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.

Volatility is returning to Hong Kong stocks.

In normal times, hot IPOs can fire up investors and propel markets higher. 

But the city needs to be careful what it wishes for, especially when the Hong Kong Monetary Authority is mopping up liquidity to manage the local currency's peg to the U.S. dollar. The way big IPOs are sold is a headache for the de facto central bank.

It's common among Western and local brokerages in Hong Kong to line up leverage of 10 times an outlay to buy into popular share offers: With HK$1 million ($128,000), you can borrow HK$9 million from the broker for a HK$10 million order.

When ZhongAn Online P&C Insurance Co. raised $1.5 billion in late September, retail investors oversubscribed their $300 million allotment by more than 400 times. On Sept. 18, when orders for ZhongAn opened, they borrowed more than HK$50 billion from brokers. To put that number in perspective, Hong Kong's entire interbank system has slightly more than HK$180 billion of liquidity.

Meanwhile, the HKMA has been reducing that level. The Hong Kong dollar was alarmingly weak this summer, edging down to 7.8262 to the dollar in late August, near the HKMA's lower limit of 7.85. In mid-September, the central bank said it would issue exchange fund bills to drain HK$8 billion per day in five installments, on Sept. 26, then Oct. 3, 10, 17 and 24. Interbank liquidity is now falling toward a 2014 low.

Tightening the Belt
Hong Kong's interbank liquidity has dropped back near 2014 levels as the HKMA manages its currency peg
Source: Hong Kong Monetary Authority, Bloomberg

That IPO margin financing arranged by brokers is borrowed from banks and tends to lock up cash for about a week. Combined with HKMA tightening, it's produced a sudden liquidity crunch. After months of small changes, the Hong Kong interbank offered rate, or Hibor, spiked around the time of ZhongAn's IPO, and again as the monetary authority drained more cash this month.

Watch Those Spikes!
Hibor is rising as the HKMA tightens and hot IPOs come to the market
Source: Bloomberg

Hong Kong's IPO market is firing up after years of anemia. ZhongAn has soared 38.7 percent since its debut Sept. 28. Qudian Inc., an online consumer lender backed by Ant Financial, an affiliate of Alibaba Group Holding Ltd., rallied 45 percent in its first two days of trading in the U.S., reinforcing investors' perception that a Jack Ma-backed IPO can't go wrong.

China Literature Ltd. is just around the corner. Backed by Tencent Holdings Ltd., that IPO is the next hot thing, as Gadfly's Nisha Gopalan predicts. 

However, these star offerings draw on the same sources of margin financing as the rest of the stock market. The week before ZhongAn started trading, the Hang Seng Index fell 1.7 percent. On Thursday, the benchmark dropped 1.9 percent, the most since Aug. 11, after Hibor rates jumped.

To be sure, the bullish signals remain intact: The Hang Seng Index still trades above its 30-day moving average after Thursday's rout. But amid a liquidity crunch, investors should brace for further volatility.

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:
Paul Sillitoe at