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Risks of an H-share rising
HOME > PAST ISSUE > COMMENTARYAugust 2006
The impending inclusion of H-shares in the Hang Seng Index is a further indication of growing mainland influence over Hong Kong's markets. But where will it all end?
No one can dispute the level of influence that mainland Chinese companies now exert over the Hong Kong stock markets. In this way, the decision to factor mainland-based H-shares into the Hang Seng Index (HSI) is entirely justified.
The 22% rise in the Hong Kong Stock Exchange's (HKEx) market capitalization to US$1.05 trillion last year from US$854 billion in 2004 was largely driven by a 58% increase in the capitalization of mainland firms listed there, from US$260.3 billion to US$411.4 billion. Mainland enterprises now account for 39% of the exchange's market value and this is expected to pass 50% within five years.
To not include any H-shares in HSI would make it unrepresentative of the market, especially now big beasts such as China Construction Bank (CCB) and Bank of China (BOC) are listed there.
At present, the only mainland presence in the HSI is the "red chips" - mainland companies domiciled in Hong Kong. And red chip listings may become a less attractive fund-raising vehicle for Chinese companies in the light of government moves to prevent potential asset stripping by imposing stricter controls on capital outflows.
HSI Services has announced it will bring on board five H-shares and adjust its weighting system to reflect the fact that H-share companies tend to float a smaller proportion of their shares than typical HSI members. Single stock weightings will be capped at 15%.
The shift - which is expected to push fund managers into making alterations to their portfolios - is further evidence of the mainland's corporate grasp tightening around HKEx. From Hong Kong's point of view, this has been no bad thing.
Thanks largely to CCB's bumper Hong Kong IPO, average deal size for capital markets in the Greater China region topped the US with US$260 million against US$170 million. This lead could well be extended in 2006 with US$11 billion already generated by BOC and even more expected from Industrial and Commercial Bank of China. This "China power" has allowed Hong Kong to stamp its authority on the region: the stock exchange raised 96% of all Greater China's IPO funds in 2005, up from 72.8% in 2004 and 54.6% in 2003.
Obviously, the year-long moratorium on new listings in the mainland has turned more attention to Hong Kong. Percentages are skewed by the sudden absence of mainland IPOs - Hong Kong's share of total Greater China IPOs went from 33% in 2003 to 40% in 2004, before jumping to 70% in 2005 - and several large Chinese companies were forced into sole offerings in Hong Kong when they might have preferred a dual listing.
But the resumption of mainland listings in late June doesn't signal the end of Hong Kong's long summer; restrictions on foreign investment in the A-share market mean that Hong Kong is the logical place for mainland firms to access international funds, whatever London and New York might say.
Even once the Qualified Foreign Institutional Investor scheme is deemed to have run its course and the markets are fully accessible to overseas players, the absence of a fully convertible currency remains a barrier. Looking beyond a freely floating yuan, Shanghai would still have to match Hong Kong's skilled labor force and business infrastructure in order to surpass it as a listing location - a realistic goal but not one that will be realized easily.
The rise of the H-share is not without risk, though. Hong Kong has considerable experience dealing with mainland companies through the red chips and has greater claim to understand corporate China than any of its global rivals. However, the likes of NYSE and NASDAQ counter that HKEx sets its bar lower, taking companies with financials that wouldn't make the grade elsewhere.
The message is: you may not like the draconian requirements of Sarbanes-Oxley, but you can sleep safe in the knowledge that an Enron Mark II nightmare won't arrive with the morning papers.
Can the same be said of Hong Kong? Yes and no. First and foremost, there has yet to be an exodus of fund managers from Central district because of a lack of confidence in the market. If anything, capital flows are making their way towards Asia as companies find they can still make a killing by listing close to home.
That said, would anyone really be surprised if a clutch of mainland companies listed in Hong Kong turned bad? Corporate governance on the mainland is improving fast but the question remains as to whether the pace of reform can match the rate at which Chinese companies are developing an appetite for an overseas listing.
At the crux of it all is the relationship between the Securities and Futures Commission (SFC) and its mainland counterpart, the China Securities Regulatory Commission (CSRC). A memorandum of understanding exists between the two but it's in no way as binding an agreement as the ones HKEx has with other exchanges.
What investors need to know is whether the CSRC would take action at the request of the SFC, and what form this action would take. In the interests of preserving its reputation as a friend to business, you would think the government would ensure that any offenders are tracked down and the rules enforced as an example to other companies.
After all, a stock manipulation investigation into the first stock offering after the moratorium, on its first day of trading, hardly inspires confidence in corporate China.
