this historical accident will persist in the face of the lobbying eforts of information technology vendors and broker-dealers promoting the HFT business model. he positive efects of the Hong Kong stamp duty for market quality could be why action has not yet been taken in following the recommendations of the Capital Markets Tax Committee of Asia, discussed by Jef Vanderwolk in Chapter 4. In early 2013, the SFC introduced regulations on computer driven trading as a new paragraph 18 of the Code of Conduct (immediately following the new sponsor rules).351 hese new rules overcome one of the principal dangers of algorithmic trading – delegation of power to an automated process – by expressly providing that ‘[a] licensed or registered person is ultimately responsible for the settlement and inancial obligations of orders sent to the market through its electronic trading system and for implementing policies, procedures and controls to supervise the compliance of the orders in accordance with applicable regulatory requirements’.352 he new rules also include detailed requirements on how a licensed or registered broker-dealer must inspect, manage and supervise 348

349 350 351

For a full discussion of the advantages and disadvantages of HFT, see Donald (2012: 22–5, 225–31). See European Commission (2013: Art. 9). See European Commission (2013: 2). SFC (2013). 352 SFC (2013: 18.3).

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not only the operation of electronic trading systems, but also their ‘design, development, [and] deployment’.353

E Do Hong Kong company and securities laws measure up? his chapter has attempted ‘doctrinally’ to measure the quality of Hong Kong company and securities laws against the particular risks and challenges presented by the shape of the Hong Kong economy and the functions of its capital market. It takes the indings of Chapter 2 on the major groups that make up the HSI and available information about the nature of companies listed on the SEHK, and examines the applicable law and regulation for adequacy to meet the risks Hong Kong’s political-economic reality presents. Other aspects to be considered are the indings from the historical analysis in Chapter 1: Hong Kong has devised almost none of its law locally, and is in transition from being a component of the British Empire to an economically integrated Region of China. Company law – both statutory and case law – has been imported from the UK and its other former colonies. Much of the securities law has arrived in Hong Kong directly or indirectly from the UK and the US. Neither the UK nor the US have an economy dominated by controlling shareholders of the type found in Hong Kong. Neither the UK nor the US must host a vast majority of listed companies that are incorporated in an unruly assortment of foreign jurisdictions. Neither the UK nor the US serve as inancial markets for another jurisdiction with an economy that is dramatically larger than its own, whose law is still a project in development, and whose government controls the companies constituting about 40 per cent of domestic market capitalization, as Chinese SOEs do on the Stock Exchange of Hong Kong. Hong Kong must adapt its transplanted tools to a new and evolving context. One aspect of path dependence in Hong Kong’s legal development is therefore that important components of its legal system were not designed for circumstances like those against which they are now deployed. his colonial history also has a bright side. It has shaped Hong Kong as a community of traders who have always acted within a service component of a larger whole, and this community is thus perfectly adapted to the role of an international inancial centre for China. A major challenge in this new role is that Hong Kong law and policy must supplement the governance frameworks for companies owned by the same government that ultimately 353

SFC (2013: 18.4).

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controls the fate of Hong Kong’s economy and regulators. Wang Jiangyu discusses this aspect in Chapter 6. Nevertheless, Hong Kong’s independence is far greater than that which Shanghai, as a potential challenger, could hope to achieve. A key indicator will be whether Hong Kong’s supervisory authorities and courts enforce laws in an unbiased manner against these SOEs. Hong Kong faces a diicult challenge in this respect, as it competes with two much simpler market models to its north and south: the clearly inland Shanghai market that is closely tied with Beijing and the clearly ofshore Singapore market that is distinctly independent from Beijing. Simultaneously besting the ofers made by each of these challengers will be a great challenge. he doctrinal analysis in this chapter has revealed only minor gaps requiring better, future adjustments. he main adjustment will be to face the governance risks actually presented by Hong Kong listed companies, and admit that they do not match those in New York and London, where the agency problem between professional managers and dispersed shareholders is key. Adjustments in this respect should be made steadily on a number of fronts. he judiciary should formulate a company law iduciary duty for controlling shareholders or follow Luck Continent in applying the unfair prejudice action to public and listed companies. he prosecutorial eforts of the SFC should be augmented, and it should be ready to use ss 213 and 214 SFO before companies become zombies suspended from listing on the SEHK and in various stages of winding up. he SEHK should increase its public loat requirement incrementally to reduce the dominant power of controlling shareholders, beginning with an increase from 25 per cent to 30 per cent. If listed companies were to meet this requirement, their controlling shareholders – whether that be a family or SASAC – would not be able to adopt a special resolution without inding a signiicant outside ally. In order better to protect unsophisticated creditors, such as employees and tort creditors, courts should consider interpreting the ‘evasion’ test under Mitrans to cover the premeditated entry into a high-risk business with an undercapitalized vehicle while other companies in the group remain well stocked with assets. he judiciary, LegCo, the SFC and the HKEx should not hesitate to extend their reach to regulate efectively the 85 per cent of listed companies that are incorporated abroad. Regulation must not discriminate against local incorporation. If the safeguards built into Hong Kong company law are steadily increased while Hong Kong does little more to improve its governance of companies incorporated in the Cayman Islands, Bermuda and other ofshore locations, Hong Kong will continue to encourage the round-trip model of foreign incorporation

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and local listing. Having over half of the companies listed on the SEHK use this model brings with it so much complexity and uncertainty that the exchange appears to be risking a major governance scandal that could seriously damage both investors and Hong Kong’s reputation for good regulation. With respect to market integrity, Hong Kong should ensure that insider shareholders receive the monitoring and discipline against insider dealing and market manipulation that beits their access to inside information. In short, Hong Kong must worry less about signalling foreign investors and the authors of jurisdiction rating reports in their own language, by adopting their favorite UK and US governance strategies – which are designed for circumstances diferent from its own – and more about crating safeguards against its own, home-grown risks. Although the opinions of such international players certainly enhance Hong Kong’s reputation, LegCo and regulators should focus less on winning the Heritage Foundation’s prize for ‘freest economy’ 21 times running and more on consolidating its position as the rule of law island for the Chinese economy. In light of what Hong Kong has achieved in this regard since the mid 1980s, there is good reason to believe that policy makers and regulators in Hong Kong will continue to be vigilant and focused on improving market quality. Given the signiicant pressure that could potentially be placed on the Hong Kong supervisory and legislative bodies both by concentrations of wealth in Hong Kong and by listed companies whose ultimate owner is the Chinese government, it is impossible to draw a conclusion more precise than betting that development hitherto achieved will continue on a like trajectory. A fuller picture emerges in Chapter 5 with the analysis of how these laws and rules have actually been enforced.

4 he role of Hong Kong’s tax policies Jefferson P. Vanderwolk

A

Historical background

Hong Kong’s development as an international business centre has undoubtedly been helped by its low taxes and limited tax base. he ability to set up shop in Hong Kong for the purpose of China-related trading activities, or wider regional trading, without incurring substantial tax costs, has been a signiicant factor in attracting business to Hong Kong. In the inancial services area, investors are able to buy and sell Hong Konglisted shares free of any income tax in Hong Kong. Unlisted stock can also be sold on a tax-free basis, enabling successful entrepreneurs to dispose of part or all of a Hong Kong business without losing any of the proceeds as a result of taxation. Dividends are not subject to tax in Hong Kong, either. From an income tax perspective, Hong Kong is an investor’s paradise. It has oten been described as a tax haven, although the deinition of that term is controversial and its applicability to Hong Kong and other populous jurisdictions is debatable. No income taxes of any kind were imposed in Hong Kong until 1940, when separate taxes on business proits, employee salaries and rental income from real property were introduced under the War Revenue Ordinance 1940. he maximum rate of tax was 10 per cent, and the tax base was limited to income arising in Hong Kong. he same limited system of income taxation has remained in place ever since, with somewhat higher maximum rates (15 per cent for individuals and unincorporated businesses, 16.5 per cent for corporations). No taxes have ever been imposed on investment income such as dividends and capital gains, nor has there been any form of wealth tax since the repeal of estate duty in 2005. he stated purpose of the income taxes enacted in 1940 was to raise funds for the support of Britain’s war efort against Germany. It was not thought necessary for the Hong Kong government to inance its own 171

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activities through income taxation. Historically the government had had no trouble funding its expenditures with revenue from land sales, stamp duty on conveyances of land and transfers of shares in Hong Kong companies, annual rates in respect of land, estate duty on decedents’ estates located in Hong Kong, and various licence fees. After the end of the Japanese occupation in 1945, the British colonial government reinstated the three income taxes that had been introduced in 1940: (1) profits tax, applicable to business profits arising in Hong Kong, (2) salaries tax, applicable to income arising in Hong Kong from an employment, and (3) property tax, applicable to non-business rental income from Hong Kong real property. The stated rationale for the taxes this time around was not to raise funds for the mother country, but rather to provide additional sources of funding for the government of Hong Kong, which was rebuilding after the devastation of the war. As time passed, it became clear that the government was easily able to inance its limited functions without expanding the scope of income taxation or raising the rates of the existing taxes. Typically the government has raised more money than it spends, resulting in ever-increasing amounts of iscal surplus. his state of afairs has continued year ater year, with rare exceptions, up to the present day.1 When particular tax reforms have been suggested, the invariable response has been, ‘he system works, so let’s leave it as it is’. he Hong Kong government’s complacency about its tax system is evidenced by the fact that there is no tax policy unit within the government. Most jurisdictions have an oice of tax policy within the ministry of inance or treasury department, but not Hong Kong. he only tax experts in the Hong Kong government are employed in tax collection at the Inland Revenue Department (IRD). To its credit, the IRD has historically been eicient and apparently free of corruption. Its dogged pursuit of revenue in recent years, however, has begun to raise questions about whether the government needs to have a separate oice of tax policy, which would be dedicated to formulating good tax laws rather than to collecting as much tax as possible under the existing laws.

1

See, e.g., Jake van der Kamp, ‘Jake’s View’, South China Morning Post (20 February 2011), stating that the Hong Kong government’s accumulated iscal surplus was currently HK$1.26 trillion (about US$162 billion), and that free iscal reserves amounted to 71 per cent of Hong Kong’s gross domestic product, far exceeding the International Monetary Fund’s recommended target of 30 to 50 per cent.

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B Hong Kong’s tax system today he Hong Kong government advertises its ‘low and simple taxes’ and ‘rule of law’ in promoting to the international business community the use of Hong Kong as a regional base.2 he website of InvestHK states: Hong Kong has one of the most tax-friendly economies in the world. Why? he city only imposes three direct taxes and has generous allowances and deductions which reduce your taxable amount. • Proits tax is capped at 16.5 percent • Salaries tax is a maximum of 15 percent • Property tax is 15 percent More important are the taxes that Hong Kong does not impose: • No sales tax or VAT • No withholding tax • No capital gains tax • No tax on dividends • No estate tax.3

he website does not mention, however, that Hong Kong imposes stamp duty on purchases and sales of Hong Kong stock – including all transactions in shares listed on the Hong Kong stock exchange – and on conveyances of Hong Kong real estate. As competing inancial centres around the globe have reduced certain tax costs in an efort to attract business, there has been a corresponding reduction in the competitive advantage that Hong Kong derives from its tax system. he management of ofshore investment funds, for example, can generally be done with lower tax costs in Singapore than in Hong Kong, due to statutory tax incentives enacted by the Singapore government.4 Nevertheless, the tax environment in Hong Kong is unusually benign. Unlike most jurisdictions, which impose a single income tax on the overall income of resident individuals and corporations, Hong Kong has a schedular system: tax is charged separately on business proits, employment income and non-business rental income from property. As noted earlier, no tax is imposed on investment income such as capital gains, dividends or non-business interest. In addition, the tax system is territorial 2

3

4

See, e.g., InvestHK, ‘Hong Kong. Right Place. Right Time’, Financial Times (3 November 2009). See www.investhk.gov.hk, the website of InvestHK, the government department for promoting foreign direct investment (last visited 10 February 2014). Ng (2009a: 487).

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in nature. he law provides that proits and salaries arising outside Hong Kong are not taxable, even when the proits are remitted to a recipient in Hong Kong.5 Only a portion of the compensation paid to Hong Kongbased employees is taxed, due to generous exemptions.6 here is no valueadded tax, or goods and services tax, or retail sales tax. Transaction taxes are limited to stamp duty on transactions in real property and listed shares; betting duty on horse racing, football and lotteries; business registration fees; a tax on the irst registration of motor vehicles; a minuscule tax on plastic shopping bags; and import duties on liquor, tobacco and motor fuel. However, in reality the application of Hong Kong’s territorial taxes on business proits and employee salaries is oten far from clear, which detracts from Hong Kong’s attractiveness to multinationals’ i nance managers, who want to be able to predict tax costs with as much certainty as possible. In the proits tax area, the primary area of uncertainty is how to determine whether proits are considered to arise in Hong Kong. he Court of Final Appeal has indicated that the inquiry should be limited to the operations that are the direct and proximate cause of the proits in question, with the acts of agents and contractors outside Hong Kong being taken into account.7 However, the Inland Revenue Department has continued to raise assessments on the basis of operations in Hong Kong that are several steps removed from the realization of the proits, oten disregarding the acts of agents or contractors outside Hong Kong who acted on 5

6

7

he territorial limitation on taxation of employment income has been interpreted by the Hong Kong courts in a manner that, in most cases, permits the government to tax Hong Kong residents on employment income earned outside Hong Kong, subject to the possibility of a foreign tax credit. In contrast, the territorial limitation on proits tax has been enforced by the courts, but a great deal of uncertainty remains in many cases as to how to determine whether the taxpayer’s proits arose in Hong Kong or ofshore. he basic exemption for a single individual is HK$120,000 per year; for a married individual it is HK$240,000 per year, as of 2013–14. Various additional allowances in respect of dependant family members can bring an individual’s total exemption up to several hundred thousand dollars for a given year. In 2011–12, half of the total revenue from salaries tax was collected from only 3 per cent of the 1,520,000 salaries taxpayers in that year. Considering that the working population in Hong Kong is at least 3,500,000 people, it appears that about half of all salaries tax was paid by about 1 per cent of the working population in 2011–12, and more than half of the working population paid no salaries tax at all. ING Baring Securities (Hong Kong) Ltd v. CIR [2008] 1 HKLRD 412. he Court of Final Appeal speciied that proits should not be considered to arise at the place where the taxpayer negotiated and entered into the contracts under which the proits were earned, but rather should be considered to arise where the operations for which the taxpayer was paid were performed, whether by the taxpayer itself or by its contractor or agent.

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behalf of the taxpayer. Moreover, such assessments have been upheld by the Inland Revenue Board of Review despite the Court of Final Appeal’s guidance.8 In the salaries tax area, the law has long been applied in a manner that both deies common sense and is diicult to apply in practice to individuals hired from abroad to perform a regional role.9 Such people include senior managers of the multinational businesses that Hong Kong is seeking to attract. Taxing them on income that they perceive as having been earned outside Hong Kong is not the best way to sell Hong Kong’s territorial tax regime to them. Because of the narrow tax base, the public revenue may decline dramatically when a downturn in the business cycle results in reduced business proits and payrolls. Recognizing this, the government commissioned a study on base-broadening which led to the publication, in July 2006, of a Consultation Document on Tax Reform.10 In that document the government advocated the adoption of a goods and services tax (GST). he government said that a GST would stabilize public inances by broadening Hong Kong’s narrow tax base, and would comply with the ‘capacity to pay’ principle (since it would be based on consumption) without damaging Hong Kong’s competitiveness or its low-tax business environment. Various organizations and individual members of the community expressed strong opposition to the GST proposal, on a number of different grounds. Some were concerned that a GST would complicate tax compliance, making Hong Kong a more expensive and less businessfriendly place. Others stressed that a GST would increase the cost of consumer goods and services, reducing Hong Kong’s attractiveness to Asian visitors as a ‘shopper’s paradise’. Still others argued that a GST would be 8

9

10

See, e.g., D16/08 (2008) 23 IRBRD, in which proits from the supply of building materials in mainland China were held to arise in Hong Kong on the basis that the relevant contracts were negotiated and signed by the taxpayer in Hong Kong. Under section 8 of the Inland Revenue Ordinance, the salaries tax charge is limited to ‘income arising in or derived from Hong Kong from … any oice or employment’. he Hong Kong courts, the Inland Revenue Board of Review and the Inland Revenue Department all take the view that the place where the employee actually worked is irrelevant in determining as a threshold matter whether his or her employment income arose in Hong Kong. Rather, they consider it necessary to look at all other facts and circumstances in order to determine whether the taxpayer’s contract of employment should be treated as located in Hong Kong. his approach has no statutory basis. In practice, it is rare for a Hong Kong-based employee to succeed in claiming that his or her income from work done outside Hong Kong should be treated as arising outside Hong Kong for salaries tax purposes. ‘Broadening he Tax Base, Ensuring Our Future Prosperity: What’s the Best Option for Hong Kong?’, available at: www.taxreform.gov.hk/eng/document.htm (accessed 10 March 2014).

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regressive, having a more burdensome efect on lower-income people than on the wealthy. In December 2006, the government published an Interim Report11 on tax reform, in which it acknowledged that, as a practical matter, a GST could not be enacted in the immediate future due to the community’s general opposition to the proposal. he government noted, however, that a majority of commentators had recognized the need to broaden Hong Kong’s tax base. he Financial Secretary (FS) mentioned the tax reform consultation exercise in his 2007–8 Budget Speech on 28 February 2007. He reiterated the government’s intention to introduce base-broadening measures ater giving due consideration to all suggestions received. In the 2008–9 Budget Speech, the FS again alluded to the consultation on base-broadening, but in non-committal terms.12 In the 2009–10 Budget Speech, base-broadening was not mentioned at all. However, in the 2013–14 Budget Speech, the Financial Secretary announced the creation of a tax reform study group to consider options for ensuring a stable, sustainable low of revenue to fund increasing public expenditure in the future. In the remainder of this chapter, four issues relating to Hong Kong’s status as an international inancial centre will be discussed: international exchange of information relating to taxation; the imposition of stamp duty on share transfers; the taxation of ofshore investment funds; and whether the current administration of the tax laws is consistent with the rule of law.

C

Hong Kong tax seen on a global scale 1

Exchange of information

In 2010, Hong Kong enacted legislation that empowers the IRD to gather and provide tax-related information upon request to a foreign government 11

12

‘Interim Report of Public Consultation on Tax Reform’, available at: www.taxreform.gov. hk/eng/interim.htm (accessed 10 March 2014). ‘We should adopt a pragmatic approach to the problem of the narrow tax base of Hong Kong. In July 2006, the Government launched a public consultation on reforming Hong Kong’s tax system to broaden our tax base. According to consultation i ndings, the community recognises that there is a need for the government to broaden the tax base. However, there is no clear consensus or inclination on how to achieve this objective. ‘We will continue to study options on broadening the tax base. I hope to provide opportunities for the community to discuss the tax reform options that are equitable and conform to the “ability-to-pay” principle, can generate stable revenue, ofer certainty and are predictable.’ he 2008–09 Budget Speech (paragraphs 59–60) available at: www. budget.gov.uk/2008 eng/speech.html (accessed 10 March 2014).

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that has entered into a tax treaty with Hong Kong, regardless of whether Hong Kong has any domestic tax interest in the information.13 In the past, this would have been a radical proposal in the traditionally secretive business culture of Hong Kong. But the world has undergone a dramatic change since the onset of the global inancial crisis in September 2008. At stake for international inancial centres such as Hong Kong and Singapore is whether they will be branded by OECD member countries14 as uncooperative jurisdictions and subjected to punitive rules that could have a devastating efect on their attractiveness to international businesses. Most of the low-tax i nancial centres around the globe – notably Switzerland – have come under strong pressure since 2008 to cooperate with higher-tax nations such as the United States and the European Union countries in cracking down on tax evasion. Tax evasion is a crime, because it involves deliberate failure to comply with the law, but it can be diicult to detect due to the ability of tax evaders to hide money in foreign bank accounts. Following revelations that banks such as UBS and LGT that are located in low-tax inancial centres have facilitated large-scale tax evasion by wealthy residents of high-tax countries, several governments – notably, the United States, Germany, France and the UK – persuaded their fellow G20 countries and OECD member states to turn up the heat on low-tax banking centres. Switzerland, Liechtenstein, Jersey, Singapore, Hong Kong and others are seen as having provided safe havens for the ofending private banks and trust companies and their tax-averse clients. he anti-haven efort has been spurred on by the G20 countries’ need for more revenue to fund domestic stimulus programmes. In the run-up to the meeting of G20 inance ministers in Pittsburgh in September 2009, the inance ministers of the G20 countries threatened sanctions against certain countries, including Hong Kong and Singapore, if they failed to show progress in moving towards a full and genuine commitment to efective exchange of tax-related information by the end of March 2010.15 he list of countries facing potential blacklisting as ‘uncooperative jurisdictions’ was created earlier in 2009 by the OECD Committee on Fiscal Afairs, at the time of the G20 leaders’ meeting 13 14

15

Inland Revenue (Amendment) (No. 3) Ordinance 2009. he member countries include Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, South Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. Gnaedinger (2009: 3).

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in London in April 2009.16 Hong Kong avoided being listed as a potentially uncooperative inancial centre, but only because China intervened, promising that Hong Kong would promptly amend its laws to permit full cooperation with other countries.17 he OECD-sponsored Global Forum on Taxation initially said that a country would not be blacklisted if it had signed at least 12 informationexchange agreements.18 he tiny nations of the world proceeded to enter into scores of new agreements – mostly with each other – in a very short space of time.19 he Global Forum then shited ground and announced that a peer-review system would be set up, with no particular number of agreements guaranteeing a passing grade. he evaluations are conducted by members of the ever-expanding Global Forum, which, under its revised name – the Global Forum on Transparency and Exchange of Information for Tax Purposes – is currently chaired by South Africa.20 Singapore moved quickly to conclude a number of new informationexchange agreements in October and November 2009 and was removed from the OECD’s ‘gray list’ in December 2009.21 Hong Kong moved more slowly, allowing its legislative process to drag on for months while ine points of the information-exchange bill and subsidiary legislation were being debated. Ater the legislation was enacted, the Hong Kong government speedily negotiated and concluded new tax treaties with 13 countries by the end of 2010. Subsequently, legislation enabling Hong Kong to enter into standalone tax information exchange agreements was enacted in 2013.

2 Hong Kong as a ‘tax haven’? What has led to this state of afairs, in which a jurisdiction such as Hong Kong that had never previously perceived a need to enter into tax treaties or exchange information with other countries in relation to tax matters, is now taking steps to do those things as quickly as possible? he answer 16

17 19

20 21

‘A Progress Report on the Jurisdictions Surveyed by the OECD Global Forum in Implementing the Internationally Agreed Tax Standard’, 2 April 2009, available at: www. oecd.org/ctp/42497950.pdf (accessed 10 March 2014). 18 Stewart (2009: 1). See OECD (2008). McIntyre (2009: 255): ‘As of September 30, 2009, the OECD reports that more than 90 TIEAs [tax information exchange agreements] have been signed and more than 60 tax treaties have been negotiated or renegotiated in response to the April call of the G-20 countries to end tax haven abuses.’ See www.oecd.org/tax/transparency (accessed 10 March 2014). Ng (2009b: 985).

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requires a brief review of the development of tax havens (or, to be more precise, low-tax jurisdictions) and the response of the higher-tax countries to their presence in the global inancial system. Tax havens have been used by wealthy individuals to avoid (or evade) tax liability in their home countries ever since the early days of income taxation in the irst quarter of the twentieth century. Switzerland’s historical role as a safe haven for foreign money began far earlier, at the time of the persecution of the Huguenots in seventeenth-century France. Although the Huguenots who stashed their cash in Geneva were seeking to preserve their capital from expropriation rather than mere taxation, the idea was the same: Switzerland not only would not impose taxes on the money, but it also would not give the French authorities or anyone else any information about where the money was or whom it belonged to.22 he widespread respect for national sovereignty under international law in the twentieth century ensured that independent nation states, no matter how small, would be free to adopt laws aimed at attracting capital from investors resident in other countries. Low tax rates and limited taxation of income and capital, combined with bank secrecy and an Englishstyle legal system, helped small jurisdictions such as Bermuda, Jersey, Hong Kong and Singapore to become important international inancial centres where multinational businesses, as well as wealthy families, could comfortably establish companies, trusts and bank accounts. Once it became clear that a small territory could prosper on the back of foreign money, the governments of such places had every reason to maintain low taxes and bank secrecy. For example, although the United Kingdom pressured the colonial Hong Kong government during the 1950s and 1960s to raise tax rates and broaden the income tax base in Hong Kong to be similar to that of the UK, the colonial oicials on the ground persuaded their London colleagues that the territory’s low tax rates and territorial system were so attractive to international business that it would be foolish to ‘kill the goose which lays the golden eggs’.23 Competition among tax havens began to grow in the latter half of the twentieth century, with countries such as Liberia, Panama, and Nevis and St. Kitts adopting US-style corporation laws and special zero-tax regimes 22

23

In 1713 the Great Council of Geneva issued rules that required bankers to keep registers of their clients but prohibited them from sharing the information without the express consent of the City Council. See Report of the Inland Revenue Ordinance Committee, Part II (Hong Kong Government, 1968) at p. 2, and remarks of the Commissioner of Inland Revenue published in he Hong Kong Accountant, Jan/Feb 1993, p. 58; see also Littlewood (2002: 212).

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to attract American investors, while the Channel Islands and numerous Caribbean colonies or ex-colonies of the United Kingdom competed for money from wealthy families worldwide. In the 1980s, Paciic island nations such as Vanuatu, Nauru, Samoa and the Cook Islands joined the fray. Larger and more developed countries even began to create tax haven jurisdictions within their borders in an efort to attract international business. he Malaysian jurisdiction of Labuan, the Canary Islands in Spain and Madeira in Portugal are examples of this phenomenon. In 1998, the OECD Committee on Fiscal Afairs issued a report on what it called harmful tax competition and concurrently set up a group called the Forum on Harmful Tax Practices.24 he theme of the report was that tax havens were damaging the economies of the OECD member countries by siphoning of productive capital and facilitating the avoidance and evasion of income and wealth taxes, thereby hurting the OECD countries’ public inances. he report called on member countries to identify ‘preferential regimes’ of taxation, including tax havens as well as special tax enclaves within larger countries. he features of a preferential regime were described as (1) nominal or zero taxes on income from foreign investments, (2) no efective exchange of information with other countries, (3) no transparency in how tax is imposed in practice, and (4) the ofering of tax beneits to foreign investors without any requirement of substantial business activity in the jurisdiction. he OECD suggested that members consider the use of ‘defensive measures’ such as unfavourable tax treatment of transactions with parties located in tax havens or other preferential regime areas, or the renegotiation or termination of tax treaties with the ofending jurisdictions. he OECD’s eforts were undermined by the US government in early 2001 when the then Treasury Secretary Paul O’Neill stated publicly that the United States was not in favour of eliminating low tax regimes, but was only interested in increasing the low of information on inancial transactions occurring in tax havens.25 Over time, the OECD Committee on Fiscal Afairs gradually moved into line with the US position. As more and more tax havens began to enter into Tax Information Exchange Agreements with the United States and other OECD countries, pressure began to be placed on holdouts such as Hong Kong to follow suit. 24 25

OECD Committee on Fiscal Afairs (1998). U.S. Dept. of the Treasury, Oice of Public Afairs, ‘Treasury Secretary O’Neill Statement on OECD Tax Havens’ (10 May 2001), available at: www.faculty.law.wayne.edu/tad/ Documents/Country/statement%20of%20Treasury%20Secretary O’Neill-5-10-2001.pdf (accessed 10 March 2014).

