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Slouching dragon

Activist investor David Webb warns that foot-dragging on financial reforms will cost Hong Kong its status as Asia's financial center.

David Webb started writing computer games when he was 14, and within five years he had created the U.K.'s No. 1 seller: Starion. The players travel back in time from 2010 in the timeship S.S. Stardate to "correct the evil wrought in the space-time continuum by evil aliens" and "save the world from chaotic collapse."

Now 38, Webb still sees the world in Manichaean terms. A private investor, he has emerged as the most dogged shareholder's rights activist in Hong Kong, determined -- as Webb, the game writer, might have put it -- to correct the evils of regulatory mismanagement and corporate governance abuse and save the city's financial markets from chaotic collapse. His Internet site -- -- skewers local companies when they lapse into what he considers slipshod governance practices, and his witty e-mail newsletter reaches 9,000 subscribers. It's free if you say you want it.

Webb has been attacking what he deems to be regulatory complacency and shoddy corporate governance since 1998. "It's just a shame," says James Squire, head of Asian equities at Baring Asset Management, "that there is only one David Webb."

Lately, however, Webb's tone has become less sardonic and more sober. He worries that Hong Kong will lose its historical position as Asia's most vibrant financial center because of what he sees as its failure to keep pace with regulatory reforms -- particularly in corporate governance -- that are advancing in other Asian financial hubs, including Shanghai and Shenzhen.

Only last month the government missed what Webb saw as a gala opportunity to fortify securities regulation: In an April 2 move, Hong Kong elected to ignore Webb's plea to strip Hong Kong Stock Exchanges and Clearing of its responsibility for approving and monitoring listed companies and pass that fundamental regulatory function over to the Hong Kong Securities and Futures Commission.

In effect, the government stuck with its current cumbersome three-tier regulatory regime, under which HKEx, the SFC and the government all play a role in securities oversight, bumping elbows like passengers clambering onto the Star Ferry. The HKEx has no legal power to investigate companies it suspects of violating its listing regulations; the SFC possesses that statutory authority and acts when it believes rules have been breached. At any time, however, the government -- in the person of Secretary for Financial Services and Treasury Frederick Ma, or even Hong Kong Chief Executive Tung Chee-hwa -- can overrule either the exchange or the SFC. In the latest regulatory initiatives, the government did give the SFC additional powers to review company pronouncements and financial disclosures, to require shareholder approval for significant transactions and to levy stiff fines.

Webb was nevertheless frustrated. He regards HKEx's dual role as a regulator of listed companies and a for-profit enterprise that relies on those same companies for remunerative fees as an inherent conflict of interest. "What the exchange should be doing is running an exchange: providing clearing and settlement and price discovery -- not regulating," Webb declares. HKEx chairman Charles Lee, supported by many of Hong Kong's most powerful businessmen, insists that the HKEx understands the market better than the SFC and that its self-regulatory model had worked well. Says HKEx board member Oscar Wong, CEO of BOCI-Prudential Asset Management: "I don't know that the SFC would be a better policeman. How far do you let the policeman have absolute power?"

Webb also complains that the government's April 2 regulatory edicts do nothing to prevent controlling shareholders from awarding themselves massive pay increases; nor do they stop big shareholders from electing "their buddies or paid advisers" as independent directors. What's more, Webb grumbles, controlling shareholders are able to dilute minority holders' positions. More than 90 percent of Hong Kong­listed companies have an owner who alone or in conjunction with family members controls 25 percent or more of the share capital, according to the Hong Kong Society of Accountants. Unlike their counterparts in the West, disgruntled shareholders in Hong Kong can't file class-action lawsuits. And because the HKEx's listing committee continues to be dominated by companies and brokers -- only two of the 25 members represent investors -- Webb contends that it is grossly out of balance.

He argues that Hong Kong must raise its governance standards to rival those of New York or London to remain competitive. Otherwise it will waste its traditional strengths: a common-law legal system, low taxes, a free market and progressive overall regulation. "If Hong Kong doesn't get it right," Webb warns, "it's unlikely that it will be the capital markets center for China in ten years." Instead, he darkly envisions Hong Kong becoming a kind of Asian Florida. "It will have a Disneyland [slated to open next year] and an investment management community," he says, "but a lot of jobs surrounding the capital markets industry -- the investment bankers, the accountants and lawyers -- will gravitate to wherever the center of the market is, which could just as easily be Shanghai."