Moves to ban sex-selective abortions represent an encroachment upon people's rights
China's "little emperor" problem is a well-documented one: families' preference for boys over girls has been accentuated by the one-child policy to the point that newborn males outnumber females by one fifth.
Abortionists who perform ultrasound tests to establish gender before offering parents the option of a termination have long grown rich off concerns that a male heir is necessary to preserve the family name. Males are also seen as being the financially viable choice for parents who are likely to become dependent on their offspring in old age.
But now this morally dubious money-spinning could come to an end as the government moves to criminalize sex-selective abortions. The National Population and Family Planning Commission (NPFPC) has vowed to continue pushing the legislation, which advocates a maximum three-year jail sentence, despite the National People's Congress (NPC) rejecting the proposed measure in late June.
"I believe this is a kind of crime," said Yu Xueyun, head of legal and policy issues at the NPFPC. "We are resolutely opposed to selective abortions."
As to the NPC's concerns about gathering evidence of illegal abortions and effectively enforcing the legislation, Yu said: "All policies have risks. We cannot be deterred because there are risks."
By overriding the will of the NPC, Yu and his cohorts have created divisions within government; but in the long term, the key disaffected party could well be the Chinese people themselves.
For a start, sex-selective abortions are not just going to go away. The need for a male heir is at present too deeply ingrained in the Chinese psyche and China remains a country where - legally or not - there is almost always an avenue down which supply can meet demand.
Parents with sufficient money and access can simply pop over to Hong Kong or Singapore for an abortion. Those at the other end of the social scale will resort to underground abortion clinics. Operating outside of the law, these backstreet abortionists' equipment and practices will no longer have to meet high clinical standards, and this poses an obvious threat to patients. Efforts to enforce a law banning sex-selective abortions would be dogged by inconsistency.
The introduction of the one-child policy saw the state reach deep into the lives of its citizens, forcing them to cede control of an area that is as personal as it gets.
Given the grossly uneven distribution of wealth in China, perhaps the government has been justified in taking measures that will see the population peak at about 1.54 billion in 2040 (although there are severe social consequences to this kind of control, as this month's cover story shows).
But by denying people the chance to choose the gender of their child, the state is once again impinging upon areas that should remain private. And getting an accurate picture of exactly who is doing what on such a sensitive issue will be very hard indeed.
At a time when Chinese people are being granted ever more economic freedoms, once again their social rights are under threat.
The 22% rise in the Hong Kong Stock Exchange's (HKEx) market capitalization to US$1.05 trillion last year from US$854 billion in 2004 was largely driven by a 58% increase in the capitalization of mainland firms listed there, from US$260.3 billion to US$411.4 billion. Mainland enterprises now account for 39% of the exchange's market value and this is expected to pass 50% within five years.
To not include any H-shares in HSI would make it unrepresentative of the market, especially now big beasts such as China Construction Bank (CCB) and Bank of China (BOC) are listed there.
At present, the only mainland presence in the HSI is the "red chips" - mainland companies domiciled in Hong Kong. And red chip listings may become a less attractive fund-raising vehicle for Chinese companies in the light of government moves to prevent potential asset stripping by imposing stricter controls on capital outflows.
HSI Services has announced it will bring on board five H-shares and adjust its weighting system to reflect the fact that H-share companies tend to float a smaller proportion of their shares than typical HSI members. Single stock weightings will be capped at 15%.
Fundamental shift
The shift - which is expected to push fund managers into making alterations to their portfolios - is further evidence of the mainland's corporate grasp tightening around HKEx. From Hong Kong's point of view, this has been no bad thing.
Thanks largely to CCB's bumper Hong Kong IPO, average deal size for capital markets in the Greater China region topped the US with US$260 million against US$170 million. This lead could well be extended in 2006 with US$11 billion already generated by BOC and even more expected from Industrial and Commercial Bank of China. This "China power" has allowed Hong Kong to stamp its authority on the region: the stock exchange raised 96% of all Greater China's IPO funds in 2005, up from 72.8% in 2004 and 54.6% in 2003.
Obviously, the year-long moratorium on new listings in the mainland has turned more attention to Hong Kong. Percentages are skewed by the sudden absence of mainland IPOs - Hong Kong's share of total Greater China IPOs went from 33% in 2003 to 40% in 2004, before jumping to 70% in 2005 - and several large Chinese companies were forced into sole offerings in Hong Kong when they might have preferred a dual listing.
