Hong Kong isn’t immune to company fraud, but proximity, a shared language and closer vetting means the market is more likely to smell a rat
Bloomberg 24 June 2011
Chinese companies in Hong Kong are less likely to fool investors than those in the United States because the city’s bourse does more to prevent fraud, Hong Kong Exchanges and Clearing chief executive Charles Li Xiaojia says.
The MSCI China Index of 147 stocks available to foreign investors is down 10 per cent since reaching a five-month high on April 21. That compares with a 27 per cent plunge by Chinese companies that went public through US reverse mergers, in which a closely held company buys a publicly traded shell and retains the US listing. While bearish bets on the MSCI China have climbed to a record, Li says companies listed in Hong Kong are subject to too much scrutiny to deceive the market for long.
“I’m not saying we have a superior system, but we do have a more prescriptive system for vetting issuers and we have a more prescriptive and sometimes a little more burdensome process,” Li said. For some Chinese companies that listed in the US, “particularly through reverse takeovers, I don’t know how they ended up there”, he said, without citing specific offerings. “They wouldn’t have seen the light of day here.”
China’s reputation among investors was strained after short-sellers said companies such as Sino-Forest were exaggerating operations. Sino-Forest shares have slumped 87 per cent in Canadian trading since June 1, the day before Carson Block of Muddy Waters said it overstated timber holdings.
Li said companies with share structures that concentrated voting power with management and that did not directly own their operating subsidiaries might not be eligible for listing in Hong Kong. The exchange also cited rules that subject some companies using takeovers to go public to the same vetting process as initial offerings. A spokesman for the US Securities and Exchange Commission declined to comment.
There are 106 Chinese reverse-merger companies listed on US exchanges, according to NYSE Euronext, the biggest American bourse operator. Nasdaq Stock Market listed 75, NYSE Amex had 24 and the New York Stock Exchange had seven.
“Nasdaq takes seriously the concerns which have arisen with reverse merger transactions and has responded by adopting enhanced screening procedures in our initial listing process,” Wayne Lee, a spokesman for New York-based Nasdaq OMX Group, said.
Richard Adamonis, a spokesman for New York-based NYSE Euronext, which runs NYSE Amex and the New York Stock Exchange, said: “We review all listing applicants to assess compliance with financial, corporate governance and qualitative listing standards as set forth in our rules, pursuant to a rigorous, risk-based due diligence process.”
Georgetown University professor James Angel said Americans faced obstacles to getting information on Chinese companies. “Hong Kong has the advantage of being much closer to the mainland language-wise and culturally,” he said. “If I were going to run a fraud, I would find the most gullible people and if the locals in my backyard know that I don’t have a business here, then I will go abroad.”
Li said investors in Hong Kong were not immune to fraud. “Regulation can always improve and it’s there to prevent detectable fraud, but when you have people that are determined to scheme the system, there’s only so much regulators and professionals can do,” Li said. “No matter how stringent your regulatory system, the bad apples will still exist.”
The former management of China Forestry Holdings falsified bank documents and logging permits, the company said in an April 29 filing with the Hong Kong exchange. China Forestry halted trading in its stock in January and replaced chief executive Li Han Chun. He was detained by police in Guizhou province in February for allegedly embezzling 30 million yuan (HK$36.12 million).
“While there’s a great macro story about China, the micro story is still one of lower-quality companies,” said Nicholas Yeo, the Hong Kong-based head of China and Hong Kong equities at Aberdeen Asset Management.
“It’s only now that investors are starting to wake up and pay attention to the individual companies. You can’t go in blindly.”
About 4.8 per cent of shares available for trading among companies in the MSCI China had been shorted, the highest level on record, according to data compiled by Data Explorers since 2006. That compares with 2.9 per cent at the beginning of the year. Short investors bet against a stock by selling borrowed shares with the hope of buying them at a lower price.
The SEC has increased its focus on Chinese-based companies. The agency cautioned investors on June 9 about buying stakes when they gain listings through reverse mergers.
“A lot of the reverse takeovers and shadowy shareholder operations, which is a very unique territory, it’s a breeding ground for issues,” Li said. “It’s easier to go to a place where the entire ecosystem is less familiar and less experienced in dealing with China and has less opportunity to verify and cross check some of the stories.”
“Inconsistencies” had been found in the valuation of Sino-Forest’s holdings in Yunnan province, Canada’s Globe and Mail said on Saturday, citing Chinese government officials and forestry experts.
Paulson & Co. sold all its stock in the Hong Kong- and Ontario-based company, which owns tree plantations, according to a regulatory filing on Monday. John Paulson’s New York-based hedge fund, which made US$15 billion in 2007 betting against subprime mortgages, was previously its its biggest shareholder.
“He’s probably absolutely top-notch in figuring out subprime, but in figuring out China, he’s probably most like everyone else on the other side of the Pacific,” Li said of Paulson. “The investor base, the practitioners and the professional advisers here have done a lot more with the Chinese companies because when you live here and you speak the language, you can easily check in the same time zone and smell out the problems.”
