(Reprinted from HKCER Letters, Vol. 87, 2009)

 

Extended "Blackout" Periods: To stay or to go?

Maurice K.S. Tse

 

Introduction

In January 2008, the Stock Exchange of Hong Kong (SEHK) published a Combined Consultation Paper to solicit market feedback on proposals to address 18 policy issues regarding corporate governance, initial listing criteria, and some amendments to improve the clarity, certainty and efficacy of the Listing Rules. The paper received 105 submissions of views and opinions from listed issuers, market practitioners, and professional and industry associations.  Having considered the market practices in overseas financial markets including the UK, Singapore and Australia, the SEHK concluded in November 2008 that the proposal had received broad market support and that 15 of the policy issues would be implemented, effective January 1 2009.  One of these 15 policy issues was a controversial proposal to extend "blackout" periods on directors' dealings in their companies' shares which would now start from a listed issuer's financial year/period end date and end on the date the listed issuer published the announced financial results.¹

 

Before January 2009 in Hong Kong, listed companies had to publish and distribute annual reports within four months of the end of the financial year, and two half-year reports within three months of the end of that period. Additionally, they only needed to report their financial results twice a year. The blackout period in Hong Kong was one month prior to the publication of financial results during which directors were prohibited from trading in their own companies' securities. However, the newly proposed blackout period would be as long as seven months in a financial year. SEHK's rationale behind the proposed extended blackout periods was to improve the corporate governance in Hong Kong by minimising the problem of asymmetric access to information between insider and outsider investors of the listed issuers.²  Allegedly, the low frequency of public disclosure of financial information, the long deadline between year/period end to the publication of financial results, together with the one-month blackout periods essentially gave directors who possess insider information about the listed companies a beneficial period of up to ten months to deal in their own company's securities.

 

The corporate sectors in Hong Kong took issue with the implementation of the proposed extended blackout periods and had grave concerns about their impact on Hong Kong's competitive position as an international financial centre.

 

In order to further understand the market's concern about the issue, we conducted a survey with four straightforward questions probing the market reaction to the extended blackout period and the implementation of mandatory quarterly reporting as proposed by SEHK. The survey was targeted at senior executives, including CEOs, chairmen and directors of listed companies with main business operations located in Hong Kong, China or overseas, as well as local professional associations and financial services companies such as securities firms and investment banks that operated in Hong Kong but were not listed with the SEHK.

 

Survey questionnaires were sent to 1,051 listed companies on 22 January 2009 and 493 were sent to professional associations and financial services companies (market practitioners) on 5 February 2009. By the cut-off date of 20 February 2009, we received 368 completed surveys from the listed companies and 43 from the market practitioners. The group of market practitioners consisted of 38 financial services companies and five professional associations not listed on the SEHK.

 

　

Profile of Survey Participants

Of the 368 listed companies, 101 reported Hong Kong as the location of main business operations, 132 reported China, 79 reported overseas, 10 reported Hong Kong and China, 5 reported Hong Kong and overseas, 5 reported China and overseas, 28 reported Hong Kong, China and overseas, and 8 did not report at all. Three hundred and forty-two listed companies also reported their market capitalisation at the end of year 2008 and the number of employees in Hong Kong and China. The median market capitalisation reported was HK$532 million; the median number of employees in Hong Kong and China were 60 and 1,000, respectively. The following tables present the quartile figures.

　

　

Firm Size in Terms of Market Capitalisation at the End of 2008 (HK$ millions)
Minimum	Lower Quartile	Median	Upper Quartile	Maximum
18.75	208	532	2,458	1,366,330

　

Firm Size in Terms of Number of Employees
Location	Lower Quartile	Median	Upper Quartile
Hong Kong	13	60	300
China	174	1,000	3,400

　

　

On Extended Blackout Periods

The first survey question asked was "Do you agree that the current blackout periods should be extended to commence from the listed issuer's year/period end date and end on the date the listed issuer publishes the relevant results?" Table 1A presents the response from the listed companies and the market practitioners.

　

　

Table 1A: Do you agree that the current blackout periods should be extended?
	Listed Companies		Market Practitioners
	Frequency	Percent	Frequency	Percent
Agree	49	13.3	16	37.2
Disagree	313	85.1	27	62.8
Don't know/No comment	6	1.6	-	-
Total	368	100.0	43	100.0

　

Of the 368 listed companies, 85.1% disagreed with the proposed extension of the blackout period, 13.3% agreed and 1.6% had no comment. Of the 43 market practitioners, 62.8% disagreed and 37.2% agreed. To examine whether the "disagree" response represented the majority view of the listed companies and the market practitioners, a statistical test was performed on whether the proportion of "disagree" responses was greater than 50% of the total number of responses.³ The test result indicated that the proportion of participants responding "disagree" were of a majority view for both the listed companies and the market practitioners at 1% and 5% level of significance, respectively. Moreover, the listed companies disagreed more than the market practitioners at 1% level of significance.⁴

　

To the 313 listed companies and 27 market practitioners who disagreed with the extended blackout periods, a further question was asked to understand why they disagreed. Five possible reasons and an "Other" option were given to the participants to choose from as shown in Table 1B. Participants were allowed to choose more than one reasons.