The other looming threat to Hong Kong's future as a financial center comes from Beijing's clampdown on democracy in the city, which could scare off both investors and businesses. Ominously, the Chinese government announced on April 26 that it had ruled out popular elections for Hong Kong's chief executive in 2007 and for the legislature in 2008. Hong Kong's stunted political development is one key reason regulatory reform is stalling, Webb believes. "At the very top there is no competition in government," he says. "That is directly at odds with a free market."

Webb's grim prognostication about Hong Kong is not shared by everyone in the city's financial community -- least of all by Financial Secretary Ma. He and others argue that Hong Kong's regulatory system is on a par with the best in Asia and that it is being upgraded in a careful, measured way. They also point out that Webb's call for one centralized regulator is not the norm in other markets.

Webb "hits the target on a regular basis, but his views represent one end of the spectrum," says Richard Williams, head of listings at HKEx. "Whilst there has undoubtedly been a trend to give statutory regulators greater power, it can't be said that the single-regulator model is the international norm. The international norm is shared regulation. How it works varies from jurisdiction to jurisdiction. Shared regulation can work in Hong Kong."

A UNIVERSITY OF OXFORD GRADUATE WITH A mathematics degree, Webb arrived in Hong Kong in 1991 to run the fledgling Asian investment banking operation of Barclays de Zoete Wedd Asia. He quit in 1994 to be an adviser to local real estate firm Wheelock & Co. Four years later, at 32, he "retired" to be a private investor.

Increasingly upset by what he saw as Hong Kong's paucity of shareholders' rights, Webb set out in 2001 to create a publicly funded shareholder advocacy organization, dubbing it the Hong Kong Association of Minority Shareholders. He envisioned HAMS lobbying for legal reforms, rating companies on governance and mounting quasi-class-action suits against the worst abusers of shareholders' rights. He proposed that the organization be funded through a levy on stock trades. Though the proposal was backed by 80 market practitioners, including 29 asset managers and trustees, the government rejected it, saying that it was impractical to have a private body funded by government revenues.

Webb had nonetheless made something of a name for himself as a shareholder activist in a city where few exist. SFC chairman Andrew Sheng named him to the commission's takeovers and mergers panel, which rules on whether acquisitions are fair to shareholders. And last year Webb became the first investor ever elected to the board of the stock exchange; in a coup he got the HKEx to open its annual meeting to the public.

But that victory has been spoiled by the April 2 declarations. Financial Secretary Ma stated that the stock exchange would continue to "be at the front line" of accepting listing applications -- that is, it would remain the primary arbiter of which companies get to list. The government's action, the secretary said, was based on overwhelming support from the financial community for "expanding the dual-

filing system," under which companies must file financial disclosures with both the HKEx and the SFC. The government said that it was "more prudent to improve on the existing system than to introduce radical changes" and dismissed talk of conflicts of interest at the exchange as "perceived rather than real" because of the many checks and balances in place.

Webb, however, points out that the purported reforms do not address the composition of the exchange's listing committee, curtail the power of controlling shareholders or dispense with a dual-filing system for IPOs. The last, he charges, makes the SFC and the exchange less, rather than more, accountable. If both bodies approve an IPO application that turns out to have been riddled with misrepresentations, "Who is going to take the blame for that?" he asks.

Officials of the government, the exchange and the SFC contend that Webb is being unnecessarily apocalyptic, and overly dramatic, about the regulatory dangers to Hong Kong. The SFC's executive director of corporate finance, Ashley Alder, says the debate has gotten bogged down in "unhelpful" squabbles over who gets to do what.

"What really matters is that there is meaningful reform to enable the regulations and those who enforce them to operate more effectively," Alder asserts. By expanding the SFC's jurisdiction and giving it wider sway to take legal action, he says, Ma's recommendations amount to "a major shift in the way in which listing regulation is going to be approached under new legislation."

Certainly, a lot of Hong Kong corporate executives will be delighted with one indirect effect of the new regulatory scheme: The troublesome Webb, who says he may lie low as an activist until the climate for reform improves, probably won't be breathing down their necks as much. "He is widely respected and even feared" by companies, says an executive who knows him well. A frequent witness of Webb's interrogations of regulatory officials offers this account: "You just sit there, and you know it's coming. He's frighteningly knowledgeable, a touch arrogant but always entertaining." Last year Webb spent some 200 hours attending 33 annual general meetings, plumping for better treatment of minority shareholders and more transparency.

Many of Webb's critics and even some partisans say that he might accomplish more if he were a tad more diplomatic. At Hong Kong and China Gas Co.'s annual meeting in April 2003, one shareholder, after having listened to Webb's grilling of the utility's executives, finally snapped: "Would you shut up? You ask too many questions. You are delaying the meeting. It is lunchtime. I want lunch now." Webb reportedly responded: "If shareholders come for dim sum, they should come over later, as in the future annual general meetings will last for more than five minutes. People like me will ask more questions."

