Cover story. Plotting

Cover story

The Hong Kong stock exchange has seen a decade of immense

growth driven by mainland initial public offerings. But as

competition grows, what’s next? HKEx Chairman Ronald Arculli

talks to

Reggie Rathour

and

Helen Luk

Photography by Brian Ching

T

When HKEx was first listed in June 2000 following the integration of Hong Kong’s securities and futures markets, it had 790 listed companies and a market capitalization of US$623.9 billion. That figure more than tripled to US$2.34 trillion this year, pushing the Hong Kong stock exchange’s world ranking to seventh from 11th. The number of its listed companies jumped to 1,356 as of August.

Profit in the first half rose 3 percent to HK$2.26 billion from the same period last year, and HKEx’s shares have soared 30-fold over the past decade – all cause for celebration for its 10th anniversary this year.

But as global equity markets become increasingly competitive, HKEx is facing a bumpy road ahead. To cope with growing challenges, the exchange seems to be leaving no stone unturned.

In an interview with A Plus, HKEx Chairman Ronald Arculli says he and Chief Executive Charles Li are trav-elling across continents to woo foreign companies to list in Hong Kong. They are boosting cooperation with mainland and overseas bourses. They want to extend trading hours and upgrade the exchange’s trading system. And in anticipation of the Chinese currency’s internationalization, they plan to introduce new yuan investment products in Hong Kong.

The hot yuan

Arculli describes the agreement in July between China and Hong Kong’s central banks expanding the scope of yuan business in the territory as a “quantum leap in terms of opportunities.”

The move, which allows companies to buy or sell yuan in Hong Kong and to transfer yuan funds between banks, boosts the territory’s status as an offshore centre for the yuan. And China’s decision in August to allow foreign and Hong Kong financial institutions to invest in its do-mestic bond market “completes the whole loop,” he says.

“If you want to encourage people to take yuan outside of China for trade settlement and a variety of other things, what are they going to do with it? They can only leave it here. But now, there’s an extra choice, they can use that to invest in yuan bonds,” he says. Compared to the US$8.5 trillion to US$9.9 trillion euro debt market or the US$7.2 trillion U.S. corporate bond market, the mainland’s yuan bond market, which stands at about US$2.7 trillion, still has huge development potential, he says.

Arculli says now that Hong Kong has been given the opportunity to develop as a yuan offshore market, the yuan-denominated products would naturally follow. “We would like very much to see the development of a strong debt market in Hong Kong, particularly in yuan-denominated debt,” he says. That market already has a value of between 20 billion and 30 billion yuan, with more companies jumping on the bandwagon of issuing yuan bonds.

“You have institutions like China Development Bank issuing five billion yuan just a year ago, you have Bank of East Asia doing it, you have Hopewell doing it and the finance ministry in China is also reportedly consid-ering doing a bond issue here,” Arculli says.

A HKEx spokesman says the exchange operator met local and foreign banks in August to see if they were interested in introducing yuan futures contracts, which could help enterprises hedge risks. Other yuan-denominated products, including exchange traded funds, structured products and options, are expected to hit the market, allowing yuan deposit holders to invest their money in Hong Kong. Local banks currently have an estimated 80 billion yuan in deposits, and CLSA Asia-Pacific Markets forecasts the figure will double in two years.

“We will probably have to look at where we may need rule changes or whether it’s simply administrative market changes. But clearly, whether rule changes are required, we obviously would devote a lot of our time and effort to take advantage of the opportunities that we see before us,” Arculli says.

Given that the yuan is not yet a fully convertible currency, regulators have warned investors to trade carefully in yuan products. Some critics have cast doubt on whether Hong Kong is indeed a testing ground for the yuan’s internationalization, given Beijing’s desire to maintain a tight grip on the country’s capital accounts.

Cross-border competition

In recent years, the Hong Kong stock exchange has

been wildly successful in attracting foreign companies to list, including Russian aluminium giant United Co. Rusal’s debut in January and French skincare retailer L’Occitane International SA, which chose Hong Kong over New York, London and Paris for a share sale in May. Arculli, however, says that China is the centrepiece of HKEx’s strategy.

“The continuation of the listings of mainland businesses and enterprises remains very much part of our core objectives,” he says. “Obviously, with the development of the financial markets in China, that presents opportunities not just for the exchange but also for Hong Kong. You see a lot of Chinese brokerages, banks, insurance and asset management companies setting up in Hong Kong.”

Over the past decade, 390 mainland enterprises went public in Hong Kong. Today, they account for 58 percent of the exchange’s market capitalization. Most of those listings took place between 2002 and 2007, with a total of 244 mainland companies listing on the main board or the Growth Enterprise Market.

But the wave of big IPOs from the mainland is slowing and competition across the border is growing: With a market capitalization of US$2.38 trillion, the Shanghai Stock Exchange is now the second-largest in Asia after Tokyo and ranks one spot ahead of Hong Kong globally. With efforts underway to introduce an international board in Shanghai, market observers say it may unseat Hong Kong’s position as the premier equity market for foreign companies in Greater China.

