Wall Street, beware: Hong Kong, China exchanges may link up
HONG KONG -- As Chinese companies displaced U.S. firms in fund-raising activities, stock-market regulators in China have confronted a unique problem: how to restructure financial markets to take advantage of the astonishing changes underway.
In response, Beijing appears to be dusting off the one-China principle, weighing plans to super-size markets in the mainland and Hong Kong into a single trading platform.
Recent signs of closer links suggest the idea might not be so farfetched, though there's no official word that any plans are in the works, either.
Merging the stock markets of Hong Kong, Shenzhen and Shanghai makes sense from a number of economic and strategic perspectives, market professionals say, and it may one day usher in a system that would rival the trading power of exchanges in London and New York.
China is already topping the league tables by several measures.
Mainland companies raised more than $62 billion through share sales in the first three quarters, accounting for more than one-quarter of initial public offerings globally, according to Thomson Financial.
During the fourth quarter alone, companies in mainland China are expected to raise $39.5 billion through IPOs, pushing the year's total past the $100 billion mark and making China one of the world's hottest markets for the second year running.
At those rates, the idea of merging the exchanges is catching on.
"With so much money flying around, they would be fools not to do it," said Francis Lun, research director at Fulbright Securities in Hong Kong.
One country, one system?
Pulling it off, however, could be difficult.
China strictly controls capital flows across its borders -- unlike Hong Kong, which has thrived as an open financial center where international funds are free to come and go.
And any such merger seems likely to run into resistance from shareholders of Hong Kong Exchanges & Clearing Ltd. (HKXCF), the local exchange operator also known as HKEx. Theyfear closer ties with the mainland could leave the exchange vulnerable to political interference from Beijing.
What's more, stock markets located in the northeastern coastal city of Shanghai and the south inland industrial city of Shenzhen hail from a regulatory culture distinct from Hong Kong, the former British territory that's governed with a high degree of autonomy from the rest of China.
HKEx Chairman Ronald Arculli, speaking in an interview with Hong Kong media in September, hinted that a merger was being explored, but he conceded any tie-up would have to overcome issues involving the non-convertibility of China's currency and other structural differences between the exchanges.
Still, Arculli saw benefits to the concept of a single market for China. Aside from enabling investors to buy and sell shares on all three exchanges, a single platform for listing and trading would give rise to new investment products. And in tong term, it could help foster development of a home-grown banking industry.
"It's a basic market necessity," said Dong Tao, Credit Suisse's chief China economist in Hong Kong. He added that a single China market would be in keeping with the trend toward consolidation in financial markets.
"The IT revolution made is unnecessary to have more than one stock exchange per country," Tao said.
If share price moves are any indication, investors appear to favor the notion. HKEx's shares have risen by almost half since Sept. 7, and are up 167% in the year to date.
Indeed, based on its recent close of HK$244.20, HKEx's market capitalization of $32 billion is more than that of the London Stock Exchange, the Nasdaq Stock Market Inc (NDAQ) and the New York Euronext (NYX) combined.
Flexing muscle at HKEx
About $1.03 trillion worth of shares changed hands on exchanges in Hong Kong, Shanghai and Shenzhen in the first seven months of the year. If they were counted together, they'd represent the eighth largest in the world.
Recent gains follow newspaper reports from the Times of London that Beijing may be building stakes in HKEx, using either its National Social Security Fund or its $200 billion strategic investment fund, launched last week.
In September, the Hong Kong government revealed it had acquired a 5.8% stake, making it HKEx's largest shareholder. Although the government didn't offer an explanation for the acquisition, investors heralded the move as a signal that some sort of exchange consolidation was inevitable.
The Hong Kong government effectively controls HKEx through the appointment of six of the 13 board members. Becoming a major shareholder will boost its influence over the rest of the board, analysts say, and help assuage mainland authorities, who are wary of HKEx's independently elected directors.
China's central government owns the stock exchanges in Shanghai and Shenzhen, and it exerts regulatory control over them via the China Securities Regulatory Commission.
"By increasing its stake in HKEx, the government can have a vote on electing the shareholders' elected members and hence raise the government control over the board," wrote DBS Vickers Securities analyst Jasmine Lai in a September research report.
It may be a first step toward a swap that analysts say would enable state bodies in Hong Kong and Shanghai to hold strategic stakes in each other's markets. If closer ties materialize, it could foster new business alliances, thereby giving momentum to market integration.