　

Table 1B: If you disagree, please provide reasons for your views.
	Listed Companies		Market Practitioners
	Frequency	Percent	Frequency	Percent
It will deter existing and future listings on the SEHK	194	62.0%	14	51.9%
It will jeopardise an important source of stable support for shareholder value in unanticipated crises or events	267	85.3%	21	77.8%
It will discourage talented individuals of the right calibre from becoming directors of listed companies	174	55.6%	13	48.1%
It will damage the continued viability and health of the Hong Kong stock market	210	67.1%	14	51.9%
It will deprive directors of their legitimate rights in respect to dealing in their companies’ securities	266	85.0%	21	77.8%
Other	66	21.1%	7	25.9%
Number of respondents	313		27

　

For the group of listed companies, the main reasons for disagreeing were (1) "the blackout will jeopardise an important source of stable support for shareholder value in unanticipated crises or event" (85.3%) and (2) "the blackout will deprive directors of their legitimate rights in respect to dealing in their companies' securities" (85.0%). All five possible reasons except "Other" represented the majority view of the group at 1% level of significance.⁵

　

Similar to the listed companies, the main reasons for disagreeing for the group of market practitioners were (1) "the blackout will jeopardise an important source of stable support for shareholder value in unanticipated crises or event" (77.8%) and (2) "the blackout will deprive directors of their legitimate rights in respect to dealing in their companies' securities" (77.8%). Unlike the listed companies, these two reasons were the only ones that represented the majority view of the group at 5% level of significance.

　

Although the response rates on "the proposed blackout period will damage the continued viability and health of the Hong Kong stock market" were significantly different between the two groups of respondents at 5% level of significance, there was inadequate statistical evidence to show that the overall view on the possible reasons for not supporting the extended blackout periods was different between them.⁶

　

The "other" reasons given by the listed companies and the market practitioners were very similar. One major argument for disagreeing was that the existing reporting system requiring companies to disclose directors' dealings in a timely manner together with market forces had effectively made directors' dealings public information to which every market participant could have easy access. There was no clear evidence that the extended blackout periods would further enhance market transparency and fairness. In fact, the extended blackout periods would likely deprive directors of an important facility that allowed them to stabilise their own company's share value during times of extreme market uncertainty or hostile takeover raids.

　

On the "Best Practice" Approach

SEHK indicated in the Combined Consultation Paper that they had also considered the rules in Australia and Singapore that leave it to the companies to set their own blackout periods. This practice relies on the effectiveness of the insider dealing laws and market forces that prompt companies to pursue tight internal control. SEHK argued that since neither of these two factors may work well enough, it was necessary to specify a fixed extended blackout period.⁷ To understand the view of the market, the second question asked was "Do you support the best practice approach with listed companies setting their own blackout period, as in Singapore?" Table 2 presents the results.

　

　

Table 2: Do you support the "best practice" approach?
	Listed Companies		Market Practitioners
	Frequency	Percent	Frequency	Percent
Support	191	51.9	14	32.6
Do not support	159	43.2	24	55.8
Don't know/No comment	18	4.9	5	11.6
Total	368	100.0	43	100.0

　

　

The views of the listed companies and the market practitioners tended to diverge from each other on the best practice approach. Of the listed companies, 51.9% indicated they supported the best practice approach with listed companies setting their own blackout period as in Singapore and 43.2% indicated they did not support it. Of the market practitioners group, 32.6% indicated they supported the best practice approach and 55.8% indicated they did not. Both the 51.9% support rate of the listed companies and the 55.8% do–not-support rate of the market practitioners represented the majority views of the two groups of respondents at 5% level of significance. Further chi-square tests on the equality of the response rates between the listed companies and the market practitioners indicated that there were significant statistical differences at 5% level of significance between the overall views of the two groups of respondents.

　

The Combined Consultation Paper also consulted the market on the shortening of reporting deadlines and the introduction of quarterly reporting for Main Board issuers.⁸  The next two survey questions purported to provide a gauge on the market sentiments in regard to these two issues.