At the same time, regional competitors such as

Sin-HKEx milEsTonEs

Hong Kong Exchanges and Clearing Ltd. listed in 2000 after it was formed from the demutualization of The Stock Exchange of Hong Kong Ltd. and Hong Kong Futures Exchange Ltd. and their subsequent merger with Hong Kong Securities Clearing Co.

27 June 2000

HKEx opened its representative office in Beijing. (From left) Chinese State Councillor Tang Jiaxuan, former HKEx Chairman Charles Lee, and Henry Tang, Hong Kong’s financial secretary at the time

17 November 2003

gapore and Taiwan are relentlessly pursuing Chinese companies to list on their bourses. China’s fourth-biggest shipmaker, Yangzijiang Shipbuilding Holdings, became the first mainland company to list in Taiwan, signalling a new era in cross-strait business relations. The Taiwan Stock Exchange has been lobbying Taiwanese-owned companies listed in Hong Kong and Singapore to move their listings back home.

When it comes to competition from Shanghai, however, Arculli is sanguine about Hong Kong in the long run.

“I don’t think it means that when and if there’s an international board (in Shanghai) that it will be at the expense of Hong Kong… China is a closed market but even if the market is open, you then compete of your own efficiency,” he says.

Arculli says Hong Kong still has an edge because of its free flow of capital, legal system, low tax regime and a strong accounting profession, which plays “a crucial role in helping Hong Kong and main-land companies understand and adopt the highest international accounting and disclosure standards” to meet investors’ needs.

“Hong Kong and its stock market, regulators, inter-mediaries and other professionals have collectively helped promote mainland companies to international investors, and they have achieved great success in this area over the last two decades,” he says.

He argues that large multinationals such as HSBC, Manulife, Standard Chartered and Prudential are all listed on more than one exchange.

Besides, the two markets cater to different types of investors. In Shanghai, 95 percent of the players are mainland institutional and individual investors, while in Hong Kong, the demographics are more varied: 42 percent are international retail and institutional investors, 50 percent are local retail and institutional investors, and the rest of the turnover is from principal trading, he says.

“With the growth of the economy in China and indeed in Asia, the pie will get bigger. It’s not a ‘you win and I die’ situation,” he says, adding that ties between the two exchanges remain strong. In January, HKEx and the Shanghai Stock Exchange said in a joint statement that they will boost cooperation and information sharing in regulating companies listed in both markets, strengthen cooperation in developing new products and support continued exchanges and training of their personnel.

To hike up its competitiveness, HKEx recently proposed extending trading hours to match those on the mainland, despite opposition from traders who are accustomed to late starts and long lunches. It wants to open half an hour earlier at 9:30 a.m. and cut lunch breaks to one hour. It kick-started a consultation last month to test the market’s reaction.

Arculli says the proposal is not profit-driven but aims to eliminate the opening share price difference between the Hong Kong and mainland markets. “The opening is where the price discovery is. And if some-one opens earlier than we do, then that market kind of dictates the price that we have,” he says.

HKEx opened its trading and exhibition hall, which offers displays on the history of Hong Kong’s exchanges and securities clearing house.

Industrial and Commercial Bank of China Ltd.’s US$21.9 billion dual listing on the Hong Kong and Shanghai stock exchanges was the world’s largest initial public offering at the time. Over the past decade, 390 mainland companies went public in Hong Kong.

Aluminium giant United Co. Rusal became the first Russian company to list in Hong Kong, raising US$2.23 billion. More mining and resource companies’ listings are on the way. Photos courtesy of HKEx

While he is unsure how the market players will respond to the proposal, he argues that Hong Kong should come in line with international practices: its four-hour trading day is among the shortest in the world, compared to six-and-a-half hours in New York and more than eight hours in London.

Casting a wider net

Taking advantage of China’s craving for resources and energy, HKEx has also become more aggressive in embracing foreign issuers from this sector in recent years. Shortly after Rusal’s US$2.23 billion share placement to institutional investors in January, Canada-based SouthGobi Energy Resources Ltd., the largest coal miner in Mongolia in terms of export sales, raised US$392.7 million from an initial public offering in Hong Kong.

Arculli says natural resources and mining com- panies listed in Hong Kong make up about 10 percent of the stock exchange’s market capitalization, a three-fold jump from 10 years ago.

“A few days after SouthGobi was listed, Robert Friedland, executive chairman of Ivanhoe Mines, the parent company of SouthGobi, said he reckons Hong Kong will be the mining and resource centre,” says Arculli. As if to prove the point, two Mongolian coal mining companies are planning to list in Hong Kong this month. Mongolian Mining Corp., a coking-coal maker, will raise between HK$4.53 billion and HK$5.28 billion in an

IPO scheduled for the second week, while Winsway Coking Coal Holdings, which provides transportation to the end-users of coal, wants to raise between HK$3.22 billion and HK$4.46 billion around the same time.

