In Defense Of Short-Selling – And The SFC – In Hong Kong by Anonymous Analytics – this article was first published by ActivistShorts – for some background on AA see this Lisa Pham Bloomberg article and this Reuters one
Last month, Hong Kong held its 4th annual Sohn Conference – a charity event that takes place each year throughout major financial centers where hedge fund managers present their best investment ideas.
What made this year’s Hong Kong conference so unique is that it was the first time in four years running that a short idea was presented. It was such a rare moment for Hong Kong that an article in the Financial Times covering the event started with a facetious trigger warning alerting readers they were about to be exposed to a short idea. Even during the previous year’s Hong Kong conference – in June 2015, at the height of China’s stock bubble – no one stepped up to present a short idea. It was just more hedge fund managers in overpriced suits promoting more overpriced stocks.
Meanwhile, in the rest of the free world, a Sohn Conference featuring numerous short ideas isn’t just expected, it’s celebrated. In this respect, we view Sohn as a barometer of free speech the same way the Big Mac Index is used to gauge purchasing power between currencies.
In open markets including New York, London, Toronto – wherever – no one is afraid to present a critical idea. In Hong Kong, not so much. If it’s not fear of retaliation from the target company, it’s fear of a heavy-handed regulator.
The Public Interest Test
In 2014, the Securities and Futures Commission (SFC), Hong Kong’s regulatory body, brought unprecedented charges against Moodys and Citron’s Andrew Left for critical research they published on Hong Kong-listed Chinese companies. The SFC insists that the cases are not about limiting free speech, but these assurances are hard to reconcile with the fact that there is substantially more promotional research published in Hong Kong and no analyst has ever been charged for being “misleading” or “reckless” in their ‘buy’ recommendation. It’s also unfortunate that these charges were brought at a time when booksellers are disappearing, newspaper editors are being attacked with cleavers in public, and Hong Kong’s press freedom index has fallen from 18th in 2002 to 69th place this year.
Furthermore, it’s difficult to see how these regulatory actions serve the public interest. How will charging Moody’s bring a net benefit to investors and market participants? What institution is now going to want to step up and publish the critical research that Hong Kong so desperately needs?
If there were more red-flag reports from rating agencies prior to the 2008 financial crisis perhaps we wouldn’t have torpedoed the global economy.
But here we are today.
And off course, these charges aren’t going to stop analysts from holding critical opinions. The SFC has only succeeded in suppressing negative opinions and views from being published and easily accessible to all investors. Therefore, it will be the hedge fund managers who can afford direct access that will have the privilege of hearing an analyst’s unfiltered thoughts on a company, at the expense of Hong Kong’s retail-heavy investor base.
Making the market a more opaque and fearful place leaves us all poorer.
For Great Justice
Yet, if we – us, the media, market commentators – are collectively going to blame the SFC for actions that we see as a step backwards, we also have to credit the SFC for actions that we see as a step forward.
Five years ago, the Hong Kong market was a cesspool of fraud and corporate corruption. It’s where questionable companies that were the runt of an already s#ty gene pool went to list. Meanwhile, investment banks were so focused on closing deals and collecting their bonuses that they cared more about a company being marketable than the accuracy of its financial statements.
But a lot has changed since then.
The SFC has been instrumental in cleaning up the Hong Kong market and holding investment banks accountable for the accuracy of an issuer’s IPO prospectus. In addition to sponsor liability, the SFC has also implemented less publicized measures for catching frauds before they have a chance to make it on the Exchange. As much as the SFC has created an air of concern among short-sellers and publishers of critical research, there is equal concern shared among investment banks and auditors for fear of slipping in their roles as public gatekeepers.
As a sign of the changing times, this year JP Morgan became the first bulge bracket casualty to end up on the HKEx’s public “name and shame” list for inadequate work on an IPO application – a humiliating blow to a global franchise, and a warning to other investment banks.
As well, new underwriting standards have led to noticeably declines in market fraud. According to Activist Shorts Research database, the number of fraud allegations against a Hong Kong-listed company were two in 2013, five in 2014, six in 2015, and only 1 so far in 2016. Almost all of these fraud allegations targeted companies that listed during the old sponsorship regime.
Yet, despite the declining number of frauds, the SFC has rarely received recognition for its efforts. Perhaps it’s difficult to get credit for something that doesn’t happen.
In the next five years, we predict short sellers will gradually turn their talents to finding undervalued companies as Hong Kong cleans up. But the road ahead remains long and will be littered with the corpses of more fraudulent companies to come.
Regulators need to continue to push for better due diligence standards just as much as they need to be more accepting of activist short sellers to improve transparency and price discovery. Holding critical research to different standards than the bullish cheerleaders that dominate Hong Kong’s market is counterproductive policy that we will all eventually pay for.