Martin Wheatley, chief executive officer of the Hong Kong Securities and Futures Commission (SFC) is trying to steady Hong Kong's market at a time when others are flailing. The day before we meet, Australia and Taiwan announce that they have barred short selling, following the US and UK's ban. Some commentators are calling for Hong Kong to do the same, fearing it will become a refuge for hedge funds looking to short on failing companies. In an exclusive interview with Asialaw, Wheatley discusses his policy on short selling, misselling, quarterly reporting and the changes that the Commission needs to make.
How have things been?
It' hard to know where to focus next. The events of recent weeks have been just staggering, for all of us, and we don't know where it's going to end up.
You are on record as saying that Hong Kong is potentially the most important market in the world, and with the right measures it would realise this potential. Last week's terrible events aside, how do you rate the progress you have made in implementing these measures?
Every market in the world is suffering at the moment, with the global meltdown but what we're not seeing in Hong Kong is systemic creaks in the system. One of the things we've seen over the last couple of days is most of the world’s major markets putting a complete ban on short selling, either for a period or for certain stocks. We haven't made any changes in Hong Kong but that's because we put the structure in ten years ago that bans naked shorting and has protections in place. So while the rest of the world's markets are reacting to what is going on, we haven't got systemic issues in Hong Kong.
Following the UK, US and now Australia and Taiwan's decision to ban short selling, have you reconsidered Hong Kong's stance? Is there a danger that Hong Kong will become a target for short sellers?
It's possible that Hong Kong could become a target and so it's something that we watch very carefully. If we do become a target and see some extreme price moves, we will look at it. You always have to keep these things under review. You can never have absolutes. But the truth is that naked short selling is illegal in Hong Kong so part of the structure that was an abuse in the US and Australian market isn't a problem here. And the tick rule that's in place prevents potentially cascading short selling which drives the market down.
But it's always a risk, so we monitor what's going on every day and what we examine particularly closely are those stocks listed in Hong Kong but also elsewhere. So stocks like HSBC, Standard Chartered and Manulife. If people are unable to short them in the UK and so use Hong Kong as the proxy, then we would look very closely. But we haven't seen evidence of that yet.
Do you have the system in place to ban it immediately, if this does occur?
Yes. Because the way the structure operates here, part of it is embedded in the law, but there is also a list of designated stocks for short selling which is maintained by the Exchange and it can agree with us which stocks should be maintained or removed from the list. We can do that at very short notice if we need to.
There have been calls in the UK for criminalising short selling. Do you think this is a kneejerk, politicised reaction, and do you think short sellers are being made scapegoats for this stage of the crisis?
Yes, I think so. We're seeing extraordinary markets so these are unusual situations. But the move to blanket short selling is a bit of a kneejerk reaction. What should be done is to remove naked short selling and perhaps if that had been done earlier in other markets there wouldn't have been such an extreme move now. The fact that we did remove it ten years has meant that Hong Kong's got a system that appears, so far, at least, to be working well.
Hong Kong has a history of following the US and UK markets. Do you think that in this instance it's the opposite and you have led the way?
I think so. You learn from every crisis. Each one you go through as a market, ideally you come out of with some sensible structural reforms. Hong Kong went through that with the 1997-8 financial crisis, and we made a number of reforms that are still in place today. We learnt our lesson then. Some of the markets that didn't go through the same pain as Hong Kong and Asia didn't make the changes that we made. So in some ways they are catching up with the structure that was put in place for Hong Kong.
Following Lehman's collapse and the protests outside the SFC over the alleged misselling of the bank's minibonds, how important do you think it is at the moment to protect investors? Or do you think the market should be allowed to correct itself?
In the Lehman minibond case, it's unclear to us at the moment the extent to which there was misselling. One of the things we're looking at very carefully is whether there was misrepresentation or misselling of the products. They were sold two years ago as a low risk product, offering 5% to 6% interest, when actually a bank deposit was paying maybe 0.5% in interest. So they were sold as a high-return investment but one with relatively low risk. At the time when people were buying these products, the risks were that one of a basket of credits would fail and typically those credits were major Hong Kong names like HSBC or Cheung Kong. But as with any product, you are also buying it with the risk that the issuer fails. And in Lehman's case, it was the world's fourth largest investment bank. People didn't really think those were risks. We are clearly now in extraordinary times where what were once seen as very remote risks are happening. But it's still early days for us now to determine whether that was the failure of individuals to understand the product, even though they signed a statement saying they did, or if it was the failure of the salespeople to properly explain to people what the risks were. And that's an issue that's going to be quite complex to unravel.
It is widely reported that banks with a lack of qualified salespeople had to rely on hiring front office staff with little financial experience. Coupled with Hong Kong's investors being notoriously keen on risky investments, do you see a problem there?
There are very clear rules in our code of conduct as to what the selling intermediary is required to do. And those clear rules are that they should understand their clients, understand the risk profile of their clients, and make sure the products sold to clients are suitable. In the case of these Lehman bonds and most other structured products, there is an addition to that: a requirement imposed by the manufacturer of the product, that the distributor gets a signed statement that, again, the investor has understood the product and that they understand that they can lose their capital and that they have verified that they can afford to lose their capital if that event was to happen. So there's quite a lot of documentation that covers what should have happened.