Mongolia aside, Arculli says he and other HKEx executives have met with potential issuers from other mineral-rich countries like Russia, Canada, Nigeria and Kazakhstan in recent months. (The Hong Kong stock exchange officials are among some of the most well-travelled in the world: Arculli himself has gone to South Korea, Japan, the U.S. and several European coun-tries this year, while HKEx’s chief marketing officer, Lawrence Fok, even attended a conference in Minsk, Belarus.) HKEx is also discussing with Latin America’s largest stock exchange, Brazil’s BM&FBOVESPA, pos-sible dual listings in Hong Kong and São Paolo. Brazil and other Latin American countries are major suppliers of mineral resources to China.

At the same time, HKEx has opened its doors to companies registered in offshore jurisdictions such as Cyprus or the British Virgin Islands. In August, West China Cement Ltd. became the first Chinese business held through a company in Jersey, an island located 135 kilometres south of Britain, to list here, raising about HK$1.6 billion.

While eager to woo issuers from the mining and resource sectors, the stock exchange also took steps to shield investors from the riskiest segment of the industry: It issued new listing rules in June to exclude

Meanwhile, Arculli stresses differences in account-ing or legal systems have not been a problem with issuers from emerging markets or tax havens. “If the Securities and Futures Commission is not satisfied, then we can’t do the listing. Right now we have some-thing like 14 countries or jurisdictions where there is no issue,” he says.

While mainland accounting standards have con-verged with international financial reporting standards since late 2007, he says Hong Kong will continue to work with the mainland to strengthen market regulations, corporate governance of listed companies and disclosure standards of the exchanges.

Threat from alternative trading

As high frequency trading becomes an increasingly competitive business with dwindling profits in the West, operators are shifting their focus to Asia.

Automated trading systems use computer pro-grammes to decide the timing, price or quantity of trade orders. They offer institutional investors, who typically move large blocks of shares, highly precise pricing (in tiny fractions of a dollar) and minimize information leakage during execution. However, a technical glitch in May that suddenly sent U.S. stocks crashing was blamed on such trading systems.

Despite the hiccup, interest in dark pools – a type of automated trading system that allows institutional investors to trade without revealing their identities, trading volumes or price – is growing in Asia: Deutsche Bank began dark pool trading in Hong Kong in August and plans to do so in Australia, Japan and Singapore later. Citigroup is mulling the same service in Singapore next year after its off-exchange trading in Australia increased to a record in June. The Australian Stock Exchange operates its own dark pool for orders worth more than A$1 million. Chi-X started a dark pool service in Tokyo in July and teamed up with the Singapore Exchange to start a dark pool called Chi-East for trading securities listed in Singapore, Hong Kong, Tokyo and Australia before the end of the year.

Arculli acknowledges that alternative trading platforms are posing keen competition to regulated exchanges all over the world. He says electronic trading platforms have cost the New York Stock

“As these developments happen in North America and in Europe, we can see what it has done to different regulated exchanges,” he says.

However, because market players in alternative trading platforms still have to pay stamp duty for trades in Hong Kong, Arculli says they may find it less attractive than other financial centres. “They may not be able to get critical mass in Asia to do the kind of damage they have done in other markets,” he adds.

Still, he is worried that alternative trading platforms have upset the level-playing field when they operate in the same market as traditional exchanges. “We have all the burden and responsibility of making sure that com-panies disclose this and that, and that they don’t mislead the public. Whereas those guys (the alternative trading platforms) get on the back of our work and operate at our expense without the corresponding responsibilities,” he says.

In Hong Kong, while the Securities and Futures Commission grants licences to banks to operate dark pools and other alternative trading platforms here, they must report and clear their trades with HKEx. Arculli says HKEx has no immediate plan to set up its own dark pool.

To brace for the competition from alternative trading platforms, HKEx has invested HK$150 million since the second quarter of the year to upgrade its securities and derivatives market systems. The AMS/3.8 project, which is due to be completed by the end of next year, will boost the capacity and speed of HKEx’s securities trading system. For derivatives, the stock exchange will conduct capacity and technology upgrades for its trading, clearing and settlement, and market data systems in phases and complete the whole project by the first half of next year.

HKEx also recently announced plans for a new data centre and is already thinking of the next generation of computer enhancements to improve execution speed. At present, the securities trading system can handle 3,000 orders per second, double the highest volume of trades during peak periods. But when the upgrade completes next year, the capacity will jump tenfold to 30,000 orders per second and can be further scaled up to 100,000 orders per second.

“It will be a nice problem to have if by the time we finish this upgrade next year that our business volume builds up to such an extent that we have to scale up… You never know, we have to prepare for when the money comes, they don’t tell you beforehand,” Arculli says.