Monday, June 18, 2007
Asia Comment: China liberalisation creates HK opportunities
By Mark Konyn
Published: June 11 2007, FT
Any lingering thoughts that developments in China's financial system would be uncorrelated with Hong Kong's financial markets must now surely be abandoned. After market close on May 11 the mainland authorities announced that Chinese banks could offer products invested in Hong Kong listed companies for the first time as part of the Qualified Domestic Institutional Investor programme (QDII).
As a result, the following Monday witnessed massive turnover on the Hong Kong stock exchange with a record-breaking $12bn of shares transacted, beating the previous record by more than 17 per cent. This day of strong trading came hard on the heels of the previous week's record, when turnover on mainland bourses in a single day exceeded the combined turnover of all other Asian exchanges including those of Japan and Hong Kong with a staggering $49bn of shares traded.
The need for mainland authorities to deflate the ever-growing speculative bubble on China's stock markets is all too evident. Presented with a lack of investment choice, a rapidly growing economy and high levels of savings and financial liquidity, Chinese investors have disregarded any fundamental valuation references, invoking memories of the Japanese stock market in the late 1980s.
The effect of this speculation is clearly visible when comparing valuations between those companies with a listing in both Hong Kong and mainland China. In spite of the most recent price rises in Hong Kong after the announcement, Hong Kong H-shares still trade on average at over a 40 per cent discount to their A-share counterparts listed on the mainland markets. Back in 2005, and prior to share reforms in China itself, there was much discussion on price convergence of the two different listings. However, following subsequent share reforms in China and its rampant bull market, the gap has widened again.
Financial liberalisation in China also promises to have a significant impact on financial service providers active in Hong Kong and beyond. Managers active in Hong Kong have long held the dream of being able to sell locally registered mutual funds into China under a so-called passport system. Concurrent with the announcement concerning eligibility of Hong Kong stocks being offered to mainland investors has been the announcement that Hong Kong registered mutual funds can also be offered on the mainland under the QDII programme. It appears the dream is about to be realised. ?
The details and conditions are now being carefully examined and assessed, as it appears that appropriately registered funds that meet certain other investment requirements can be offered to the growing market of mainland investors. The implications could be profound indeed. So far some $14.2bn of QDII quota has been issued by the authorities and it is estimated that less than $500m has been utilised. The hope is that a potential outflow of China's savings will take the heat out of the stock market speculation and ease the continued upward pressure on the currency. Realistically these quotas are unlikely to make an immediate difference and the opportunity will be longer term, as the quota is gradually increased.
For fund managers active in Hong Kong this liberalisation expands the mutual fund market well beyond the constraints implied by a relatively small but wealthy population of 7m people. It is also a great achievement for the Hong Kong financial authorities, who have delivered a tangible boost to the fund management industry ahead of other jurisdictions. There are currently almost 2,000 authorised funds registered in Hong Kong and these funds are domiciled across a number of different international jurisdictions - largely in Europe. Dependent on the precise requirements for distribution in China, this liberalisation may also increase the number of funds choosing a Hong Kong domicile. Currently, mostly only the funds organised for the Mandatory Provident Fund are locally domiciled, as is required.
Experience elsewhere in the Asian region, however, suggests that the take-up of internationally invested funds could be slow in building. Whereas the immediate attraction of Chinese companies listed in Hong Kong can be understood as investors seek to exploit the discount, the opportunity to diversify internationally through fund investment may be less well accepted.
First and foremost, as experience in other Asian economies has demonstrated, it is hard to persuade an investor to divert savings away from a strongly performing domestic market. This was the case in Taiwan, Korea and Hong Kong in the early days of the mutual fund market development. Second, the prospect of allocating to an investment denominated in a foreign currency when the local currency is expected to continue to strengthen is less than compelling. This was the case for many years in Japan when the yen was a one-way bet.
