Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

Thrill-seekers in Hong Kong who want to gamble in casinos usually have to take a bumpy, hour-long ferry ride to Macau. Those who crave excitement without leaving the city might do just as well punting on Hong Kong's small-cap stocks.

Structural weaknesses and a reluctance by regulators to delist miscreant companies has turned Hong Kong's $4.6 trillion stock market into fertile ground for individual speculators and short sellers, exemplified by last week's sudden plunge in a series of small-cap shares.

China Jicheng Holdings Ltd., an umbrella maker, started the week with a market value of $2.7 billion; by the end it was worth about $125 million. Like many of the other stocks that collapsed, Jicheng was a member of the so-called Enigma Network, a complex web of companies with cross-shareholdings identified by investor activist David Webb in May.

Penny Pinching
Before the crash, China Jicheng was a penny stock with a $2.7 billion market cap
Source: Bloomberg

Jicheng shows how regulators have allowed penny stocks to flourish in Hong Kong. The Jinjiang City-based company listed on the stock exchange's main board in February 2015, raising about HK$165 million ($21 million) and pricing its shares at HK$1.10 each. They rocketed to as high as HK$35 on June 9 of that year. One day later, Jicheng conducted a 25-for-1 stock split, and followed that with a 5-for-1 split 10 months later.

Jicheng has been trading as a penny stock -- defined as a price of less than HK$1 --  since last April.

Major exchanges in the U.S. have clear rules on penny stocks, which are typically considered high risk because of their lack of liquidity and small capitalization. They often trade over the counter rather than on the exchange's main board. Companies on the New York Stock Exchange, for example, face delisting if their shares drop below $1 for 30 consecutive days.

Hong Kong has no such safeguards. About 40 percent of the 2,000 common stocks listed in the city trade at less than HK$1, commanding an aggregate $145 billion of market value. 

Penny stocks often carry financial health warnings because of their small size; if their shareholder base is limited they may be even more vulnerable to potential manipulation.

Jicheng founder Huang Wenji holds a 74.48 percent stake, according to data compiled by Bloomberg. That means the number of shares in other hands and available to be freely traded -- the public float -- is barely above the 25 percent minimum required by the Hong Kong exchange.

But how many shares are really available for retail investors? On Tuesday, Lerado Financial Group Co. and China National Culture Group Ltd. sold 3.1 billion Jicheng shares between them, or 4.1 percent of the number outstanding. Both companies also feature in Webb's Enigma Network.

When companies apply to hold an initial public offering in Hong Kong, the exchange requires them to have at least 300 shareholders to list on the main board, or 100 to join the Growth Enterprise Market. Those rules are aimed at ensuring there's sufficient depth in the market for their shares. Once listed, though, scrutiny is less strict.

Jicheng has been on the Securities and Futures Commission's radar ever since its IPO. In May 2015, the SFC issued a so-called concentration warning, alerting investors that a small number of shareholders held a high proportion of the shares and urging "extreme caution." Seventeen shareholders, including Huang, owned 99.02 percent of Jicheng's stock, the regulator said. But nothing more has been done since.

Dark Clouds
China Jicheng's earnings have fallen since its initial public offering in 2015
Source: Bloomberg

On Dec. 30, Jicheng changed its mind on how it planned to use the money raised through the 2015 IPO. Instead of spending 71.5 percent of the net proceeds to build a new factory in China, it decided to divert most of that into "buying new brand names" and marketing. The shares barely budged that day. The company traded at 42 times book value before last week's crash and, like most penny stocks, isn't covered by any equity analyst tracked by Bloomberg.

Sudden slumps wiping out billions in shareholder wealth have been happening too frequently in Hong Kong, from Hanergy Thin Film Power Group Ltd. in 2015 to China Huishan Dairy Holdings Co. earlier this year. The fact that Webb could write: "The SFC should be taking a close look at this network," six weeks before the collapse is an indictment of the policing of the Hong Kong market.

Civilized warning letters are no longer enough. Hong Kong urgently needs to consider borrowing from the U.S. playbook, delisting the most illiquid of its 800 penny stocks, asking more questions about frequent and suspicious stock splits, and looking more closely at cross-shareholdings and unusually low floats.

As Macau knows, running a casino can attract well-heeled and shady types who fancy their chances of beating the house. That's not the kind of customer a global financial center should be catering to.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shuli Ren in Hong Kong at

To contact the editor responsible for this story:
Matthew Brooker at