But we're still facing the complaints that people just signed the documents because they were told to and they didn't really understand it. For a regulator, these misselling actions are always some of the most difficult to unravel because two years ago clients weren't really worried about risk and were just signing documents saying: 'that's fine, I don't need to understand too much.' And it may have been the case that the selling agents didn't understand the features of the product either. But this is not uniquely a Hong Kong problem.
Is this part of a wider problem in terms of whose job it is to actually educate these investors? Is it the banks' or the regulators' job?
The question we need to ask ourselves is whether the selling channel has been operating effectively or whether good discipline has broken down in the desire to generate market share and commission.
Do you think it has?
It's too early. It's something that we will be looking at, the Hong Kong Monetary Authority will be looking at and I know other regulators in the world will be looking at.
The Hong Kong Stock Exchange has recommended quarterly reporting, but some listed companies view it as a potential burden and worry about the danger of short termism. What is your view?
There is relatively little price sensitive announcements in Hong Kong and Asia generally and we don't have the same culture of continuous disclosure as the UK and Australian markets. So there is a strong case for better and more frequent disclosure. I think there is a real question about the extra burden it places on companies. The audit profession is pretty stretched. There is a real concern that imposing too much of an imposition of figures on a quarterly basis is an unnecessary burden. But the UK model is seen as very helpful. Companies will, in between the six months statements, will give a forward looking view as to what the prospects are for the company and for the market. So there's a strong case for more frequent dialogue between a company and its shareholders but there are a number of ways to do that, either continuous disclosure or quarterly and we're in the debate about how exactly we do that.
There seems to be some ambiguity over the recently introduced closing auction system. What is the reasoning behind the move, and what was at fault with the old system?
I don't think there is ambiguity over the closing auction system. There was some lack of familiarity with it when it started. Closing auctions had been pretty well adopted as the global best practice because it creates a price at the close which best reflects the available volume that wants to execute at that close. And the previous models of either the last trade or the average of a set of small trade could open the market to abuse. But what happens, and I had the same experience in London [Wheatley implemented the system there] and people take a while getting used to that system and so you have a bit of volatility in closing prices until people are geared up to it. We had that early one when there was the large MSCI [Morgan Stanley Capital International] rebalancing which meant that there were some quite strong price swings at the close.
I think it's settled down a lot since then. I know the Exchange is planning to consult on some further tweaking to it, but from my experience in London, we were still tweaking it for about three years introducing slightly different variants, trying to get the best model. So it is the best model, but it takes time to settle down and we're still doing that.
Do you think enough is being done to regulate family-run, Hong Kong listed companies?
In theory there are no different rules that apply to a family company than any other company. They are still subject to the corporate governance code and are expected to operate with non-executive independent directors with an audit committee. And where they don't meet all those requirements they need to explain why to their shareholders. Hong Kong and many Asian countries do have a number of companies that are still family run. But they are still subject to the same corporate governance code as any other company.
But do you think there is perhaps a gap in compliance from these family-run companies?
No I don't. I think there is a general problem in Hong Kong finding independent directors and that is the same for all companies, but many family run companies are extremely well run and take their responsibilities very seriously.
Are you happy with your enforcement record?
We're not expanding our powers, because clearly they are set within the Securities and Futures Ordinance, but we're being more creative about the ways we use the powers we have. So we recently had the first criminal conviction for insider trading, the first custodial sentence imposed, we have directed companies to seek compensation against former directors for abuses to the benefit of shareholders. So we're doing quite a few things now that are taking a more aggressive approach to dealing with what we think are serious market abuses.
There have been some complaints about the statutory force of the SFC with regards to listing rules. The Hong Kong Stock Exchange doesn't have a huge amount of power in enforcing these but while the SFC does, it hasn't been involved in very many. Do you agree with this?
It's an area that needs to change. It is a gap, and it has been a gap for certainly all the time I've been in this job. It's quite complex to change but we are working closely with the government on what that new structure could look like. That will require potentially some legislative change to achieve it but it's something that's very much on the agenda and will be introduced.
Do you have a timeline for that?
No, I can't give you a specific timeline on that.
How do you view Hong Kong's relationship with Chinese listing venues developing? Do you think it will maintain its upper hand as a capital raising centre?
I think it will be more balanced, to be honest. Hong Kong's role as an international capital raising centre is an important one and will remain so. Shanghai will go through a number of cycles before it stabilises as a strong and reliable capital raising platform.
What are your plans for the commission in the future?
In the last year, with markets very buoyant, everyone has wanted good compliance people so we've had a higher turnover than I would have wanted. But we've made our packages more attractive and tried to focus more on the sort of people we want to bring in. But we're also doing a lot of work internally to ensure that we're using our staff as efficiently as possible. We have a fairly major IT project which is to change the processes by which we grant and renew licenses and give approval for different types of product.