Thursday, January 24, 2019

David Webb: Why stock-plunges happen so often in HK

After several recent stock plunges in the market, numerous journalists have asked us why stock-plunges due to forced sales of pledged shares happen so often in HK.
The answer: it's partly because investors are often in the dark about the share pledges by controlling shareholders, so they don't know that there is a risk of a sell-off, which allows prices to rise higher than they otherwise would, particularly if the controller has been buying up stock with borrowed money. The HK Government is ultimately responsible for this darkness, because it has failed to remove a statutory exemption (section 323 of the SFO) for "qualified lenders" - banks, brokers and insurers - from having to disclose security interests (of 5% or more) in pledged shares.
And why has the Government failed to close that loophole? That's partly because the banks, brokers and insurers have a combined 3 seats in the 70-seat Legislative Council and 57 seats (including the 3 legislators) in the 1200-seat Election Committee for HK's Chief Executive. Investors and asset managers have no such seats. The system is rotten to its core. 
Feeble attempts to close the disclosure loophole can be seen as far back as a Jun-1998 consultation on the then Securities (Disclosure of Interests) Ordinance, back when the disclosure threshold was 10%. In a conclusions paper in Mar-1999, the SFC said (page 51):
"In the SFC’s view, imposing a duty on banks and licensed brokers to disclose share pledges before enforcement of security would create undue burden on their normal business activities."
The paper also contained a bunch of excuses on why substantial shareholders should not have to disclose pledges either, including "the substantial shareholder's right to privacy" and that it would "increase the compliance burden on them" and that "disclosure of the pledge itself would not provide meaningful information on the likelihood of a forced sale". We disagree. The probability of a forced sale is zero if there is no pledge, and non-zero if there is a pledge. That in itself is meaningful, and so is the extent of the pledge - the more stock that is pledged, the larger the likely size of the loan. We covered the arguments in more detail in our article of 7-Sep-2004.
Following a further consultation in 2005, the SFC concluded (pages 11-12) that there was a "lack of consensus" (that's always the case when there is opposition from vested interests to reform) but it did set up a working group on the issue, on which your editor served. Lacking any political backing to overcome the vested interests, the SFC gave up after 1 meeting.
So that's the 20-year history, and the next time there's a cluster of foreclosures and stock plunges, we'll just point journalists to this article.
In the meantime, investors can make educated guesses about share pledges by following the movement of major blocks of shares amongst banks and brokers in CCASS, using the "big changes" feature of the Webb-site CCASS Analysis system as explained here.