(SINGAPORE) China has opened up its equity market to foreign investors in recent years but market players need to tread carefully in the mainland, with minority shareholder rights still an issue there.

A study by the RiskMetrics Group has noted that investors in China are still unsure of how corporate governance works there, with shareholder protection laws still very much untested.

In contrast, Hong Kong - which shares certain characteristics with the mainland, such as the prevalence of controlling shareholders in companies - has better established and more consistently enforced shareholder protection rules.

RiskMetrics, which is a provider of risk management and corporate governance services, found, upon comparing the governance practices in these two markets, that Hong Kong enjoys a comparative advantage over mainland China in protecting minority investor interests.

Its study underscores the growing recognition of corporate governance as an investment consideration not only in protecting investments but also in driving growth and securing corporate advantage.

RiskMetrics noted that China has made significant progress in recent years: it has reformed its securities markets; mandated independent directors, making it easier to sue directors; and brought financial reporting substantially in line with International Financial Reporting Standards (IFRS).

Like Hong Kong, it has significant legislative/regu-latory support for shareholder rights and protection from related party transactions damaging to shareholder wealth. Both Hong Kong and China allow derivative actions, but not class actions, for shareholders. They also allow cumulative voting, but prohibit shares with multiple voting rights.

But, as David Smith, RiskMetrics Group Analyst and author of the report, notes: 'While China has moved forward on governance reforms, the report findings showed that these improvements had yet to be tested.'

RiskMetrics has noted that many mainland companies have tried to 'piggy-back' on the perceived higher standards of corporate governance in Hong Kong, which has a governance environment that's arguably the best in Asia.

But, investors keen on the China growth story need to be aware that appearances can be deceiving.

Many Chinese companies are majority-owned by the State, which results in independent directors often being nominated and elected by the majority shareholder - with robust challenge and constructive debate in the board room possibly lacking as a result.

'Until share ownership becomes more widely dispersed across the region, investors are unlikely to see progress towards a culture of genuine independent directorship. Investors should apply special scrutiny to related-party dealings in the absence of independent boards,' Mr Smith notes.

Mergers and acquisitions in China could also be challenging, with rules and regulations being both opaque and untested.

More needs to be done on insider trading regulation in China, for example, to extend the definition of insiders to include former directors and executives. And while reporting requirements in China reflect IFRS and International Standards on Auditing, the mainland suffers from a shortage of trained and experienced auditors and accountants.

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