Webb's all-or-nothing approach can annoy even allies. "Everything's black and white for him," says a former colleague. "It's not easy for David to see that another person's point of view might be a valid perspective." Webb himself concedes that he's not given to compromise.

As an active investor, he has had a front-row seat from which to observe the ways the HKEx's conflicts of interest have resulted in missteps. One mistake, in his estimation, came at the height of the dot-com craze, in late 1999, when the exchange created a second board, known as the Growth Enterprise Market, to help small and midsize enterprises raise capital. Webb says the HKEx didn't adhere to uniform listing standards, admitting too many companies that were unprepared to weather the storm in technology shares. Almost two thirds of GEM's companies have seen their stock prices fall more than 70 percent since their listing, even after a solid 31 percent rally in the index this year.

"For sure, this was highly profitable for the placees, investment banks, brokers, lawyers and accountants who make the wheels of the market go around," says Webb. "But tens of thousands of retail investors lost billions of Hong Kong dollars as they got sucked into the postlisting hype and, in the process, GEM, which started as a sensible idea to provide capital for small and medium enterprises, was hijacked into a tycoons' and con artists' playground, destroying its credibility."

The HKEx stumbled again in 2002 when it issued a consultation paper proposing to delist penny stocks. The plan, which would have resulted in 370 listed companies being ejected from the exchange, caused a mini-crash, and the government intervened to force HKEx to withdraw the idea. "HKEx's penny stocks proposal reflected a complete lack of comprehension of the way markets work from a regulator that claims to be market savvy," says Webb. "It simply did not realize that if a company is deprived of a listing, then investors are left without a marketplace and without a regulatory framework for their investments."

Webb charges that the HKEx has been overly accommodating of bigger listees. He cites as a recent example Hutchison Whampoa being allowed in February to sell its fixed-line telecommunications business, Hutchison Global Communications, to Vanda Group, a listed company. The exchange permitted the deal to go through even though it didn't meet HKEx's rule that businesses may be injected into listed companies only after they have had three consecutive years of profits. HKEx sidestepped the standard, he says, by decreeing that Hutchison Global was already listed because it was part of the public Hutchison Whampoa. "The transaction fitted with previous established practice in the area," says listings chief Williams. Recent rule changes, however, bar such backdoor transactions.

Webb says that Hong Kong's regulatory framework faces fresh stresses as state-owned mainland Chinese enterprises line up to go public in Hong Kong. In January the exchange relaxed its listing rules to allow companies lacking the normally required three-year track record to sell shares. But the easing troubled many investors, who note that Beijing-based China Life Insurance Co. and China Minsheng Banking Corp. have already run into governance problems. China Life, which went public in New York and Hong Kong last December, is the subject of a class action following allegations that its predecessor failed to disclose accounting irregularities before the IPO. China Minsheng has been forced to delay its Hong Kong listing after admitting that its executives faked holding a shareholder meeting and forged documents before its Shanghai listing in 2000. Webb says these examples illustrate why making it easier for such companies to list in Hong Kong strikes him as a bad idea. "In a disclosure-based market, that relaxation of rules is fundamentally wrong," he says. "We need disclosure."

Responds Williams, "We are a venue for raising risk capital -- with emphasis on the word 'risk.'" For the HKEx listing chief, a profitable track record is not an absolute test of a quality issuer. "A modest profit-generating record may not stand up against a much larger company and its progress, notwithstanding that it hasn't been profitable," he points out. And when there is investor appetite for particular stocks, says Williams, the HKEx must grapple with the issue of which minimum requirements should apply. "If you have a disclosure-focused regime, as we do," he says, "then so long as you are providing sufficient information about trading performance and the business model on listing that should be sufficient."

To be sure, HKEx isn't the only major exchange that has suffered corporate governance embarrassments. And even Webb acknowledges that Hong Kong is headed in the right direction. But the government must step up the "glacial" pace of reforms, he says. The Shanghai Stock Exchange and the Shenzhen Stock Exchange already have a combined market cap of $562 billion, compared with HKEx's $487 billion, and they have begun to improve in Standard & Poor's governance ratings. For instance, their listed companies must report quarterly; Hong Kong­listed companies need do so only once every six months.

Financial Secretary Ma's reforms don't give Hong Kong much breathing room, warns Webb. "Every time there is a revision of any aspect of our regulatory framework," he laments, "we seem to come out at a range of one to two on a scale of zero to ten, ten being what should be done and zero being doing nothing."