[In]Securities GUEST BLOG: Hit the Road, Jack by Aegis Frumento Esq

September 19, 2019

Hit the Road, Jack

"Oh, East is East and West is West, and never the twain shall meet," wrote Rudyard Kipling before describing how Kamal and the Colonel's son tested each other's mettle on the northern border of the British Raj and, despite their cultural differences, emerged as friends. Perhaps hoping for a similar outcome, the Hong Kong Stock Exchange offered to buy the venerable London Stock Exchange for $39 billion last Wednesday. By the end of the week, the LSE had curtly shot it down. https://www.reuters.com/article/us-lse-m-a-hkexlse/hong-kong-exchange-vows-to-press-on-with-39-billion-lse-bid-after-rebuff-idUSKCN1VY19O.  East won't meet West on this frontier, and it's worth exploring why.

There are political angles galore. https://www.bbc.com/news/business-49659779. Hong Kong has been roiled in street protests all summer, boiling over into riots at times. The crux of the problem is that the 1997 treaty by which the U.K. ceded Hong Kong back to China only promised Hong Kong an autonomous government for 50 years. That promise expires in 2047, which is only 28 short years away. https://www.nytimes.com/2019/07/01/world/asia/hong-kong-china-handover.html?module=inline

Already, the Beijing government is flexing its muscles, punishing workers who deign to participate in the protests. https://www.nytimes.com/2019/09/11/business/cathay-pacific-hong-kong-protests.html The HKEX, for all its capitalist trappings, is governed by a board 6 of whose 13 members are appointed by the Hong Kong government. Sooner or later, as the protesters fear and Beijing intends, Hong Kong will become just another Chinese city. And since the LSE already has a partnership in place with the Shanghai Stock Exchange, why would it want to make a long-term bet on the less certain fate of Hong Kong? In the past few days, clearly looking to further undercut Hong Kong's independence, even the mainland Chinese press has been lambasting HKEX's bid. When the LSE cited "political considerations" in its rejection, most thought it referred to 2019 and its riots. But it could as well have referred to 2047 and whatever that will bring. The latter reading is more fundamental.

HKEX is also a bit of a paper tiger when it comes to stock listings. It's not the exchange of choice for major Chinese companies. Alibaba, for example -- China's answer to Amazon, Ebay and Etsy combined -- is not listed on the HKEX. Nor is ZTO Express, China's answer to FedEx and UPS. If you want to buy BABA or ZTO, the only place to get them is as American Depositary Shares on the New York Stock Exchange. That has been the norm for most of China's large corporations (most of which are, by the way, incorporated in the Cayman Islands; you see a pattern here, don't you?).

Admittedly, that may change. The current US-China trade war has some folks concerned enough to consider dual-listing on the HKEX. https://www.nytimes.com/2019/08/22/business/alibaba-hong-kong-ipo.html. See also https://www.scmp.com/business/banking-finance/article/3024858/three-firms-file-ipo-hong-kong-suggesting-thawing and https://www.cnbc.com/2019/07/25/alibaba-could-be-listing-in-hong-kong-other-chinese-firms-may-follow.html. Those decisions would become no-brainers if HKEX also owned the LSE. But make no mistake whom that would benefit. Listing on a major exchange allows Chinese plutocrats like Jack Ma to monetize their enormous stock holdings. Easy access to the LSE if things get sticky in the US (or in China) is their lifeboat. https://www.ft.com/content/d19bf30c-d478-11e9-8367-807ebd53ab77. It doesn't do much for the rest of us.

As the LSE's rejection note said, the political ramifications here "complicate matters." Politics might have driven LSE's rejection, and you could see it that way. But I think there's a more fundamental matter at stake, and it involves Refinitiv.

To trade securities (or anything else) you need two things. You need information and you need a market. You can't decide on a trading price or strategy without knowing something about the thing you want to trade. Only after you've made a trading decision do you need the machinery of a market to make it happen. More than a difference between East and West or the uncertain political future of Hong Kong, last week's short dialogue between the HKEX and the LSE was a debate whether, in the future, information will be more valuable than infrastructure.

Refinitiv is a data company, formerly part of Thompson-Reuters. It delivers information feeds to analytical and trading platforms. Its role is to supply the intelligence that traders need to make decisions. The LSE entered into a definitive agreement to buy Refinitiv for $27 billion. But the HKEX could not afford to buy the LSE if Refinitiv was also part of the package, so the HKEX conditioned its bid on the LSE abandoning Refinitiv. HKEX essentially said, "Instead of you spending $27 billion on Refinitiv, how about we give you $39 billion instead." For the HKEX, it was, "What's not to like?"

Plenty, apparently. The LSE put a finer point on its rejection of the HKEX's offer by at the same time reiterating its intent to close its purchase of Refinitiv. The LSE essentially sees its future in data rather than in an East-West trading infrastructure.

Some short-term thinkers don't get it. See https://www.wsj.com/articles/lse-still-needs-to-prove-logic-of-buying-refinitiv-11564660893. But I think the LSE made the only right move. As I've argued elsewhere, technologies like blockchain will eventually make the machinery of stock exchange trading obsolete. And more than that, because blockchains can be made infinitely scalable at hardly any marginal cost, there won't be any money to be made in the future plumbing of stock trading. However, what technology taketh away, it also giveth. Blockchain technology may eviscerate traditional stock exchanges, but data technology will enrich those who can control its flow to the traders who need it. The LSE is betting on it.

So, when HKEX's CEO told the British press that HKEX's bid for LSE was a "corporate Romeo and Juliet story," he was righter than he realized, because it too would have ended in a double-suicide. Made to choose between being a leading purveyor of high-margin trading data or becoming a Western outpost of the Chinese government, between owning or being owned, the wonder is not how the LSE responded, but why it took so long. I like to think that its lawyers needed the 2 days to cast their answer in the proper Queen's English. "Your assertion that implementation of a transaction would be ‘swift and certain' is simply not credible," it said. "Given the fundamental flaws in your proposal, we see no merit in further engagement." A whiff of the two-word first draft lingers. That is not the sort of rejection that politely says, "Sorry, not tonight -- maybe next week?" It's more like, "Hit the road, Jack -- an' don't ya come back no mo'!"


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog. 

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