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In February 2008, the international news media reported a sensational story about a Liechtenstein bank employee who had stolen information on thousands of account holders and sold the information to the tax authorities of several countries for large sums of money, leading to tax evasion charges against several high-proi le individuals in Germany and elsewhere.26 Not long thereater, the United States authorities arrested a visiting employee of UBS’ Geneva branch on charges of aiding and abetting tax evasion by US citizens and residents.27 Subsequently a US federal court issued a ‘John Doe’ summons to UBS demanding information on up to 50,000 accounts allegedly held by US taxpayers with the bank in Switzerland.28 he arrested employee had alerted the US authorities to large-scale facilitation of US tax evasion by the Swiss private banking arm of UBS. hese events gave a strong forward push to the OECD’s eforts to persuade recalcitrant countries to agree to exchange tax-related information on the basis of the ‘internationally agreed standard’.29 Subsequently, the dramatic events of September 2008 which catalyzed the global inancial crisis created an environment in which the G20 leadership found it easy to agree that any facilitation of tax avoidance or evasion by tax havens was unacceptable to the global community, since tax revenues would be needed more than ever before for the propping up of the world’s inancial system. he Hong Kong government could clearly see, by 2009, that it would have to agree to exchange tax-related information on request, or else face punitive sanctions that could drive business away in short order. 26

27

28

29

‘Liechtenstein’s Shadowy Informant: Tax Whistleblower Sold Data to the US’, Spiegel Online International (25 February 2008), available at: www.spiegel.de/international/ business/0,1518,537640,00.html (accessed 10 March 2014). See Carlyn Kolker and David Voreacos, ‘Ex-UBS Banker Birkenfeld Pleads Guilty in Tax Case’, Bloomberg News (19 June 2008), available at: www.bloomberg.com/apps/news?pid =20601087&sid=axVtNAPEHa7o&refer=home (accessed 10 March 2014). U.S. Dept. of Justice Press Release, ‘Federal Judge Approves IRS Summons for UBS Swiss Bank Account Records’ (1 July 2008), available at: www.justice.gov/tax/txdv08584.htm (accessed 10 March 2014). See ‘A Progress Report on the Jurisdictions Surveyed by the OECD Global Forum in Implementing the Internationally Agreed Tax Standard’, 2 April 2009, available at: www. oecd.org/ctp/42497950.pdf: ‘he internationally agreed tax standard, which was developed by the OECD in co-operation with non-OECD countries and which was endorsed by G20 Finance Ministers at their Berlin Meeting in 2004 and by the UN Committee of Experts on International Cooperation in Tax Matters at its October 2008 Meeting, requires exchange of information on request in all tax matters for the administration and enforcement of domestic tax law without regard to a domestic tax interest requirement or bank secrecy for tax purposes. It also provides for extensive safeguards to protect the conidentiality of the information exchanged.’

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The role of Hong Kong’s tax policies

What form might sanctions against uncooperative jurisdictions take? here are at least two possible scenarios. One is that a number of G20 countries would agree to amend their domestic tax laws so as to impose unfavourable tax treatment on speciied business or investment transactions with banks or other companies located in a blacklisted jurisdiction. For example, if Hong Kong were on the blacklist, a US citizen depositing money in an account at a bank branch in Hong Kong might be presumed to be evading US tax and be required to pay tax in the US in an amount equal to 30 per cent of the deposit. While it is unlikely that such a group efort would be joined by G20 members such as China and India, which are still in the process of building their international tax systems, it is conceivable that the United States, Canada Australia, and large EU countries such as Germany, France, Italy and the United Kingdom would agree to act together in this way. A second scenario, which is perhaps more likely, is that individual high-tax countries will act on their own, as the United Kingdom has done in passing a special tax on banks, in the hope that others will follow their lead. France has already taken the step of enacting legislation that imposes special, tough tax rules on dealings with residents of 18 blacklisted ‘noncooperative states’.30 In the United States, a bill proposed in Congress in 2009 would have penalized those who do business with companies or banks located in uncooperative ‘tax secrecy jurisdictions’ named in the bill.31 If such legislation was seen to be efective in raising revenue, it is quite possible that other governments would jump on the bandwagon and introduce similar legislation. In the tax-sensitive world of global trade and investment, any inancial centre would sufer a drastic loss of business if a number of major economic powers were to create signiicant tax disincentives to doing business with entities located in that inancial centre. For a jurisdiction such as Hong Kong that depends on international inancial services for its livelihood, the efect could be disastrous. Hong Kong and other low-tax jurisdictions have no realistic choice but to cooperate with the G20 and OECD members in agreeing to exchange information related to tax enforcement on the terms that those organizations require. 30

31

Borenstein (2010a: 1). he rules include a 50 per cent withholding tax on certain payments and nondeductibility of certain payments. he blacklist was published on 17 February 2010. See Borenstein (2010b: 12). he 18 listed jurisdictions do not include any signiicant inancial centres. S. 681, the Stop Tax Haven Abuse Act, was introduced in the US Senate by Sen. Carl Levin and three other senators on 3 March 2009.

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As noted earlier, Hong Kong has amended its domestic legislation to permit the government to conclude information exchange agreements with other countries, either as part of comprehensive double taxation agreements or as standalone Tax Information Exchange Agreements. his is consistent with the continuing international trend towards greater transparency in tax matters. For example, the OECD’s Action Plan on Base Erosion and Proit Shit ing, announced in July 2013 at the G20 inance ministers’ meeting in Moscow, includes several measures premised on broader disclosure of tax-related information by both taxpayers and government authorities.32

D

Taxation and the inancial centre 1 Stamp duty on stock transfers

In one respect, Hong Kong is not a low-tax inancial centre. Stamp duty is payable at the rate of 0.2 per cent of the price of every transfer of Hong Kong stock (including both stock in Hong Kong companies and stock in overseas companies listed in Hong Kong).33 his cost is unusual in major inancial centres. In 2001, the Capital Markets Tax Committee of Asia (CMTC), a Hong Kong-based group composed of tax executives from large inancial institutions, proposed that Hong Kong should enact legislation providing an exemption from stamp duty for ‘market-neutral’ trades in Hong Kong stock. hree types of market-neutral traders were identiied: • Block traders, who enable institutions to execute large transactions quickly by taking the trade onto their own books and unwinding the position through the markets in which they operate. • Arbitrageurs, who buy, or short-sell, shares to establish two or more positions which exploit temporary pricing discrepancies between two or more inancial markets. • Option traders, who hedge against market exposure resulting from their option positions by holding shares. he CMTC argued that stamp duty has a deleterious impact on marketneutral trading in derivative products such as Hang Seng index futures. 32

33

he Action Plan is available online at: http://dx.doi.org/10.1787/9789264202719-en (accessed 10 March 2014). Stamp Duty Ordinance s 19 and First Schedule, Head 2. here is an exemption under Head 2(2) for transfers by options market makers holding Hong Kong stock to hedge their positions in options.

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It was noted that the Hong Kong government had recognized the importance of derivative products, stating in a 1998 report that ‘derivative products including index futures are important risk management tools in portfolio management. hey add liquidity to the market and increase the diversity of the market product base. As such they are essential for the development of the Hong Kong market.’34 he CMTC commissioned a study on the market efects of stamp duty on stock transfers.35 he study found that, in general, stamp duty on share transactions has a negative efect on the quality of the market in which such transactions occur. he authors of the study concluded: [T]he Stamp Duty imposition on stocks in Hong Kong signiicantly retards the relative performance and level of activity on the Hong Kong stock market. he continued imposition of Stamp Duty on stocks is profoundly contrary to growing as a leading inancial centre.

Based in part on that study, the CMTC again proposed, in 2007, that the Hong Kong government should enact a stamp duty exemption either for all listed shares in Hong Kong or at least for market-neutral trades. It was argued that abolition of stamp duty would not result in a loss of revenue for the government in the medium to long term, because there would be a substantial increase in activity in the Hong Kong market, which would lead to more revenue from income taxes on business proits and salaries in the inancial services sector. Other beneits asserted by the CMTC included enhanced liquidity in the market for both cash equities and derivative products, producing greater market depth and larger share trading volumes. In turn, this would signal to the international inancial community that Hong Kong was sensitive to the needs of sophisticated market participants and committed to improving the quality of the Hong Kong market. As the activity in the market increased, more supervisory and support functions within global inancial irms would be moved to Hong Kong, adding further to the growth of Hong Kong as a inancial centre. he government has not, however, taken any meaningful steps towards eliminating stamp duty on transfers of Hong Kong stock, despite the arguments advanced by the CMTC. he inancial markets in Hong Kong appear to have grown relative to those in other competing i nancial

34 35

Report on the Financial Market Review, April 1998, Introduction. KPMG, ‘Hong Kong Stamp Duty on Instruments Efecting Stock Transactions: he Case for Reform’, November 2005 (unpublished).

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centres,36 so it is not surprising that the Hong Kong government is content to let the stamp duty revenue from transfers of Hong Kong stock continue to low in.

2 Exemption of ofshore investment funds from proits tax In 2006, Hong Kong enacted legislation providing for exemption of ofshore investment funds from proits tax if certain conditions are met.37 his legislation was prompted by concerns that Singapore was attracting fund management business that otherwise would have been conducted in Hong Kong. Singapore law explicitly exempted many ofshore funds from income taxation and also provided for a reduced rate of tax on the Singapore-based managers of those funds.38 Under Hong Kong law, in contrast, any person, including an investment fund (whether in the form of a corporation, partnership or unit trust), is generally subject to proits tax in Hong Kong in respect of any business proits arising in Hong Kong from a trade or business carried on in Hong Kong. he presence of a Hong Kong manager exercising a general authority to trade on behalf of a nonresident fund could give rise to proits tax liability in respect of proits from trades in Hong Kong stock or other assets located in Hong Kong. To address the potential loss of fund management business to Singapore or other more tax-friendly locations, the Hong Kong government consulted interested parties and then proceeded to enact a tax exemption for ofshore funds. he legislation generally exempts non-resident fund entities from proits tax in respect of proits from ‘qualiied transactions’ executed through Hong Kong brokers licensed under the Securities and Futures Ordinance. Qualiied transactions include sales of debt and equity securities, futures and foreign exchange contracts, and exchange-traded commodities such as gold and silver. Sales of shares in private companies are not included in the deinition of ‘qualiied transactions’, which is problematic for funds that invest in real estate through special purpose holding companies, and also for private equity funds. In the 2013–14 Budget, however, the government proposed to extend the proits tax exemption for ofshore funds to include transactions in private companies which are

36

37 38

See, e.g., ‘HKEx Leads World Again in IPO Funds Raised’, Exchange (January 2011), available at: www.hkex.com.hk/eng/newsconsul/newsltr/2011/Documents/2011–01– 02-e.pdf (accessed 10 March 2014). Revenue (Proits Tax Exemption for Ofshore Funds) Ordinance 2006. Ng (2009a: 487).

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incorporated or registered outside Hong Kong and do not hold any Hong Kong properties or carry out any business in Hong Kong. he deinition of a non-resident fund requires that the central management and control of the fund be exercised outside Hong Kong. Since the location of central management and control of an entity is oten uncertain in the context of international investment activities, the application of the Hong Kong tax exemption is not always clear. he legislation also contains anti-avoidance provisions aimed at preventing Hong Kong residents from taking advantage of the exemption. hese provisions have been questioned on policy grounds, since Hong Kong proits tax does not apply on the basis of residence but rather on the basis of whether business proits arise in Hong Kong. Overall, the Hong Kong tax exemption for ofshore investment funds has not been as successful as the government was hoping it would be at the time of enactment. Singapore has broadened its tax exemption for ofshore funds, covering a wider range of investment products, and has continued to ofer reduced rates of income tax for fund managers based in Singapore. hus, for example, regional property investment funds are much more likely to be managed in Singapore than in Hong Kong, since there is a risk that the gains realized on sales of stock in property holding companies would be subject to Hong Kong proits tax if done in Hong Kong by a Hong Kong-based fund manager.

E

Taxation and the rule of law in Hong Kong

One inal point can be made regarding taxation as an aspect of Hong Kong’s status as an international inancial centre. Disturbingly, there is increasing evidence that Hong Kong is becoming a jurisdiction in which an individual or company cannot win in a tax dispute with the government. Of the 100 or so tax cases that were heard by the Inland Revenue Board of Review in the three years’ worth of reported cases from 2007 through 2009, not a single case was decided in favour of the taxpayer. his contrasts very unfavourably with tax tribunals in other inancial centres, where taxpayers typically achieve a partial or complete victory in at least 20 per cent of cases.39 he trend in Hong Kong is not due to a rash of frivolous appeals; some of the cases have been argued by expert advocates on 39

See, e.g., New York City Tax Appeals Tribunal Annual Report July 1, 2007 – June 30, 2008, available at: www.nyc.gov/html/tat/downloads/pdf/annual_report_2008.pdf; New York State Division of Tax Appeal, Tax Appeal Tribunal, Annual Report Fiscal Year 2009–2010, available at: www.nysdta.org/2009–2010AnnualReport.pdf (accessed 10 March 2014).

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the basis of substantial evidence in favour of the taxpayer’s position. Most observers of the current Hong Kong tax scene feel that the government, including the Board of Review and the lower courts, have adopted an attitude of intolerance towards tax appellants that, although unjustiied, is becoming increasingly entrenched. In addition, the Inland Revenue Department (IRD) has been aggressive in its interpretation of the territorial limitation on both proits tax and salaries tax. In 2008, following a decision of the Court of Final Appeal on the source of business proits that went in favour of the taxpayer (a rare event), the IRD issued a practice note stating that it would follow the decision only in cases involving the same set of facts. he IRD made this pronouncement despite the Court of Final Appeal’s efort, in its report of the case, to enunciate general principles for determining the territorial source of business proits for tax purposes. In the salaries tax area, the IRD has efectively negated the territorial limitation on the tax by taking the view that all employment income arises in Hong Kong if the employee’s employer is resident in Hong Kong – even if the employee works outside Hong Kong most of the time. Admittedly, the courts have aided the IRD in taking this approach.40 However, on occasion the IRD has asserted, successfully, that an employer is resident in Hong Kong despite clear evidence showing that the employer is actually managed and controlled elsewhere.41 he situation looks even worse when one considers the fact that the salaries tax statute says nothing to indicate that the residence of the employer is a relevant factor in determining the territorial source of income from an employment. For a jurisdiction that advertises itself to the international business community as beneitting from the rule of law, Hong Kong is taking a risk by allowing the Inland Revenue Department and the Inland Revenue Board of Review to be so aggressive in tax enforcement. Efectively, they may be seen as sending a message that the rule of law is not necessarily supreme in Hong Kong. Granted, given the relatively low rates of tax in Hong Kong, it is probable that most investors will prefer to pay than to ight about a tax assessment. However, the rule of law is arguably a fragile lower, susceptible to wilting from even a slight infringement. he Hong Kong government would be well advised to address the areas in which its application of the tax laws is possibly inconsistent with the rule of law. 40

41

Commissioner of Inland Revenue v. George Andrew Goepfert, 2 HKTC 210 (1987); Lee Hung Kwong v. Commissioner of Inland Revenue, 6 HKTC 543. Ahn Sang Gyun v. Commissioner of Inland Revenue, HCIA4/2008 (25 February 2009).

5 Enforcement of corporate and securities law in Hong Kong

A he institutional framework 1 Introduction As discussed in Chapter 3, laws and rules should address real, local problems rather than simply matching generally accepted schema. To this end, Chapter 2 examined the shareholding structures of leading Hong Kong corporate groups and the national composition of the SEHK. However, rules on the books are not enough to guarantee fair and balanced regulation. Powerful and pertinent laws and rules could be enacted or issued by a given jurisdiction, regulatory body or securities exchange to signal quality oversight to the world, yet never be efectively enforced. Enforcement could also be selective or biased in such a way that the announced ends of the regulatory framework are not supported or are even thwarted. In such case, regulation for fairness and eiciency would be signalled but never realized. his is a particularly undesirable situation because casual observers would receive unfounded reassurance of regulatory soundness. To understand the quality of regulation in a given jurisdiction one must therefore also evaluate how it is actually applied rather than simply catalogue the provisions. hat is the purpose of this chapter. For corporate and securities law as well as related rules, enforcement in Hong Kong takes place in the courts, through agency of the SFC, and at the hands of the HKEx. An important area of enforcement not addressed in this study is the function performed by the Companies Registry, which reviews and approves the incorporation of companies, monitors their compliance with regular i ling requirements (which, as discussed in Chapter 3, are extensive even for unlisted companies), and also reviews company names for completeness and duplication.1 he courts hear actions under both the Companies Ordinance and the SFO, and as will be discussed in Section B, have generally shown themselves 1

See, e.g., CO 2012, ss 100, 875.

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disposed toward both policing the inancial sector to protect the market and reading statutory provisions in a way that does not forestall relief for investors. he SFC is the primary actor against entities and persons – such as broker-dealers – that it licenses, but it also has power to initiate actions to disqualify dishonest directors and prosecute violation of rules on insider dealing and market manipulation. he intensity of the SFC’s activity has not been constant over the ten-year period examined in this chapter, and the possible causes for this will be discussed in Section C. he last primary actor in the regulation of Hong Kong securities markets is the HKEx, through its subsidiaries, the SEHK and the Hong Kong Futures Exchange (HKFE). he SEHK is the main regulator of primary market disclosure, and it also reviews listed companies for their compliance with continuing obligations under the listing rules. As the HKEx is a private body, the most signiicant penalty its subsidiaries the SEHK and HKFE can impose is to delist a company or cancel the trading rights of a participant. Enforcement of listing and trading rules will be examined in Section D. Subsections 2–4 of this section will examine the institutional structure of these three routes to enforcement.

2 he courts he Hong Kong judiciary as relevant for purposes of this analysis is straightforward, with the exception of one court of specialized jurisdiction, the Market Misconduct Tribunal (MMT), which was created under Part XIII of the SFO to hear actions involving the ofences of insider dealing and other forms of market misconduct (such as false trading, disclosure of false or misleading information, or stock market manipulation), and which need not be stafed by members of the judiciary.2 In hearing a challenge under the Basic Law to the shape of proceedings in the MMT’s predecessor, the Insider Dealing Tribunal, Hong Kong’s highest court held that the structure and procedure of the tribunal provided the required guarantees,3 and a later decision stressed that part of this arrangement is that the MMT does not have jurisdiction to impose criminal sanctions.4 Within the ordinary court system, actions will begin within a trial court named the Court of First Instance (CFI), the decisions of which can be 2 3 4

See SFO, Part 13. Koon Wing Yee v. Insider Dealing Tribunal (2010) 13 HKCFAR 133. Securities and Futures Commission v. Tiger Asia Management LLC [2011] HKEC 824 CFI, at para 16.

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Enforcement of corporate and securities law

appealed to the Court of Appeal (CA) and the avenue of appeal from the CA’s decisions runs to the Court of Final Appeal (CFA), but not by right.5 For criminal matters not requiring a jury, a magistrate’s court would hear the action instead of the CFI. his is a very important forum, as is evident from the fact that magistrate’s courts heard 74 per cent of the 39 criminal market misconduct cases between 2004 and 2011. Shareholders’ derivative actions and unfair prejudice actions under the Companies Ordinance would begin in the CFI, with the ordinary routes of appeal to the CA and then (rarely) the CFA. he Hong Kong judiciary is expressly independent under the Basic Law,6 but as was discussed in Chapter 1, this guaranteed independence has been called into question given the ultimate appellate power of the National People’s Congress (NPC). However, during the initial 16 years this arrangement was in operation, no commercial case was referred to the NPC. Indeed, only one of the 32 statutory derivative cases decided in Hong Kong reached the CFA.7 For actions under the SFO, the path within the Hong Kong courts would be somewhat more varied, because there is both the possibility of criminal action in the courts and civil action in the MMT. In most cases market misconduct actions would be initiated by the SFC. However, the MMT, which has only heard a handful of cases since its creation in 2003,8 is not an exclusive route for these actions. here are four separate routes that may be taken to enforce SFO prohibitions, all of which potentially see the SFC as initial actor. First, the SFC may seek summary disposition of ‘less signiicant’ ofences in a magistrate’s court.9 Second, the SFC may refer a matter to the Secretary for Justice for criminal prosecution,10 for which penalties range up to a ine of HK$10 million and ten years’ imprisonment.11 hird, either the SFC12 or an injured party13 may seek a civil penalty in the MMT against an inside dealer. Fourth, the SFC may in the CFI seek injunctive relief against an inside dealer so as to restrain action, obtain restitution or protect property against removal,14 an SFC power

5 7 8

9

10 12 14

Basic Law, Art. 81. 6 Basic Law, Art. 85. See Waddington Ltd v. Chan Chun Hoo (2008) 11 HKCFAR 370. See the list of rulings provided by the MMT at www.mmt.gov.hk, ‘rulings’ (accessed 15 March 2014) See SFO s 388 and Securities and Futures Commission v. Tiger Asia Management LLC [2011] HKEC 824 CFI, at para 18. 11 See SFO s 252A(2)(a), (4). See SFO s 303. 13 SFO s 252(1). SFO s 281. Securities and Futures Commission v. Tiger Asia Management LLC [2012] 2 HKLRD 281 CA, at paras 29–37.

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that was challenged but ultimately airmed in a 2012 Court of Appeal Decision.15

3 he Securities and Futures Commission (SFC) When dealing with persons and entities it licenses, the SFC can impose licensing related sanctions without taking recourse to any court or tribunal. As will be discussed in more detail in Section C, the SFC reports that its Enforcement Division engaged in over 1,300 disciplinary proceedings under various provisions of the SFO and the CO during the period from 1997 to mid 2013 (including actions in court). his far outnumbers complaints brought to court by aggrieved, private persons, and makes the SFC one of the most important components of Hong Kong’s regulatory enforcement framework. Jackson and Roe have empirically examined the assertion that private action by damaged parties through the courts is a much more efective regulator of securities markets than trusting ‘unmotivated bureaucrats’ to take efective action through public enforcement.16 In a study that plots regulatory bodies’ budget per national GDP and staing per national population – which incidentally showed Hong Kong at the top of both resources categories17 – against the success of a jurisdiction’s capital markets, Jackson and Roe showed that resources expended in public regulation strongly correlate with the success of a inancial centre.18 Moreover, one of the objections that Jackson and Roe point out as being raised against public enforcement – corruption that disproportionately afects public regulators19 – could not be raised against Hong Kong given its relatively low level of corruption.20 he SFC is a statutory body outside of the Civil Service, which was established in 1989 on advice of a government-appointed committee, led by Ian Hay Davison, which was set up to investigate a market collapse of 1987. At the time of that market collapse, Hong Kong had only a very informal body for the supervision of its securities markets.21 he SFO gives the SFC 15

16 18 20

21

Securities and Futures Commission v. Tiger Asia Management LLC [2012] 2 HKLRD 281 CA. Jackson and Roe (2009). 17 Jackson and Roe (2009: 226–7). 19 Jackson and Roe (2009: 237–8). Jackson and Roe (2009: 236). In 2012, Hong Kong ranked 14th out of 176 countries and territories in Transparency International’s Corruption Perceptions Index. See http://cpi.transparency.org (accessed 15 March 2014). To better understand Hong Kong’s placement internationally, it is useful to know that the United States ranked 19th. See, e.g., Fell (1992) on the appointment, duties and resources of the Hong Kong Securities Commissioner prior to the creation of the SFC.

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its primary functions, inter alia, ‘to maintain and promote the fairness, eiciency, competitiveness, transparency and orderliness of the securities and futures industry’, to educate and protect the investing public, ‘to provide protection for members of the public investing in or holding inancial products’, ‘to minimize crime and misconduct’ and reduce systemic risks ‘in the securities and futures industry’.22 As the body that licenses all non-banks that engage in one of the ‘regulated activities’23 on the inancial markets – such as dealing in securities or futures contracts, or providing investment advice – the SFC stands over Hong Kong market participants as their primary supervisor. Given the importance of the SFC in the Hong Kong markets, a potential structural concern derives from the fact that the SFC is fully independent neither from the government nor from the market. Its chairperson and board are appointed by the chief executive, and the chief executive has express statutory power to issue instructions to the SFC on how to carry out its duties.24 he chief executive of the Hong Kong SAR is appointed by the Central People’s Government of the PRC,25 the same body that indirectly controls the SOEs constituting about half of the market capitalization of the SEHK. On the other side, private market participants also have a direct channel into the policy making of the SFC through a statutorily mandated ‘advisory committee’ of inancial community members that meets at least quarterly with the SFC chair and CEO to provide them with advice on matters of policy.26 Given its susceptibility to structurally embedded inluence exercised both from Beijing (controlling the listed SOEs) and the Hong Kong business and inancial community, the SFC could easily sufer from bias. he examination of its enforcement activity in this section does not, however, indicate that such structural tendency towards bias has become manifest. A signiicant counteracting force in Hong Kong is the fact that the entire Special Administrative Region is acutely visible to the international inancial community to which it sells its services, and this market force may be the strongest impediment to the biased and corrupt application of securities laws in Hong Kong. Like most administrative agencies, the SFC has a set procedure for the internal and external review of its enforcement decisions. Internally, the 22 23

24 25

See SFO, s 4. here are currently ten ‘regulated activities’ under the SFO. hey are: (1) dealing in securities, (2) dealing in futures contracts, (3) leveraged foreign exchange trading, (4) advising on securities, (5) advising on futures contracts, (6) advising on corporate i nance, (7) providing automated trading services, (8) securities margin i nancing, (9) asset management, and (10) providing credit rating services. See SFO Sch 5, Pt 1. See SFO, s 11 and Sch. 2, para 1. Basic Law, Art. 45. 26 See SFO, s 7.

