Can Hong Kong Learn To Behave?

Scandals are straining the market's credibility

Hong Kong officials love to boast that their island is the ultimate free market, where the pursuit of wealth is gently but firmly disciplined with Western-style regulation. But perhaps it's time to stop crowing. A long-simmering stock market scandal erupted on Aug. 12, implicating several former highfliers in the colony's clubby business Establishment. Regulators believe those involved breached the rules on corporate takeovers by acquiring controlling interest in a company without making a tender offer to all shareholders, and then selling assets to the company at inflated prices.

The surprise arrest of five high-profile figures, each charged with multiple counts of conspiracy and bribery, comes at a time when Hong Kong is already under special scrutiny as the clock ticks toward China's takeover in July, 1997. Although some of the anything-goes practices of the 1980s have been cleaned up, the case is a reminder that corruption and inefficiency are deeply ingrained in Hong Kong's financial system.

BACKWATER. High costs and overregulation are eating away at the colony's competitiveness. If standards become even more lax as China uses Hong Kong to raise capital for its fast-growing young companies, the colony could revert to a regional backwater instead of evolving into a global power. "There are great rules on the books, but [they have] no teeth," says a Western analyst who worries that already shoddy enforcement will deteriorate further under Chinese sovereignty.

Regulators have been working overtime trying to prevent that from happening. The recent dustup started in 1990, when Australian magnate Alan Bond, short on cash, needed to unload his investment vehicle, then called Bond Corp. International Ltd. and renamed twice since. Investigators uncovered a ring of well-known businessmen who allegedly conspired to buy out Bond on the cheap, without tendering offers to minority shareholders, and bribed associates to "park" the shares so officials wouldn't notice the transactions.

Gambling tycoon Stanley Ho, who became chairman of Bond Corp., had his home and office searched as part of the investigation, although he wasn't indicted. Prosecutors expect to call HSBC Holdings PLC Chairman Sir William Purves and former Standard Chartered Bank corporate finance chief David Stileman, although neither one has been implicated in any wrongdoing, because of connections to Bond and other parties in the case. Bond himself was sentenced to jail on Aug. 20--his second time--on unrelated company fraud charges after employing unusual means to buy and sell an important painting by Edouard Manet.

Those charged with conspiracy and bribery in the takeover case include brothers Arthur and Raymond Lai, who were among Hong Kong's best-known stockbrokers during much of the high-flying 1980s, and David Tong, husband of Hsu Feng, who produced the award-winning movie Farewell My Concubine. Hsu's sister, Hsu Jye, and Peter Mou, an associate of the Lais and Tong, were also charged. The five arrested could not be reached or refused to comment on the case.

"RAT TRADING." To show they are upholding standards in the waning days of British rule, regulators have been beavering away on other cases as well. In late July, Chen Po-sum, former vice-chairwoman of the Hong Kong Stock Exchange, was indicted for accepting a bribe to approve the transfer of a seat on the exchange to Nomura Securities Co. (Nomura was not charged with any wrongdoing.) In mid-July a local legislator, Chim Pui-Chung, was arrested on fraud charges related to his share dealings. Chim, who represents the financial community in the colony's Legislative Council, ran for office on a promise that he would win amnesty for those convicted of "rat trading," or trading in advance of large orders that will move a stock up or down. Neither Chen nor Chim would comment on the charges.

But despite the regulators' increased vigilance since the beginning of the 1990s, the chronic dirty dealing makes many observers worry that standards will crumble when China takes control. Indeed, since China began experimenting with the stock, bond, and commodity markets at the start of the decade, financial scandals have dogged many of its moves. Market insiders now fear that well-connected Chinese will get special treatment from Hong Kong regulators once China takes the territory back.

It may already be happening. None of the Chinese companies listed in Hong Kong--via so-called H shares--has received more than a slap on the wrist from regulators. Yet their numerous and flagrant violations of Hong Kong rules range from failing to disclose major events in a timely manner to misusing proceeds from an initial public offering.

But Hong Kong can't afford to turn up its nose at China. The colony of 6 million people needs Chinese business to keep growing. In the past three years, Chinese companies have already raised more than $3.5 billion by listing H shares in Hong Kong. More are on the way as the colony tries to nail down its position as China's financial capital. "Hong Kong's future and sex appeal are linked to the fact that it is perceived as China's international window," says William Phillips, chairman of the Asia Pacific Region of Salomon Brothers Inc.

Unfortunately, the general agreement among Hong Kong officials on how transition to Chinese rule should be handled has often been overshadowed by internal conflict. Some disputes are simply turf battles. For example, earlier this year the Securities & Futures Commission, the financial watchdog, angered stock exchange officials by coming out with its own plan for market reforms. But there are also debates over whether Hong Kong should relax its standards to accommodate mainland companies. "The conflicts emerging on anything related to policy are extraordinary," says a senior executive for a U.S. investment bank.

No wonder. The issue of Chinese succession plays out against a backdrop of fierce squabbling between local brokers, who see reform as a threat to their survival, and foreign brokers, who want more Western practices to prevail. Many observers fear that the local firms will ally with Chinese officials against the Western financial houses and thwart any further reform.

For their part, foreign brokers resent the dominance of tiny, undercapitalized local traders who drive up the cost of doing business. It costs an estimated 30% more to trade in Hong Kong than in New York or London, thanks to fixed commissions and a lack of facilities for block trading. The SFC wants to abolish fixed commissions, which are set by the stock exchange. There is one brokerage house for each of the 560 listed companies on the exchange--far more than are needed.

These conditions are already costing Hong Kong business. On Aug. 20, U.S. mutual-fund behemoth Fidelity Investments announced it was considering establishing its Asian regional hub in Sydney rather than Hong Kong. Hong Kong's high real estate costs, astronomical salaries for financial professionals, and the expensive commission structure will probably figure in its choice.

CRACKING DOWN. For all its faults, Hong Kong has come a long way in recent years. Although its stock market's $340 billion capitalization is only one-tenth of Tokyo's, Hong Kong has taken advantage of Japan's xenophobia to leave Japan far behind as a regional financial center. The SFC, founded in 1989, has lately shed its image as a toothless tiger by starting to crack down on time-honored market abuses.

Hong Kong's officials realize they are playing a high-stakes game. If the world perceives that the island is starting to do business the Chinese way, it stands to lose its hard-won status as the capital of Asian capitalism. Hong Kong Stock Exchange Chairman Edgar W.K. Cheng insists that China, like Hong Kong's reformers, wants to stamp out corruption, and vows that his organization will "not revert back to the old days." So far, the skeptics who worried that Hong Kong might regress to its reptilian past have been proven wrong. But the real test begins next July.