But the resumption of mainland listings in late June doesn't signal the end of Hong Kong's long summer; restrictions on foreign investment in the A-share market mean that Hong Kong is the logical place for mainland firms to access international funds, whatever London and New York might say.
Even once the Qualified Foreign Institutional Investor scheme is deemed to have run its course and the markets are fully accessible to overseas players, the absence of a fully convertible currency remains a barrier. Looking beyond a freely floating yuan, Shanghai would still have to match Hong Kong's skilled labor force and business infrastructure in order to surpass it as a listing location - a realistic goal but not one that will be realized easily.
The rise of the H-share is not without risk, though. Hong Kong has considerable experience dealing with mainland companies through the red chips and has greater claim to understand corporate China than any of its global rivals. However, the likes of NYSE and NASDAQ counter that HKEx sets its bar lower, taking companies with financials that wouldn't make the grade elsewhere.
Beware an Enron
The message is: you may not like the draconian requirements of Sarbanes-Oxley, but you can sleep safe in the knowledge that an Enron Mark II nightmare won't arrive with the morning papers.
Can the same be said of Hong Kong? Yes and no. First and foremost, there has yet to be an exodus of fund managers from Central district because of a lack of confidence in the market. If anything, capital flows are making their way towards Asia as companies find they can still make a killing by listing close to home.
That said, would anyone really be surprised if a clutch of mainland companies listed in Hong Kong turned bad? Corporate governance on the mainland is improving fast but the question remains as to whether the pace of reform can match the rate at which Chinese companies are developing an appetite for an overseas listing.
At the crux of it all is the relationship between the Securities and Futures Commission (SFC) and its mainland counterpart, the China Securities Regulatory Commission (CSRC). A memorandum of understanding exists between the two but it's in no way as binding an agreement as the ones HKEx has with other exchanges.
What investors need to know is whether the CSRC would take action at the request of the SFC, and what form this action would take. In the interests of preserving its reputation as a friend to business, you would think the government would ensure that any offenders are tracked down and the rules enforced as an example to other companies.
After all, a stock manipulation investigation into the first stock offering after the moratorium, on its first day of trading, hardly inspires confidence in corporate China.
The right to choose
Moves to ban sex-selective abortions represent an encroachment upon people's rights
China's "little emperor" problem is a well-documented one: families' preference for boys over girls has been accentuated by the one-child policy to the point that newborn males outnumber females by one fifth.
Abortionists who perform ultrasound tests to establish gender before offering parents the option of a termination have long grown rich off concerns that a male heir is necessary to preserve the family name. Males are also seen as being the financially viable choice for parents who are likely to become dependent on their offspring in old age.
But now this morally dubious money-spinning could come to an end as the government moves to criminalize sex-selective abortions. The National Population and Family Planning Commission (NPFPC) has vowed to continue pushing the legislation, which advocates a maximum three-year jail sentence, despite the National People's Congress (NPC) rejecting the proposed measure in late June.
"I believe this is a kind of crime," said Yu Xueyun, head of legal and policy issues at the NPFPC. "We are resolutely opposed to selective abortions."
As to the NPC's concerns about gathering evidence of illegal abortions and effectively enforcing the legislation, Yu said: "All policies have risks. We cannot be deterred because there are risks."
By overriding the will of the NPC, Yu and his cohorts have created divisions within government; but in the long term, the key disaffected party could well be the Chinese people themselves.
For a start, sex-selective abortions are not just going to go away. The need for a male heir is at present too deeply ingrained in the Chinese psyche and China remains a country where - legally or not - there is almost always an avenue down which supply can meet demand.
Parents with sufficient money and access can simply pop over to Hong Kong or Singapore for an abortion. Those at the other end of the social scale will resort to underground abortion clinics. Operating outside of the law, these backstreet abortionists' equipment and practices will no longer have to meet high clinical standards, and this poses an obvious threat to patients. Efforts to enforce a law banning sex-selective abortions would be dogged by inconsistency.
The introduction of the one-child policy saw the state reach deep into the lives of its citizens, forcing them to cede control of an area that is as personal as it gets.
Given the grossly uneven distribution of wealth in China, perhaps the government has been justified in taking measures that will see the population peak at about 1.54 billion in 2040 (although there are severe social consequences to this kind of control, as this month's cover story shows).
But by denying people the chance to choose the gender of their child, the state is once again impinging upon areas that should remain private. And getting an accurate picture of exactly who is doing what on such a sensitive issue will be very hard indeed.
At a time when Chinese people are being granted ever more economic freedoms, once again their social rights are under threat.
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