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David Smith: Dual-class shares -- more trouble than they are worth

It's hard for shareholders to be company stewards when some are more than equal

Listed stock exchange operators are in a bind. As regulators, they play an important role in upholding a market's reputation for strong supervision and good governance.

But as listed companies, the bourses need to ensure their shareholders are happy. They do this in part by fighting for business in a changing and competitive landscape. After all, there are plenty of exchanges hoping to land the next big initial public offering.

That's why the issue of so-called dual-class shares is a headache. A dual-class equity structure, as the name implies, confers different levels of voting rights. Some companies have insisted on this kind of ownership structure because it helps an individual, or a handful of people, retain management control after an IPO. Inevitably, the rights of other shareholders suffer.

Stock exchanges are under pressure to relax restrictions to attract business. The next big Chinese technology company could well make the acceptance of dual-class shares a condition of listing overseas.

That could explain why Singapore Exchange and Hong Kong Exchanges & Clearing are each reviewing their stance on dual-class shares. Earlier this year, SGX clarified that under its existing rules, companies with a primary listing in a developed market can offer dual-class shares via a secondary listing in Singapore.

The job of professional investors is to allocate capital to companies. We invest money on behalf of millions of savers around the world and we have an obligation to look after their interests.

That's why investors cannot, in good conscience, endorse any attempt to allow dual-class shares to be introduced in Asia. This would subvert the rights of other shareholders and damage trust in markets.

There is a sense of deja vu to all this. In 2014, Hong Kong's stock exchange asked for feedback on the idea of weighted voting rights. Its proposal would have permitted some shareholders to hold voting rights disproportionate to their economic interest in a company. Dual-class shares and shares with so-called super-majority votes are both forms of weighted voting.

Despite objections from Aberdeen Asset Management and many other institutional investors, the exchange arrived at the conclusion that "there is support for a second-stage consultation on proposed changes to the listing rules on the acceptability of [weighted voting rights] structures."

However, the Securities and Futures Commission of Hong Kong took the unusual step of repudiating these findings. "The SFC considers both long-term and short-term objectives and seeks to uphold the core principles of fairness and transparency which underpin Hong Kong's reputation as an international financial center," the regulator said at the time.

Weighted voting rights, the SFC said, were incompatible with the strong and equitable regulatory system that Hong Kong capital markets are known for. However, the Hong Kong exchange resurrected its idea earlier this year, this time with a proposal to launch a third board that would allow listings including those with "non-standard governance features."

EFFECTIVE MONITORING Investors are expected to behave as long-term stewards of the companies they invest in. Stewardship codes have multiplied in recent years, and indeed Singapore released its own last year.

Most of these codes focus on the responsibility of shareholders to monitor and engage with companies in their portfolios. For example, the SFC's consultation paper on the principles of responsible ownership -- Hong Kong's equivalent to a stewardship code and released in 2015 -- noted: "Shareholders are expected to take action where they believe that directors are not acting in the interests of the company or its shareholders. The law therefore provides all shareholders with voting and other rights to enable them to engage with directors and to monitor the progress of their investment in the company."

The emphasis here is on engagement and voting as a disciplinary mechanism. Engagement gives investors the ability to voice concerns, while voting gives them a chance to influence how a company behaves. Shareholders acting together can veto transactions they deem to be contrary to their interests, or censure directors by not supporting their re-election.

Dual-class shares rob investors of these rights. Under such condition, and with no mechanism through which to effect change, shareholders who are able to sell -- and many passive investors are not -- would simply be forced to walk away if they become frustrated. This is neither in the interests of shareholders, nor companies, nor society at large.

Effective monitoring by shareholders ensures better behavior by management teams, better and more efficient allocation of capital and thus, better outcomes for the economy.

Investors are being asked to act as long-term stewards of companies while at the same time a discussion is taking place around the introduction of a structure which would inhibit their ability to do so. Regulators, and society as a whole, cannot have it both ways.

David Smith is head of corporate governance for Aberdeen Asset Management Asia in Singapore.

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