　

On Shortening the Reporting Deadline

The deadline for listed companies to publish and distribute annual reports used to be four months from the year-end for annual results and three months for half-year results. This requirement provided companies substantial flexibility in managing their reporting activities. Not all listed companies used the maximum deadline periods allowed. As a matter of fact, companies had their own "normal" reporting dates set within the deadline period in such a way that they fell within market expectations. To explore what the market participants thought of shortening the reporting deadline, the third question asked was "Do you support bringing forward the deadline to report year-end/period-end results?" Table 3 presents the feedback.

　

　

Table 3: Do you support bringing forward the reporting deadline?
	Listed Companies		Market Practitioners
	Frequency	Percent	Frequency	Percent
Support	137	37.2	27	62.8
Do not support	219	59.5	13	30.2
Don't know/No comment	12	3.3	3	7.0
Total	368	100.0	43	100.0

　

The views of the listed companies and the market practitioners diverged significantly on whether or not the deadline to report year-end or period-end results should be brought forward. Of the listed companies, 37.2% indicated they supported and 59.5% indicated they did not support shortening the deadline. The 59.5% response rate for "Do not Support" also represented the majority view of the listed companies at 1% level of significance.

　

On the other hand, 62.8% of the market practitioners indicated they supported whereas 30.2% indicated they did not support bringing the reporting deadline forward. The 62.8% support rate also represented the majority view of the market practitioners at 1% level of significance. A chi-square test on the equality of the response rates between the two groups of respondents indicated that their overall views diverged significantly from each other.⁹

　

On Implementation of Mandatory Quarterly Reporting

Major international financial markets such as London and New York require quarterly financial reporting. It has been perceived that that quarterly reporting can help better align Hong Kong with those advanced markets in terms of information flows and disclosure practice, enhanced company transparency, creating a more level playing field between outside investors and directors, and tighter corporate governance due to closer scrutiny by the market. However this perception has come under some skepticism in Europe in the last few years. The listed companies in Hong Kong had serious concerns about mandatory quarterly reporting as well. To understand the underlying reasons for the concerns, the fourth question asked to the listed companies and the market practitioners was "Do you support the proposed implementation of mandatory quarterly reporting?" Table 4A presents the feedback.

　

Table 4A: Do you support mandatory quarterly reporting?
	Listed Companies		Market Practitioners
	Frequency	Percent	Frequency	Percent
Support	58	15.8	27	62.8
Do not support	307	83.4	13	30.2
Don't know/No comment	3	0.8	3	7.0
Total	368	100.0	43	100.0

　

First of all, there were significant statistical differences between the responses of the listed companies and those of the market practitioners. Of the listed companies, 15.8% indicated they supported and 83.4% indicated did not support the move to mandatory quarterly reporting. The 83.4% indicating they did not support the measure represented the majority view of the listed companies at 1% level of significance. On the contrary, 62.8% of the market practitioners indicated they supported and 30.2% indicated they did not support the move to mandatory quarterly reporting. The 62.8% support rate also represented the majority view of the market practitioners at 1% level of significance. The chi-square test on the equality of the response rates between the two groups of respondents provided strong statistical evidence for the divergent overall views between the two groups.¹⁰

　

To the 307 listed companies and the 13 market practitioners that did not support the proposed implementation of mandatory quarterly reporting, a further question was asked to solicit the possible reasons. Four possible reasons together with "Other" were given to the participants and more than one possible reason could be chosen. Table 4B presents the findings on the possible reasons.

　

　

Table 4B: Reasons for Not Supporting Mandatory Quarterly Reporting
	Listed Companies		Market Practitioners
	Frequency	Percent	Frequency	Percent
Insufficient accounting resources	131	42.7	6	42.9
Cost concern	247	80.5	8	57.1
Insufficient manpower	124	40.4	4	28.6
Too much emphasis on short-term results	243	79.2	10	71.4
Other	73	23.8	2	14.3
Number of Respondents	307		14

　

Among the 307 listed companies, the main reasons cited for not supporting the implementation of mandatory quarterly reporting were "cost concern" (80.5%) and "too much emphasis on short term results" (79.2%). Among the 14 market practitioners, the main reasons cited for not supporting mandatory quarterly reporting were "too much emphasis on short term results" (71.4%) and "cost concern" (57.1%).

　

"Insufficient accounting resources" was not a main concern among the respondents. There was strong statistical evidence that the 42.7% response rate on "insufficient accounting resources" by the listed companies represented less than the majority view of the group.¹¹ On the other hand, the 42.9% response rate by the market practitioners was of fifty-fifty split view of the group.¹²

　

"Cost" was more of a concern for the listed companies than the market practitioners. The 80.5% response rate by the listed companies represented the majority view of the group,¹³ whereas the 57.1% response rate by the group of market practitioners was statistically no different from the fifty-fifty view. The views of the two groups of respondents also diverged significantly from each other at 5% level of significance.¹⁴

　

"Insufficient manpower" was not a main concern of the respondents. The response rates for "insufficient manpower" were 40.4% for the listed companies and 28.6% for the market practitioners. They both represented less than the majority view of the two groups of respondents at 1% and 5% level of significance, respectively. Statistical evidence suggested that views on manpower issues between the two groups of respondents were just the same.

