Hong Kong ruling may curtail critical analysis

Added 11th April 2016

Hong Kong's recent ruling on Moody's Ratings for a research report will have a chilling effect on further critical research, argues activist David Webb.

Hong Kong ruling may curtail critical analysis

Last week, the Securities and Futures Appeals Tribunal denied an appeal by Moody's Ratings, affirming an earlier decision  by the Securities and Futures Commission to impose a fine and public reprimand on the ratings agency due to a 2011 report entitled "Red Flags for Emerging-Market Companies: A Focus on China".

Webb, a former investment banker and now a local activist, writes on his website that "the SFC and SFAT's general approach" is "deeply disturbing".

"It sets far too high a floor on the acceptable standards of critical research and will have a chilling effect on negative criticism of companies in Hong Kong, in a market in which there is little enough of that already.

"This approach is part of a pattern that indicates a regulatory bias against negative criticism and short­selling."

The Moody's report evaluated 49 non-financial Chinese entities against 20 warning signs it called "red flags" to identify possible corporate governance and accounting risks.

The Hong Kong regulator believes the report "painted an unfair, unclear and misleading picture of the companies" and "failed to ensure the accuracy of the red flags assigned to the companies."

The red flags report was issued shortly after short seller Carson Block, head of research house Muddy Waters, issued a damning report on China's Sino Forest with details of what it said was massive fraud.

The allegations were denied by Sino Forest management. Nonetheless, the report sent valuations of all overseas-listed Chinese companies tumbling as investors ran for the exits over concerns about mainland accounting practices.

A bias toward positive analysis

The Moody's report was five years ago.

Recently, Webb looked six of the companies (five of which were listed in Hong Kong) that Moody's had cited as "negative outliers".He found that four of the six had since defaulted on their debts and the other two "massively underperformed the stock market".

"If the Moody's report was so shoddy, you would think that the red-­flagged companies would have rebounded from the criticism by now.

"If Moody's (or anyone) had published a "Green flags report" singling out those companies (positive outliers) which it thinks have exceptionally good accounting and governance, causing their share and bond prices to go up, would the SFC have clobbered them for minor errors in the flags?"

Webb said Hong Kong needs the kind of critical research that was evident in the Moody's report.

"[B]ut what licensed firm will now dare to publish such a report if the regulator is going to pick it apart afterwards and then slam them with a fine and potential loss of licenses for the individuals involved?"

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