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decisions of an individual division within the SFC can be appealed to the Commission itself, and then to the Securities and Futures Appeals Tribunal.27 Externally, the activities of the SFC are reviewed annually by an independent ‘Process Review Panel’ operating out of the HKSAR Financial Services Branch, which examines the licensing and regulatory activity of the SFC ‘on the adequacy of [its] internal procedures and operational guidelines governing the actions taken and operational decisions made by [it] and its staf in the performance of its regulatory functions, including the receipt and handling of complaints, licensing and inspection of intermediaries, and disciplinary action’.28 In its 2011/12 report, the Panel discussed with the SFC the handling of 55 cases, and raised in response to a query regarding the number of its investigations, very interesting issues regarding the SFC’s conduct of its activities. First, the ‘SFC elaborated that it adopted a risk-based approach in the regulation of intermediaries, by directing more regulatory attention to medium to high-risk areas, and to those having a signiicant impact on SFC’s regulatory objectives’.29 his could be meaningful for the downward trend in enforcement actions coupled with an upward trend in high-proi le actions examined in Section C, below. Second, with regard to the duration of investigations and disciplinary actions, it was found that due to ‘a limited number of inhouse experts’, decisions were not made as promptly as the Panel would have liked, because the experts need to ‘prioritise their work among competing commitments’.30 Both of these observations show that in spite of having more resources than most such regulatory bodies in other jurisdictions, even more would be better. One way the SFC has reduced necessary expenditures on resources is to share its regulatory burden with the HKEx, as explained in following.

4 Hong Kong Exchanges and Clearing Limited (HKEx) he SEHK, a subsidiary of HKEx, is the ‘frontline’ regulator of listings and public oferings of securities in Hong Kong. he SFO provides for the power of a recognized exchange company like the SEHK to adopt binding 27 28

29

30

See SFO, s 216. Process Review Panel for the Securities and Futures Commission, Annual Report for 2011–12, para 1.3. Process Review Panel for the Securities and Futures Commission, Annual Report for 2011–12, para 3.5. Process Review Panel for the Securities and Futures Commission, Annual Report for 2011–12, para 3.18.

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rules,31 and also allows the SFC to delegate part of its regulatory functions to such a company,32 but does not give the exchange company any special powers (beyond altering the relationship between the exchange and an issuer) to enforce those rules. As explained in Chapter 3, the SEHK has adopted rules imposing ‘company law’ obligations on companies listed in Hong Kong, reaching into the structure and composition of their boards of directors, the requirements for capital and allocation of shares, and the voting rights that may be exercised by members. he goal is to bring non-Hong Kong companies up to the standard of shareholder protection created under Hong Kong company law. In addition to having responsibility for such listing standards, the SEHK has been legally transferred the SFC’s power under the CO to examine and authorize prospectuses for the sale of securities.33 In accordance with these statutory provisions, the SFC has adopted rules that place responsibility for approving the applications of companies seeking to list their securities on the SEHK primarily in the hands of the SEHK.34 he result is that the SEHK, unlike other stock exchanges (e.g. the NYSE or the LSE, whose regulators review listing documents and determine their contents), administers nearly all of the disclosure regulation for listed companies, including the content and approval of securities prospectuses and annual reports. he SEHK also collects information on related party contracts and other transactions that must be notiied under the SEHK. his is why the SEHK is said to be Hong Kong’s ‘frontline’ securities regulator.35 he SEHK’s powers over listed companies are not commensurate with its responsibilities. he SEHK is merely a private entity, a Hong Kong company limited by shares, whose powers are limited to shaming its listed companies or ultimately denying them access to the market through delisting. Much of Hong Kong regulation thus takes place on a purely contractual basis. In only one case does the SFC retain direct supervision over a listed company, and that is the HKEx, which is listed on its 31 32 33

34

35

SFO s 23. SFO s 25. Securities and Futures (Transfer of Functions – Stock Exchange Company) Order, CAP 571AE, s 3. See Securities and Futures (Stock Market Listing) Rules, Ch. 571V, Ordinances of the HKSAR. See, e.g., Hsu et al. (2006: 170–81) and the Memorandum of Understanding Governing Listing Matters between the Securities and Futures Commission and the Stock Exchange of Hong Kong, dated 28 January 2003 (Listing Matters MoU), which creates a dual i ling system for disclosure documents according to which all i lings may be made with the SEHK, which acts as an accepting agent for the SEHK and remains the ‘front-line regulator for all listing-related matters’ (Listing Matters MoU, para 4.5).

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subsidiary. For any regulatory or disciplinary actions regarding its parent, the SEHK has ceded authority to the SFC pursuant to a SFC–HKEx MoU, a key provision of which is that ‘he SFC shall, instead of SEHK, take all actions and make all decisions in relation to HKEx that would be taken by SEHK in the case of other applicants and issuers’.36 However, for other listed companies the SEHK retains such authority, and enforces its listing rules against listed companies through its Listing Division. he Listing Division may bring a listed company, its substantial shareholders, or its oicers or directors before the Listing Committee for a breach of the listing rules,37 and the Listing Committee may impose one of the following sanctions afecting the party’s relationship with the Exchange: • • • •

a private reprimand; a public statement which involves criticism; a public censure; report the ofender’s conduct to the SFC or another regulatory authority; • require a breach to be rectiied or other remedial action to be taken; or • suspend or cancel the company’s listing.38

A person against whom the sanction is made may request that the same Listing Committee conduct a review hearing of its decision, and then if such review decision is unfavourable, appeal the decision to the Listing Appeals Committee.39 he decision of the Appeals Committee is, as the listing rules state, ‘conclusive and binding’.40 he procedure used before the Listing Committee, particularly the absence of legal counsel at the irst stage, was challenged by New World Development Co. Ltd., with the argument that the Committee is essentially a court, and that the Basic Law’s guarantee to legal representation should be preserved before the Committee. he case went up to the Court of Final Appeal, which held through Bokhary PJ ‘that the Listing Committee is not a court within the meaning of art.35 of the Basic Law’.41 Although the sanctions available to the HKEx are not essentially limited to withholding its own services, discretion as to imposition of such sanctions also remains within its own purview.

36

37 39 41

Memorandum Of Understanding For the Listing Of Hong Kong Exchanges And Clearing Limited On he Stock Exchange Of Hong Kong Limited Between Securities And Futures Commission, Hong Kong Exchanges And Clearing Limited And he Stock Exchange Of Hong Kong Limited, dated 22 August 2001, para 3.1.1. SEHK Disciplinary Procedures, s 2.4. 38 SEHK Listing Rules, Rule 2A.09. SEHK Listing Rules, Rule 2A.11. 40 SEHK Listing Rules, Rule 2A.11. Stock Exchange of Hong Kong v. New World Development Co Ltd [2006] 2 HKLRD 518.

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B Private enforcement through litigation 1 Unfair prejudice actions As discussed in Chapter 3, the Hong Kong Companies Ordinance provides shareholders with an action for unfair prejudice, which for years had been applied in a manner very similar to that found in the UK, that is, to police for fairness in relationships among members of small, private companies qualifying as ‘quasi-partnerships’. his interpretation of the unfair prejudice action persisted in Hong Kong despite the presence of powerful majority shareholders in most of the companies listed on the SEHK. With the availability of the unfair prejudice action limited in this way, Hong Kong law was essentially beret of an avenue to obtain relief against the abusive, albeit legal, acts of a majority shareholder absent personal dealings between shareholders. As Figures 5.1 and 5.2 make clear, of the 95 cases in which a theory of unfair prejudice was raised or an aspect of an unfair prejudice proceeding was appealed in Hong Kong courts between 1996 and 2012,42 32, or about 34 per cent, were successful, and there has not been a particular pattern or trend in either the number of petitions or their chance of success. Only one petition was allowed for a claim against a member of a listed, public company.43 In listed companies, personal relationships between controlling and minority shareholders, creating expectations of behaviour beyond what is written in the law, would be rare. Another obstacle for plaintifs seeking unfair prejudice relief in Hong Kong courts is that controlling shareholders are also oten directors, and may exercise at least part of the abusive power as directors. Courts have developed a distinction between actions 42

43

Based on cases available through the homson Reuters service, WestLaw, searching for the section number of the Companies Ordinance (sec 168A) for the unfair prejudice action and both words ‘unfair’ and ‘prejudice’. One of the earliest cases available, Re Taiwa Land Investment Co Ltd [1981] HKLR 297, 305, declares the consistently held position in citing the House of Lords in Ebrahimi v. Westbourne Galleries Ltd. and Other [1973] A.C. 360 to ai rm that it is ‘considerations … of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights’. h is line of argument continues until the most recent decisions. For example, in the 2013 case of Ho Po Yeng v. Ho Ming Chun [2013] HKEC 378, the CFI notes the facts present ‘a classic case in which the Court inds that the relationship between the shareholders, having its origin in their relationship as partners, imported the type of duties and obligations that exist between true legal partners, and thus engages the application of equitable considerations when assessing whether or not one of the shareholders has behaved in a way which is unjust, inequitable or unfairly prejudicial’, at para 14.

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Cases

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Figure 5.1 Unfair prejudice actions, 1996–2012 Success rate 100%

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Figure 5.2 Annual success rate of unfair prejudice actions

meant to stop the illegal behaviour of directors (‘misconduct’) and those meant to stop legal behaviour of management that is unfairly prejudicial (‘mismanagement’).44 he irst route would be a derivative action, and the second an action for unfair prejudice. he Companies Ordinance does 44

See Re Chime Corp Ltd (2004) 7 HKCFAR 546, 571, citing Hof mann LJ in Re Saul D Harrison & Sons Plc [1995] 1 BCLC 14.

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now and in the past also contain express provision that, as one form of relief in the context of an unfair prejudice action, the court may order that an action on behalf of the company be commenced against any person (essentially a derivative action).45 Nevertheless, when such relief might be a component of an unfair prejudice action, Hong Kong courts dismiss petitions for unfair prejudice that contain allegations of misconduct as an abuse of process. An example of this treatment is found in Re Shun Tak Holdings Ltd, in which the petitioners claimed that the company had failed to insure receipt of dividends from its subsidiaries.46 he payment of dividends under Hong Kong law requires the participation of both the board and the shareholders, and absent speciic agreement, there is no bright line as to the quantity of dividends that should be paid. hus, only in very special circumstances could a director be charged with misconduct if a company were to underpay or overpay dividends. Nevertheless, rather than interpret this situation as one in which mismanagement could be corrected by ordering commencement of an action against directors under the CO to vote the shares of the subsidiary to correct the nonpayment of dividends, the court dismissed the suit as an abuse of process (derivative action in disguise).47 Regretfully, the courts which have dismissed unfair prejudice actions as derivative actions in disguise have failed to comment on why, if the two remedies are mutually exclusive, LegCo included in the Ordinance an order to commence a derivative action as a remedy for unfair prejudice.48 Given the pressing need to address the power of controlling shareholders, Hong Kong’s courts must face their duty to extend the common law in this area, both for orderly governance in the Hong Kong market and so as to meet the increasing need that the Region provides high quality law to China. It appears that this has begun to happen, and the opening was achieved without announcing any break with English Common Law or that of the Commonwealth countries. he irst unfair prejudice action to award relief to a shareholder of a listed company was Luck Continent Ltd v. Cheng 45

46 47 48

‘[T]he Court may make … an order that proceedings … be brought in the company’s name against any person’, s 725(2)(a)(ii) CO 2012. In the former CO, the relevant provision s 168A(2)(a)(ii) Chapter 32 was essentially identical (‘the court may … order that such proceedings … be brought in the name of the speciied corporation’). Re Shun Tak Holdings Ltd [2009] 5 HKLRD 743. Re Shun Tak Holdings Ltd [2009] 5 HKLRD 743, para 72. See, e.g., Re Gen2 Partners Inc [2012] 4 HKLRD 511; Sai Kung P L B (Maxicab) (No.1 & 2) Co Ltd v. Hiew Moo Siew [2011] HKEC 255 (‘the use of [an unfair prejudice] petition in order to circumvent the rule in Foss v. Harbottle … in a case where the nature of the

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Chee Tock heodore [2012] HKEC 567. Like many cases that tug common law development in a new direction, Luck Continent had unusual facts. First, the action was i led by a large, not a minority, shareholder, Luck Continent Ltd., which had acquired the listed Bermuda company CY Foundation Group Ltd. through a reverse merger.49 hrough a required public ofering of shares to meet listing requirements, the plaintif ’s investment vehicle dropped from a holding of approximately 97 per cent to about 46 per cent of issued shares, and the plaintif was subsequently forced of the board.50 When he sought to call a meeting to regain control of the company by removing directors with a simple majority of votes, as is required under the SEHK listing rules, the company’s counsel informed him that the removal would require a special resolution.51 he drop in Luck Continent’s holding meant that the plaintif was well below the 75 per cent threshold to adopt a special resolution.52 he ‘prejudice’ resulted from the fact that CY Foundation Group Ltd.’s articles of association did not allow removal of a director with an ordinary resolution, but rather demanded a special resolution, so that they breached the SEHK listing rules, which mandated that removal be possible with a simple majority.53 his discrepancy would eventually result in the company being suspended from the SEHK.54 Even though when the SEHK threatened the company with sanction and a number of general meetings were called at which proposals were made to correct the situation by amending the articles, a member with a holding exceeding 25 per cent blocked the resolution.55 he delisting of equity securities is widely understood to decrease their value. his decrease in value presents the second unusual aspect of Luck Continent. Unlike most company decisions alleged to create unfair prejudice, here we ind a failure to act that has a causal relationship to damage with 100 per cent probability of occurrence: blocking the vote

49 50 51 52

53 54 55

complaint is misconduct rather than mismanagement is, in my opinion, an abuse of process’). Luck Continent [2012] HKEC 567, para 3. Luck Continent [2012] HKEC 567, paras 5, 9, 11. Luck Continent [2012] HKEC 567, para 11. Luck Continent [2012] HKEC 567, paras 15–16. he original concern was not to amend the articles, but to remove directors and regain control of the company’s management. Because Luck Continent did not have 75 per cent of the votes, it was unable to remove directors under the existing articles (which called for a special resolution), at which point it became interested in the deviance of the articles from the listing rules requirement. See SEHK Rules, Appendix 13, together with Appendix 3, s 4(3). Luck Continent [2012] HKEC 567, para 14. Luck Continent [2012] HKEC 567, paras 16–17.

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to bring the company into compliance with the rules will certainly have the prejudicial efect of the company being delisted from the SEHK, so that the court had no doubt that the relief requested would eliminate the prejudice.56 With respect to the existence of an agreement or understanding among members that was breached, the CFI found that there was a tacit agreement – whether through collateral contract, contract for the beneit of a third party, or implied promise – between the company and the shareholders that the company comply with the SEHK listing requirements, and thus equity demanded such agreement be enforced.57 As such the company’s continuing failure to meet the listing rules (as caused by the blocking shareholder) unfairly prejudiced the plaintif ’s interests, and the court ordered that the company’s articles of association be amended to allow for removal of directors by majority vote.58 In airming the decision, Lam JA for the Court of Appeal observed: I see no diiculty in holding in the present case that the blocking of the amendment of the Bye-law to facilitate the resumption of trading of the shares of CYF was in breach of a fundamental understanding between the shareholders in associating together and this gave rise to ground for equitable intervention by the court. he Judge was correct in inding that there was unfair prejudice in the present case.59

Luck Continent ’s logical extension of UK precedent to listed companies and the arrangements accompanying listing could indeed prove lucky for minority shareholders in Hong Kong – and for the quality of Hong Kong law seeking to safeguard fair management in listed companies. he causal ties between compliance with listing rules, remaining listed on the SEHK, and the existence of a liquid market for shares are beyond all doubt: if the irst falls the others will too. It is therefore unlikely that courts will ind it problematic to see a breach of arrangements and understandings among shareholders when such rules are breached. However, a breach of these rules could also plausibly be interpreted as ‘misconduct’ by the company’s board in many instances. For this reason, if Hong Kong courts continue to avoid considering why LegCo made a decision to include a derivative 56

57 58 59

he problem at the core of the complaint was compliance with a rule, which is binary (one either complies or does not) and results in sanction or delisting from the exchange. herefore, unlike most business decisions, the opportunity costs of not making the decision could be known in advance with certainty. his fact permitted the court extraordinarily to apply the unfair prejudice remedy to the actions of a minority shareholder. Luck Continent [2012] HKEC 567, para 97. Luck Continent [2012] HKEC 567, paras 100–103. Luck Continent [2013] HKEC 1209, para 92.

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action within the possible relief for an unfair prejudice action, and instead regard the two actions as mutually exclusive alternatives, the solution to dominant shareholder abuse ofered by Luck Continent could in many cases still be sidestepped by skilful counsel and a willing court.

2 Shareholder derivative actions he common law shareholder derivative action has been available at least since the 1843 case of Foss v. Harbottle,60 which was exactly coterminous with the linking of Hong Kong courts to the English Common Law.61 Prior to 2004, only seven common law derivative actions are evidenced in the WestLaw and Lexis databases as being brought in Hong Kong. Of these, ive were not dismissed by the court upon irst review,62 an average of about one every three years from the irst of these cases in 1987 to the last in 2003. In the late 1990s, a movement arose particularly among American economists to promote US-style shareholder litigation as the best method to check management misconduct in companies.63 With the support of organizations like the World Bank and the IMF, this evolved into a global trend of legislative reform,64 and Hong Kong was at the forefront in this trend, amending its Companies Ordinance in 2004 to include a statutory derivative action.65 his ofered a route separate from, and – if the increased number of approved actions per year is seen as a result – less burdensome than the common law principles expressed in Foss and its progeny for a shareholder to seek court approval of an action on the 60 62

63

64

65

61 Foss v. Harbottle (1843) 67 ER 189. See Chapter 1, Section C.3. Junestar Investment Corp & Another v. Boldwin Construction Co Ltd & Another [2003] HKEC 1111; King Paciic International Holdings Ltd v. Chun Kam Chiu & Others [2002] HKEC 711; Chung Hung Sau Ling & Another v. Asia Women’s League Ltd & Others [2001] HKEC 587; Tan Eng Guan and Another v. Southland Company [1996] 2 HKLR 117; Anglo Eastern (1985) Ltd & Another v. Knutz [1988] 1 HKLR 322. See the account of this in Jackson and Roe (2009: 209) (‘Key policy analysts quickly accepted the relative value of private over public enforcement, with the World Bank advising “[i]n banking and securities markets, characteristics related to private monitoring and enforcement drive development more than public enforcement measures”’). In addition to the World Bank promotion of private actions to developing countries, a number of highly developed countries sought to close the gap between their law and that of the United States. In 2005 Germany signiicantly lowered the shareholding threshold expressed in §148(1) AktG from 5 per cent to 1 per cent for a shareholder or group of shareholders to be eligible to act on behalf of the company (see Gesetz zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts – UMAG). In 2006, the UK introduced a statutory derivative action through Part 11 of its Companies Act 2006. Introduced by the Companies (Amendment) Ordinance 2004.

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company’s behalf against (in most cases) the misfeasance of management. he CO contains a four-part test, two criteria of which are procedural and two are substantive. In the case that new proceedings are brought by the shareholder: (1) he company must not have brought the same proceedings already. (2) he shareholder must have given the company at least 14 days’ notice of the proceedings. (3) he proceedings must appear to be prima facie in the interest of the company. (4) he proceedings must present a serious question to be tried.66 In one of the early decisions under the statutory scheme, Kwan J explained that the plaintif ’s burden to show the action is ‘prima facie in the interest of the company’, ‘is not a high one’ and is consciously lower than that used in Australia, Canada and Singapore. She explained that Canada and Singapore require a inding that the plaintif is acting in good faith, with Australia also requiring that the action be shown to actually be (not just prima facie seem) in the company’s interest.67 In a more recent decision, Harris J stated that in deciding whether the plaintif ’s claim presents ‘a serious question to be tried’, ‘the court should be slow to ind against the Plaintif unless his prospects are so slim that he cannot be said to have any expectation of success’.68 hus, if LegCo’s intention when inserting a statutory derivative action in the CO was to facilitate shareholder action, the Hong Kong courts have interpreted the measure in that spirit. As Figure 5.3 makes clear, the introduction of the statutory derivative action in 2004 led to a signiicant increase in the number of actions iled and a near doubling of the absolute number of actions that annually survived dismissal. In the eight-year period from 2005 to 2013, a total of 33 derivative actions were heard, of which 15, or about 45 per cent, were successful. Overall, for the period 1996 to 2013 the only other discernible trend is a spike in actions iled around the outbreak and atermath of the Global Financial Crisis, although the dismissal rate for these actions is above the average.

66

67 68

he version applied in all the cases analysed here is found in Chapter 32, s 168BC(3). he current location of the statutory derivative action prohibitions is in CO, ss 731–738. CO 2012 renders the Latin ‘prima facie’ in English as ‘on the face of the application’. Lucky Money Ltd & Others [2006] HKEC 1379, paras 40 and 41. Li Chung Shing Tong (Holdings) Ltd [2011] HKEC 1192, para 33.

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Actions 7 6 5 4 3 2 1

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Figure 5.3 Derivative actions, 1996–2013

As mentioned above, both Hong Kong and the UK introduced statutory derivative actions in response to a strong push from scholarship and regulatory policy making originating in the United States that advocated private litigation over public regulation. he market-centric philosophy behind such a choice was of course welcome in (largely) laissez-faire Hong Kong, but the problem sought to be cured with such litigation in the United States is not commonly found in Hong Kong. As discussed at length in Chapter 3, unlike Hong Kong, the US economy is marked by relatively dispersed shareholdings and a class of powerful, professional managers. he derivative action allows a shareholder with a small equity stake to leverage her inluence through the judiciary in order to remedy the wrongs that managers have inlicted on the company.69 he action addresses the agency problem between shareholders and the management to whom they have delegated power over the company. However, when controlling shareholders also directly dominate the board of directors or directly control who is elected to that board, this agency problem does not arise in any signiicant way. Rather, a tension between the minority shareholders and the controlling shareholders will be a principal concern for good governance. In this regard, an important fact about the derivative 69

See, e.g., Baums and Scott (2005); Cofee (1999).

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actions in Hong Kong for which leave was granted between 2005 and 2013 is that in 12 of the 15 actions, the defendants were not only directors of the company, but also substantial shareholders and persons acting in concert with the same.70 his is not the scenario envisaged for derivative action relief, but rather one in which an avenue should be given for minority shareholders to seek judicial remedy against controlling shareholders. 70

In David Chien v. Francis Cheung [2013] HKEC 896, para 4, the ‘1st defendant … [was] the Chairman of the Board of directors and the single largest shareholder of the Company, holding about 40.59% of its shares’. In Hang Heung Cake Shop Co Ltd [2013] HKEC 163, paras 7–8, ‘the issued share capital of the HHCS was held as to 75% by the Cheng family … and as to the remaining 25% by the Tsoi family’. In New-Asia Optical Co Ltd [2011] HKEC 1150, para 2, the company had ‘three shareholders. In addition to the Applicant, Lam Chi-cheung was, prior to his death on 26 December 2010, the registered owner of 58 per cent of the company’s share capital.’ In AR Evans Capital Partners Ltd v. Gen2 Partners Inc [2012] HKEC 875, para 1, ‘he Company … at all material times had three shareholders – Novel Alternative Investment Ltd (“Novel”), Mr Barry Lau Wang-Chi (“Mr Lau”) and A R Evans Capital Partners Limited (“AR Evans”), holding respectively 50%, 10% and 40% of its issued shares. Novel is … owned by Mr Paul Lincoln Hef ner … while AR Evans is … owned by Mr Raymond Lai. he Company ha[d] three directors – Mr Hef ner, Mr Lau and Mr Raymond Lai.’ In Li Chung Shing Tong (Holdings) Ltd [2011] 5 HKLRD 274, para 6, the primary defendant was ‘at all material times … the majority shareholder of the Company [and] a director of the Company for many years until her purported resignation in 19 October 2001, ater which she continued to participate in the management of the Company and supervise the operations of the Company. She was reappointed to the board of directors on 30 April 2008.’ In FBC Construction Co Ltd v. Big Island Construction (HK) Ltd [2009] HKEC 467, paras 1–2, the Company was at ‘all material times … 99.9999% owned by “Big Island Asia” which, in turn, was 99.9% owned by Ben Lee’, the defendant director. In Grand Field Group Holdings Ltd [2009] HKEC 338, para 4–16 ater founders of the company let the board and brought in a strategic investor who took a board seat, the defendant board member shareholders allegedly siphoned funds of to their own companies through PRC subsidiaries. In Nice & Well Ltd [2008] HKEC 2134, para 2, the court describes the action as one by ‘a shareholder and director of the Company’ against ‘its other shareholder and director’. In Waddington Ltd v. Chan Chun Hoo [2008] 11 HKCFAR 370, para 38, ‘the irst defendant … [was] and at all material times … Chairman and Executive Director of [the Company] and is alleged to have been a director at the relevant times of each of the companies in the … group to which I have referred. hrough the second defendant and a family trust he is alleged to hold and, at all material times, to have held an indirect controlling interest in [the Company] and hence in each of its subsidiaries and sub-subsidiaries.’ In Myway Ltd [2008] 3 HKLRD 614, para 3, the applicant and the opposing respondent were ‘the only shareholders of the Company, each holding 50% of its issued shares. hey [were] also its only directors.’ In Re F & S Express Ltd [2005] 4 HKLRD 743, para 5, which was an action against a Mr Li for siphoning of funds into his own company, the company allegedly damaged had ‘three shareholders … each holding one-third of the shares. he applicant [was] a shareholder. Li Pui Lam [the defendant] [was] another shareholder … [and] also a director.’ In Ng Lee Wah v. Lam Chun Wah & Another [2005] HKEC 907, para 1, the ‘1st defendant and the plaintif … were … the only two shareholders and directors of the 2nd defendant (“the Company”)’.

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For this reason, we can see that if it were not for the restricted application of the ‘unfair prejudice’ action in Hong Kong before the Luck Continent case discussed above, 80 per cent of the derivative actions for which leave was granted in Hong Kong between 2004 and 2013 might have been better heard in an unfair prejudice context, given that the ultimate agency problem being addressed is that between controlling and non-controlling shareholders, not one between shareholders and management. his would be particularly advantageous because the unfair prejudice action does not contain the initial procedural hurdles built into the derivative action.71 Focusing on a solution designed for the ‘Berle and Means’ corporation is thus not only ill suited to Hong Kong, but also creates unnecessary hurdles for minority shareholders seeking relief.

3 Securities fraud actions Chapter 3 discussed the substantive nature of Hong Kong’s various measures in the securities area that allow the market to be policed for unfair and distorting behaviour. If a securities prospectus contains untrue statements, the issuer and persons authorizing distribution of the prospectus can face both civil and criminal liability.72 he SFO contains a type of ‘false trading’ ofence – ‘disclosure of false or misleading information inducing transactions’73 – that could also be triggered both in connection with the market generally and between counterparties in connection with the sale of securities. he SFC prohibits insider dealing and a number of manifestations of market manipulation. To date, every action in Hong Kong to impose civil or criminal liability for prospectus liability, market manipulation or insider trading has been advanced by the SFC, the Hong Kong Financial Secretary or the Hong Kong Department of Justice.74 here are no visible instances of private securities fraud actions in Hong Kong. 71

72

73 74

As Kwan J observed in Re Shun Tak Holdings Ltd [2009] 5 HKLRD 743, para 42, ‘irrespective of whether a derivative action is brought under common law or by statute, there is the safeguard of a i lter, by the threshold requirement or the leave application, to prevent unmeritorious claims or claims which it was not in the interest of the company to pursue. here is no such safeguard in a petition under [an unfair prejudice] petition.’ See the Companies (Winding up and Miscellaneous Provisions) Ordinance, Chap 32, ss 40–40A. SFO, ss 277, 298. h is is based on an examination of cases appearing in Hong Kong courts, in the MMT and in the Insider Trading Tribunal, as reported in WestLaw and on the websites of the Hong Kong judiciary and special tribunals, as well as notices given in the enforcement news and bulletins published by the SFC and HKEx.

