David Webb: A combination of the two. It's tech heavy and internet heavy, due to the timing of its launch in November 1999. But the index base level of 1000 was only calculated in early 2000, right at the top of the tech bubble. Today it's around 180, so the crash clearly reflects the poor performance of the few, large tycoon spin-offs from the point at which they were introduced to the index. Companies like tom.com, SUNeVision, Henderson Cyber etc. These are the companies which dominated the index.
On the other hand, a lot of these companies would not have been listed in the first place if the rules had been adhered correctly. The GEM was hijacked by Hong Kong big business interests. The GEM was originally designed for small to medium enterprises which can't raise capital from banks. They might not have enough collateral and banks in Hong Kong haven't historically been very good at assessing business plans and trusting people on the basis of the business plans. The banks always look for collateral, especially real estate.
When you say SMEs does that necessarily mean start ups?
No, it means companies that don't satisfy the main board profit and listing requirements - HK$100 million market cap and a HK$50 million market cap for new shares; profit requirements of not less than HK$20 million, and an aggregate of not less than HK$30 million in profits in the two preceding years. For example, a GEM company could be a medium cap which has had a couple of bad years but needs capital for a turnaround. So rather than reduce the profit requirement for the main board, it seemed to make sense to have a second board. But the GEM wasn't meant for complete startups.
Originally, businesses had to demonstrate two years of active business pursuits, meaning that you were actually trying to run your business. The GEM doesn't require profit or turnover - that was meant to help, say, a company developing a drug, a time consuming and expensive process. But the GEM was sucked into the Internet Bubble and became a startup market almost exclusively.
We also built in a two year lock up requirement on the management shareholders so they couldn't 'pump and dump'. That was the framework. It was never intended that companies could bypass that framework by purchasing a company with a track record and stuffing it into the listing vehicle prior to a listing. But that's what tom.com did. It injected a company that did software in Shenzhen, and that was the track record. Then it bought some assets of the Metro Radio website. When the company listed the web portal was just a few weeks old. And the regulators turned a blind eye to this. There are plenty of other examples.
These companies undermined the whole concept of the GEM, since they came from groups which had tens of billions of capital. Clearly the purpose of the deal was to get more capital cheaply by capitalizing on the Internet craze. The collapse of the index was mainly a result of that rush to the market and did a lot of damage to investors' perception of the GEM.
What was the effect of the waivers regarding lockup periods, track record etc which the regulators kept giving to the high profile companies?
The waivers the GEM listing committee was giving out got ridiculous. By waiving the same rules for every company it had the effect of changing the rules, but rules should only be changed with the approval of the SFC. Eventually a compromise was reached. By that stage (Summer 2000) the track record has been waived to one year, the lock up to six months and the share options schemes has been raised from 10% to 50% of the old shares.
All the investor submissions to my website indicated they wanted a higher quality market with good quality companies. On the other hand, the issuers and the sponsors wanted a free-for-all, which would permit more of the 'pump and dump' schemes we've seen. This demonstrates the lack of a government mandate for the SFC. It couldn't force the issue, since the SFC cannot directly change rules, it can only approve or deny rule changes.
In the end, the compromise was that from the beginning of 2002, companies do need a two-year track record unless the market cap or turnover or gross assets are at least HK$500 million. To me this suggests that if you want a create a scam, it has to be a big one! The lock up was put up to one year. Clearly, big business interests still want the option to list spin offs on the GEM.
The compromise was all rather contrived around the spin offs that might come in the future. But the quality of the companies coming to the market is still quite poor. And the bad reputation lingers. The desperadoes keep on coming, while the good companies are worried about being tarred with the same brush as the bad companies. It's economic theory that buyers will discount the whole market to compensate for the overall risk. So good companies don't want to go, since capital will be more expensive to raise.
Why do you think the waivers were granted so abusively?
To facilitate spin offs from large companies and to reach the much publicized goal of having a HK$100 billion market cap, which is quite contrary to the purpose of having a second board for SMEs. A true second board, by definition, should not be aspiring to a large market cap. It was also due to the GEM being touted as a rival to the Nasdaq in New York, so the government wanted to grow the market as fast as possible.