HKEx chief Arculli suggested it was possible the three exchanges could have different shareholdings and regulatory structures but operate a single listing and trading platform.
"Trading on each other's exchanges could give a boost to each other's volume," said Louis Wong Wai-kit, research director at Phillip Securities in Hong Kong.
Awakening giant casts a shadow
What's emerging is broadly in line with proposals set forth by advisers last year after the Hong Kong government turned to the financial industry for ideas on how to keep up with its fast-transforming neighbor.
A first step might see a platform for trading in the shares of companies that are already listed in Hong Kong under so-called Class-H shares and in Shanghai under Class-A shares.
It is widely believed markets in Shanghai and Shenzhen could be shifted into limited-company structures and listed in relatively short order. Any such revamp would likely wait until at least March, ahead of key political meetings in the spring.
Self preservation is thought to be behind support in Hong Kong for change on the exchanges: Officials have become increasing worried the city's role as a gateway to China is under threat as mainland markets displace the former colony as a preferred destination for Chinese IPOs.
Fund-raising activities by Chinese companies in Hong Kong declined dramatically after mainland authorities began to push firms to list A shares, which are denominated in yuan, earlier this year.
And media reports in Hong Kong this week suggested mainland regulators may be further tightening the screws.
Regulators reportedly plan to ban simultaneous listings in the mainland and Hong Kong, potentially choking off lucrative investment-banking fees and knocking trading volume. Under the new proposal, mainland companies would also be required to sell shares at home before listing on another exchange, such as Hong Kong.
Mainland markets accounted for $40.51 billion of the $54.69 billion raised by Chinese companies in Hong Kong and China during the first nine months of this year, according to Thomson Financial. Last year, $39.17 billion was raised by mainland companies selling shares in Hong Kong, while $21.09 billion was raised through A shares.
"There is this fear our exchange is being marginalized by an increasingly stronger and bigger Shanghai exchange," Wong added. "The ultimate objective is to bring about a closer cooperation between the two exchanges."
Chinese companies are able to raise funds at home on more favorable terms. Firms selling shares in Hong Kong have also recently run afoul of foreign exchange regulators trying to fend off further inflows of capital into an economy already glutted with liquidity.
In August, for example, China Railway Engineering Group, a state-owned railway builder, was reportedly given permission by mainland regulators to issue $2 billion worth of Hong Kong shares on condition it did not send any proceeds from the listing to China -- a condition at odds with the company's growth strategy. Outside of China, it had only limited investments in Indonesia.
"Our future lies in helping the mainland export capital," Shirley Yam, a markets columnist with the South China Morning Post, wrote in a recent editorial. "The role of Hong Kong as a fundraising center for Chinese enterprises is nearing the end, if not already there."
Hong Kong is already benefiting as China lets down barriers to capital outflows.
China unveiled a program in August that will enable its citizens to invest directly in Hong Kong stocks. The start date for the scheme has been rolled back, but many expect it to be given the green light later this month.
By late September, Beijing had approved $23.8 billion in fund outflows under another program, known as the Qualified Domestic Institutional Investor program. Announced in April, the scheme enables individuals to invest in offshore stocks and bonds using specialized funds.
DBS estimates Chinese capital outflows into Hong Kong of $90 billion under QDII and $77 billion under the individual investor scheme next year.
Fears for market freedoms
Not everyone is convinced the idea of a single trading platform would fly. Some say the concept of a single China exchange violates the spirit of free markets and undermines the principles that have made Hong Kong so successful.
Shareholder activist and HKEx director David Webb criticized the Hong Kong government for failing to make clear it intentions, adding the stake purchase undermined the enclave's reputation as a financial center free from government intervention.
It showed Hong Kong was moving toward regulation at a time when China was moving away from it, Webb asserted.
"It sends a very negative signal to the market as a whole and increases uncertainty," Webb wrote in a note published on his blog. "Until now, the government has not visibly intervened in the market since 1998."
Citi Investment Research analyst Bob Leung said there's also a conflict of interest emerging. "The Chinese government's ultimate interest is to develop China's own exchanges and financial markets and not really to look after the interests of HKEx shareholders," Leung said.
Others worry the stake purchase would scare off potential suitors, leaving Hong Kong -- which ranks as Asia's third-biggest regional market -- out of the running when it comes to forging alliances with other regional markets. Tokyo and Sydney, the two largest regional markets, have no government stakes.
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