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Given the economic realities of such litigation, most plaintifs would not initiate a securities fraud action alone to seek redress for ofences afecting prices in open market – as opposed to larger, negotiated – transactions. As this book goes to press, Hong Kong does not have a class action form through which similarly situated investors could bundle their claims in a single action. he same trend that advocated US-style derivative actions also advocated investor class actions of the kind available in the United States since 1938 for the private investor policing of the securities markets. Australia introduced rules for such actions in the early 1990s,75 the UK introduced them in 2000,76 Germany introduced them in 2005,77 the Irish Law Commission proposed such legislation in 2005, but has not enacted it,78 and New Zealand introduced legislation to this end in 2009, but has not enacted it.79 In 2012, a Law Reform Commission constituted for this purpose recommended that such an action be introduced in Hong Kong, but no further steps had been taken by the time this book went to print. As a result, beyond the corporate derivative and unfair prejudice actions discussed in Subsections 1 and 2, above, all enforcement in Hong Kong is undertaken by public bodies.

C Public enforcement 1 he range of the SFC’s activity As stated above, all judicial action taken against false and misleading securities prospectuses or to punish violations of rules against insider dealing or market manipulation have been commenced by a public body. he SFC also initiates actions to disqualify corporate directors who have recklessly brought their company into insolvency. Between 2005 and 2012, the SFC initiated 18 such actions,80 over half as many as the 33 statutory 75

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See the Federal Court of Australia Amendment Act 1991, discussed in Law Reform Commission of Hong Kong (2012: 25–9). See the Civil Procedure (Amendment) Rules 2000, discussed in Law Reform Commission of Hong Kong (2012: 35–46). See the Gesetz über Musterverfahren in kapitalmarktrechtlichen Streitigkeiten [he Capital Market Disputes Collective Actions Act], BGBl. I S. 2437, 16 August 2005. See Law Reform Commission of Ireland, Report on Multi-Party litigation (2005, Report LRC 76–2005), discussed in Law Reform Commission of Hong Kong (2012: 46–9). Discussed in Law Reform Commission of Hong Kong (2012: 49). he data used here on SFC enforcement activity is taken from the SFC’s ‘Enforcement News’, published on its website beginning in 1997. Multiple reports published at diferent stages of the same enforcement action have been excluded. SFC ‘Enforcement News’ is available at www.sfc.hk, ‘News & announcements’ > ‘News’ ‘Enforcement news’ (accessed 15 March 2014).

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derivative actions initiated by all Hong Kong shareholders against director misconduct during the same period. Moreover, one of the most important roles of the SFC is to license all non-banks81 that engage in ‘regulated activities’ on the Hong Kong inancial markets; these activities range from dealing in securities or futures contracts to operating a rating agency.82 Part of the licensing process is ongoing reporting to and oversight by the SFC, which has the result that almost all legal actions against market participants in Hong Kong are initiated by or involve sanctions imposed through the SFC. Most sanctions only extend to licensing related penalties, such as suspension or revocation of licence, at times combined with a ine, but others are court actions initiated by the SFC under the SFO, resulting in civil or criminal sanctions. During the irst 17 years of the Hong Kong SAR’s existence, the SFC has reported an average of 80.5 enforcement actions per year, a total of 1,369 in aggregate.83 It reports statistics on its enforcement actions both under 18 speciic categories84 and broadly classiied into intermediary misconduct, market manipulation, insider dealing, corporate governance, and unlicensed activities. For each of the last four quarters, the ratio of each type of action to the whole is

81

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84

It ‘registers’ banks that the HKMA advises should be granted permission to undertake regulated activities, and the HKMA remains the primary supervisor for such entities. here are currently ten ‘regulated activities’ under the SFO. hey are: (1) dealing in securities, (2) dealing in futures contracts, (3) leveraged foreign exchange trading, (4) advising on securities, (5) advising on futures contracts, (6) advising on corporate i nance, (7) providing automated trading services, (8) securities margin inancing, (9) asset management, and (10) providing credit rating services. See SFO Sch 5, Pt 1. he data used here on SFC enforcement activity is taken from the SFC’s ‘Enforcement News’, published on its website beginning in 1997, and the igure of 1,370 indicates actions on which information is published until November 2013. Multiple reports published at diferent stages of the same enforcement action have been excluded. SFC ‘Enforcement News’ is available at www.sfc.hk, ‘News & announcements’ > ‘News’ ‘Enforcement news’ (accessed 15 March 2014). As many as four claims have at times been raised against a single entity or person in a single action. he speciic categories that since 2003 have been reported annually by the SFC (with some slight variation over the years) are failure to comply with Financial Resources Rules, failure to safekeep client securities, failure to maintain proper books and records, failure to safekeep client money, unlicensed dealing and other registration issues, breach of licensing condition, breach of requirements of contract notes/statements of account/receipts, failure to make i ling/notiication, breach of margin requirements, marketing malpractices, illegal short selling of securities, dealing malpractices, breach of Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, breach of Corporate Finance Adviser Code of Conduct, breach of Fund Manager Code of Conduct, non-compliance with anti-money laundering guidelines, breach of other rules and regulations of the Exchanges, internal control weaknesses, and ‘others’. See the annual reports of the SFC for years 2003–4 to present, under the rubric ‘Breaches noted’.

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nearly identical to that seen in the proportions evidenced in Figure 5.4 for the second quarter of 2013. From Figure 5.4, we can see that one large area of the SFC’s enforcement activity (41 per cent) is connected either with disciplining those who engage in regulated activities without a licence (oten unlicensed employees within a licensed broker) or enforcing the various internal control and account maintenance rules applicable to those intermediaries holding licences (intermediary misconduct plus unlicensed activities). he other, larger area involves market discipline generally, in connection with both licensed and unlicensed persons. he largest portion of this 59 per cent of activities focuses on policing against market manipulation (23 per cent), while roughly equal parts are allotted to prosecuting insider dealing and seeking to have grossly negligent or disloyal management removed from listed companies. Although relatively stable in recent years, the aggregate number of claims brought by the SFC has varied signiicantly over time, as Figure 5.5 makes very clear.85 As discussed above, the SFC explained to the Process Review Panel in 2012 that ‘it adopted a risk-based approach in the regulation of intermediaries, by directing more regulatory attention to medium to high-risk areas, and to those having a signiicant impact on SFC’s regulatory objectives’.86 his philosophy is already expressed in the statement for 2007 of the SFC’s then CEO, Martin Wheatly, who had been appointed in 2006: A pragmatic shit in our enforcement activities over the past 12 months saw us become more resourceful in the type of actions we took to address unacceptable behaviour in the market. At the same time our aim has been to send a potent message when breaches occur … Our Enforcement team took strong action where we felt misconduct was signiicant and particularly harmful to the market. Our objective is to take action which drives changes in behaviour.87

If this ‘pragmatic’, ‘risk-based approach’ has guided the SFC since 2006, the question remains: why did enforcement actions spike so quickly in the run up to 2005? here are a number of possible causes for this peaking in 85

86

87

Figure 5.5 shows the total number of defendants against which claims are brought each year, not the total number of claims. In any given action against a defendant, multiple claims might be lodged, such as unlicensed trading by the personnel of a broker-dealer whose internal controls were not adequate to prevent such violations and misappropriation of client assets by the same unlicensed personnel of the poorly managed brokerdealer. Process Review Panel for the Securities and Futures Commission, Annual Report for 2011–12, para 3.5. SFC Annual Report 2007–8, p. 6.

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7% Intermediary misconduct 18%

34% Market manipulation Insider dealing Corporate governance 18%

Unlicensed activities

23%

Figure 5.4 SFC enforcement actions by nature, quarter ended 30 June 2013 Source: www.sfc.hk, Regulatory functions > Enforcement > Enforcement statistics > Investigations by nature (accessed 15 March 2014).

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Figure 5.5 Aggregate annual SFC enforcement actions, 1997–2013 Source: SFC Enforcement News

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SFC enforcement volume, and it is my opinion that it derives primarily from market volume, with contributions from generally accepted regulatory philosophies and market mood. Between 1997 and 2007, the SEHK experienced its largest growth spurt since the exchange had been created in 1986, with market capitalization of the Main Board catapulting from HK$3.2 trillion to HK$20.5 trillion, a six-fold increase during the decade.88 he increase in the market capitalization of the mainland SOEs through H-shares for the period was even more dramatic: in 1997, H-share capitalization stood at HK$48.6 billion, and by 2006 this igure had increased nearly 70-fold to about HK$3.4 trillion. his rapid increase in market size naturally led to a similarly rapid rush for new licences to conduct regulated activities like dealing in securities and providing investment advice. Ater decreasing by an annual average rate of 10 per cent between 2001 and 2003, the number of new licensed intermediaries then increased at an average of 13 per cent annually from 2004 to 2008.89 Listed companies from an unruly Chinese legal system and inexperienced broker-dealers seeking proits in the rising market naturally begged increased scrutiny and discipline, particularly in the wake of the Asian Financial Crisis and the dot.com bubble. It is well known that a period of global support for rigorous corporate governance began with the US Sarbanes-Oxley Act of 2002, was carried forward with the EU Transparency Directive of 2004, and certainly was not in any way dampened by the codiication of existing law in the Hong Kong Securities and Futures Ordinance of 2003. In its annual report of 2005, published for the last year of Andrew Sheng’s tenure as SFC CEO, the SFC explained: he theme of this year’s Annual Report is ‘Investors First’ – the same theme as last year’s. he continuation of this important message shows our determination to put the interest of investors irst in the performance of our functions. Investors, like consumers, will only be attracted to a market that is well regulated and where irm and fair enforcement action will be taken against malpractice.90

his was particularly true about Hong Kong, as the market was selling shares in poorly governed companies to international investors, and attempting to supplement the inchoate mainland regulation with its 88 89

90

HKEx (2013: 27). During 2009 and 2010, licensees then decreased by an average of 2 per cent, and have since regained the upward trend. Data is taken from SFC Annual Reports 2003–4 until 2012–13, under the heading ‘Number of Licensees’. SFC Annual Report 2005–2006, p. 1.

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own more stable system. Mr Sheng and the other directors might have concluded that a rapidly expanding market was best met with a quick surge of enforcement actions, particularly against the new licensees. Mr Sheng – as a former World Bank oicial – was very familiar with the governance philosophy of the time, and we know from his account of Hong Kong’s response to speculative attempts to crack the Hong Kong dollar and inancial market during the Asian Financial Crisis, that he would not shy away from regulatory muscle when this was deemed necessary.91 Figure 5.6 presents a detailed picture of the type of enforcement claims made as declared in SFC annual reports for the period 2003–5. We can see that during the period in question, enforcement activity was focused on ‘intermediary misconduct’ over various types by the large and growing number of licensed intermediaries that were entering the market. In this group of claims brought against market participants, breaches of the Code of Conduct for licensed and registered persons and failure of such persons to maintain adequate internal governance and controls together easily outnumber all of the 16 other categories of claims. Moreover, a reading of the SFC’s enforcement reporter entries shows that during this period, claims made outside of licensing supervision were scarce: the SFC did not bring any actions for insider dealing or ask the court to disqualify misbehaving corporate directors, and it only lodged 28 claims for market misconduct. Such actions might have served as efective deterrence to a more seasoned group of broker-dealers, but when these licensed intermediaries were directly charged with breach of duty and failure to meet licensing requirements, the regulatory message could not be missed. As the number of licensees stabilizes, we see the proportion of actions policing broker-dealers’ compliance with licensing requirements decrease and the proportion of more high-proi le court actions against market participants engaged in market manipulation and insider dealing, among other violations, increase. hus, far from being an irrational spike of regulatory activity, the regulatory action swell of 2003–6 and its subsequent passing may have been a calculated exercise in educating the new entrants into the Hong Kong inancial markets.

2 Supervising licensed corporations he claims that the SFC makes against licensed persons relect the requirements for licensing. During the 17-year period for which the SFC reports 91

See Sheng (2009: 270–1).

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Figure 5.6 SFC enforcement claims, 2003–5 Source: SFC Annual Reports

enforcement actions up to 2013, the claims speciied in those reports include a level of detail that exceeds that found in the standard types of breaches reported in the SFC’s annual reports beginning in 2003, as discussed above. he claims described in the enforcement notices for individual cases can be grouped into those connected with licensing and those involving a form of market abuse. he licensing-related category includes: (1) trading without licences, which sometimes occurs within a licensed broker-dealer and sometimes when the entity trades in a new area, (2) failure duly to disclose trades, (3) trading without client authorization, (4) failures of internal management controls within broker-dealers, (5) violation of inancial resource requirements, and (6) general negligence or misconduct in relation to client accounts. A second category of claims can be seen as cases in which behaviour of a licensed intermediary exceeds the negligent and moves towards the reckless, intentional or fraudulent, such as for charges of (1) misappropriating client funds, (2) soliciting client business in illegal ways, such as cold calling, (3) false and misleading disclosures in advertising and disclosure documents, (4) placing orders that are either unauthorized or suspicious in nature placing, and (5) placing orders in front of client orders (front running). A third category of

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claims reported is the market policing actions – such as for insider dealing – discussed in the following subsection. As Figure 5.7 illustrates, for the 17-year period examined, the SFC raised over 1,000 claims of the irst and second categories against licensed corporations, with failures of internal management controls constituting about 20 per cent of them, and misfeasance on accounts, unauthorized trading and concealed trading comprising another 37 per cent. By contrast, only 6 per cent of the claims were for misappropriation of client assets. his appears to indicate that the roughly 30,000 licence-holding corporations, individual traders (representatives) and broker managers (responsible oicers) are more oten sloppy and disobedient than outright dishonest. However, when seen in conjunction with the igures presented in the following subsection, it becomes apparent that the SFC was kept very busy preventing the various forms of market misconduct prohibited by the SFO.

3 Policing the market against misconduct In policing the market against misconduct, the SFC appears to have indeed taken on a risk-based approach that replaces launching over a hundred actions a year with a focus on fewer visible, high-proile targets with high deterrent impact, but it has also been aggressively innovative by opening new avenues to exercise its supervisory and enforcement powers. As explained in Section B.3, above, there is currently no vehicle for damaged investors to bring securities class actions against issuers or market participants. In 2011, the SFC sought to i ll this void, although rather belatedly given the length of time that Hong Kong has been a leading international inancial market. he transaction in question was the 2009 listing of a Cayman Island red chip company, Hontex International, which had published misleading statements regarding its accounts in a securities prospectus. Using s 213 SFO, the SFC requested injunctive relief from the CFI in the form of an order to Hontex to make a repurchase ofer to all damaged shareholders.92 he SFC also levied a record ine on the lead manager (sponsor) for the listing, Mega Capital (Asia). he ine against Mega Capital amounted to HK$42 million, and the company lost

92

SFC Enforcement News, ‘SFC Seeks Final Orders in Hontex Case’ (19 May 2011). he power of the SFC to seek relief directly from the CFI was initially rejected, but then approved by the CA and the CFA. h is is discussed in the next paragraph.

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Figure 5.7 Violations of licensing requirements and duties to clients, 1997–2013 Source: SFC Enforcement News Note: he categories used in this igure are not identical to those employed by the SFC in its annual declarations on enforcement, but rather track the individual enforcement notices that the SFC publishes on a rolling basis as enforcement actions arise. A single action will oten include more than one claim, and the summary of the claim provided here is based on the judgement of the author and his research team.

its licence to advise on corporate inance matters.93 Hontex’s mandatory repurchase ofer to about 7,700 public shareholders who had purchased Hontex shares on the basis of the defective prospectus had a value of HK$1.03 billion.94 Hontex was also delisted from the SEHK.95 In a less

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SFC Enforcement News, ‘SFC Fines and Revokes the Licence of Mega Capital (Asia) Company Limited’ (22 April 2012). SFC Enforcement News, ‘Hontex Issues Repurchase Ofer to Shareholders’ (24 September 2012). HKEx News Release, ‘In Relation to the Matter of Hontex International Holdings Company Limited (Stock Code: 946) Cancellation of Listing’ (19 September 2013).

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traditional type of market policing, already discussed in Chapter 3, the SFC also exercised a hitherto dormant power provided under s 385 SFO to intervene in a scheme of arrangement through which PCCW Ltd. sought to buy out its public shareholders at a historically low price and delist voluntarily from the SEHK.96 PCCW is a holding of Li Ka-shing’s son, Richard Li. hat matter inally went to the Court of Appeal, where it was found that because of a vote-generating scheme set up by the controlling shareholders, the shareholder approval of the roll up transaction could not be considered valid, and the transaction could not be approved.97 In both Hontex and in PCCW, the SFC used untried legal tools to enter the market aggressively to protect investors from activity that could be placed under the rubric of securities fraud. In both instances, the SFC was rebufed and blocked by conservative decisions in the CFI, but then given permission to proceed by the appellate court. h is is evidence both of a highly vigilant securities regulator and a judiciary that (eventually) is well disposed to protect investors. As discussed in Chapter 3, the term ‘market misconduct’ includes a broad array of prohibited acts under the SFO, such as insider dealing, false trading, price rigging, information-based market manipulation, inducing transactions with false or misleading information, and trade-based market manipulation. he SFC, together with the Department of Justice and the Financial Secretary, brought all actions recorded for such violations in Hong Kong. he SFC reports initiating a steadily swelling number of insider dealing investigations for the ive-year period from 2008 to 2012, increasing in a progressive series 31, 35, 43, 56 until more than doubling at 67.98 As indicated in Figure 5.8, the SFC reports initiating action in 31 of the 33 civil insider dealing actions heard in the period examined. In addition, actions for insider dealing were brought against activities within powerful and well known entities, such as CITIC Paciic Ltd.,99 Morgan Stanley Asia Ltd.,100 and ABN Amro Asset Management (Asia) Ltd.101 he rising trend for investigations, the strong conviction percentage and the willingness to take on powerful institutions for matters of insider dealing indicate a robust and efective execution of the law, creating a sizeable deterrent impact on the market. As discussed in the context of Hontex, 96

97 98 99 100 101

SFC Enforcement News, ‘Court Grants SFC Application to Intervene in PCCW Scheme of Arrangement’ (24 February 2009). Re PCCW Ltd [2009] HKEC 738, CA. SFC Annual Report 2012–13, p. 57. See Securities and Futures Commission v. Chui Wing Nin [2013] HKEC 1483. See HKSAR v. Du Jun [2012] HKEC 1280. See Leung Chi Keung v. Market Misconduct Tribunal [2012] HKEC 535.

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above, the SEC has also sought and received approval to seek injunctive relief against accused insider dealers directly from the CFI. In this case, the SFC sought an injunction pursuant to s 213 SFO in the CFI against a hedge fund, Tiger Asia Management LCC, to block use of what it alleged were the proceeds of insider trading. he CFI agreed with the defendant that the case, civil in nature, must go irst to the MMT, but the CA and the CFA found that the provisions of the SFO creating the MMT do not prevent the SFC from seeking injunctive relief immediately in the CFI under s 213 SFO, thus creating an additional avenue for SFC action against insider dealing.102 he SFC’s actions against market manipulation have been much more numerous than against insider dealing, but much less high proile. Figure 5.8 shows that market misconduct other than insider trading is the second most frequent enforcement action taken by the SFC. he SFC also states that for the ive-year period 2008 to 2012, its investigations into possible market manipulation have more than doubled in the following series: 39, 58, 55, 90 and inally 95.103

4 Direct government action: a tale of two bailouts ‘Direct government action’ as used here is the kind of ad hoc responses we see governments patch together when faced with problems larger than anything their regulatory system was designed to deal with. he Global Financial Crisis presented a number of governments around the world with exactly such an opportunity. When the maker and enforcer of law sets out on an ad hoc path through an event caused in part by its very laws, how it treats law can be very telling. In late 2008, AIG and major US banks were approaching a bankruptcy that would have meant their demise and radically reshaped the structure of the US inancial system. However, the US government did not allow the contractual commitments of these major inancial institutions to bring them to ruin. Rather, it bought AIG’s outstanding credit default swaps and opened a number of facilities to provide liquidity ‘to primary dealers authorized to acquire US treasuries’, ‘special purpose vehicles of major banks … that invested heavily in sovereign and corporate bonds’, and ‘intermediaries with exposure to asset-backed commercial paper of non-inancials’.104 Katharina Pistor describes this as a loosening of the strictures of contract at the apex of the inancial system: 102 103 104

Securities and Futures Commission v. Tiger Asia Management LLC [2013] HKEC 703. SFC Annual Report 2012–13, p. 57. Pistor (2013: 319).

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ur es

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Figure 5.8 Policing against market misconduct, 1997–2013 Source: SFC Enforcement News Note: he categories used in this igure are not identical to those employed by the SFC in its annual declarations on enforcement, but rather track the individual enforcement notices that the SFC publishes on a rolling basis as enforcement actions arise. A single action will oten include more than one claim, and the summary of the claim provided here is based on the judgement of the author and his research team. A complex system of interdependent contractual commitments can be maintained and might even appear to be lat as long as there are enough intermediaries willing and able to acquire all kinds of i nancial instruments … A legal system committed to the rule of law is meant to apply law irrespective of status or identity. Contracts are designed to create credible commitments that are enforceable as written. Yet, closer inspection of contractual relations, laws and regulations in inance suggests that law is not quite as evenly designed or applied throughout the system. Instead, it is elastic … In general, law tends to be relatively elastic at the system’s apex, but inelastic on its periphery … Consider the diferent fates of homeowners in the context of plummeting real estate markets … While major i nancial intermediaries received emergency liquidity support from the Fed or government bailouts, homeowners faced personal bankruptcy and foreclosure in accordance with the law.105

105

Pistor (2013: 319–20).

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Enforcement of corporate and securities law

When faced with situation in which the rule of law would mean a cracking of the inancial system’s apex, the US government makes law lexible at the apex while substantially retaining law’s rigidity at the periphery. During the same period, Hong Kong was also faced with a very political dimension of the inancial crisis, during which it also bent contract law, although in the other direction. Between 2003 and 2008, a Cayman Island company called Paciic International Finance sold about HK$11 billion of Lehman Brothers arranged credit-linked notes referred to as ‘minibonds’ to retail investors in Hong Kong,106 and these were joined by about another HK$10 billion of Lehman arranged notes from other issuers. he notes, which promised to make payments linked to the creditworthiness of a basket of Hong Kong blue chip companies, were supported by swap contracts arranged by Lehman. hey were not guaranteed as to principal, and this was stated on the securities prospectus. Nevertheless, the notes were sold through a number of banks in Hong Kong to retail investors looking for a safe place to put their retirement savings. When Lehman Brothers entered insolvency proceedings, it was wholly possible that the savings of over 34,000 Hong Kong investors would be lost.107 he contract between the issuers and the buyers of these notes was clear: there was no guarantee that full payment would be made. Nevertheless, the damaged investors went to the streets and to LegCo, arguing that although the instruments might have met the legal subtleties of the disclosure rules, they were unfair. In response, the Hong Kong government through the SFC and the HKMA began negotiating a settlement with the banks which distributed the notes in Hong Kong for repurchase agreements.108 As at mid 2012, most of these investors had received nearly 100 per cent repayment on their investment, and another group received about 70 per cent repayment because the series of notes that they had purchased was too poorly collateralized.109 his was achieved without a class action lawsuit, in a negotiated settlement between the public authority of Hong Kong and the distributing banks. Just as the United States had sought to bend 106 108

109

107 See HKMA (2011: 11). SFC (2008: 28). A total of 16 distributing banks participated in a settlement in which they repurchased notes from investors. hese were the Bank of China (Hong Kong), the Bank of Communications, the Bank of East Asia, Chiyu Banking Corporation, Chong Hing Bank, CITIC Ka Wah Bank, Dah Sing Bank, Fubon Bank (Hong Kong), Industrial and Commercial Bank of China (Asia), MEVAS Bank, Nanyang Commercial Bank, Public Bank (Hong Kong), he Royal Bank of Scotland, Shanghai Commercial Bank, Wing Hang Bank, and Wing Lung Bank. See www.hkma.gov.hk (accessed 15 March 2014). Enoch Yu, ‘Minibond Saga Drawing to a Close’, South China Morning Post (4 June 2013).

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219

the law in the midst of a crisis, so too did Hong Kong. However, while the United States loosened contractual commitments at the top of the hierarchy and held those at the bottom rigid, Hong Kong tightened contractual commitments at the top of the hierarchy according to basic fairness, making them even more rigid than they were, and made those at the bottom correspondingly lexible – banks which were not obliged to make payment, did so, and investors who did not have a right to receive payment, nevertheless did. One lesson from this story of two bailouts is that in the United States it is good to be a large bank, while in Hong Kong it is good to be a small investor. Certainly, playing roulette with the rule of law is never a good idea, but the United States appears to have done so to support an existing network of inluence, while Hong Kong did so to achieve fundamental fairness.110 his is a healthy signal for Hong Kong to send if it intends to be known as a safe and investor friendly international inancial centre. he result might not be as unusual as it seems, for it does relect the different economic situations of New York and Hong Kong. he former is a national inancial centre with a large international component, while the latter is an international inancial centre with a limited national component. Of the banks discussed in Chapter 2 , only HSBC was a major inancial player on a global scale in 2008. he other globally active banks were present in Hong Kong at that time, but did not look to Hong Kong to protect their very existence. Moreover, although 34,000 investors is a large number for Hong Kong, it would be less signiicant for a country the size of the United States. Banks operating in Hong Kong would never face an exposure to local investors of a dimension that might present itself in a substantially larger economy. When declaring through the minibond settlement that Hong Kong protects investors, even if this might be uncomfortable for the banks operating in the Region, it does not place its main economic base at risk. A similar stance in New York might have done exactly that.

110

A more sceptical view might be that because the Hong Kong government lacks democratic legitimacy, it responds to popular protest – the only avenue the largely disenfranchised public has to make its inluence felt – in an appeasing manner, and the banks go along with this in order to prop up the status quo. h is view, however, does not contradict the fact that the Hong Kong government intervened to bend the law in the direction of popular fairness rather than against it. If the US bailout is viewed in a similar light, the government and the major banks are also in collusion, but it is the banks rather than the public which receives immediate economic beneit from the arrangement.

