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For Hong Kong's bourse operator, proposals for a 3rd board spark debate

Hong Kong investors could soon have a new trading board dedicated to technology and other "new economy" companies. But while some observers are cautiously optimistic about the Hong Kong bourse's proposal for a new board and its ability to attract business over the long term, others are wary that an accompanying shift in listing rules could dampen investor enthusiasm.

Hong Kong Exchanges & Clearing Ltd., which operates the main board for large companies and Growth Enterprise Market for small and midsize companies, started a public consultation in June for a third board. The aim would be to attract a swath of businesses that do not meet the listing rules of the other two boards, which would include pre-profit companies, companies with "non-standard" governance features — notably those with weighted voting rights — and mainland companies seeking a secondary listing.

As Stephen Chan, partner at law firm Dechert LLP, notes, "the advantage that Hong Kong has [over Western bourses such as Nasdaq in the U.S.] is its nexus to China." But the third board is likely to face big competitors closer to home. China's National Equities Exchange and Quotations, which was launched in 2012 to target startups, has nearly 11,400 companies listed. In comparison, Hong Kong has a total of 2,060 companies listed on its main board and GEM.

Thorny issues

Hong Kong's main board requires a company to have at least HK$50 million of total profit over the three years before listing, while the GEM board, in lieu of a profit requirement, allows companies with HK$20 million of annual cash flow to apply for a listing. Perhaps more critically in terms of their ability to attract new listings are their governance rules. Both boards, for example, bar companies with dual class share structures. Such a structure enables, for example, a company's founder to own a small portion of its stock yet maintains most of the voting power.

Some observers believe the ban has led the Hong Kong exchange to miss out on big "new economy" listings, such as that of Alibaba. The Chinese e-commerce company, after its application to list in Hong Kong was declined in Hong Kong because it did not want to offer only single-class shares, headed to the NYSE, where dual-class structures are allowed, to raise a staggering US$25 billion via an IPO in 2014.

But the third board's strategy to allow dual-class shares might not go down well with potential investors, Chan said. "Given the inherent complexities of weighted voting rights, it is more likely that ordinary retail investors may be prejudiced," he observed. "Also for institutional investors, weighted voting rights in favor of a founder or management would mean that they have less control over a company with the same shareholding."

'It will take time'

But even offering the dual-class structure might not be enough to spur the third board's growth. David Yin, an analyst at Moody's Investor Services, expects a slow start in terms of attracting. "For a new board, secondary trading will usually not be active so expect trading volume to be quite low," he advised.

Meanwhile, a credit ratings analyst who declined to be named when speaking with S&P Global Market Intelligence questioned whether the third board would become a magnet for poor-quality or shell companies that are set up for the sole purpose of being sold to other companies seeking a "backdoor" listing. "Hong Kong investors are conservative and will invest mostly in mature companies," he asserted, adding that concerns about the quality of the assets could be a turn-off for them, leading to low trading volume.

Christina Lee, partner at law firm Baker McKenzie, is more optimistic. "It will be a case of supply creating new demand in earlier stage and sector-driven equity capital," which will be "an encouraging move" benefiting the entire investor ecosystem by spurring M&A among other areas, she said.

"However, these developments don't happen overnight and it will take time and many elements to come together for the market to develop, evolve and mature," she said.

The public consultation will end Aug. 18 and will determine if there is market support for the proposal, which will pave the way for the bourse to finalize listing rules for the new board in early 2018.