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Why dodgy firms go West
Hong Kong isn’t immune to company fraud, but proximity, a shared language and closer vetting means the market is more likely to smell a rat
Bloomberg
24 June 2011
Chinese companies in Hong Kong are less likely to fool investors than those in the United States because the city’s bourse does more to prevent fraud, Hong Kong Exchanges and Clearing chief executive Charles Li Xiaojia says.
The MSCI China Index of 147 stocks available to foreign investors is down 10 per cent since reaching a five-month high on April 21. That compares with a 27 per cent plunge by Chinese companies that went public through US reverse mergers, in which a closely held company buys a publicly traded shell and retains the US listing. While bearish bets on the MSCI China have climbed to a record, Li says companies listed in Hong Kong are subject to too much scrutiny to deceive the market for long.
“I’m not saying we have a superior system, but we do have a more prescriptive system for vetting issuers and we have a more prescriptive and sometimes a little more burdensome process,” Li said. For some Chinese companies that listed in the US, “particularly through reverse takeovers, I don’t know how they ended up there”, he said, without citing specific offerings. “They wouldn’t have seen the light of day here.”
China’s reputation among investors was strained after short-sellers said companies such as Sino-Forest were exaggerating operations. Sino-Forest shares have slumped 87 per cent in Canadian trading since June 1, the day before Carson Block of Muddy Waters said it overstated timber holdings.
Li said companies with share structures that concentrated voting power with management and that did not directly own their operating subsidiaries might not be eligible for listing in Hong Kong. The exchange also cited rules that subject some companies using takeovers to go public to the same vetting process as initial offerings. A spokesman for the US Securities and Exchange Commission declined to comment.
There are 106 Chinese reverse-merger companies listed on US exchanges, according to NYSE Euronext, the biggest American bourse operator. Nasdaq Stock Market listed 75, NYSE Amex had 24 and the New York Stock Exchange had seven.
“Nasdaq takes seriously the concerns which have arisen with reverse merger transactions and has responded by adopting enhanced screening procedures in our initial listing process,” Wayne Lee, a spokesman for New York-based Nasdaq OMX Group, said.
Richard Adamonis, a spokesman for New York-based NYSE Euronext, which runs NYSE Amex and the New York Stock Exchange, said: “We review all listing applicants to assess compliance with financial, corporate governance and qualitative listing standards as set forth in our rules, pursuant to a rigorous, risk-based due diligence process.”
Georgetown University professor James Angel said Americans faced obstacles to getting information on Chinese companies. “Hong Kong has the advantage of being much closer to the mainland language-wise and culturally,” he said. “If I were going to run a fraud, I would find the most gullible people and if the locals in my backyard know that I don’t have a business here, then I will go abroad.”
Li said investors in Hong Kong were not immune to fraud. “Regulation can always improve and it’s there to prevent detectable fraud, but when you have people that are determined to scheme the system, there’s only so much regulators and professionals can do,” Li said. “No matter how stringent your regulatory system, the bad apples will still exist.”
The former management of China Forestry Holdings falsified bank documents and logging permits, the company said in an April 29 filing with the Hong Kong exchange. China Forestry halted trading in its stock in January and replaced chief executive Li Han Chun. He was detained by police in Guizhou province in February for allegedly embezzling 30 million yuan (HK$36.12 million).
“While there’s a great macro story about China, the micro story is still one of lower-quality companies,” said Nicholas Yeo, the Hong Kong-based head of China and Hong Kong equities at Aberdeen Asset Management.
“It’s only now that investors are starting to wake up and pay attention to the individual companies. You can’t go in blindly.”
About 4.8 per cent of shares available for trading among companies in the MSCI China had been shorted, the highest level on record, according to data compiled by Data Explorers since 2006. That compares with 2.9 per cent at the beginning of the year. Short investors bet against a stock by selling borrowed shares with the hope of buying them at a lower price.
The SEC has increased its focus on Chinese-based companies. The agency cautioned investors on June 9 about buying stakes when they gain listings through reverse mergers.
“A lot of the reverse takeovers and shadowy shareholder operations, which is a very unique territory, it’s a breeding ground for issues,” Li said. “It’s easier to go to a place where the entire ecosystem is less familiar and less experienced in dealing with China and has less opportunity to verify and cross check some of the stories.”
“Inconsistencies” had been found in the valuation of Sino-Forest’s holdings in Yunnan province, Canada’s Globe and Mail said on Saturday, citing Chinese government officials and forestry experts.
Paulson & Co. sold all its stock in the Hong Kong- and Ontario-based company, which owns tree plantations, according to a regulatory filing on Monday. John Paulson’s New York-based hedge fund, which made US$15 billion in 2007 betting against subprime mortgages, was previously its its biggest shareholder.
“He’s probably absolutely top-notch in figuring out subprime, but in figuring out China, he’s probably most like everyone else on the other side of the Pacific,” Li said of Paulson. “The investor base, the practitioners and the professional advisers here have done a lot more with the Chinese companies because when you live here and you speak the language, you can easily check in the same time zone and smell out the problems.”
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