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Enforcement of corporate and securities law

D Contractual sanctions by the HKEx 1 he enforcement record As discussed in Section A.4, the HKEx has a limited number of enforcement powers, ranging from a private reprimand to the cancellation of an issuer’s listing. Essentially, it can make public that a listed company has failed to meet its standards or deny a listed company access to its listing. hese all presuppose, irst, that the listing standards are generally considered desirable for investors and, second, that the listed company needs the exchange more than the exchange needs the listed company. his last aspect – which might be considered to create a conlict of interest for efective enforcement – will be considered in the next subsection. It is impossible to specify in advance a i xed ratio of listed companies that should be investigated, warned or ultimately suspended and delisted. his will depend on the quality of the issuers’ compliance with the corporate governance standards and other requirements contained in the listing rules. Not surprisingly, Figure 5.9 shows an increase and peaking of investigations and warnings around 2005 that corresponds to the increase evidenced in Figure 5.5 for SFC enforcement actions. Similar to the steady annual increase of 13 per cent in licences from 2004 to 2008, the absolute number of SEHK Main Board listings increased about 67 per cent between 2004 and 2007, from 49 to 82.111 Moreover, the HKEx would have been well aware of the SFC’s increased activity during the period, and the accompanying perception that tough enforcement against possible ofenders was seen as useful. Although the number of investigations initiated and warning or caution letters given listed companies dropped by about 36 per cent between 2004 and 2007, the number of suspensions and delistings remained relatively steady. More information would be useful to know whether the 161 companies issued a warning letter in 2004 responded to the Exchange at a much higher rate than did the 63 companies that received warnings in 2007, given that the rate of suspensions in the following years (78 and 52) did not vary proportionately. he peak and drop in investigations and warnings during the period examined, together with the steady rates of suspensions and delistings, and the relatively constant ratio of one delisting for every three suspensions, seem to indicate that the HKEx, like the SFC, reacted to the surge of growth and eventually brought its activity within a normalized routine of enforcement. 111

See HKEx (2009: 45).

Contractual sanctions by the HKEx

221

Investigations Warnings Suspensions Delistings

Number 250

200

150

100

50

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Year

Figure 5.9 HKEx enforcement actions, 2003–12 Source: HKEx Annual Reports, ‘number of disciplinary actions’, and HKEx News Release, ‘Report on Initial Public Ofering Applications, Delisting and Suspensions’

2 Quality versus volume Although it is impossible to specify an absolute ratio of enforcement actions to listed companies that would allow a stock exchange to achieve a perfect rating for enforcement, it is possible to form a reasonable judgement as to whether a stock exchange is pandering to listed companies in order to increase its market capitalization at the cost of good enforcement. he HKEx is in an interesting position because the main service – aside from a freely convertible currency – it sells to mainland SOEs seeking an ofshore listing is good governance. Chapter 3 explained just how strict the rules applying to mainland Chinese companies are. hus, in trying to attract these companies and investors in the Chinese economy to the SEHK, the HKEx has been in the comfortable position of the dominatrix, pleasing its customer the more vigorously it applies its whip. his was particularly true for SOEs. However, in the third quarter of 2013, the HKEx fell into uncomfortable temptation from a kind of company that it does not see oten – a large, well-known private mainland company headed by a dynamic founding shareholder: Alibaba.com Ltd. and Jack Ma.

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Enforcement of corporate and securities law

Mr Ma, who at the time owned about 7 per cent of Alibaba’s ordinary shares, sought permission from the HKEx to list two classes of shares with diferent voting rights, so he could bring the SEHK a HK$230 billion listing, the largest in years, and by a dynamic privately owned company in the attractive area of IT. As we saw in Chapter 2, the SEHK does not accept any new listings of shares with diferent voting rights between classes of shares, and the only company with more than one class of shares listed on the SEHK is Swire, with two classes of shares expressing diferent dividend rights, and such shares were listed before the SEHK replaced its predecessor, the Hong Kong Stock Exchange. his was a very important question for the HKEx, because both the NYSE and the Nasdaq Stock Market allow such dual class shares, and for decades best practice on listing rules has come from New York. However, as we saw in Chapter 2, Hong Kong is unique among the top three inancial centres in that its market is dominated by companies with controlling shareholders. he rule against disproportionate voting rights for any class of shares was designed expressly in this context and is important for Hong Kong in a way that it could not be for New York. HKEx held its ground and refused to make an exception for Mr Ma. hen Mr Ma ofered the possibility of a provision in Alibaba’s articles of association which would give a group of founding managers referred to as the ‘partners’ the right to nominate the majority of the board.112 Ater long deliberation, the HKEx also refused to accept that arrangement.113 As this book goes to press, however, the matter remains unresolved. HKEx CEO, Charles Li, has loated the idea of accommodations to meet the needs of more dynamic companies, like Alibaba. If dual class listings were made available for companies exhibiting a requisite age and growth proile, this could allow the SEHK to adjust its rules without relaxing its protection against dominant family and state shareholders, whose companies are larger and more stable. Such a relaxation would resemble the decrease in investigations and enforcement actions conducted by the SEHK and SFC following the Hong Kong market’s irst spurt of China-related growth. It might be evidence of a maturing Hong Kong market. Such a change in response to a maturing of the Chinese economy and legal system would not be unusual, for as we have seen since Chapter 1 of this book, Hong Kong exists in a constant and lexible reaction to changes in its environment. 112

113

Neil Gough, ‘Alibaba Said to Push to Allow Partners to Nominate Board Members’, New York Times (23 August 2013). Lex column, ‘Alibaba: No Open Sesame; Hong Kong Exchange is Right not to Allow Minority Owners Special Powers’, Financial Times (25 September 2013).

6 China’s impact on Hong Kong’s position as an international inancial centre: the legal and policy dimensions Wang Jiangyu

A Introduction: integration, competition and erosion Hong Kong’s ambition to maintain its position as an international inancial centre – or even to become a more signiicant one, depends overwhelmingly on the market of mainland China (hereinater the mainland, China or the PRC). China, however, provides a mixed blessing for Hong Kong in this regard, arising out of the inevitable co-existence of integration and competition between the two regions under Chinese sovereignty. As the hub of China trade and investment for more than a century,1 Hong Kong has played a signiicant historical and current role in the development of the Chinese economy. Hong Kong’s importance for China, at least from an economic perspective, is beyond doubt. As noted by historian Steve Tsang, by 1997, the year Hong Kong was returned to China by the United Kingdom, ‘Hong Kong had become the largest source of investments in a very wide spectrum of economic activities and the most important capital market for the PRC … It was the PRC’s key trading partner, middleman, inancier and facilitator that underpinned the economic reform of Deng Xiaoping.’2 In short, ‘Hong Kong’s economy did not merge into that of the PRC in 1997 but the two economies had by then become so intricately linked that the wellbeing of one had become crucial for the other’.3 he reuniication in 1997 has accelerated economic integration and independence between Hong Kong and the mainland.4 Prasad (2004) 1

2 4

For a survey of Hong Kong’s historical role as the hub of China trade, see generally, Meyer (2000). Tsang (2004: 178). 3 Tsang (2004: 179). For a survey of Hong Kong’s increasing integration with the mainland ater 1997, see, generally, Prasad (2004).

223

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China’s impact on Hong Kong’s position

revealed that post-1997 integration deepened in the following areas: ‘mainland-related entrepôt trade has continued to increase; a large share of China’s foreign currency inancing is raised in the Hong Kong SAR inancial market; a growing range of economic activities are becoming integrated across the border; and business in Hong Kong SAR has increasingly become focused on China-related activities’.5 Fully aware of Hong Kong’s position vis-à-vis China, the elites in Hong Kong never hesitate to hide the SAR’s ambition to be a leading international inancial centre by riding on the coat-tails of the mainland’s unprecedented economic growth. In 1998, a year ater Hong Kong’s return to Chinese sovereignty, Edgar Cheng, the then chairman of the Council of the Stock Exchange of Hong Kong, wrote passionately: Hong Kong’s success as a global centre in the long run will … be closely bound up with our success in becoming not just a ‘window on China and China’s window on the world’, but the main international inancial centre of a China which will be part of a world market.6

If Mr Cheng was simply making a wish, a speech of Donald Tsang, Hong Kong’s then chief executive, ventured to take this as a reality by stating that ‘[a]s China’s premier international inancial centre, Hong Kong has an important part to play in the Mainland’s new phase of opening up and reform’.7 Indeed, Tsang would not be shy when he felt it was necessary to seek help from the central government in Beijing in order to strengthen Hong Kong’s position as a inancial centre.8 For a long time, Beijing’s willingness to provide economic support seemed to be beyond doubt, as evidenced by the policies to ofer unilateral concessions through a free trade agreement (FTA) with Hong Kong, encourage state-owned enterprises (SOEs) to list shares on the Stock Exchange of Hong Kong (SEHK) and make Hong Kong the experimental ield for the mainland’s new measures on inancial liberalization, e.g. the irst ofshore RMB centre for the use of the Chinese currency at the international level. However, insofar as its position as an international inancial centre is concerned, what Hong Kong can expect to get from the mainland are not 5 8

Prasad (2004: 3). 6 Cheng (2002: 380–1). 7 Tsang (2009). In early 2009, Donald Tsang indicated to the media that he would seek support from the central government to help Hong Kong survive the current Global Financial Crisis, mainly through a Chinese policy to sustain Hong Kong’s aspiration to be an ofshore centre for the settlement transactions in RMB (or Renminbi), China’s oicial currency. Tsang (2009).

CEPA’s direct benefits

225

just beneits, but also challenges. First, increasing integration with the mainland itself is a double-edged sword, making Hong Kong vulnerable to certain economic and political forces originated in China. Second, the rapid improvement of China’s competitiveness have been eroding Hong Kong’s traditional advantages and position. In particular, the rise of Shanghai as a inancial centre – and potentially a global one – will significantly weaken Hong Kong’s position in this regard. his chapter examines the impact of mainland China on Hong Kong’s status as an international inancial centre from legal and policy perspectives. It is organized as follows: Section B looks at the direct economic concessions ofered by China through the FTA. Section C discusses the challenges of China’s SOEs, many of them are listed in the Hong Kong Exchange, to the regulatory environment of Hong Kong’s stock market. Section D analyses the impact of the rise of Shanghai and Shenzhen on Hong Kong, focusing on the implications of Shanghai’s ambition, driven by China’s relevant industrial policies, to be an international inancial centre. Section E concludes.

B CEPA’s direct beneits for Hong Kong’s inancial sector An international inancial centre depends, irst of all, on the existence of a robust inancial sector, which has both the capacity and access to the international market. In this respect, the FTA signed in June 2003 between Hong Kong and the mainland’s central government, in the name of the mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA), ofers peculiar beneits to Hong Kong’s inancial sector. he service component of CEPA grants Hong Kong business a ‘irst move’ advantage in the Chinese market, as the concessions from the mainland went far beyond China’s commitments as relected in its WTO service schedule.9 For example, on foreign banking in China, the relevant regulations made in accordance with China’s WTO commitments mandate a minimum asset requirement of US$20 billion for overseas inancial institutions to establish branches in China. Under CEPA, however, Hong 9

Wang (2004: 123). In short, under CEPA, Hong Kong service suppliers can enter the mainland market, under favourable terms, one to ive years ahead of the implementation of China’s service schedule under the WTO. hey may acquire higher equity ownership in service companies incorporated in the mainland. hey may also establish new service irms with lower capital requirements than under the WTO schedule. In addition, Hong Kong professionals are allowed to take the relevant PRC professional examinations and to practice in the mainland.

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China’s impact on Hong Kong’s position

Kong investors were only required to have US$6 billion as a minimum asset to set up branches on the mainland.10 As noted in Harrison (2004), in regards to the securities industry in Hong Kong, CEPA contains two speciic measures. One measure authorizes the establishment of a representative oice of the SEHK, and the other recognizes the qualiications of Hong Kong securities professionals for the purpose of practising on the mainland.11 he recognition of qualiications entails great signiicance as it unprecedentedly extends the professional activities of Hong Kong’s securities industry to one of the major markets in the world. In addition, the following other measures in relation to banking, securities and insurance envisaged in CEPA would tremendously strengthen Hong Kong’s position vis-à-vis other global cities by relocating i nancial resources from the mainland to Hong Kong:12 • Mainland state-owned commercial banks and other shareholding banks (with private ownership to various degrees) are supported in relocating their international and foreign exchange trading centres to Hong Kong. • Mainland banks are supported in developing their network and business activities in Hong Kong through acquisition. • he mainland supports the full utilization of inancial intermediaries in Hong Kong for the reform, restructuring and development of the mainland inancial sector. • he two sides will support the listing of mainland insurance companies and other companies in Hong Kong. • Financial regulators on both sides will strengthen cooperation and information sharing, supposedly to a level higher than what they each do with regulators of other jurisdictions. he most recent wave of service liberalization by the mainland is embodied in the Supplement X to CEPA (known as CEPA X), which was signed on 29 August 2013, which gives Hong Kong service suppliers exclusive preferential access to the Chinese market.13 CEPA X covers 73 new measures on trade in services, adding the total number of such measures 10

11 13

Wang (2004). See Table 1 ‘he Mainland’s Speciic Commitments on Liberalization of Trade in Services for Hong Kong Sectors or Sub-sectors’, Annex 4 to CEPA. Harrison (2004: 2). 12 Harrison (2004: 3). Hong Kong Government (2013).

CEPA’s direct benefits

227

to 403 since CEPA took efect in 2003. In summary, the measures give Hong Kong service suppliers the following advantages: • Branches or subsidiaries of Hong Kong banks are allowed to conduct RMB business to service mainland-incorporated enterprises which are owned by Hong Kong investors. • Hong Kong inancial institutions are allowed to set up joint venture fund management companies in the mainland, and hold majority ownership in such companies. In contrast, qualiied foreign investors could only take a minority of the equity interests in such irms. • Hong Kong inancial institutions may set up one fully licensed joint venture securities company each in Shanghai, Guangdong and Shenzhen with a maximum aggregate shareholding of 51 per cent. • he mainland agreed to consider mutual recognition of fund products between the two sides, and to support Hong Kong issuers to take part in compulsory traic accident liability insurance business in the mainland. An important innovation in CEPA is the establishment of the category of ‘Hong Kong service supplier’. hat is, to qualify for the CEPA beneits, a company, recognized as a juridical person under CEPA, must be duly incorporated in Hong Kong and has engaged in substantive business operations for three to ive years, pay proit tax, has a business premise, and employ 50 per cent or more of its staf in Hong Kong.14 he strategic importance of this dei nition is obvious. In essence, it compels international service business to set up substantial commercial presence in Hong Kong should they plan to enjoy the preferential treatment ofered under CEPA. Hong Kong’s company law treats all investors (including foreigners) equally in terms of business incorporation. To obtain access to the Chinese market ahead of others, one of the best strategies of an international investor is to establish a Hong Kong company or to acquire Hong Kong companies that are qualiied for CEPA beneits. h is will undoubtedly bring international investors, including i nancial institutions, to Hong Kong to strengthen the city’s already robust i nancial sector. In addition, it will also solidify Hong Kong’s role as the dominant intermediary of foreign direct investment (FDI) and portfolio investment lows in Asia. 14

HKTID (2013).

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China’s impact on Hong Kong’s position

C Listing Chinese companies in Hong Kong: the regulatory and legal challenges 1 he China factor, especially SOE listings, in Hong Kong’s stock market To a very large extent, Hong Kong’s competitiveness as a inancial centre stems from its role as a centre for China’s international capital-raising activities.15 Increasing placements by large Chinese SOEs and private irms in the Hong Kong stock market continuously made Hong Kong the largest market for initial public ofering (IPO) in the world. Chinese companies listed in Hong Kong take two legal forms: H-share companies and red-chip companies. H-shares are shares issued by companies incorporated in the mainland that are traded on the Stock Exchange of Hong Kong (SEHK), which is a wholly owned subsidiary of the Hong Kong Exchanges and Clearing Limited (HKEx). H-share companies are Chinese companies subject to PRC law, but they also have to comply with – and hence are bound by – certain portions of the company law and securities regulations and listing rules of Hong Kong. A red-chip company is deined as a China-controlled company which is however incorporated outside the PRC. he HKEx identiies a company as red chip if: (1) the company has at least 30% shareholding held in aggregate directly by Mainland China entities [dei ned as state-owned organizations and entities controlled by Chinese provincial or municipal authorities], and/ or through companies which are controlled by Mainland China entities; or (2) the company has below 30% but 20% or above shareholding held in aggregate directly by Mainland China entities, and/or through companies which are controlled by Mainland China entities and, there is a strong inluential presence, on a judgmental basis, on the company’s board of directors.16

Although the number of H-share companies and red-chip companies currently only constitutes a third of the total listed companies in SEHK, the capitalization of H-share and red-chip companies accounts for more than 60 per cent of the Exchange’s market, up from 58 per cent in 2007 and 39 per cent in 2006.17 In August 2013, of the 1,578 listed companies 15 17

Prasad (2004: 8). 16 HKEx (2013a). Statistics are available at: www.hkex.com.hk (accessed 11 March 2014). By the end of 2008 there was a total of 1,083 companies listed on Hong Kong’s Main Board, of which ten were foreign irms and 464 H-share and red-chip irms. See also EIU (2009).

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on the HKEx’s Main Board and GEM, 176 were H-shares companies, 122 were red-chip companies and 450 were private enterprises. hese companies with mainland roots formed 56.6 per cent of HKEx’s total market capitalization, and 72.3 per cent of its turnover value.18 Furthermore, one could argue that even this very high igure is an underestimation of the weight of the China factor in Hong Kong’s stock market as the HKEx’s deinition of red chips does not cover listed companies controlled by mainland private persons. he importance of mainland companies for Hong Kong is, however, not conined to constituting the bulk of its market capitalization. As the Hong Kong Securities and Futures Commission (HKSFC) has noted: [he presence of mainland companies] provides a growing client base and triggers the need for a full range of professional support services such as legal, accounting and auditing, underwriting, loans syndication, merger and acquisition, investment advisory, etc. It is therefore not surprising that all top investment banks have operations in Hong Kong.19

Mainland companies have therefore been a deciding factor in Hong Kong’s status as one of the largest equity fund-raising centres in the world. For over a decade, initial public ofering (IPO) activities of mainland companies helped Hong Kong maintain its position as the largest centre for raising equity funds in Asia.20 However, in 2007, the number of H-share IPOs dropped sharply from 17 in the previous year to six. he drop in the number of mainland companies listing in Hong Kong was accompanied by a wave of H-share companies returning to listing on the mainland exchanges (hereinater the A-share market). Most big Chinese SOEs have already been listed in Hong Kong, causing the city’s reliance on the fund-raising of those companies.21 SOEs’ listings had supported Hong Kong’s position as the world’s top IPO market from 2009 to 2011. As observed by the Financial Times, in the last decade, Hong Kong ‘was blessed with a steady stream of large, liquid oferings 18 19 20

21

Statistics available at www.hkex.com.hk (visited 19 September 2013). See HKSFC (2006: 9). In 2006, 17 H-share companies raised HK$290 billion in Hong Kong, which accounted for 85 per cent of the total funds raised through IPO in Hong Kong in that year. Industrial and Commercial Bank of China’s (ICBC) IPO, the world’s largest IPO ever, raised US$19 billion worth of shares in 2006. In 2006, Hong Kong became the second largest IPO fundraising centre, surpassing the New York Stock Exchange. See PricewaterhouseCoopers (2008). Ruoben Tu, ‘Zuihou Shengyan: Binjia Yao Guo Jinrizi’ [‘he Last Banquet: Banks Will Have to Tighten heir Belts’], Wen Wei Po (7 December 2012).

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from state enterprises such as China Construction Bank, China Telecom, CNOOC and China Life’.22 All the big state-owned commercial banks are now listed in Hong Kong. he 2010 dual listing of the Agricultural Bank of China, the last Chinese state bank that went public, alone raised an unprecedented amount of US$22.1 billion, a record in the history of the Hong Kong stock market.23 In comparison, only 13 oferings of privately owned enterprises from China reached US$1 billion in the Hong Kong market since 1997.24 In 2012, Nasdaq, the New York Stock Exchange and Shanghai Stock Exchange became the leading players, and Hong Kong suddenly dropped to seventh place in the global ranking.25 As for the reason, it is observed that ‘[t]he problem for Hong Kong is that its traditional source of IPOs – big state-owned enterprises – is running dry because most of them have been listed during the past decade’.26 Heavy reliance on the supply of listed shares from Chinese SOEs is undoubtedly a double-edged sword, which may hit Hong Kong hard under certain circumstances. he following sections will analyse the legal governance framework (the law on paper) and the administrative governance or political control (the law in reality) of the SOEs in China, and discuss their implications for the legal and regulatory environment of the capital market in Hong Kong.

2 he legal framework for corporatized SOEs: the law on paper Business companies in China are governed by the national Company Law, or Gongsi Fa,27 which was adopted in December 1993 by the Standing Committee of the PRC National People’s Congress. It was substantially 22

23

24

25

26

27

Robert Cookson, ‘Hong Kong Slips Down the IPO Ranking’, Financial Times (20 June 2012). Ruoben Tu, ‘Zuihou Shengyan: Binjia Yao Guo Jinrizi’ [‘he Last Banquet: Banks Will Have to Tighten heir Belts’], Wen Wei Po (7 December 2012). Ruoben Tu, ‘Zuihou Shengyan: Binjia Yao Guo Jinrizi’ [‘he Last Banquet: Banks Will Have to Tighten heir Belts’], Wen Wei Po (7 December 2012). Robert Cookson, ‘Hong Kong Slips Down the IPO Ranking’, Financial Times (20 June 2012). Robert Cookson, ‘Hong Kong Slips Down the IPO Ranking’, Financial Times (20 June 2012). It is correctly stated in this Financial Times report that ‘Hong Kong investors are sceptical about small, private, Chinese groups. Most of these companies have short track records and all too oten they sufer corporate governance problems.’ Zhonghua Renmin Gongheguo Gongsi Fa [Company Law of the People’s Republic of China] (hereinater Gongsi Fa).

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revised in October 2005. Since the revision rewrote most provisions of the law, the revised text is commonly referred to as the ‘2005 Gongsi Fa’. Like most jurisdictions that have a company law, the PRC Gongsi Fa provides a common structure for business corporations, which possesses the ive core structural characteristics including legal personality, limited liability, transferable shares or equity interest, centralized management under a board structure, and shared ownership by contributors of capital.28 In particular, the 2005 Gongsi Fa has abandoned most of the restrictive rules on company incorporation and operation which originated in China’s planned economy, and introduced new rules in line with international practice.29 In addition to the Gongsi Fa, business companies are also subject to a wide range of other laws, including the PRC Securities Law (Zhengquan Fa), 30 the PRC Law on State-owned Assets in Enterprises (Guoyou Zichan Fa), Accounting Law, a number of Administrative Regulations issued by the State Council (which is China’s central government), a voluminous body of ministerial rules formulated by the various ministries under the State Council, as well as the self-regulatory rules of the stock exchanges. Under the Gongsi Fa, business companies take two legal forms: limited liability company (Youxian Zeren Gongsi, or LLC) and joint stock limited company (Gufen Youxian Gongsi, or JSLC). An LLC is a functional equivalent of the ‘private company’ under English law or the ‘closely held corporation’ in the United States. Its capital, however, is not divided into equal units in the form of shares (Gupiao). hat is, although members of the LLC are also called ‘shareholders’ (gudong), the company does not issue shares to the shareholders. Instead, the percentage of ownership of a shareholder in the LLC is provided in the shareholders’ agreement and the company’s articles of association. In addition, an LLC cannot 28

29

Kraakman et al. (2009: 1) (noting ‘corporate law everywhere must, of necessity, provide for [these characteristics]’). CSRC (2011: 16) notes that the 2005 Gongsi Fa has the following improvements: [It] improved companies’ governance structure and mechanisms to protect lawful shareholders’ rights and public interests. It highlighted the legal obligations and responsibilities of those in actual control of the company – the directors, senior management and supervisors. It improved companies’ i nancing and i nancial accounting systems of companies and the systems governing corporate mergers, divisions and liquidation. While ensuring the lawful rights and interests of the creditors are well protected, it facilitated the reorganization of companies.

30

he Securities Law of the People’s Republic of China.

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have more than 50 shareholders.31 For these reasons, an LLC cannot ofer shares to the public and become a listed company. In comparison, the JSLC is the business form for public companies. Its capital is divided into equal units in the form of shares, which can be ofered to the general public, and listed in a stock exchange.32 he corporate governance structure of a typical Chinese company adopts a two-tier board system, and comprises the general shareholders’ meeting (also known as the general assembly), a board of directors, a supervisory board, and a (general) manager (chief executive oicer). he general shareholders’ meeting is called the ‘power organ’ (quanli jigou) of the company,33 indicating that the shareholders in China are more powerful than their counterparts in some other jurisdictions. Indeed, in addition to the usual power of electing directors and supervisors, the general meeting can also decide on the company’s business strategies and investment plans, although the aforesaid ‘strategies’ and ‘plans’ were never deined in any law. It has also the authority to hear reports from the board of directors and the supervisory board, and to adopt resolutions as to whether to approve such reports. It has similar authority with respect to issues concerning the company’s inancial budgets, proit distribution or the make-up of losses, amending the company’s articles of association, increase or decrease of the company’s registered capital, the issuance of corporate bonds, and fundamental corporate changes such as merger, division, dissolution and liquidation.34 he board of directors is the company’s ‘operational implementation organ’.35 It reports and is ‘responsible to’ the general shareholders’ meeting, and has both the power and duty to ‘implement the resolutions’ of the general meeting. It also has the power to establish the internal management structure for the company, and appoint or remove the key management personnel including the general manager. In addition, it is tasked to formulate the various reports or plans that are subject to the approval of the general shareholders’ meeting.36 Listed companies are required to install independent directors on their board of directors, which should constitute at least a third of the board’s membership. he independent directors are empowered by the China Securities and Regulatory Commission (CSRC) to examine and approve 31 32 33 35

Gongsi Fa, Articles 23, 24 and 25. Gongsi Fa, Articles 77, 126, 127, 130, 135, 145. 34 Gongsi Fa, Article 37. Gongsi Fa, Article 38. 36 CSRC (2011: 18). Gongsi Fa, Article 47.

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major related-party transactions, propose to convene board meetings and extraordinary general meetings of the shareholders, independently hire auditors and consultants to help them perform duties, and launch proxy battles against the board.37 he supervisory board (SB) supposedly adds another layer of protection for the interests of the company and shareholders. Reporting and responsible to the general shareholders’ meeting, the supervisory board is on the same level as the board of directors in the company’s internal governance structure. Although the SB does not participate in corporate management, it exercises independent supervisory power over the board of directors and management executives, including inspecting the company’s inancial status, proposing to remove from oice any director or senior executive that has violated relevant laws or rules, proposing to convene general shareholders’ meetings, as well as initiating lawsuits against directors and senior executives under certain conditions.38 he 2005 Gongsi Fa confers upon the shareholders a broad array of rights. In general, they have the rights of transferring their shares, inspecting company documents to obtain information, participating and voting in the general shareholders’ meeting, electing and removing directors and supervisors, and suing the company, directors and supervisors. hey are not entitled to compulsory proits distribution. However, certain CSRC rules make it compulsory for listed companies to distribute dividends to shareholders.39 From a legal perspective, directors, supervisors and senior executives are responsible to the company and its shareholders under the newly unveiled framework of legal duties ‘resembling common law iduciary duties’.40 With Articles 148, 149, 150, 152 and 153 of the 2005 Gongsi Fa, amongst others, China appeared to be the irst major jurisdiction that systematically – not yet entirely – conided the contents and enforcement of 37

38 39

40

See, generally, Guanyu zai Shangshi Gongsi Jianli Duli Dongshi Zhidu de Zhidao Yijian [Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies], Zhengjianfa (2001) No. 102, 16 August 2001. Gongsi Fa, Art. 54. For instance, the CSRC issued the Provisions on Strengthening the Protection of the Rights and Interests of the General Public Shareholders in 2004 to order listed companies to implement ‘proactive proit distribution’. he CSRC’s Guidance for the Articles of Association of Listed Companies (most recently revised in 2006), which has been adopted by all listed companies under regulatory pressure, stipulates that shareholders are to receive dividends or other forms of interest distribution in proportion to their equity stake in the company. CSRC (2011: 33). Howson (2008: 198).

