There is no stopping the floodgates

Major corrections aside, the freight train of global investment via Hong Kong appears unstoppable. IPO fundraising is setting new records at break-neck speed, topping HK$192bn in 2005, and set to exceed that this year. And it is all because of three little words: the China phenomenon.

As former Chinese state-owned enterprises (SOEs) morph into massive private companies, the Hong Kong Stock Exchange is their preferred platform. They feel comfortable there due to a shared understanding of language and culture, and know they can gain access to a huge array of international investors.

Equally, overseas players can invest with confidence in Hong Kong, an international financial centre with an established reputation and global savvy. Other leading fundraising centres such as New York and London might be able to offer much the same, but they lack the China connection – an edge Edmond Chan, partner in the Capital Market Services Group of PricewaterhouseCoopers (PwC), regards as unbeatable.

“Hong Kong is politically part of China, and has been playing a very important role in China’s economic development for the past 20 years,” Chan says. “Apart from the language and culture, Hong Kong has the financial infrastructure and professional talent that already takes into consideration the Chinese element. When (Chinese) companies come to Hong Kong, they don’t feel as if they are in a foreign land.”

Hong Kong also has a first mover advantage, having listed Mainland companies as H-shares since 1993, and built up considerable experience dealing with red chips – companies incorporated in Hong Kong but with controlling Mainland shareholders – even earlier.

According to a recent report by PwC, funds raised in Greater China region through IPO have been powering upwards for five years. In 2005, the average deal size surged to US$260m, up from US$83m in 2004 – an increase of 214%. The figure exceeded that of the NASDAQ and NYSE combined total, which dropped to US$170m in 2005 from US$220m in 2004.

Growing sophistication

Of this new money, almost all – about 97% – was raised in Hong Kong, making this market the world’s fourth largest fundraiser in 2005. Chan said this was a reflection of Hong Kong’s growing sophistication and maturity as an important international capital formation centre. “At the same time, the Hong Kong stock market continues to be seen as the major international fundraising platform by Chinese enterprises because of its well established finance and legal systems, geographical proximity to China and good corporate governance standards.” Chinese companies that once would have gone offshore for a primary or secondary listing now realise this is no longer necessary, he added.

Louis Wong Wai Kit, director of Phillip Capital Management HK, describes the mood in Hong Kong as “a kind of euphoria”. He has seen it before, in the heady days of the dotcom bubble, but says this time the fundamentals are different. “At that time [2000], the valuation of many newly listed dotcom companies had been stretched and they did not have the sound fundamentals to support such valuations,” Wong says. “Currently, [the situation] is healthier. Today’s IPOs are not too pricey, and the large capitalised SOEs, including banks, have solid fundamentals and revenues behind them.”

Investors have reaped handsome early rewards from China’s recent IPOs, fuelling demand for upcoming supply. And with the quota on qualified foreign institutional investors (QFII) restricting access to China’s domestic market, Wong believes Hong Kong’s status is assured, at least in the short-term. “With US interest rate hikes looking to have peaked, and local inter-bank money rates edging down from 4% to 3%, liquidity is awash in Hong Kong. This all bodes well for fundraising activities,” he says.

Steven Leung, director of institutional sales at UOB Kay Hian Securities, believes there is no end in sight to Hong Kong’s dominance. Blockbuster IPOs such as China Construction Bank last year, which accounted for HK$62bn or one-third the total raised in 2005, and this year’s Bank of China listing – the world’s biggest IPO in six years and the seventh biggest in history – had been the catalyst, he says. Since then there has been strong interest in mega-IPOs from China, resulting in a wide choice for investors, and increased activity in worldwide financial markets. International investors will “keep pouring liquidity into Hong Kong”, maintaining that market’s international position, says Leung.

Boost in confidence

A further spin-off is the improved corporate governance and transparency within those Mainland companies which, by listing on the Hong Kong Stock Exchange, are required to meet international standards. This has boosted investor confidence in China, a market which had languished for years amid trading and corporate governance scandals, and which only this year resumed IPOs after a year-long break for shareholding reforms.

“It doesn’t look like there will be any risk in the Mainland phenomenon. China’s economy will keep growing at near double digit percent in the next few years, and Chinese officials have learned their lessons so they will watch very closely for any over-shooting.” The revaluation of China’s yuan remains the main focus for international investors, Leung adds. “Before the free-float of RMB, Hong Kong will continue to be the number one market for these mega-IPOs.”

While Hong Kong prospers, rival exchanges in China and elsewhere in the region are under pressure to claim market share. The PwC report indicates the opposite is in fact occurring, with the number of new listings in the key Chinese cities of Shanghai and Shenzhen decreasing last year, mainly as a result of share segregation reform in Mainland China. Only three IPOs in Shanghai and 12 in Shenzhen were seen in the first half of 2005, and there were none in these two stock markets in the second half of the year. Kenny Tang, associate director of Tung Tai Securities, sees this trend continuing, predicting no credible threat from either domestic or external markets in the foreseeable future.

“Mainland companies still want to list in Hong Kong, and not just as a means of raising funds,” Tang says. “It also helps them to go into international markets, see more international players, and improve their corporate governance.”

Mainland capital markets are still developing and will not be considered as competitors to Hong Kong until “a lot of improvement” has been achieved, and China’s yuan becomes an international currency.

PwC partner Richard Sun agrees. “Looking ahead to the next 12 months, there will be more Mainland-based financial services and other companies coming to Hong Kong’s capital market. It is likely that IPO activities will resume for stock markets in Mainland China in the second half of 2006.

“As China’s economy continues to grow, we expect that 2006 will be another robust year for IPO activities in Greater China, and we will be seeing an increase in average size of offerings. The announcement and implementation of the rules and guidelines for QDII will also reinforce Hong Kong as the gateway for both domestic and international funds.”

Peta Tomlinson is a freelance journalist who writes for the South China Morning Post and the Hong Kong Trade Development Council.