Delving Further Into HK Equity Market

Hong Kong has been trying to court new listings as it deepens its equity market, which has been increasingly dominated by mainland China listings in recent years. Hong Kong exchanges have been putting a particular emphasis on companies from the Commonwealth of Independent States (CIS), including Russia and Kazakhstan, as well as Mongolia.

Ernst & Young notes that the Hong Kong Stock Exchange will be the top fundraising exchange in 2009, with US$17.7 billion raised, or 18.7% of the global total. In 2010, Hong Kong could raise as much as US$47 billion in IPOs.

The aluminum company Rusal was set to be the first Russian company to list in Hong Kong in December 2009, but its listing was deferred due to concerns about its outstanding debts and corporate governance issues. The Hong Kong Securities and Futures Commission granted approval in December, but the stock will trade in lots of 200,000 shares to prevent retail investors from potential losses. The FT's Lex says "regulating by a nudge and a wink" could backfire by encouraging retail investors to lever up to buy the stock.

Inflows from China and accomodative monetary policy stemming from Hong Kong's U.S. dollar peg have added to the liquidity in Hong Kong's market in 2009. Hong Kong's monetary agency has been intervening heavily in the FX markets to maintain the peg, with only some of its interventions sterilized. In H2 2009, new public offerings have picked up strongly after a credit-crisis-induced lull.

In 2008, Hong Kong outstripped the fundraising capabilities of Tokyo and Toronto and was second only to Shanghai in pre- and post-IPO fundraising. However, fundraising abilities fell sharply in 2008 and early 2009 compared to 2007. Hong Kong also attracts both local and international retail investors. The development of Hong Kong Depository Receipts (HDRs) opened up the possibility of new listings from Russian, Indian and Middle Eastern companies. In 2007, foreign investors accounted for 43% of the market turnover and foreign and domestic institutional investors accounted for 65%.

In 2009, Hong Kong's equity market has jumped sharply on expectations of improvement in economic conditions in China and a huge surge in domestic liquidity. Abundant liquidity has attracted new listings in H2 2009 and narrowed the valuation gap between shares that trade in Hong Kong and China. As liquidity conditions are likely to remain into 2010, some analysts suggest that the equity market could rally further. However, any sign of tightening could spark a correction.

A s of December 8, the Hang Seng Index has surged 95% from a four-month low on March 9 and 53% YTD. Shares in the benchmark are valued at 17.4 times estimated earnings, compared with an average of 13.7 times during the past five years. Hong Kong-listed Chinese stocks traded at a 17% premium over China-listed shares as of December 8, according to the Hang Seng China AH Premium Index. This is below the 31.5% average since 2006.

In the Hong Kong Monetary Authority’s most recent quarterly report (December 2009), the central bank said that a reversal of the region’s massive fund inflows could spark “sharp corrections” in domestic asset markets. Hong Kong's H-share market (mainland companies listed in Hong Kong) has not fallen as sharply as the mainland market. This seems to suggest that H-share investors are more optimistic than mainland investors about any coming tightening in Chinese monetary policy. However, it probably is more a reflection in the differences in liquidity between the markets. A-shares are facing liquidity constraints that H-shares should avoid.


The Hong Kong stock market has benefited from strong growth in China and a large boost in liquidity. Monetary authorities have been intervening in foreign currency markets to defend the upper bound of the Hong Kong dollar's (HKD) peg against the U.S. dollar (USD), which has required selling local currency for USD. This boost to liquidity looks to continue as the overnight bank rate remains close to zero. A return to growth in Chinese exports would help Hong Kong equities as well. In H1 2009, 16 companies listed in Hong Kong to raise a total of US$2.6 billion. An additional 19 companies planned IPOs in H2 that could raise US$23 billion. Several of these IPOs slumped on their first day of trading in September/October 2009, with China South City tumbling 30% on its debut. The long list of planned IPOs remaining in H2 may fetch lower than expected valuations as investor appetite for new shares appears to be waning.

The gap between A-shares (listed in Shanghai and Shenzen) and H-shares (listed in Hong Kong) has fallen since February 2009. As of September 22, A-shares trade at an 18% premium over H-shares, down from a 59% premium in February 2009 and high of 90% hit in early 2008. As of September 22, stocks listed in Shanghai and Shenzhen (CSI-300 index) have fallen 17.3% from their August 4 peak on concerns about liquidity. Shares in Hong Kong (Hang Seng index) have gained 4.4% over the same time frame. Mainland shares are down because of a slowdown in bank lending, tighter credit restrictions and a release of previously locked-up shares. Hong Kong is not affected by these dynamics, and its liquidity comes mostly from global funds which are not facing liquidity constraints. Citi expects the gap to widen in the last two months of 2009.

Capital controls are the main impediment to arbitrage between A-shares and H-shares. In spite of a halving of mainland share values over the eight months to July 2008, China's three markets (Shanghai, Shenzhen and Hong Kong) still account for 9.6% of the world’s total stock market capitalization (unadjusted for free float). That is well behind the US, at 30%, but puts it ahead of Japan, at 8.3%. While Hong Kong's position is secured and Shanghai is increasingly the venue for high-profile listing, Shenzhen continues to struggle to reinvent itself, for example with a new SME exchange.


p/s photos: Sharon Xu