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iduciary duties. In particles, Article 148 provides that ‘Directors, supervisors and senior management executives shall abide by laws, administrative regulations and the company’s articles of association, and have a duty of loyalty and duty of care to the company’. Most SOEs have been corporatized companies with the modern structure as described above, and hence they are subject to Gongsi Fa and other relevant laws. hose Chinese SOEs that are listed in the Hong Kong Exchange (HKEx), must be, irst of all, JSLCs as provided in the Gongsi Fa. In theory, the players in the SOEs, including the state-shareholder and other shareholders, the general manager and its deputies, the chairman and directors of the board, and the supervisors, are entitled to exercise the rights and obliged to perform the obligations provided in the Gongsi Fa. Indeed, in a rule of law country, they only need to act within the four corners of corporate law. As will be discussed below, this is far from being true in China given the political control of SOEs by the party-state, although SOEs still have to comply with, at least on the surface, the formalities and rules of China’s corporate and securities law.

3 Legal-political governance of SOEs a From traditional to corporatized SOEs Existing literature on corporate governance and control in SOEs has largely focused on the legal framework as described above, looking at the interactions among the shareholders, directors, supervisors and managers, as if the rights and duties with respect to their relations are mainly or only provided in the company law.41 his is misleading. In fact, legal governance and political governance coexist in the control and operation of Chinese SOEs, and, in most cases, the informal, non-legal rules in political governance prevail over the legal rules in the corporate and securities laws. At the outset of this analysis, it is important to distinguish between the traditional Chinese SOEs and the corporatized ones. In the 1950s the PRC started building a planned economy, the major component of which is the state-run industrial enterprises, oicially named Quanmin Suoyouzhi Gongye Qiye (industrial enterprises owned by the whole people). It would be entirely mistaken to equate these traditional SOEs to 41

Lin and Milhaupt (2013: 701) also point out that ‘scholars [working on corporate governance in China] oten begin and end their analyses by benchmarking the governance attributes of Chinese listed companies against global (which typically means U.S.) corporate governance standards and institutions’.

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modern companies with separate legal personality, limited liability, centralized management and investor ownership. hey are simply part of the state (or party-state) in charge of executing the state’s economic plans. As described by Wu Jinglian, one of China’s most renowned economists: [A]n [traditional] SOE had the basic task of carrying out all the instructions and directives from its supervisors. In terms of economic activities, the primary task of an SOE was to accomplish the plan mandated by the government, rather than bringing into play its ‘vigor’ and engaging in innovative activities. Government departments determined everything for an enterprise through planned directives: what to produce, how many to produce, how to produce, where to get raw and processed materials, and to whom the products would be sold. he role of the management of an enterprise was simply to carry out the instructions.42

hese SOEs, no matter how productive they used to be, became very ineicient and even a burden to the national economy, resulting in a state of stagnation of industrial production and shortage of industrial products. From the start of China’s Reform Era in the late 1970s, new measures, such as the power-delegating and proit-sharing regimes (Fenquan Rangli), the enterprise contracting system (Qiye Chengbao Zeren Zhi) and the business alliance system (Lianying), were constantly implemented by the Chinese government with a view to bringing back the proit-making ability of SOEs by increasing their enterprise autonomy and ofering inancial incentives to the managers.43 However, none of these measures was proven to be successful in terms of achieving the dual objectives of realizing proitability of SOEs and maintaining the state’s efective control of them. In 1993, the Chinese Communist Party (CCP) launched the second stage of SOE reform, which features the transformation of traditional SOEs into ‘modern enterprises’ with ‘clearly established property rights, well-deined power and responsibility, separation of enterprise from government, and scientiic management’, using the business structures provided in the 1993 Gongsi Fa, the irst ever company law adopted in the PRC since 1949.44 Since 1993, an overwhelming majority of the traditional SOEs have been converted into companies registered under the Gongsi Fa, and most of them, mainly those small and medium-sized SOEs, were actually privatized. The establishment of the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council in March 42 43

Wu (2005: 140). Wu (2005: 139–54).

44

Wu (2005: 154–5).

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2003 marks a milestone in SOE reform. SASAC’s main responsibility is to represent the State Council to ‘exercise the duties and responsibilities of the state investor’.45 Ostensibly, the creation of SASAC at both the central and local levels is an efort by the Chinese government to consolidate the control rights over SOEs. Before SASAC, the ownership of SOEs within the government was very fragmented, and many bureaucracies, from central ministries to departments of local governments, had SOEs belonging to them. As the sole representative of the state investor at least for industrial enterprises, SASAC ‘will assume a combination of powers previously dispersed among diferent ministries and agencies’.46 Corporatization of traditional SOEs by no means suggests the abandonment of political control of SOEs by the party-state. Instead, it has led to the existence of a two-tiered monitoring framework, which constitutes, arguably, the biggest characteristics of corporate governance in the SOEs. he irst tier is based on the corporate law, in which SASAC is authorized to exercise the responsibilities – including, ostensibly, the rights and duties – of the controlling shareholder on behalf of the state.47 hese two tiers of monitoring jointly constitute the legal-political governance structure of SOEs in China, which is examined in detail in the following sections.

b SASAC as the de facto state shareholder Although SASAC is oten mistakenly regarded as the controlling shareholder,48 it does not have such a role, although it actually has the authority to act as the state shareholder. hat is, SASAC is not the state shareholder itself according to the legal conceptualization of state ownership as envisaged in the Qiye Guoyou Zichan Fa (Law on State-owned Assets of Enterprises, hereinater the State Assets Law);49 which provides state assets, including equity interests in SOEs, belong to the state, namely the Chinese people as a whole (Quanmin suoyou).50 In essence, the de jure shareholder is the state, which is otherwise known as the whole people. he State Council (China’s central government), representing the state to act as the ‘investor’, is to perform the investor’s functions and responsibilities as well as to enjoy the power and interests of an investor.51 he State 45 47 48

49 50

SASAC (2013). 46 Naughton (2003: 2). As discussed below, SASAC itself is not the state shareholder. See Lin and Milhaupt (2013: 736) (stating incorrectly that ‘the law formally recognizes SASAC as an investor – a shareholder in the national SOEs’). he State Assets Law was adopted on 28 October 2008 and took efect as of 1 May 2009. 51 State Assets Law, Article 3. State Assets Law, Article 4.

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Council further authorizes – or delegates the power to – the SASAC to exercise the aforesaid rights, duties and responsibilities.52 SASAC, however, is not entitled to receive the beneits to a shareholder, e.g. it cannot take the dividends distributed. he dividends distributed to the state shareholder will actually go directly to the central or local government, received irst of all by the relevant inance department. For these reasons, the SASAC may be regarded as a de facto shareholder only insofar as exercising the shareholders’ rights is concerned. Corporatized SOEs, including those listed ones, shall comply with all the rules of China’s national laws. Legal governance based on the corporate law is thus the external aspect of SOE governance, under which SASAC, acting as the de facto shareholder, ‘represent the people’s government of the same level to receive the earnings from investment, participate in major decision-making, and elect the management personnel in accordance with the law’. 53 For example, SASAC’s appointment power is secured in Article 22 of the State Assets Law, under which it can, in accordance with national laws (made by the National People’s Congress or its Standing Committee), administrative regulations (made by the State Council) or the SOE’s articles of association, (1) appoint or remove the (general) manager, deputy (general) manager, chief of inancial afairs and other senior executives of a wholly state-owned enterprise (which is presumably not yet corporatized pursuant to the Gongsi Fa), (2) appoint or remove the chairman and deputy chairman of the board of directors, directors, chairman of the supervisory board, and supervisors, and (3) propose to the general shareholders’ meeting of a company in which the state has controlling interest or one in which the state has equity (but not controlling) interest candidates of directors and supervisors. As will be discussed below, SASAC’s actual ability to exercise these legal rights is subject to tight control by the party-state regime in China. In one sense, SASAC itself is part of the party-state establishment, fully controlled by the CCP. It is not wrong to say that SASAC exercises shareholders’ rights on behalf of the party-state. his, however, has not prevented the party-state from adding several other layers of control over the SOEs, especially those biggest ones.

52 53

State Assets Law, Article 11. State Assets Law, Article 12. See also 2005 Gongsi Fa, Article 4.

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c Direct political control of SOEs by the party One of the foundations of the party-state regime of China is the Dangguan Ganbu Yuanze (Principle of the Party Assuming the Responsibility to Manage State Personnel),54 under which the CCP dominates the appointment of all state oicials in China. he CCP, through its Organization and Personnel xitong,55 maintains the nomenclature system which covers cadre selection and appointment in all state-related institutions in China. It is a uniied management system that ‘reaches into almost every important nook and cranny in the public sector of the Chinese system’.56 hrough this massive nomenclature system, the CCP controls the appointment, ranking, promotion, transfer and removal of all but the lowest ranking state oicials. Personnel in SOEs, especially those leaders such as the chairman, deputy chair and senior executives, are also managed and openly appointed by the CCP organizational departments. Each SOE is placed in the political system of the party-state and given a bureaucratic ranking, and the personnel management of its leaders is done by the organization department of its level. he personnel of the central SOEs, ranked at either the ministerial level or vice-ministerial level in the political system, is under the jurisdiction of the CCP Central Organization Department. Among the 117 central SOEs under SASAC, at least 54 of them are companies of vice-ministerial level.57 hese however do not include those big stateowned i nancial institutions such as banks, insurance companies and securities companies, which are not considered as under the umbrella of SASAC.58 As a result, the Central Organization Department directly 54

55

56 57

58

Dangguan Ganbu Yuanze, in Encyclopaedia of Party History, available at: http://dangshi. people.com.cn (visited 15 September 2013). Xitong, literally meaning ‘system’, is dei ned as a group of bureaucracies in the partystate of China, from top to local levels, that handles the af airs in a particular sphere. Kenneth Lieberthal notes that ‘six Xitong have been particularly important for concrete management of the country: Party Afairs, Organization and Personnel, Propaganda and Education, Political and Legal Afairs, Finance and Economics, and the Military’. Lieberthal (2004: 218). Lieberthal (2004: 221). ‘Fubuji Yangqi Laozong Huo Tiba Shengqian Cheng Changtai’ [‘It’s Becoming Increasingly Normal for the Top Leaders of Central SOEs to Get Promoted in heir Political Career’], Zhongguo Xinwen Zhoukan [China Newsweek] (9 April 2012). So far only two state-owned companies are ranked at the ministerial level. hey are the China Investment Corporation (CIC) and the newly established China Railway Ltd. Banks are under the China Banking Regulatory Commission (CBRC) and the People’s Bank of China (which is China’s central bank). Securities companies and insurance companies are supervised by the China Securities Regulatory Commission (CSRC) and the China Insurance Regulatory Commission (CBRC), respectively.

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appoints the top leaders of these vice-ministerial-level i rms, including the chairman of the board of directors, chairman of the supervisory board, the general manager and other senior executives.59 SASAC is completely deprived of the power of appointment for the management team of these companies. It merely has the responsibility to make suggestions to the Central Organization Department with respect to the appointment or removal of the member of the management team in such companies.60 Under the uniied nomenclature system, the CCP maintains a cadre rotation system which opens the ‘revolving door’ wide for movement of personnel between roles as SOE executives and senior government oicials or regulators. Gore (2011) points out that, as of 2010, of the 263 governors and vice governors for China’s provinces and provincial-level municipalities, 43 had business backgrounds. Further, 23 of China’s 31 provinces were equipped with governors or vice governors who had worked as SOE executives.61 For these former executives, the ‘new positions … greatly extend their career ladders in the party-state hierarchy, bringing them more prestige and a higher political status’.62 On the other hand, a recent report by the People’s Daily, the CCP’s ‘mouth and tongue’ newspaper, suggests that the positions of senior SOE executives are compensation for those senior government oicials who do not see the possibility of being promoted in their political career.63

59

60

61 63

Although appointment of SOE executives by the CCP is not codiied in the Gongsi Fa or any other national laws – and thus remain shadow, informal rules – the party-state has never intend to hide this practice from the public. As a matter of fact, such appointments are usually reported publicly in newspapers. See ‘Zhongzubu Xuanbu Zhongguo Renbao Zhongguo Renshou Gaoceng Renshi Biandong’ [‘Central Organization Department Announces the Change of Top Personnel in PICC and China Life’], Zhongguo Baoxian Bao [China Insurance Daily] (20 March 2012) (reporting that a Deputy Director of the Central Organization Department went to PICC and China Life, two of the largest insurance companies in China, to appoint Mr Wu Yan as the chairman of the board of PICC, Mr Lin Fan as the chairman of the supervisory board of PICC, and Mr Yang Mingsheng, who was then a vice chairman of the China Banking Regulatory Commission, as the chairman of board of directors of China Life). ‘Fubuji Yangqi Laozong Huo Tiba Shengqian Cheng Changtai’ [‘It’s Becoming Increasingly Normal for the Top Leaders of Central SOEs to Get Promoted in heir Political Career’], Zhongguo Xinwen Zhoukan [China Newsweek] (9 April 2012). Gore (2011: 2). 62 Gore (2011: ii). ‘Yangqi Gaoguan Cheng Shengguan Wuwang Buchang, Dangbuliao Shengzhang jiu Dang Dongshizhang’ [‘Top Management Positions in Central SOEs became Compensation for hose Who Could Not Get Promoted in heir Political Career, and hus if You Cannot become a Provincial Governor then Come to be a Chairman of the Board of Director of an SOE’], Renmin Ribao [People’s Daily] (16 January 2013).

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4 Political and policy considerations behind the listing of SOEs in Hong Kong a he good policy pursuance: inancial and political reasons for listing SOEs in Hong Kong As noted previously, the listing of PRC companies in HKEx has been the largest driving force for Hong Kong’s success as an international inancial centre for over a decade. Why did these Chinese companies choose to list in Hong Kong? Corporate and inancial literature has advanced several independent theories on why irms pursue listing abroad. On the assumption that a irm will always make rational decisions to maximize its economic interests (mainly shareholder’s value), the decision to list abroad should be based on a cost–beneit analysis.64 As such, the business motivations for cross-listing could include larger inancial gains (raising a large amount of capital in a foreign market at lower costs), increased liquidity (‘expected returns positively correlate with liquidity, measured in terms of the bidask spread’), increased shareholder base (with the inclusion of foreign investors), increased visibility (a irm becomes more credible by providing information to the host capital market which further makes it easier to raise more capital), marketing motivations (‘foreign listing can boost corporate marketing eforts by broadening product identiication among investors and consumers in the host country’), and technical issues (‘cross-listing can improve a irm’s ability to efect structural transactions abroad such as foreign mergers and acquisitions, stock swaps, and tender ofers’).65 A recently developed theory, coined as the ‘bonding hypothesis’ by John C. Cofee, Jr., advocates that issuers seek listing in a foreign market with the aim to improve their corporate governance by subjecting themselves to a foreign regulatory regime that is superior to that in their home country.66 As Cofee remarks, ‘Large irms can choose the stock exchange or exchanges on which they are listed, and in so doing can opt into governance systems, disclosure standards, and accounting rules that may be more rigorous than those required or prevailing in their jurisdiction of incorporation’.67 As such, ‘the most visible contemporary form 64 65 66

67

See Karolyi (1998: 34); Alferez (2007: 24); Licht (2000: 66–83); Licht (2003: 143–5). Licht (2003: 144–5). See, generally, Cofee (1999); Cofee (2002); Rock (2002); Doidge, Karolyi and Stulz (2004). Cofee (1999: 651).

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of migration [to foreign stock exchanges] seems motivated by the … impulse … to opt into higher regulatory or disclosure standards and thus to implement a form of “bonding” under which irms commit to governance standards more exacting than that of their home countries’.68 In essence, the bonding hypothesis suggests that an arguably better regulatory regime, such as that of the United States, is out for rent by foreign issuers. For instance, cross-listing on the US stock exchange subjects the listing company to the enforcement power of the Securities and Exchange Commission (SEC), grants investors efective and lowcost means of legal remedy and commits the irm to fuller disclosure.69 US securities law could more efectively deter corporate insiders from engaging in fraud and embezzlement and hence provides stronger protection for minority shareholders. Arguably, bonding could attract quality investors to the irm and result in a higher value for the irm’s shares. By allowing or even encouraging SOEs to get listed in Hong Kong, was it the intention of the Chinese government to bind those SOEs under a better regulatory framework? It is submitted that neither business motivations nor the bonding hypothesis fully explain the listing of PRC irms in Hong Kong. I take this position mainly for three reasons. First, many, if not most, of the H-share companies were predominantly SOEs, at least when they applied for listing in Hong Kong. hat is to say, they were hardly entities with independent interest and decision-making power. For H-share SOEs, the listing decisions, even at the irm level, were made by the relevant administrative oicial at some level of the Chinese government. Second, whether a PRC company can seek listing in Hong Kong is legally subject to state approval. hird, although it cannot be excluded that the government might have considered the respective irm’s business interest, the decisions to send PRC enterprises to Hong Kong were based primarily on politically oriented ‘national considerations’ rather than on irm-level business considerations. In the author’s view, the Chinese government’s decision to allow or disallow Chinese irms to list in Hong Kong is based on balancing the following commercial and political aims: • Raise funds from international investors to recapitalize Chinese enterprises, especially the SOEs. • Privatize SOEs in some industries by introducing to them foreign investors through H-share ofering. 68

Cofee (1999: 652).

69

Cofee (2002: 1780–1).

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• Improve corporate governance of the SOEs by subjecting them to Hong Kong’s better regulatory regime. • Allocate the resources of listing companies between the mainland and Hong Kong to (1) develop the mainland’s own securities market and (2) support Hong Kong’s economy when this is politically necessary. However, the desires of the individual companies cannot be ignored, as, in many cases, it was the irm that applied to the state for permission to ofer and list shares in Hong Kong. he motivations of such irms are probably no diferent from those of private irms in matured market economies, namely inancial gains, liquidity, visibility, employee incentives and global strategy. Not surprisingly, some of the irm-level considerations might converge with the Chinese government’s national aims. It is also important to note that another key reason why many Chinese enterprises migrate to foreign stock exchanges is that they are not approved for listing in China, or they are frightened by the arbitrarily strict – sometimes unnecessarily draconian – regulatory rules controlling the public ofering of securities in the mainland’s own stock market.70 hese factors and their implications for the regulatory cooperation and competition between the mainland and Hong Kong are examined in the following sections.

b Bonding Chinese SOEs to Hong Kong’s better regulatory regime Business enterprises in China, especially the SOEs, have been known for their poor corporate governance.71 Having the state as the single or controlling shareholder can lead to two corporate governance problems. In some SOEs, the central or local government agencies, acting in the name of the state, completely ignore the internal governance structure, resulting in the state’s over-interference in the company’s management. Other SOEs are actually controlled by the civil servants and government oicials appointed by the state as managers, leading to the absence of [state] owners in those SOEs. h is model was characterized as guanjianren kongzhi [key-person-control] in China’s SOEs.72 One of the key purposes for the re-establishment of the securities market was to invite outsiders to become shareholders to monitor the management, which was once solely the task of the state. Driving some SOEs 70

71

For an examination of Chinese regulatory framework on public ofering, see Wang (2009b: 54–65). Wang (2005: 40–2). 72 Tan and Wang (2007: 149–50).

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to Hong Kong is part of the efort to improve corporate governance in those irms. he 1993 promulgation of the Mandatory Provisions of Articles of Association for Companies to be Listed in Hong Kong (the ‘Mandatory Provisions for Hong Kong Listing’) by the then State Commission for Restructuring of the Economic System (SCREC) of the State Council provides strong evidence in this regard. In September 1992, while the mainland and Hong Kong were in the process of negotiating the 1993 Memorandum of Regulatory Cooperation (MORC), the State Council announced its irst list of nine SOEs selected to issue H-shares in Hong Kong. Despite the vagueness of the text of the MORC, the adoption of the Mandatory Provisions for Hong Kong Listing was regarded as an important outcome of the MORC negotiations. As Alice de Jonge remarks, ‘[t] hese Mandatory Provisions resulted from joint eforts by the [HKSFC] and the [SCREC] to bring corporate governance standards within Hong Kong-listed mainland irms more into line with those prevailing in other Hong Kong listed irms’.73 On 9 November 1993, the Securities Commission of the State Council (SCSC), which once existed as CSRC’s supervising body but was abolished with the adoption of the PRC Securities Law in 1998, issued a circular requiring all Chinese enterprises listing overseas to fully comply with host jurisdiction’s laws and regulations.74 In August 1994, the SCSC and SCREC jointly issued the Mandatory Provisions for the Articles of Association of Companies to be Listed Overseas (hereinater the Mandatory Provisions),75 which replaced the mandatory provisions for listing in Hong Kong as the major law governing H-share companies on the part of the mainland. A key feature of the Mandatory Provisions is that they subject the listed irm’s directors, supervisors and senior corporate oicers to a number of iduciary duties that are largely in line with Hong Kong’s company law.

73 74

75

de Jonge (2008: 24). GuoWuyuan Zhengquan Weiyuanhui: Guanyu Jiaqiang Jingnei Qiye Dao Haiwai Shangshi Zunshou Dangdi Fagui Guanli de Tongzhi [SCSC, ‘Circular on Strengthening Eforts to Ensure Domestic Enterprises to be Listed Overseas to Comply with Local Laws and Regulations’, 9 November 1993]. GuoWuyuan Zhengquan Weiyuanhui Yu Guojia Jingji Tizhi Gaige Weiyuanhui ‘Guanyu Zhixing “Dao Jingwai Shangshi Gongsi Zhangcheng Bibei Tiaokuan” de Tongzhi’ [Circular on Implementing the Mandatory Provisions for Articles of Association of Companies to be Listed Overseas, jointly promulgated by the SCSC and SCREC, 27 August 1994].

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Indeed, Hong Kong does have a better governance regime for corporations, and this was especially the case in the 1990s, when the mainland’s corporate law was at its most primitive stage (the irst PRC Company Law was not adopted until 1993). When mainland companies ofer and list shares in Hong Kong, they are mainly governed by SEHK’s Rules Governing the Listing of Securities (hereinater the ‘Listing Rules’), in addition to the general supervisory power of the HKSFC.76 he Listing Rules set out initial and continuing obligations applicable to all listed issuers irrespective their place of incorporation, and make special provision for non-Hong Kong companies. As is common with most exchanges, a special section, here Chapter 19 of the Listing Rules, set out additional provisions applying to non-Hong Kong issuers seeking either a primary or a secondary listing on the SEHK. Notably, however, another section, Chapter 19A, creates provisions applying only to issuers incorporated in the mainland, i.e. the H-share companies. As pointed out by Hsu et al.: Probably the most central requirement is that shareholders are given adequate protection, meaning protection at least equivalent to that provided in Hong Kong. h is requires a consideration of the jurisdiction in which the issuer is established, or in some cases, the constitutive documents of the issuer. he Listing Document prepared by the issuer will need to summarize the relevant local laws and regulations as well as the issuer’s constitutive documents insofar as they concern shareholder rights, in each case highlighting any diference from that prevailing under Hong Kong law.77

he special treatment – namely compliance with additional requirements, modiications and exceptions to the Listing Rules – for mainland issuers in Chapter 19A is based on the manifested rationale that the domestic shares (‘A-shares’) and H-shares issued by the same mainland company in efect operate in separate markets subject to diferent legal systems (the PRC is not a common law system), PRC law imposes various foreign exchange restrictions including on remittance out the PRC, and A-shares may only be owned by PRC nationals while overseas shares may only be owned by investors from Hong Kong, Macau, Taiwan or a foreign country.78 76

77 78

he legislature in Hong Kong has given the Listing Rules statutory backing through the Securities and Futures (Stock Market Listing) Rules of the Hong Kong SAR (hereinater the ‘SMLR’). In this sense, the Listing Rules become now oicially part of Hong Kong securities law. Hsu et al.(2006: 177). Listing Rules, 19A.01(1). See also Hsu et al. (2006).

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he general listing requirement under Chapter 19A is that H-share holders must be suiciently protected under PRC laws and constitutive documents of the issuer.79 Speciic requirements include:80 • PRC issuers are expected to present their annual accounts in accordance with Hong Kong or international accounting standards. • he articles of association of PRC issuers must contain provisions which will relect the diferent nature of domestic shares and overseas listed foreign shares (including H-shares) and the diferent rights of their respective holders. • Disputes involving holders of H-shares and arising from a PRC issuer’s articles of association, or from any rights or obligations conferred or imposed by the Company Law and any other relevant laws and regulations concerning the afairs of the PRC issuer, are to be settled by arbitration in either Hong Kong or the PRC at the election of the claimant. In addition, the sponsor for the PRC issuer is required to shoulder the responsibility to ensure that the issuer complies with relevant Hong Kong rules and that the directors of the issuer understand their obligations under the Listing Rules and applicable laws.81 H-share companies are also subject to the enforcement powers of the SFC, which is known for its professionalism in enforcing the law. As the regulator of the securities and futures market, the SFC may investigate, on its own initiative or in cooperation with the HKEx, into market misconduct.82 For instance, under Hong Kong securities law, any person who is involved in false disclosure or misrepresentation in listing or continuing disclosure documents commits an ofence, and is subject to the statutory powers of the SFC.83 Failing to cooperate with the SFC or providing false or misleading information during an SFC investigation will lead to criminal liability.84 However, as will be discussed later, cross-border enforcement with respect to H-share companies by the SFC is subject to a number of legal and political constraints. Is there really a bonding efect here? Several studies show that PRC H-share irms do make better disclosure of information, and that their cross-listing results in a bonding premium.85 Ferguson et al. (2002) 79 81 82

83 85

Listing Rules, 19A.03(4). 80 Listing Rules, 19A.01(3). Hsu et al. (2006: 179). Securities and Futures Ordinance of the Hong Kong SAR, s. 180 and s. 183 (hereinater the ‘SFO’). See SMLR, s. 384. 84 SFO, s. 107. See also de Jonge (2008: 67). See Ferguson et al. (2002) and Sun et al. (2006).

