In mid-August, Business Live published an opinion piece titled “Making deals with the devil” in which the author accuses the JSE of compromising its commitment to shareholder rights 1. This follows proposed changes to the listing requirements in which the JSE loosens the rules on dual class shares for new listings. Specifically, the JSE’s proposal reads:
“Considering developments in other leading international markets, the JSE is proposing the introduction of dual-class shares. This proposal will be accompanied with appropriate safeguards to afford the necessary investor protection and will allow the JSE to remain competitive and to attract new listings.”
This proposal has sparked widespread controversy, with the opinion piece mentioned above being but one example. Critics of the proposal perceive this to be a dangerous step backwards for shareholder rights, increasing the potential for abusive practices.
The amendments to the listing requirements are being introduced at a time when a growing number of issuers are delisting from the JSE. The past few years reflect 20 delistings in 2020, 25 in 2021 and, at the time of writing, the expected number of delistings for 2022 comes to 32. Moreover, a low number of new listings means that the JSE experienced a net decline in the number of listings over this period. In part, the decline in listings can be attributed to increased competition from alternative platforms that have less stringent rules. As a commercial for-profit exchange, the JSE competes with stock exchanges in the United Kingdom (LSE), Hong Kong (HKEX), Singapore (SGX) and elsewhere. All these exchanges are keen to attract listings from companies in high-tech industries and innovative sectors. Problematically, these companies tend to have founders that have a strong preference for dual-class share (DCS) structures as a mechanism to retain control of the business that they started and that, quite often, are strongly associated with their own personal brand. Against this backdrop, the JSE must compete for new listings on a global level, whilst having to ensure appropriate levels of investor protection. The exchange is therefore faced with the conundrum of having to strike a balance between an enabling regulatory environment for issuers on the one hand and shareholder rights (in the form of protection against market abuse and good corporate governance principles) on the other.
At 36ONE, we appreciate that exchanges compete with each other and that the playing field is not always level for an emerging market exchange, such as the JSE. We know that issuers and their founders can choose between many different exchanges and will choose the exchange that best ensures the freedom to execute their idiosyncratic vision. As a result, regulatory arbitrage remains a valid concern for commercial stock exchanges around the world. However, we believe that DCS gives too much power to management and other insiders. This induces agency costs that harm outside investors, as it allows companies to largely ignore general investor opinion that would otherwise keep management in check. Moreover, we do not agree with arguments that a company’s track record can justify an opaque share structure or weak corporate governance. A company may have an excellent track record without any questionable transactions (such as related party arrangements) that tarnish its reputation, but there is absolutely no guarantee that this track record will be maintained in the future. This is especially true when there is no mechanism to prevent a first and isolated transgression of good management principles from snowballing into repeated (and larger) missteps. In support of this, research shows that advantages of DCS tend to fade over time as agency costs rise and the structures become inefficient. Worryingly, when matters have gone badly wrong, public shareholders of listed DCS companies have limited to no influence to effect change. As Shari Redstone wrote in the Financial Times:
“Shareholder democracy is a burden to companies that are well run. But for shareholders, this is akin to the burden of carrying an umbrella. When it begins to rain…the cost can suddenly seem like one worth paying.” 2
By contrast, some argue that it is up to investors to decide in which companies to invest and that investors must ultimately decide if DCS should detract from a company’s value. However, in a world that has embraced passive investing, it is worth noting that these investment vehicles do not deviate from the index constituents, so their investors would therefore be forced to invest in firms with DCS, particularly if the firms are very large. Furthermore, the argument that one can rely on market forces alone for investor protection is nonsensical. In fact, the lack of investor protection in an unregulated market is the reason that we have regulators, who must ensure effective monitoring of markets and enforce high corporate governance standards when market mechanisms fail.
However, putting ideological arguments aside, it is worth considering if DCS bring any practical benefits to investors. More flexibility in listing requirements could entice more firms to enter the listed environment. This would increase the depth and breadth of capital markets, increasing investment choices and adding to the vibrancy of financial markets. These advantages cannot be easily dismissed, so it is worth considering whether appropriate safeguards are able to minimise the risks for shareholders. Such safeguards have been suggested by several research firms and consultancies and include, for example, sunset clauses (both time and event-based), capping the maximum vote differential between different share classes and reverting to one-share-one-vote for large and related party transactions. In this respect, the proposed safeguards of the JSE include many of these recommendations, such as time-based sunset clauses (where shares are automatically merged into a single class at the end of this period), capped vote differentials between different share classes and regulated voting processes for specific decisions.
Therefore, we believe that the JSE is taking a pragmatic approach to this highly contested proposal and that the suggested safeguards will significantly reduce the risks imposed by DCS. In our view, the JSE is attempting to reach a middle ground (similar to the HKEX, SGX and LSE) where issuers have the flexibility that they desire, but appropriate safeguards are in place to mitigate the risk to corporate governance and shareholder rights. If the proposal should succeed in attracting new listings to the JSE, we believe that the benefits of this piece of regulatory innovation could well outweigh the risks. However, in our view, the caveat remains that effective safeguards need to be in place and rigorously implemented for a successful long-term outcome. As the familiar saying goes: “The devil is in the detail.”
1 Rob Rose: Making deals with the devil, 18 August 2022. Available at: https://www.businesslive.co.za/fm/opinion/editors-note/2022-08-18-rob-rose-making-deals-with-the-devil/
2 Shari Redstone: A dysfunctional family reunion at CBS/Viacom, 15 May 2018. Available at: https://www.ft.com/content/a309565a-5829-11e8-b8b2-d6ceb45fa9d0