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By Denny Thomas and Elzio Barreto
HONG KONG (Reuters) - Lauded by many for its principled stance in rejecting Alibaba Group's plans to list shares, the Hong Kong Stock Exchange has left the city's financial community fuming at a lost opportunity, and re-ignited calls for market reforms.
The Chinese e-commerce giant founded by billionaire Jack Ma failed to convince Hong Kong regulators to waive rules over the group's unique partnership structure - specifically that 28 partners, mainly founders and senior executives, would keep control over a majority of the board, even though they own only around 10 percent of the company.
An inflexible Hong Kong's loss is likely to be New York's gain - as the NYSE Euronext and the Nasdaq OMX Group battle to attract what is expected to be one of the world's largest stock offerings in the last five years.
This has left Hong Kong's banking community ruing the one that got away, and blaming arcane regulations for missing out on a fast growing Chinese Internet stock - and an IPO fee bonanza.
DAMNED IF IT DOES, DAMNED IF ...
In denying Alibaba special status, Hong Kong's regulators made clear they're not willing to compromise when it comes to safeguarding small investors and treating all shareholders alike.
Deal bankers, lawyers and advisers contacted by Reuters in Hong Kong queried whether regulators couldn't have done more to accommodate a company that wanted to list in the city, is worth an estimated $80 billion, and rising, and would have boosted a thin IPO pipeline at a time when Hong Kong Exchanges and Clearing Ltd's (HKEx) net profit is around a fifth below what it was three years ago.
The loss of Alibaba should prompt changes to the city's financial market framework, they said.
"One IPO won't have an impact, but in terms of the bigger picture, HKEx's ability to attract big IPOs, especially high-profile banner deals, will have a bearing on its long-term success," said UBS analyst Stephen Andrews.
CONFLICT OF INTEREST
One issue to resurface is the Hong Kong Exchange's dual role as IPO regulator and a publicly traded company that benefits from listing fees and trading volumes.
It's a conflict of interest debate that has been going on for a decade. In 2003, a Hong Kong government expert panel recommended merging the exchange's listing authority into the Securities and Futures Commission (SFC) - but only one aspect of the entire proposal was eventually implemented.
While refusing to buckle to Alibaba's demands has cheered Hong Kong's corporate governance advocates, the exchange itself recognizes its own inflexibility. In a long blog post this week, HKEx CEO Charles Li suggested maybe leaving open the door to potential changes, so long as discussions aren't rushed.
"He's clearly struggling with this issue," said David Neuville, a partner at law firm Cadwalader, Wickersham & Taft LLP in Hong Kong, specializing in capital markets. "Certainly, the U.S. exchanges are more flexible and appear to be doing just fine. Additional flexibility may come in handy for them to continue the development of the Hong Kong stock exchange."
SOME WIGGLE ROOM
The Hong Kong exchange, second only to Chicago Board of Trade and New York Mercantile Exchange operator CME Group Inc in market value, has been here before - and budged.
In 2009, the exchange allowed Russian aluminum giant United Company Rusal to list in Hong Kong, even though the company failed to meet the city's profitability standards. Regulators allowed the offering to go ahead but restricted the retail portion of the deal, which remains below its IPO price.
In March 2011, Hong Kong lost a $5.5 billion IPO when Hutchison Port Holdings Trust, controlled by Asia's richest man Li Ka-shing, listed in Singapore as Hong Kong did not allow business trusts. Trusts come with unique shareholding structures which Hong Kong opposed for years, though they have been welcomed in markets from Bangkok to Kuala Lumpur.
That loss prompted heated debate among bankers, government officials and legislators concerned that Hong Kong was losing a competitive edge on listings. Months later, officials were able to create a structure similar to business trusts - called a single investment - and in November of that year PCCW Ltd, headed by Li's son, raised $1.2 billion with the listing of HKT Trust.
Hong Kong has also been open to Chinese Internet stocks, with Tencent Holdings market value soaring to $98 billion today from just $800 million when it listed in 2004. Tencent stock accounts for about 3 percent of the Hong Kong exchange's average daily turnover and is among the top 5 traded stocks.
Some in Hong Kong lamented the loss of a lucrative Alibaba IPO, noting that the exchange's average trading volumes last year were 39 percent below a 2007 peak. Slowing Chinese economic growth and lack of big stock listings have been a drag on Hong Kong in the last two years. To reduce an equity market reliance, the Hong Kong exchange last year bought the London Metal Exchange for $2.1 billion, betting on China's hunger for commodities, but the benefits of that acquisition are only expected to fully kick in from 2015.
David Webb, a shareholder activist and Hong Kong regulator, said it's hard to make exceptions - even for a company as big as Alibaba.
"If regulators make an exception for one new listing, then many future applicants will want the same thing, and existing listed companies will complain they should be allowed to do it too," Webb posted on his website.
(Editing by Michael Flaherty and Ian Geoghegan)