What's the alternative for Hong Kong companies if they don't list on GEM?
They are restricted to growing more slowly from retained profits, and will lose out to companies which can benefit from raising money from a better quality second board. Actually, this problem extends to the main board as well. A local manufacturer listing on the main board will get a lower valuation in Hong Kong than say, London or New York.
Don't you think the GEM has been very successful at attracting Taiwanese and Chinese companies?
There are many well-managed, high performing Taiwanese companies on the GEM. But these companies get frustrated at the lack of attention. Historically, they tend to get tarred with the same brush as the bad companies. Yu Yuen for example is trading on a p/e of 10 to11 times earnings even though it's got 15% of the global market for athletic shoes. But the people who sell those shoes in the US are trading on 20 times. Do the branded resellers really add that much more value, or is there a feeling that the next corporate scandal is never far away, so Hong Kong-listed companies gets discounted?
Mainland Chinese companies are risky and corporate governance needs much improvement. Nobody really knows what's going on there.
Richard Yeung the CEO of GEM-listed Convenience Retail Asia recently told FA that although the GEM's reputation stinks, it works from the functional point of view of raising capital.
But CR Asia is big, almost 4% of the whole index. And its parent company is Li & Fung, a highly respected, main board company. So they won't have any problem raising capital. But so many companies on the GEM are dross, down 90% from their IPO prices. Sometimes these companies are placed with fewer than ten people, then the share price collapses, or it's ramped up. Companies get listed by hook or by crook and then hope they can make some profit in the after market.
What do you think of the SFC's Andrew Sheng's comment that it's up to the investor to carefully check companies, and that the SFC's function is simply to ensure companies are abiding by the rules?
I think it's very weak. Even if you do a lot of research, you don't know if somebody is going to cheat you. And selling after the event, which Sheng tells investors to do if they are dissatisfied with the company, is not worth a whole a lot. It's like having your house burned down and trying to sell the wreckage. If somebody complies with all the rules and rips off investors, either the rules, or the enforcement are at fault.
What powers does the SFC have to prevent abuse?
The SFC can actually go to court and petition for the winding up of a company, or alternative remedies such as forcing the major shareholders to buy out minorities. But they have only used these powers twice, and that was a long time ago. In the mid 1990's, against Mandarin Resources, the legal costs came to HK$30 million, which the SFC eventually got back, although it took a long time. But that's what should be done; it's not enough to send out 'reprimands' which are quickly discarded in wastebins or forgotten. What's the deterrent effect? If you have to choose between ripping of your shareholders and saving your financial skin, even if you do get a little bad publicity later, you will obviously rip off the company!
Are there any moves underway to increase shareholder protection?
There are proposals to give the SFC and shareholders the right to bring a derivative action, rather than first having to convince a judge to let an action go through. That would enable the SFC to sue directors or abusive shareholders on behalf of a company directly, since an individual shareholder could not afford it, and there's no class action action allowed in Hong Kong. But it makes me wonder what the point of giving Andrew Sheng's SFC more powers is, if he wants to adopt the hands off approach.
The alternative is my idea, the Hong Kong Association of Minority Shareholders. That would have provided enforcement, since by aggregating minority shareholders and being funded from a market levy, we could have had a quasi-class action system without actually changing the law. But the government rejected that , and doesn't want to introduce class action lawsuits either. So the minority shareholders end up with very little protection indeed.
Why have the regulators been so timid in cracking down?
They lack the mandate, the resources and the funding. They have the legal powers, but the big business interests and their politicians are obviously not keen in facilitating litigation against listed companies.
With Hong Kong's unique status within Greater China on the decline, how important is to modernize the financial markets?
Clearly very important. We (Hong Kong) have to strengthen the services sector. We have to raise our game, but we're not going to do that if we don't accelerate the reform process and overcome the tycoons and politicians blocking reform, who are afraid the reforms might upset their cosy cartels.
For more from David Webb, visit his website www.webb-site.com