　

For "too much emphasis on short-term results", the listed companies and the market practitioners shared a very close majority view of concern, with a 79.2% and 71.4% response rate respectively.¹⁵

　

"Other" popular reasons for not supporting mandatory quarterly reporting in Hong Kong given by the listed companies and the market practitioners can be summarised as follows:

• It is not clear that quarterly reporting will improve the quality of information disclosed.

• It will cause a deadweight loss to shareholders by shifting the management’s focus from operations to window-dressing quarterly reports.

• It will encourage management to pursue short-term results at the expense of long-term opportunities.

• It will lead to excessive market volatility by prompting more speculative activities.

• The cost involved may be substantial to small cap firms.

• The value added to the financial disclosure practice using half-yearly and annual financial reporting is at best marginal.

Conclusion

An important aspect of the SEHK's financial regulations is to strengthen the overall market integrity in Hong Kong by enhancing the fairness, efficiency, transparency, orderliness and robustness of the market.

　

The market sentiments obtained from this survey suggest that the existing rules and regulations are adequate for fighting market misconduct, namely, false trading, price rigging, disclosure of information about prohibited transactions, disclosure of false or misleading information inducing transactions, stock market manipulation and insider dealing. The effectiveness of any set of rules and regulations hinges on the timeliness of whistle blowing and the quality of law enforcement.

　

On the balance of costs and benefits, there is as yet no clear evidence that the new measures will further strengthen corporate governance in terms of board structure and operation, management responsibility and accountability, personal dealings of directors, protection of shareholders rights, and the making of timely disclosure of material information. While hasty regulations will likely meet with strong resistance from listed companies and hence cause value destruction for the market, a flip-flop in policies will definitely tarnish the image of Hong Kong as an international financial centre and should definitely be avoided at all costs. This survey suggests that follow-up research on extended blackout periods, shortening the reporting deadline and mandatory quarterly reporting should be done.

　

　

Notes:

    1 See Issue 18 on "Review of Model Code for Securities Transactions by Directors of Listed Issuers" in Combined Consultation Paper on Proposed Changes to the Listing Rules, January 2008, Hong Kong Exchanges and Clearing Limited.

    2 "Directors' blackout period in Hong Kong – A test of Corporate Governance in Hong Kong", Association for Sustainable & Responsible Investment in Asia, 22 January 2009.

    ³ The null hypothesis that the proportion of "disagree" (p) is larger than 0.5 was tested with the following test statistic:

　

　

　

　

    ⁴ The null hypothesis that the proportion of "disagree" (p) is the same between the listed companies and the financial services companies was tested with the test statistic given by

　

　

  

     where p_c is the pooled proportion of "disagree" in the combined samples of listed companies and financial services companies.

    ⁵ See footnote 3 for the test.

   ⁶ The chi-square test statistic for testing the null hypothesis of the equality of response rates between the listed companies and the market practitioners is given by

　

    n is the number of respondents of the combined sample and is equal to 411 (= 368 + 43). N_j is the observed frequency of each set of outcomes, and np_j is the expected frequency of each set of outcomes. The degree of freedom is equal to 2.

    ⁷ See Section 18.16 of Combined Consultation Paper on Proposed Changes to the Listing Rules, January 2008, Hong Kong Exchanges and Clearing Limited.

    ⁸ See Section 18.19 of Combined Consultation Paper on Proposed Changes to the Listing Rules, January 2008, Hong Kong Exchanges and Clearing Limited.

    ⁹ See footnote 6 for the test statistic.  The corresponding chi-square test statistic with 2 degrees of freedom and the p-value are 13.61 and 0.001, respectively.

    ¹⁰ See footnote 6 for the test statistic.  The corresponding chi-square test statistic with 2 degrees of freedom and the p-value are 61.69 and 0.000, respectively.

    ¹¹ One percent level of significance.

    ¹² There is not enough statistical evidence to reject the null hypothesis that the proportion of "insufficient accounting resources" is equal to 50%.

    ¹³ The null hypothesis that the proportion 80.5% is less than 50% is rejected at 1% level of significance.

    ¹⁴ See footnote 4 for the test.  The corresponding p-value for the test is 0.02.

    ¹⁵ Both 79.2% and 71.4% represent the majority views of the two groups of respondents at 1% level of significance.

   

　

Dr Maurice Tse is Associate Professor at the School of Economics and Finance, The University of Hong Kong.

　

　

　

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