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compared the disclosure practice of 142 companies listed on the SEHK in 1995/6, which included 20 H-share and 20 red-chip irms. heir inding suggests that, consistent with a cost–beneit framework, PRC H-share i rms voluntarily disclosed signiicantly more strategic and i nancial information than other SEHK irms. A horizontal comparison demonstrated that those H-share irms disclosed voluntarily less information on the PRC exchanges than on the SEHK.86 Sun et al. (2006) tested a general ‘bonding premium’ by contrasting a sample of 111 Chinese irms listed on the Chinese B-share market, which has stricter listing requirements, and 53 Chinese irms listed on the H-share market, which has even higher regulatory standards, against a control sample of Chinese irms listed only on the domestic A-share market. heir inding provides strong support for the bonding hypothesis: irms cross-listed in the H-share market do enjoy a higher valuation that is proved to be the premium earned by those irms as a result of their listing in a market with a better governance system.87

c Political control of SOE listings by the PRC One however has to be cautious about the causal link between the Hong Kong listing of the H-share irms and their higher market prices. An underlying assumption of the bonding hypothesis is that the cross-listing decision is made autonomously by irms with independent legal status in a market economy and, on the whole, irms are free to choose whether they wish to be listed in a foreign market. h is has not been the case in China, at least not entirely. Without denying the possibility that many listing decisions were rendered on a commercial basis, as if they were made by independent irms to maximize their business interest, it is important to understand that the listing of PRC irms in Hong Kong has always been controlled by the Chinese government from the very beginning, through both legal and political means. It was the central government who picked out the nine SOEs that became the irst batch of H-share companies in Hong Kong.88 In 1994, a State Council regulation entitled Special Provisions of the State Council for Companies Limited by Shares Issuing and Listing Shares outside China, which is still in force, conirms that overseas ofering and listing of shares 86 88

Ferguson et al. (2002: 127–8). 87 Sun et al. (2006). de Jonge (2008 : 27–8). Tsingtai Brewery Corporation (Tsingtao) was the i rst H-share company. de Jonge notes that it was originally decided that the much larger Shanghai Petrochemical Company Limited (SPCL) IPO would be conducted irst, but the central government in Beijing decided that Tsingtao listing would be more suitable for testing

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by PRC companies must be approved by the SCSC (which later merged into the CSRC).89 hroughout the 1990s, the selection of Chinese irms listing overseas was completely controlled by the central and local governments through a ‘recommendation system’, with the SCSC remaining as the ultimate decision-maker. Under a 1996 circular that codiied the SCSC’s relevant criteria,90 only provincial governments and central ministries were granted the power to recommend potential enterprises to the SCSC for approval, and their selection of enterprises had to be based on the following criteria: • he business of the enterprise is consistent with the state’s industrial policy. • he enterprise has growth potential and is in urgent need of money. • he enterprise has a certain size (net assets not less than RMB400 million) and good economic proitability (net proit ater tax not less than RMB60 million). • State ownership must exceed 51 per cent if state policy requires absolute state control in the enterprise or industry concerned. • he total amount of funds raised in the foreign markets should reach RMB400 million (or US$50 million). • he enterprise has the capability to earn foreign exchange. • he enterprise has a certain brand name and level of good business management. Since July 1999, the CSRC has replaced the recommendation system with a direct ‘application and approval’ system, under which an enterprise may directly approach the CSRC for application to seek overseas listing. he CSRC will consider the application on a case-by-case

89

90

the water of the international inancial markets. Beijing initially also refused to allow primary listings to be conducted in New York, London or anywhere other than Hong Kong, as ‘they believe that the Hong Kong market for China-based issues should be developed before proceeding further’. de Jonge (2008: 28). In a sense, this conforms to the ‘gradualism and experimentalism’ tradition of China’s reform approach. Guowuyuan Guanyu Gufen Youxian Gongsi Jingwai Muji Gufen Ji Shangshi De Tebie Guiding, Guowuyuan Ling [Di 160 Hao] [Special Provisions of the State Council concerning Issuing and Listing of Shares Overseas by Companies Limited by Shares, 4 August 1994] (hereinater ‘the 1994 Special Provisions’). Guowuyuan Zhengquan Weiyuanhui Guanyu Tuijian Jingwai Shangshi Yuxuan Qiye De Tiaojian, Chengxu Ji Suoxu Wenjian De Tongzhi, Zhengquanfa [Circular of the Securities Committee of the State Council Concerning the Conditions, Procedures and Required Documents for Recommending Pre-selected Domestic Enterprises to be Listed Overseas, 17 June 1996]. his Circular was abolished in 1999.

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basis.91 Still, the CSRC looks at consistency with state policies concerning industrial development, foreign investment and i xed assets investment, good corporate governance and business management, foreign exchange earning capability, and the same net assets and proitability requirements.92 State approval enables the government to take two political factors into consideration when it decides whether a mainland enterprise can be listed in a foreign exchange. Both factors beg a revised interpretation of the bonding efects of mainland irms listing in Hong Kong. First, the better corporate governance (especially the higher disclosure) of H-share companies might have resulted from the Chinese state’s macro-level cost–beneit analysis. Possibly, ‘higher disclosure by H-share irms may relect the efect of state-initiated disclosure policies rather than management’s response to irm-speciic costs and beneits of disclosure’.93 he Chinese government presumably might treat the overseas listed irms as China’s ambassadors to the international society, and as such, the government would send out to foreign markets its best irms and the irms are expected to behave well. here are also actual beneits associated with this practice: ‘A policy carefully selecting and showcasing irms to signal to international investing communities that PRC irms are willing to increase transparency and act as good corporate citizens may not only inluence investor conidence, but may also pave a wider avenue for other issuers’.94 Second, the Chinese regulators purposely – and politically – allocate the resources of listing companies between the mainland and Hong Kong by controlling the pace of Hong Kong listing of PRC irms. For over a decade ater 1993, the Chinese government sent only large, growth oriented enterprises (most of which are SOEs) to foreign markets for listing. In 2006–7, when China’s stock market was experiencing its most sustained bull market, the CSRC encouraged Hong Kong listed mainland companies (including both H-share and red-chip irms) to return to the domestic A-share market. his was partly under the pressure of mainland investors to share those irms’ proits, as the investors have long been angry at the

91

92

93

Zhongguo Zhengquan Jiandu Guanli Weiyuanhui Guanyu Qiye Shenqing Jingwai Shangshi Youguanwenti De Tongzhi [CSRC Circular on Certain Issues Concerning Domestic Enterprises Applying to be Listed Overseas, 17 July 1999]. Zhongguo Zhengquan Jiandu Guanli Weiyuanhui Guanyu Qiye Shenqing Jingwai Shangshi Youguanwenti De Tongzhi, Article 1. Ferguson et al. (2002: 142). 94 Ferguson et al. (2002: 147).

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authorities for their decisions to list overseas and pay dividends only to foreign investors.95 During that period, 14 H-share companies issued A-shares in China’s domestic market. At the same time, Chinese companies wishing to be listed overseas were asked by the CSRC to ofer and list shares in the mainland’s stock market simultaneously.96 Since December 2007, companies have been requested to issue and list A-shares irst in China before they sell shares in Hong Kong.97 Clearly, the regulator’s purpose was to keep the resources of listed companies in the mainland to foster the development of China’s own securities market.

5 SOE listing: challenges for Hong Kong’s regulatory and legal environment a SOE operations: business judgement or political judgement? On 1 July 2013, the CCP Central Organization Department convened a meeting of all corporate oicers of the middle and above level of China Ocean Shipping (Group) Co. (commonly known as the Cosco Group), China’s largest state-owned shipping company, to announce the party’s decision to remove Mr Wei Jiafu from the position of the chairman of the Cosco board.98 Wei had served as Cosco chairman for 15 years, but was recently called to be accountable for Cosco’s continuous massive losses in the past three years. In response to public criticisms of Cosco’s poor performance, he notoriously said, in the Boao Forum of Asia in 2013, that ‘it is good enough for me as long as the central leading body of the Party and the State Council understand me’.99 Mr Wei was also the chairman of China COSCO Holdings Co. Ltd., the listed subsidiary of Cosco Group, whose H-shares and A-shares have traded in Hong Kong and Shanghai since 2005 and 2007 respectively. he above statement of Mr Wei raises a serious question insofar as the supervision and regulation of listed SOEs is concerned: to whom do the 95

96 97 98

99

‘HK listed companies encouraged to return to A-share market’, Xinhua newswire, 26 December 2006. See also Qiao and Song (2009). hose companies issued and listed their new shares on the Shanghai Stock Exchange. Qiao and Song (2009). ‘Wei Jiafu Xieren Zhongyuan Dongshizhang, Cengcheng Zhiyao Dang Lijie Wo Jiu Goule’ [‘Cosco Chairman Wei Jiafu Steps Down. He Once Said It’s Enough for Him that the Party Understood Him’], Xin Jing Bao [New Beijing Daily] (2 July 2013). ‘Wei Jiafu Xieren Zhongyuan Dongshizhang, Cengcheng Zhiyao Dang Lijie Wo Jiu Goule’ [‘Cosco Chairman Wei Jiafu Steps Down. He Once Said It’s Enough for Him that the Party Understood Him’], Xin Jing Bao [New Beijing Daily] (2 July 2013).

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senior executives of SOEs owe allegiance? One may reasonably conclude that SOE executives are more loyal to the CCP, since they were appointed by the party, and their promotion and welfare depend on the party. Richard McGregor has most vividly depicted how the top executives of the biggest SOEs were politically ailiated and embedded in the partystate system by having the ‘red machines’.100 he red machine is actually a red phone allocated to oicials with the rank of vice-minister and above, allowing them to communicate in a secret and safe way. As noted by McGregor, ‘[p]ossession of the “red machine” means you have qualiied for membership of the tight-knit club that runs the country, a small group of mainly men, with responsibility for about one-it h of humanity’.101 As a matter of fact, ‘the heads of China’s it y-odd biggest state companies’ have such a phone on their desks.102 here is hence an inherent dilemma in the roles assumed by the senior SOE executives, which generates a potential conlict of interest. On the one hand, the SOEs, especially those corporatized ones, are independent enterprise legal persons which are legally obliged to operate on a commercial basis.103 he senior executives owing iduciary duties to the company and shareholders must only aim at maximizing the investors’ value by making more proits for the company. At the current stage, the partystate’s legitimacy is mainly based on achieving economic growth and improving Chinese people’s living standards. As a result, the common task of SOE leaders is to generate revenues and proits for the company. But it is highly likely that the party-state’s agenda or priority for SOEs might change, leading to a situation where SOE executives, as loyal senior party members, must make the political judgement to follow the party line rather than the business judgement to advance shareholders’ interest.104 Ater all, SOEs with both corporate forms and the party’s direct control are not ordinary companies which may be easily put in any legal framework based on corporate laws familiar to regulators of developed market 100 102 103

104

McGregor (2010: 8–33). 101 McGregor (2010: 9). McGregor (2010: 8). hat all enterprise legal persons are separate legal entities operating on a commercial basis is provided in Article 3 of the 2005 Gongsi Fa and, more generally, Article 36 of the 1986 Minfa Tongze [General Principles of Civil Law of the PRC]. When China National Ofshore Oil Corporation (CNOOC) launched its deep-water oil rig in South China Sea, an area where overlapping claims between China and a few south-east Asian countries have made tensions high, CNOOC Chairman Wang Yilin told company employees as well as his party superiors that this move was for China’s ambitions abroad by saying ‘[l]arge-scale deep water rigs are our mobile national territory and a strategic weapon’. See Spegele and Ma (2012).

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economies such as the United States, the UK, Germany, France or Hong Kong. Chinese leaders eventually turned to the corporate form, using it to restructure and reorganize SOEs into business corporations with corporate governance structures which were not strange to foreigners, making them fantasize that Chinese irms would someday be like corporate entities in their own countries. However, the prevailing practices in SOEs of ‘[d]irect involvement of the Communist Party in high-level executive appointments, SASAC’s practice of bypassing boards of directors in the appointment and remuneration processes and maintaining veto power over downstream corporate transactions are all inconsistent with basic corporate law principles’.105 No matter how one might be critical of the Chinese style of state capitalism based on SOEs, we have to admit that they are successful and are actually gaining new strength. Rather than being ineicient, backward and dying any time soon, the SOEs have become increasingly competitive and proitable. As observed by Lin and Milhaupt, ‘[s]tate capitalism may prove to be a durable institutional arrangement because of interest group politics, public policy and path dependence’.106 he regulators of the stock market where Chinese SOEs are listed, especially Hong Kong, which is the second home of almost all the biggest state enterprises, have to be aware of the structural incompatibility between their legal framework and the governance of those SOEs, as well as the potential challenges posed by the SOEs.

b Challenges on cross-border enforcement of securities fraud between Hong Kong and mainland China Cross-border cooperation – or the lack thereof – between the regulators in Hong Kong and mainland China on the supervision of H-share and red-chip companies has been another major challenge for Hong Kong. he regulators in the two jurisdictions – albeit under one sovereignty – have to share supervisory authority over those companies: Hong Kong regulators assert primary authority over the H-share market in relation to listing and trading, as well as investigation into market misconduct. However, as noted by de Jonge: [I]t is the mainland authorities that exert practical control over most of the irm’s management personnel, as well as over its assets and business operations. Likewise, decisions regarding whether or not a particular Hong Kong-listed irm and/or any of its senior management have failed 105

Lin and Milhaupt (2013: 752).

106

Lin and Milhaupt (2013: 752).

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China’s impact on Hong Kong’s position to comply with Hong Kong requirements are made by the HKEx under Hong Kong laws. But carrying out investigations into, for example, the business operations and/or on-site accounts of an H-share irm to check compliance with Hong Kong requirements requires assistance from, and action by, the mainland authorities.107

Martin Wheatley, former chairman and now chief executive oicer of the SFC, once noted certain cases of misconduct by mainland companies listed in Hong Kong, including ‘issuers falsifying inancial information in their prospectuses, channeling the funds raised from the public market to purposes other than for the beneit of the company, or providing substantial amounts of inancial assistance to related parties on unfair terms’.108 For those matters, ‘Where it is outside your own jurisdiction you have to rely on the powers of the “home” regulator’.109 Despite the friendly comments usually expressed by the regulators on both sides,110 diiculties have arisen with respect to deining the nature of the cooperative relationship between them. Martin Wheatley once openly admitted the weakness of the SFC in that its capacity to take action against Hong Kong listed mainland companies is seriously impaired by the ‘“unpalatable fact” that there was no full reciprocity of regulatory and law enforcement between Hong Kong and the mainland and no mutual transfer of fugitives between jurisdictions’.111 here were however a few unhappy events between the two jurisdictions with respect to major enforcement actions initiated by the SFC. A report of the South China Morning Post in February 2004 claimed that that the mainland ‘has consistently rejected requests for information by Hong Kong regulators investigating locally listed mainland companies and businessmen’.112 For example, Chinese authorities denied SFC requests on several suspects in high-proi le corporate scandals involving criminal elements, including Liu Jinbao, former deputy chairman 107 108 110

111 112

de Jonge (2008: 73). Wheatley (2006). 109 Wheatley (2006). For example, former SFC Chairman Martin Wheatley remarked in a speech: ‘he SFC and the CSRC meet regularly to discuss regulatory issues and policies and share public and non-public information with, and render regulatory assistance to, each other. While there are diferences between the legal frameworks in Hong Kong and the Mainland, both regulators have fully co-operated with each other as far as possible. he SFC has in the past received useful assistance from the CSRC which facilitated our enforcement actions’. Wheatley (2006). Justine Lau, ‘Hong Kong Regulators Admits Weakness’, Financial Times (11 May 2006). Wang Xiangwei and Enoch Yiu, ‘Mainland Refusing to Help HK Probe Locally Listed Companies’, South China Morning Post (20 February 2004), p. 1.

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and chief executive of Bank of China (Hong Kong) Ltd., Shanghai tycoon Zhou Zhengyi, chairman of Shanghai Land Holdings Ltd., and Yang Bin, chairman of embattled orchid-grower Euro-Asia Agricultural Co. All three companies were listed in Hong Kong, while their business operations were mainly based in mainland China. Hong Kong investigators were denied access to Liu and Zhou, who were under detention in the mainland for possible fraud or corruption related criminal charges.113 he cases concerning Liu Jinbao and Yang Bin are especially illustrating. Liu, the CEO of Bank of China’s Hong Kong subsidiary, was in efect appointed by the ruling Chinese Community Party through its personnel system in Bank of China. He was hence a senior CCP member. Under the prevailing practice in China, the Communist Party’s Central Commission for Discipline Inspection (CCDI) is in charge of probing into corrupt oicials who are party members. he CCDI is responsible only to the Communist Party’s national Congress and the Central Committee. When the CCDI takes over a corruption case, no other agencies in the bureaucracy, even including the police and the judiciary, are allowed to interfere with or participate in the CCDI’s secretive investigation. hat is to say, even the CSRC itself does not have access to the investigation, and then can certainly not provide assistance to its counterpart in Hong Kong.114 Yang Bin, a Chinese-born Dutch citizen, was the founder of Euro-Asia Agricultural Co. (‘EAA’) whose main business operation was in China. EAA falsiied documents to inlated revenue igures for four years and got listed on the SEHK. It was also involved in many other problems such as illegal loans, illegal use of land and tax evasion in China, as well as an unauthorized relationship with North Korea. Yang Bin was secretly arrested in the mainland in September 2002 when the HKEx and SFC launched investigations into the role of ICEA, an investment vehicle jointly controlled by the Industrial and Commercial Bank of China – China’s largest state-owned bank – and Hong Kong based Bank of East Asia. he investigation focused on whether ICEA fulilled its duty of due diligence as the listing sponsor for EEA’s IPO in Hong Kong. Reportedly, the SFC ‘failed to obtain any useful information from the mainland, making it diicult to build a stronger case against ICEA’.115 113

114

115

Wang Xiangwei and Enoch Yiu, ‘Mainland Refusing to Help HK Probe Locally Listed Companies’, South China Morning Post (20 February 2004). he organization and function of the CCDI can be found at: http://news.xinhuanet. com/ziliao/2002-11/05/content_629565.htm (accessed 31 March 2009). See Loretta Ng, Chan Ka Sing and Andrew Baston, ‘Tycoon Yang Detained in China; Co Said under Probe’, he Wall Street Journal (9 October 2002) and Enoch Yiu, ‘Regulators

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he aforesaid two cases, one involving a state-controlled bank and the other a private company, illustrate the political and legal constraints on law enforcement cooperation between the two jurisdictions arising out of the structural diferences between their respective political and legal systems. In April 2007, the SFC signed an agreement with the CSRC, under which the SFC may request assistance from the CSRC to obtain information in mainland China. If a person from whom the information is sought refuses to comply, the CSRC may seek court sanctions against that person pursuant to the 2005 amended PRC Securities Law. In contrast, previously the SFC could only rely on the CSRC seeking voluntary cooperation from persons from whom the information was sought.116 However, crossborder cooperation on law enforcement is doomed to experience diiculties and limitations until the structural constraints mentioned above are eliminated.

D he potential rise of Shanghai as a inancial centre Since the PRC Ministry of Commerce released the news on its website that China’s State Council decided to set up a free-trade zone (FTZ) in Shanghai on 22 August 2013,117 the enthusiasm of domestic and international business ‘has reached fever-pitch levels’,118 even before the detailed programme was hammered out by the Chinese government. Hong Kong tycoon Li Ka-shing, the world’s richest Chinese, warned the people of Hong Kong that the Shanghai FTZ would have a quick impact on Hong Kong and drove Shanghai to surpass Hong Kong in economic development.119 he Chinese government’s ambition to make Shanghai an international inancial centre started at least four years ago. In March 2009, the State Council announced a plan to establish Shanghai as an international i nancial centre and international shipping centre. A State

116 118

119

Keep Euro-Asian under Close Scrutiny’, South China Morning Post (10 December 2002). SFC (2007). 117 MOFCOM (2013). Shen Hong, ‘Shanghai Free-Trade Zone Sparked Excitement but is Short on Speciics’, he Wall Street Journal Online (13 September 2013). Peggy Sito, ‘Shanghai Free-Trade Zone will Hit Hong Kong Quicker than Expected, Says Li Ka-shing’, South China Morning Post (19 September 2013); George Chen, ‘Exclusive: China to List Ban on Facebook – but only within Shanghai Free-trade Zone’, South China Morning Post (24 September 2013).

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Council directive published in April 2009 vowed to make Shanghai an international inancial centre which ‘suits China’s economic power status and the international status of Renminbi [as a global currency]’.120 Shanghai is already the de facto inancial hub of China (excluding Hong Kong), with a relatively complete i nancial sector. As noted in Yang et al. (2010), in 2008 a total of 689 inancial institutions, including 165 foreignfunded ones, were operating in Shanghai, of which 124 were commercial banks, 291 were insurance companies and 94 were securities companies (investment banks). In 2008, the added value generated by Shanghai’s inancial sector was about RMB144 billion. Although it is relatively small compared with other global inancial cities, it was based on a remarkable annual growth rate of 15 per cent. In addition, Shanghai is the home to the Shanghai Stock Exchange (SHSE), which is becoming an increasingly important stock market thanks to the rapid growth of direct inancing by irms in China.121 Its markets for the trading of bonds, foreign exchange, gold, futures and derivatives are also growing fast.122 Reportedly, in the Shanghai FTZ, inancial services and the inancial sector will be fully liberalized, the RMB will be fully convertible, and capital accounts will be liberalized as well. In addition, foreign banks will be allowed to expand on a large scale, and may establish joint venture inancial institutions with privately owned enterprises in China. Domestic banks, which are restricted in their overseas activities by the existing laws, will be allowed to experiment with new inancial products which are currently banned in China.123 If successfully established, the Shanghai FTZ might pose serious challenges to Hong Kong, although mainland oicials have attempted to play down the competition between Shanghai and Hong Kong.124 For instance, not only consumers will go to tarif-free Shanghai to buy luxury products, foreign capital might be shited to Shanghai if the RMB becomes fully convertible and China lits its restrictions on capital low, as suggested by Li Ka-shing. here is, however, a long distance for Shanghai to go before it catches up with and surpass Hong Kong as a inancial centre, if that will ever happen. A survey of the representatives of foreign companies that have bases in Hong Kong suggests that international business considers the following facts as Hong Kong’s major advantage: ‘(1) low tax rates and 120 122 124

State Council (2009). 121 Yang et al. (2010: 6). Yang et al. (2010: 7). 123 Sohu (2013). Chris Yeung, ‘Shanghai Free Trade Zone set to Shake up Hong Kong’, EJ Insight (18 September 2013).

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a simply tax system; (2) free low of information; (3) political stability and security; (4) corruption-free government; (5) up-to-date communications, transport, and other infrastructure; (6) rule of law and independent judiciary; (7) business-friendly government economic policy; (8) absence of exchange controls; (9) free-port status; and (10) level-playing ield.’125 It might be easier for Shanghai to outshine Hong Kong in infrastructural building and providing lower tax rates, and it has certainly an increasingly business-friendly government. With strong political will,126 Shanghai is even able to carve out the Shanghai FTZ to allow free low of information. Indeed, reportedly, the Chinese government ‘has made the landmark decision to lit a ban on internet access within the Shanghai Free-trade Zone to foreign websites considered politically sensitive by the Chinese government, including Facebook, Twitter and newspaper website he New York Times’.127 he biggest challenge for Shanghai will be the rule of law and independent judiciary. It does not seem to be likely to create an isolated, special, region of ‘rule of law’ in Shanghai if the ruling party, the government and the more powerful ones are still above the law in China.128

E Concluding remarks Ever since Hong Kong became a trading port as a British colony, its fate as commercial centre has always been closely tied to mainland China. his association has generated a huge dilemma that modern Hong Kong has to face: on one hand, its status as an international inancial centre heavily depends on the resources and opportunities provided by the mainland, such as market share on the mainland, as well as investment and listed companies from the mainland. he economic concessions ofered by the mainland under special arrangements such as CEPA put Hong Kong business ahead of foreign investors from other countries on competition in the Chinese markets. On the other hand, this dependence has resulted in challenges to Hong Kong’s legal and regulatory environment, largely due 125 126

127

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Prasad (2004: 9). he Shanghai FTZ is actually a product of the strong political determination of Li Keqiang, China’s new prime minister, to champion market-based reform measures. ‘Free-Trade Zone for Shanghai: Mr Li’s Big Idea’, Economist (16 July 2013). George Chen, ‘Li Warning Heats up Hong Kong-Shanghai Debate’, South China Morning Post (19 September 2013). It is of course a separate question whether the success of an international inancial centre depends on ‘irst class’ rule of law as possessed by New York, London or Hong Kong.

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to the incompatibility between the ‘Two Systems’ under ‘One Country’. In particular, the direct political control of the SOEs by the Communist Party has embarrassed the enforcement of Hong Kong’s corporate and securities law under many circumstances. Further, in the long run, the rise of Shanghai as an international inancial centre might pose potential challenges to Hong Kong’s position as the inancial hub in Asia. Hong Kong will gradually lose its status as the most modern, advanced and productive city in China as the unprecedented economic growth in China has been producing cities which will be better than Hong Kong in these aspects. However, Hong Kong will still be distinctive from all other Chinese cities in that it is the only place in China that has the rule of law. If Hong Kong can be more deeply and smoothly integrated into the Chinese economy – so as to maintain its unique competitive advantage over London and New York, namely the ‘China dimension’ – while still retaining its rule of law, it will be unlikely to be replaced by any city in the foreseeable future in terms of being the leading international inancial centre in Asia and China.