Regardless of the expected development pace of international diversification, this recently announced change allows international managers to build a China entry strategy without having to consider a joint venture arrangement; these JVs remain focused on offering funds invested in China's domestic markets, providing investors with more opportunities to fuel the speculation. ¶ 12:38 AM
Published: June 11 2007, FT
Any lingering thoughts that developments in China's financial system would be uncorrelated with Hong Kong's financial markets must now surely be abandoned. After market close on May 11 the mainland authorities announced that Chinese banks could offer products invested in Hong Kong listed companies for the first time as part of the Qualified Domestic Institutional Investor programme (QDII).
As a result, the following Monday witnessed massive turnover on the Hong Kong stock exchange with a record-breaking $12bn of shares transacted, beating the previous record by more than 17 per cent. This day of strong trading came hard on the heels of the previous week's record, when turnover on mainland bourses in a single day exceeded the combined turnover of all other Asian exchanges including those of Japan and Hong Kong with a staggering $49bn of shares traded.
The need for mainland authorities to deflate the ever-growing speculative bubble on China's stock markets is all too evident. Presented with a lack of investment choice, a rapidly growing economy and high levels of savings and financial liquidity, Chinese investors have disregarded any fundamental valuation references, invoking memories of the Japanese stock market in the late 1980s.
The effect of this speculation is clearly visible when comparing valuations between those companies with a listing in both Hong Kong and mainland China. In spite of the most recent price rises in Hong Kong after the announcement, Hong Kong H-shares still trade on average at over a 40 per cent discount to their A-share counterparts listed on the mainland markets. Back in 2005, and prior to share reforms in China itself, there was much discussion on price convergence of the two different listings. However, following subsequent share reforms in China and its rampant bull market, the gap has widened again.
Financial liberalisation in China also promises to have a significant impact on financial service providers active in Hong Kong and beyond. Managers active in Hong Kong have long held the dream of being able to sell locally registered mutual funds into China under a so-called passport system. Concurrent with the announcement concerning eligibility of Hong Kong stocks being offered to mainland investors has been the announcement that Hong Kong registered mutual funds can also be offered on the mainland under the QDII programme. It appears the dream is about to be realised. ?
The details and conditions are now being carefully examined and assessed, as it appears that appropriately registered funds that meet certain other investment requirements can be offered to the growing market of mainland investors. The implications could be profound indeed. So far some $14.2bn of QDII quota has been issued by the authorities and it is estimated that less than $500m has been utilised. The hope is that a potential outflow of China's savings will take the heat out of the stock market speculation and ease the continued upward pressure on the currency. Realistically these quotas are unlikely to make an immediate difference and the opportunity will be longer term, as the quota is gradually increased.
For fund managers active in Hong Kong this liberalisation expands the mutual fund market well beyond the constraints implied by a relatively small but wealthy population of 7m people. It is also a great achievement for the Hong Kong financial authorities, who have delivered a tangible boost to the fund management industry ahead of other jurisdictions. There are currently almost 2,000 authorised funds registered in Hong Kong and these funds are domiciled across a number of different international jurisdictions - largely in Europe. Dependent on the precise requirements for distribution in China, this liberalisation may also increase the number of funds choosing a Hong Kong domicile. Currently, mostly only the funds organised for the Mandatory Provident Fund are locally domiciled, as is required.
Experience elsewhere in the Asian region, however, suggests that the take-up of internationally invested funds could be slow in building. Whereas the immediate attraction of Chinese companies listed in Hong Kong can be understood as investors seek to exploit the discount, the opportunity to diversify internationally through fund investment may be less well accepted.
First and foremost, as experience in other Asian economies has demonstrated, it is hard to persuade an investor to divert savings away from a strongly performing domestic market. This was the case in Taiwan, Korea and Hong Kong in the early days of the mutual fund market development. Second, the prospect of allocating to an investment denominated in a foreign currency when the local currency is expected to continue to strengthen is less than compelling. This was the case for many years in Japan when the yen was a one-way bet.
Regardless of the expected development pace of international diversification, this recently announced change allows international managers to build a China entry strategy without having to consider a joint venture arrangement; these JVs remain focused on offering funds invested in China's domestic markets, providing investors with more opportunities to fuel the speculation. ¶ 12:38 AM
