With the first ‘public filing’ of Alibaba’s prospectus with the US Securities Exchange Commission overnight, Alibaba’s choice of the US as its IPO venue has been formally confirmed. Foreshadowed in preceding months, its choice of the US over Hong Kong is no surprise.
Much attention has been focused on the regulatory issues that have driven this move. The US regulators have a much more permissive approach than Hong Kong to the so-called ‘Variable Interest Entity structures’ -- complex contractual arrangements designed to circumvent Chinese prohibitions on foreign investment in the internet sector while shifting the economic benefits of the business to the foreign listed company.
Hong Kong also has notoriously refused to waive its ‘one share, one vote’ rule to allow Alibaba founder Jack Ma and his management team to retain control of the company. While this led to much hand wringing and soul searching in Hong Kong, this was the correct decision. Hong Kong is a market where listed companies are invariably dominated by powerful controlling shareholders, whether in the form of dynastic ‘tycoon’ families or Chinese state-owned conglomerates. Allowing these controllers to extract more money from the investing public without having to suffer commensurate dilution of their control would have quickly made a mockery of corporate governance and shareholder rights in Hong Kong, and may ultimately have led to the death of the market. While the Hong Kong authorities have announced their intention to conduct a market consultation to consider amending the rules, this process was always going to be too slow for Alibaba.
But regulatory issues aside, it is also important for Alibaba to consider that life as a listed company begins, not ends, at IPO. A listed company does not exist in isolation but in an ecosystem comprising the broader market in which the company trades. This ecosystem depends on a sufficient core of investment bank research analysts covering the sector and willing to write research reports and provide ongoing coverage of the company, which in turn attracts investor attention and hopefully trading volume from what needs be a large pool of fund managers focused on the company and its sector. All of this benefits from the network effect of a large number of similar companies listed on the same market providing a ready source of ‘comparables’ to help investors assess valuation and allow investors to diversify their investments across a portfolio of companies in the sector.
The US market -- and the Nasdaq market in particular -- has all of these features. Hong Kong cannot compete with the tech sector research coverage, large tech-savvy institutional investor base, and the significant number of Chinese dotcoms already listed and actively trading in the US, including major players such as Baidu. Tencent is the only notable Chinese tech company listed in Hong Kong.
So, in light of all of this, it is not at all a surprise that Alibaba should choose to follow the herd to the US. Rather, the surprise is that China’s powers-that-be should acquiesce in its doing so.
Alibaba began essentially as a sourcing agent, connecting Chinese manufacturers with global buyers. It has since grown into a behemoth with increasing significance to the wider Chinese economy. Just one figure demonstrates this: Alibaba represents 5 per cent of retail sales in China. Not just ‘online’ sales -- all retail sales. Its payment channel, Alipay, is also the dominant player serving other online retailers. And, as reported in China Spectator and elsewhere, Alibaba is now looking to branch out into financial services as well, with Jack Ma's bold pledge that “If banks don’t change, we will change them” (The Secret to Alibaba’s success, April 17).
In the context of the Chinese government's ongoing efforts to realign the economy from an export-driven to a consumption-led model, the importance of consumer market players like Alibaba will only increase. That the Chinese government would allow such a strategic player to subject its fortunes to the whims of a foreign regulator is astounding -- especially a foreign regulator that is actively engaged in an ongoing and bitter dispute with its Chinese counterparts on access to auditors’ working papers. If a recent US administrative court decision to ban Chinese branches of the global Big Four auditors from signing off on US GAAP audit reports is not overturned on appeal, it could ultimately lead to the mass delisting of all Chinese companies from US exchanges, and cut off their access to international capital markets. It is hard to believe that the Chinese government would be sanguine about this.
It is also surprising that Alibaba -- recognising that its continued business success, in particular as it seeks to expand into financial services, necessarily requiring numerous government approvals and permits -- would not be inclined to take seriously any ‘friendly advice’ being offered to it by Beijing that a listing in Hong Kong (regarded as much closer to home and within the control of Beijing) would be preferred to a US listing.
All of this gave the sense that what we were witnessing in the course of the past year or more of posturing from all sides was a large and very public game of regulatory ‘chicken’, and sooner or later one side would blink. But, even now that it appears no side has blinked and the US listing is confirmed, this should really be seen as just the latest step in a lengthy and ongoing negotiation, and by no means the end game.
One possible next step, resulting in a (typically Chinese) ‘face saving’ resolution for all parties, would be for Alibaba to undertake a secondary listing of its shares in Hong Kong after the US listing is completed. Hong Kong’s requirements for companies seeking a secondary listing are significantly relaxed, with many listing rule requirements readily waived under the assumption that the overseas ‘primary’ regulator (in this case, the US SEC) carries most of the responsibility for regulating the company and protecting investors’ interests. One of the Hong Kong rules that might be readily waived in this case could be -- you guessed it -- the ‘one share, one vote’ rule. This would be politically palatable in Hong Kong, as it would only be a secondary listing, and the standards for companies seeking a primary listing in Hong Kong would not be compromised. At the same time, a Hong Kong secondary listing would bring Alibaba a step closer to home. This would give the Hong Kong regulators time to conduct their market consultation, and if this ultimately were to result in the rules being relaxed, Alibaba’s secondary listing in Hong Kong could be upgraded to a primary listing -- and the homecoming would be complete.
Antony Dapiran is an international lawyer based in Hong Kong.