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I N DE X

ABN Amro Asset Management, 215 accountancy profession, influence of, 116–17 Acemoglu, Daron, 22 agency problems, 105–6 Agricultural Bank of China, 230 AIG, 216–18 algorithmic trading, 166–8 Alibaba Group, 221 American Depository Receipts (ADRs), 153 Armour, John, 106 Asian Financial Crisis, 46 Atanasov, Vladimir A., 134 audit committee, 108n. 12 auditors’ reports, 116–17 Australia, 141, 202, 206 Banco Bilbao Vizcaya Argentaria (BBVA), 95–97 Bank of China (BOC), 62, 64, 69, 99, 252–4 Bank of East Asia (BEA), 62, 99, 101 banking Closer Economic Partnership Arrangement (CEPA), 225–7 public offerings, 164–5 regulation, 238n. 58 Barma J, 139n. 187 Basic Law, 36, 72 Berkowitz, Daniel, 29 Berle, Adolf A., 55, 108, 108n. 11 Bermuda, 102, 152, 154–5, 179 Black, Bernard S., 134 BlackRock, 67–8 Bloomberg, 41–3 Bokhary, (PJ) Kemal, 33, 146, 195

bonding hypothesis, 240–6 Brazil, 152 Britain colonies, success of, 22–3 handover of Hong Kong, 34–5 Privy Council, 23, 28, 32–3 unintended consequences of colonial influence in Hong Kong, 4–9 see also colonial heritage of Hong Kong; United Kingdom (UK) British Virgin Islands, 152 Cahn, Andreas, 135n. 162 CaixaBank, 63–4 Caldwell, Daniel, 14, 30–1 California, 132 Campbell, Charles Molly, 29 Canada, 141, 152, 202 Canary Islands, 180 capital maintenance, 144–5 Capital Markets Tax Committee of Asia (CMTC), 167, 183–5 capitalization of companies, 134–5 case law and statute law, 27 Cayman Islands, 102, 152, 154–5 Central Commission for Discipline Inspection (CCDI), 253 Chan, Gerald, 71, 77 Chan, Paul, 116 Chan, Ronnie, 71, 77 Chan Tan Ching Fen, 77 Chan Tseng-Hsi, 77 Chang, Eric C., 56 charges, 141–2 Cheng, Edgar, 224 Cheng, Henry, 73 Cheng Yu-tung, 71, 73

269

270

Index

Cheung Kong Holdings, 71, 99, 101 Cheung, Yan-Leung, 56 China births in Hong Kong, 6–7n. 21, 38–9n. 211 Closer Economic Partnership Arrangement (CEPA), 225–7 company law, 230–4 control of Hong Kong, 3n. 5 cross-border financial law enforcement, 251–4 emigration to Hong Kong, 9–15 financial centre characteristics of Hong Kong, 2–3 financial services sector, 63, 64 foreign incorporated companies, 152, 154–5 handover of Hong Kong, 34–5 impact on Hong Kong, 223–5, 256–7 industry sector, 89, 93, 95 international financial centre in Hong Kong, 223–5, 256–7 National People’s Congress, 33–4, 190 political control of SOE listings, 246–9 political governance of Chinese companies, 234–9, 249–51 property development sector, 76, 77 securities law, 231 securities market, 248–9 SEHK listings for Chinese companies, 57–9, 102, 103, 228–30, 240–9 Shanghai free-trade zone, 254–6 Standing Committee of the National People’s Congress, 33–4 unintended consequences of influence in Hong Kong, 4–9 see also state-owned enterprises (SOEs) China Mobile, 89, 99, 101 China National Offshore Oil Corporation (CNOOC), 250–1n. 104 China Ocean Shipping Group (COSCO Group), 249–50 China Resources, 86, 93, 99

China Securities Regulatory Commission (CSRC), 247–9, 253, 254 China United Network Communications Group, 137 Chinese Estates, 113 Chow Tai Fook, 73 Chuenpi Convention, 10–11 Ciccotello, Conrad S., 134 CITIC Pacific, 86, 95, 99, 215 civil justice, 33n. 173 CK Life Sciences, 73 Claessens, Stijn, 55, 61, 133–4 Clarke, Donald C., 108n. 12 class actions, 206, 213–15 Closer Economic Partnership Arrangement (CEPA), 118, 225–7 Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, 164–5 Coffee, John C., Jr., 240–1 colonial heritage of Hong Kong government model, 9–21 institutional framework, 4–9 legal system, 22–34 commerce sector, 85, 99 Commodities Trading Ordinance, 121 common law for Hong Kong, 49–53 link to English common law, 27–34 ordinances, introduction of, 27 origins of legal system, 22 communism, 36n. 190 community leaders, 19–21 companies directors’ personal data, 40–3 dominant shareholders, 54–7, 60–1 family ownership, 55, 61 limited liability, 42n. 227 minority shareholders, protection of, 117, 123–33 see also corporate governance; foreign incorporated companies Companies Acts, UK, 144 Companies Ordinances (COs) directors’ personal data, 40–3

Index foreign incorporated companies, 155–7 as framework of company law, 112–17 shareholder derivative actions, 201–5 Companies Registry, 188 company law in China, 230–4 corporate groups, 133–40 courts, role of, 188–91, 196–206 creditors, protection of, 140–7 derivative actions, 196–205 enforcement, importance of, 188 evolution of, 111–17, 168 foreign incorporated companies, 102–103, 152–7, 169–70 future of, 168–70 HKEx enforcement role, 189, 193–5, 220–2 majority shareholders, protection from abuse by, 117, 123–33, 169 private companies, 147–52 private enforcement, 196–206 professional interest groups, influence of, 116–17 public enforcement, 206–19 risks addressed by, 104–11 securities fraud actions, 205–6 SFC enforcement role, 97, 189, 191–3, 206, 245 unfair prejudice actions, 196–201, 205 Competition Bill, 111 competitiveness, 44n. 233 computer-driven trading, 166–8 Confucian system, 18 consumption tax, 175–6 Cook Islands, 180 corporal punishment, 31–2 corporate governance corporate structure, 99 dominant shareholders, 54–7 SOE listings in Hong Kong, 242–6 state-owned enterprises (SOEs), 234–9 corporate groups, 133–40; see also stateowned enterprises (SOEs) corporate law, see company law

271

corporate structure commerce sector, 85, 99 corporate groups data, 59–61 family ownership, 55, 61 financial services sector, 62, 99 foreign incorporated companies, 57–9, 102–103, 110 governance, 54–7, 99 industry sector, 85, 99 property development sector, 55, 69 corporatized state-owned enterprises, see state-owned enterprises (SOEs) Court of Appeal (CA), 190–91, 216 Court of Final Appeal (CFA), 32–4, 190–191, 216 Court of the First Instance (CFI), 138–9, 190–191, 215 courts, role of, 188–91, 196–206 Cowperthwaite, John, 45 creditor protection, 140–7 criminal justice, 33n. 173 cumulative voting, 124n. 117 currency exchange, 118 Cyberport, 46 Davison, Ian Hay, 121–2, 191 Davos Investment Holdings, 63–4 De Jonge, Alice, 243, 246–7n. 88, 251–2 Delaware, USA, 115–16, 132–3 Deng Xiaoping, 95, 223 Denning, Lord, 28–9 derivative actions, 196–205 directors constraints on, 130n. 143 misconduct, 196–201 mismanagement by, 196–201 protection of personal data, 40–3 disclosure by unlisted companies, 142–4 Disneyland, 46 dividends, 237, 248–9 Djankov, Simeon, 55, 61, 133–4 Donald, David C., 135n. 162 Du Jun, 97 duty of loyalty, 124–5, 132–3

272

Index

Easterbrook, Frank H., 145n. 218 economic structure corporate governance, 54–7 foreign incorporated companies, 57–9, 102–103, 110 property development, 55 Elliot, Charles, 10–11, 12–13, 24 employment, 48, 48n. 249 English law, imposition of, 12–13, 23–5, 27–34 Euro-Asia Agricultural (EAA), 252–4 European Union (EU), 135n. 164 executive pay, 56 family ownership of companies, 55, 61; see also corporate groups Far East Exchange, 119 Ferguson, Michael J., 245–6 fiduciary principles in unfair prejudice, 125, 132–3 financial crisis, 46–7 financial markets, 46–7 financial services sector, 62, 99 First China Financial Network Holdings, 130 Fischel, Daniel R., 145n. 218 fi xed charges, 141–2 floating charges, 141–2 Forbes, 72 foreign incorporated companies company law, 102–103, 152–7, 169–70 securities law, 152–7, 169–70 on the SEHK, 57–9, 102–103, 110 SFC unfair prejudice actions, 128–30 Fortis Group, 138 France, 177, 182 Fraser Institute, 47 fraud, 205–6 free-trade agreement (FTA) between China and Hong Kong, 225–7 free-trade zones, 254–6 Friedman, Milton, 45 Fung King Hey, 83 Fung Lee Woon King, 81 Germany class actions, 206

foreign incorporated companies, 152 majority shareholder’s fiduciary duty, 51, 132 parent–subsidiary relations, 135n. 162 shareholder action, 201n. 64 tax information exchange agreements, 177 Gini coefficient, 48n. 250 global financial crisis, 46–7 Gongsi Fa, 230–4 goods and services tax (GST), 175–6 Goodstadt, Leo F., 20, 36, 45–6, 67n. 52, 70–2, 88, 91, 120n. 80 governance, see corporate governance government bailouts, 216–19 and laissez-faire, 44–9 political governance of SOEs, 234–9 socio-political model, 9–21 tax policy, 172 Grand Bauhinia Medal, 63, 72, 75–76, 81 guilds, 15, 17 Gyoshev, Stanley B., 134 Haddon-Cave, Philip, 45 Hang Lung Group, 71, 77, 99–100 Hang Seng Bank, 67 Hang Seng Index, 120 Hang Seng Index Futures, 121 Hansmann, Henry, 106, 147 Harris J, 110n. 15, 202 Harrison, Matthew, 226 He Xianchi (Ho Amei), 20 Henderson Land Development, 56, 71, 79, 99, 101 Heng, Michael S.H., 255 Hennessy, John Pope, 14, 16 Heritage Foundation, 43, 45, 47, 48 high-frequency trading (HFT), 166–8 Ho Amei (He Xianchi), 20 Ho Kai, 20 Ho Po Yeng v. Ho Ming Chun, 196n. 43 Ho, Stanley, 75n. 87 Hoff man, Lord, 125 Hong Kong adaption through time, 6–9

Index births in, 6–7n. 21, 38–9n. 211 British and Chinese influences, amalgamation of, 4–9 caretaker model, 4–5, 8–21, 36–44 civil justice ranking, 33n. 173 Closer Economic Partnership Arrangement (CEPA), 118, 225–7 colonial founding, 10–15 control of, 3n. 5 criminal justice ranking, 33n. 173 cross-border financial law enforcement, 251–4 financial centre characteristics, 1–3 government model, 9–21 handover, 34–5 Japanese occupation, 7, 20–1 legal system, 4–5, 22–34, 49–53 ‘one country, two systems’ role, 34–6 population, 69 see also company law; institutional framework; international financial centre; securities law; tax system Hong Kong and China Gas, 79 Hong Kong Depository Receipts, 153 Hong Kong dollar, 118 Hong Kong Exchanges and Clearing (HKEx) Chinese company listings, 228–9 creation of, 122 enforcement role, 189, 193–5, 220–2 foreign incorporated companies, 153–5 see also Stock Exchange of Hong Kong (SEHK) Hong Kong Ferry (Holdings), 79 Hong Kong Futures Exchange (HKFE) demutualization, 122 enforcement role, 189 securities law, 118, 121 Hong Kong Monetary Authority (HKMA), 118, 218 Hong Kong Securities and Futures Commission (HKSFC), see Securities and Futures Commission (SFC) Hong Kong Securities Clearing Company Ltd (HKSCC), 122

273

Hong Kong Society of Accountants, 133 Hong Kong Stock Exchange, 119–21; see also Stock Exchange of Hong Kong (SEHK) Hong Kong Telecommunications, 137–40 Hontex International, 213–14 HSBC Holdings, 62, 66, 69, 72, 99 H-share companies cross-border law enforcement, 251–4 SEHK listings, 103, 241, 244–6 Hsu, Berry Fong Chung, 244 Huang, Yasheng, 5–6, 50 Hulme, John Walter, 29 Hutchison Whampoa, 67, 71, 72, 73, 90, 99, 101 ICEA, 253 immigration, 9n. 34, 9–15 income inequality, 48n. 250 income tax, 171–2, 173–5, 174n. 6; see also tax system industry sector, 85, 99 information exchange agreements, 176–8 ING Baring Securities (Hong Kong) Ltd v. CIR, 174n. 7 Inland Revenue Department (IRD), 186–7 insider dealing, 56, 159–62, 208, 215–16 Insider Dealing Tribunal, 159–60, 189 institutional framework British and Chinese influences, amalgamation of, 4–9 caretaker model, 4–5, 8–21, 36–44 common law for Hong Kong, 49–53 community leaders, 19–21 democratic legitimacy, movement towards, 36–44 financial centre characteristics, 1–3 government model, 9–21 institutions created by local leaders, 15–18 intermediaries, 14–18 laissez-faire policies, 44–9, 70–1 legal system, 22–34 ‘one country, two systems’ role, 34–6

274

Index

international financial centre attractiveness to Chinese SOEs, 240–9 characteristics, 1–3 China’s impact on Hong Kong, 223–5, 256–7 Chinese company law, 230–4 Chinese company listings, 228–30, 240–9 cross-border law enforcement, 251–4 political governance of Chinese companies, 234–9, 249–51 Shanghai free-trade zone, 254–6 International Institute for Management Development (IMD), 44n. 233, 47 investment banks, 164–5 Investor Protection Ordinance, 120–1 Ireland, 206 Jackson, Howell E., 191 Japan, 7, 20–1, 152 Jardine Matheson, 85–6, 99, 101 Jardine, William, 88 Jersey, 179 Johnson, Simon, 22, 76n. 91 joint stock limited companies (Gufen Youxian Gongsi, or JSLC), 232–34 Jones, Gordon, 42n. 227 JPMorgan Chase, 67–8, 72–73 Judicial Committee of the Privy Council, 23, 32–3 judicial system, 4–5 Kam Ngan Exchange, 119 Kay, John, 166 Keswick family (Jardine Matheson), 88 Klerman, Daniel, 22–3 Kowloon Stock Exchange, 119 Kraakman, Reinier, 106, 147 Kwak, James, 76n. 91 Kwan J, 138–9, 202 Kwok, Adam, 83 Kwok Chun-pong, Stephen, 43 Kwok, Edward, 83 Kwok, Raymond, 71, 83–5 Kwok Tak Seng, 83

Kwok, Thomas, 71, 83–5 Kwok, Walter, 83, 85n. 118 Kwong Siu-hing, 83 Labuan, 180 laissez-faire policies, 44–9, 70–1 Lam, Kevin C.K., 245–6 Lam J, 139, 200 Langevoort, Donald C., 106 Latter, Tony, 46 Lau, Stuart, 44n. 233 Lau, Thomas, 75n. 87 law, see English law, imposition of law enforcement courts, role of, 188–91, 196–206 cross-border law enforcement, challenges of, 251–4 derivative actions, 196–205 HKEx role, 189, 193–5, 220–2 importance of, 188 private enforcement, 196–206 public enforcement, 206–19 securities fraud actions, 205–6 SFC role, 97, 189, 191–3, 206, 245 unfair prejudice actions, 196–201, 205 Law Wing Sang, 9n. 31, 16, 37n. 199 Lee, Grace Meina, 245–6 Lee Ka Kit, 81 Lee Ka-shing, 81 Lee Pui Ling, 81 Lee Shau-kee, 56, 71, 79, 83 Lee Tat Man, 81 legal system, 4–5, 22–34, 49–53 legal-political governance of Chinese companies, 234–9 LegCo (Legislative Council of Hong Kong), 36, 63, 170 Lehman Brothers, 218–19 Lenovo, 5 Li, Andrew, 63 Li, David K.P., 62–4 Li Ka-shing, 67, 71, 90, 91, 254 Li Keqiang, 256n. 126 Li Ning, 81 Li Tzar Kai, Richard, 137, 215 Li, Victor, 73

Index

275

Liberia, 179–80 licensing of bodies engaged in financial activities, 207, 210–13 Lieberthal, Kenneth, 238n. 55 Liechtenstein, 177 Lim, Tin Seng, 255 limited liability, 42n. 227 limited liability companies (Youxian Zeren Gongsi, or LLC), 231–232 Lin, Li-Wen, 234n. 41, 251 Liu Jinbao, 252–4 Loh, Christine, 36, 38n. 206, 111 London, 1–2, 3 Loo Aqui, 15 Lovell, Julia, 10–11n. 39 loyalty, duty of, 124–5, 132–3 Luck Continent Ltd v. Cheng Chee Tock Theodore, 131–2, 157, 198–201 Luxemburg, 152

minibonds, 46–7, 218–19 minimum wage, 48 minority shareholders and corporate groups, 133–40 derivative actions, 201–5 protection of, 117, 123–33 misconduct of directors, 196–201 mismanagement by directors, 196–201 Mitrans Shipping case, 146–7, 169 Model Business Corporation Act, USA, 144 Model Code for Securities Transactions by Directors of Listed Issuers, 161 Morgan Stanley, 97, 215 Morningside Group, 77 Munn, Christopher, 11–12, 13n. 60, 14, 16, 24, 29–31

Ma, Jack, 221 Macao, 12 MacDonnell, Richard Graves, 13, 16, 19 Madeira, 180 Magistrate’s Court, 190 Mahoney, Paul, 22–3 majority shareholders abuse of power, 51–2, 123–33 company law, 117, 123–33, 169 and corporate groups, 133–40 derivative actions, 201–5 dominant owners, 54–7, 60–1 Man Mo Temple, 15–16 management, 208, 238–239 Mandatory Provisions of Articles of Association for Companies to be Listed in Hong Kong, 243 market manipulation, 208, 216 Market Misconduct Tribunal, 159–60, 189–91, 215 Matheson, James, 88 McGregor, Richard, 36n. 190, 250 McSwyney, Percy Caulincourt, 29–30 Means, Gardiner C., 55, 108, 108n. 11 media reporting, 44n. 233 Mega Capital (Asia), 213–14 Milhaupt, Curtis J., 234n. 41, 251

Nanjing Treaty, 11 National People’s Congress of the People’s Republic of China, 33–4, 190 Nauru, 180 negligence, 208 New World Development Co, 71, 73, 99, 101, 195 New York, 1–2, 3 New York Stock Exchange (NYSE), 102 New York Times, The , 41–3 New Zealand, 141, 206 Ng Choy (Wu Tingfang), 19–20 Ng Kang-chung, 44n. 233 nonexecutive directors, 108n. 12 oath taken in court, 30–2 offshore investment funds, 185–6 ‘one country, two systems’, 34–6 O’Neill, Paul, 180 opium, 10 ordinances, 25–7; see also Commodities Trading Ordinance; Companies Ordinances (COs); Investor Protection Ordinance; Securities and Futures Ordinance (SFO); Securities Ordinance

276

Index

Organisation for Economic Co-operation and Development (OECD), 180

Roe, Mark J., 108n. 11, 191 Rogers V-P., 139 rule of law, 33n. 173, 186–7

Pacific Century CyberWorks (PCCW), 137–40, 214–15 Pacific International Finance, 218–19 Panama, 179–80 Patten, Chris, 88 Patterson, John, 88 Pinegar, Michael J., 56 Pistor, Katharina, 29, 216–217 political governance of Chinese companies, 234–9, 249–51 Prasad, Eswar, 223–4 price manipulation, 162–3 private companies company law, 147–52 groups of, 150–2 limited liability companies in China (Youxian Zeren Gongsi, or LLC), 231–232 private enforcement of securities law, 196–206 Privy Council, 23, 28, 32–3 profits, tax on, 174–5, 185–6 property development, 55, 69 public companies, 232–34 public enforcement of securities law, 206–19 public float requirement, 169 public offerings, 158, 164–5 punishment, 13–14

Saint Kitts and Nevis, 179–80 Samoa, 180 San Imperial Corporation, 113 Second World War, 171–2 Securities and Exchange Commission (SEC), 63 Securities and Futures Commission Ordinance, 122 Securities and Futures Commission (SFC) Chinese companies’ importance for Hong Kong, 229 computer-driven trading, 167–8 court actions, 190–1 creation of, 122 cross-border law enforcement, 252–4 enforcement role, 97, 189, 191–3, 206, 245 fraud, 205 government bailouts, 218 insider dealing, 161–2 price manipulation, 162–3 prosecutions by, 169 public offerings, 158, 164–5 regulatory strength, importance of, 118 SEHK powers, 194 short selling, 163–4 unfair prejudice, 127–30 Securities and Futures Commission v. Tiger Asia Management LLC, 160 Securities and Futures Ordinance (SFO) court actions, 190–1 creation of, 122–3 fraud, 205 HKEx powers, 193–4 insider dealing, 159–62 price manipulation, 162–3 public offerings, 164–5 regulatory infrastructure, 118, 122 SFC prosecutions, 169 short selling, 163

Re Shun Tak Holdings Ltd, 131n. 147, 198 Re Styland Holdings Ltd (No 2), 129–30, 157 Re Taiwa Land Investment Co Ltd, 196n. 43 Re Yung Kee Holdings Ltd, 156n. 271 red-chip companies, 228–30, 245–6 regulation, 102–103, 110, 238n. 58; see also company law; law enforcement; securities law remuneration, 48, 48n. 249, 56 Richard, Jean-Francois, 29 Robinson, James A., 22

Index Securities Commission of the State Council (SCSC), 243, 247 securities fraud actions, 205–6 securities industry, 226–7, 238n. 58 securities law in China, 231 courts, role of, 188–91, 196–206 derivative actions, 196–205 enforcement, importance of, 188 evolution of, 117–23, 168 foreign incorporated companies, 152–7, 169–70 future of, 168–70 HKEx enforcement role, 189, 193–5, 220–2 insider dealing, 159–62 market abuse, prevention of, 157–65 price manipulation, 162–3 private enforcement, 196–206 public enforcement, 206–19 public offerings, 164–5 risks addressed by, 104–11 securities fraud actions, 205–6 SFC enforcement role, 97, 189, 191–3, 206, 245 short selling, 163–4 unfair prejudice actions, 196–201, 205 securities market in China, 248–9 Securities Ordinance, 120–1 SEHK, see Stock Exchange of Hong Kong (SEHK) Shanghai free-trade zone, 254–6 Shanghai Land Holdings, 252–3 Shanghai market, 169 Shanghai Petrochemical Company Limited (SPCL), 246–7n. 88 Shanghai Stock Exchange (SHSE), 255 share classes, 222 share transfers, 165–7 shareholders company law, protection under, 123–33 corporate groups, protection against, 133–40 derivative actions, 201–5 dominant owners, 54–7, 60–1

277

family ownership, 55, 61 majority shareholders’ abuse of power, 51–2, 123–33 minority shareholders, protection of, 117 SASAC’s role in state-owned enterprises, 236–7 unfair prejudice actions, 131–3, 196–201, 205 Sheng, Andrew, 46, 210–11 short selling, 163–4 Shun Tak Holdings, 75n. 87 Singapore characteristics of a financial centre, 1, 2 foreign incorporated companies, 152 independence of, 169 offshore investment funds, taxation of, 185, 186 shareholder derivative actions, 202 as tax haven, 179 tax information exchange agreements, 177, 178 Sinn, Elizabeth, 12, 16–18 Snowden, Edward, 34, 39 social class, 17–18 Sociedade de Turismo e Diversoes de Macau, 75n. 87 socio-political model, 9–21 Sogo Department Store, 75n. 87 South China Morning Post, 44n. 233 Spamann, Holger, 22–3 Special Administrative Region (HKSAR), 34–5, 122, 192; see also Hong Kong stamp duty, 165–7, 173, 183–5 Standard Chartered, 62, 68, 99 Standing Committee of the National People’s Congress, 33–4 State Assets Law (Qiye Guoyou Zichan Fa, Law on State-owned Assets of Enterprises), 236–7 state capitalism, 249–51 State Commission for Restructuring of the Economic System (SCREC), 243

278

Index

State-owned Assets Supervision and Administration Commission (SASAC), 235–7 state-owned enterprises (SOEs) background, 234–5 Chinese company law, 230–4 corporatized SOEs, 234–6 cross-border financial law enforcement, 251–4 direct political control, 238–239 Hong Kong listings, 228–30, 240–9 market capitalization of, 210–11 political control of listings, 240–9 political governance, 234–9, 249–51 SASAC’s role, 235–7 SEHK listings, 49–50, 57–9 see also corporate groups statute law and case law, 27 statutory derivative actions, 201–5 Stiglitz, Joseph, 53 Stock Exchange of Hong Kong (SEHK) Chinese companies, 57–9, 102, 103, 228–30, 240–9 Closer Economic Partnership Arrangement (CEPA), 226 creation of, 119–21 demutualization, 122 enforcement role, 189, 193–5 foreign incorporated companies, 57–9, 102–103, 110, 155–7 growth of, 210–11 Listing Rules, 244–5 Luck Continent Ltd v. Cheng Chee Tock Theodore, 198–201 market capitalization, 58 public float requirement, 169 securities law, 118 short selling, 163–4 SOE listings, 49–50, 57–9 voting power, 60–1 see also Hong Kong Exchanges and Clearing (HKEx) Stouraitis, Aris, 56 Studwell, Joe, 75 Styland Holdings, 129–30, 157 Sumitomo Mitsui Banking Corporation, 64 Sun Hung Kai Group, 71, 79, 83, 99, 101

Sun, Qian, 246 Supreme Court, 27–8 Swire Pacific, 71, 91, 99, 222 Switzerland, 177, 179, 181 Tam Achoy, 15 tax havens, 178–83 tax system and algorithmic trading, 165–7 attractiveness to business, 171 background, 171–2 current system, 173–6 disputes, 186–7 income tax, 171–2, 173–5, 174n. 6 information exchange agreements, 176–8 offshore investment funds, 185–6 rule of law effects, 186–7 share transfers, 165–7 stamp duty, 165–7, 173, 183–5 tax base, 175–6 tax haven, Hong Kong as, 178–83 Temasek Holdings, 69 tepo (dibao, neighbourhood watch), 14 The Artemis (Cargo Owners) v. Artemis Transportation Corp, 156n. 271 Thompson, Robert B., 146 Tong, Wilson H.S., 246 Too-hing, 26 transparency, 42–3 Treaty of Nanjing, 11 Tsang, Donald, 224 Tsang, Steve, 16, 18, 24, 72, 88, 223 Tsingtai Brewery Corporation (Tsingtao), 246–7n. 88 Tung Wah Hospital, 16–20 tunnelling, 134 tycoons, 6 UBS, 181 undercapitalization of companies, 134–5 unfair prejudice, 124–33, 169, 196–201, 205 United Kingdom (UK) civil justice ranking, 33n. 173 class actions, 206

Index company law, 168 criminal justice ranking, 33n. 173 foreign incorporated companies, 152 international fi nancial centre, 1–2 , 3 rule of law, 33n. 173 shareholder action, 201n. 64 stock exchange, 58 tax information exchange agreements, 177 tax on banks, 182 veil piercing, 145–6 see also Britain United States of America (USA) American Depository Receipts (ADRs), 153 civil justice ranking, 33n. 173 company law, 115–16, 168 criminal justice ranking, 33n. 173 foreign incorporated companies, 152 government bailouts, 216–18 immigration, 9n. 34 majority shareholders, 132–3 rule of law, 33n. 173 Securities and Exchange Commission (SEC), 63 shareholder derivative actions, 203 stock exchanges, 58, 102, 241

tax havens, 180–1, 182 tax information exchange agreements, 177 veil piercing, 145 unlisted companies, 142–4 Vanderwolk, Jeff, 165, 167 Vanuatu, 180 veil piercing, 145–7 Wang Jiangyu, 169 Wang Yilin, 250–1n. 104 Wei Jiafu, 249–50 Weinstein, Mark, 22–3 Wheatley, Martin, 208, 252 Wong, Anita W.S., 56 Wu Jinglian, 235 Wu Tingfang (Ng Choy), 19–20 Wu Yujun, 246 Xi Guahua, 89 Yang Bin, 252–4 Yang, Mu, 255 Zhang Zidong, 20 Zhou Zhengyi, 252–3 Zhu, Jun, 56

279