Alarming Talk in Hong Kong

Its stock market is soaring, but prospects of an all-China exchange raise fears

It's one of the most audacious proposals in global finance. Hong Kong financial authorities are exploring whether to integrate some operations of the highly regulated and sophisticated Hong Kong Stock Exchange with the Chinese mainland's two rapidly expanding and freewheeling bourses in Shanghai and Shenzhen. The vision: a loosely confederated megabourse for local and global investors alike to play Chinese equities. Yet sorting out currency matters and vastly different legal systems and regulatory regimes would take years, and may be insurmountable. And even modest moves in that direction, some worry, could start to alter Hong Kong's image for regulatory integrity that has made it a leading finance center in Asia.

In January a panel of the high and mighty in Hong Kong finance and government convened an economic summit to explore linking local clearing and settlement systems with mainland exchanges and establishing ways to cross-trade securities listed on all three bourses. That was followed by the Hong Kong government's decision in early September to acquire a near 6% stake, up from 4.4%, in the Hong Kong Stock Exchange that could be used as part of an equity swap between one or more of the mainland bourses or their respective local governments. What has free-market purists alarmed is the move toward more government intervention in the Hong Kong markets and perhaps less oversight rigor if the regulatory gap on the mainland isn't truly addressed.

On Oct. 9 legislators grilled Hong Kong Monetary Authority Chairman Joseph Yam, Financial Secretary John Tsang, and Hong Kong Exchanges Chairman Ron Arculli about the wisdom of the government's direction. Hong Kong's future as a vibrant financial center depends on a steady stream of Chinese companies there to raise capital, and more ties with Chinese exchanges will help secure that, the government argues. "Mainland China is of paramount importance to us," Tsang said.

There are sound commercial reasons for this trio of exchanges to work together. On paper, drawing together the Hong Kong, Shanghai, and Shenzhen exchanges would create a huge bourse with a $5.3 trillion market capitalization that would eclipse the regional leader Tokyo Stock Exchange, now at $4.5 trillion. Also, there is no denying that Hong Kong's future will depend on continued access to China's massive $5 trillion in savings.

It's also true that many of the Hong Kong Stock Exchange's biggest global rivals have engaged in a flurry of strategic alliances in pursuit of scale, high-tech trading technology, and lower trading costs. The marriage of the New York Stock Exchange and Euronext and the more recently proposed three-way tieup between NASDAQ, Bourse Dubai, and Swedish Exchange operator OMX haven't gone unnoticed among Hong Kong's money pros. And even modest moves toward market integration can yield huge payoffs. The benchmark Hang Seng Index has powered through this summer's global credit crisis and is up nearly 40% since Aug. 20, thanks to a pilot program that will allow individual mainland investors to buy Hong Kong stocks. As a result, the market capitalization of the Hong Kong Exchanges & Clearing, the listed company that owns the local bourse, hit $34.2 billion on Oct. 10. That's more than the combined value of NYSE Euronext (NYX ) and the NASDAQ Stock Market (NDAQ ).

Yet despite the market euphoria, Hong Kong Stock Exchange officials seem far less enthusiastic than the pols about teaming up with the mainland exchanges in a significant way. For one thing, the Hong Kong bourse is much more open, regulatory-savvy, and technologically sophisticated than the upstart Shanghai Stock Exchange, a corruption-prone market where share prices are up an absurdly high 113% this year. "We have different regulatory systems," says Arculli, the chairman of the exchange's corporate parent. "So if you are talking about integration, that really requires an awful lot of consideration."

The other bigger obstacle: China has tight controls on capital flows in and out of the country and keeps its currency trading in a narrow range vs. a basket of foreign currencies. The Hong Kong dollar, meanwhile, is pegged to the U.S. dollar. Unifying the currencies would mean the possible loss of Hong Kong's prized monetary independence from Beijing. "Will the Hong Kong dollar be pegged to the [Chinese] renminbi and fade into history?" asks David Webb, an independent nonexecutive director at the Hong Kong Stock Exchange.

More to the point, Hong Kong has little reason to cede a great deal at the moment. Plenty of Chinese capital continues to flow its way as things stand now. A program created in 2006 to allow Chinese domestic institutional investors such as banks and fund-management companies to invest offshore should send $90 billion in investments overseas over the next year, a third of which will go to Hong Kong, predicts Jing Ulrich, chairman of China Equities at JPMorgan Securities (JPM ). "Hong Kong is the single biggest beneficiary of capital outflows from China," she notes.

Still, Hong Kong would be foolish not to explore partnerships as Chinese markets continue to liberalize and Beijing moves toward more currency and capital control reforms. Zhou Chunsheng, professor of finance with the Cheung Kong Graduate School of Business in Beijing, asserts that a tieup between Hong Kong and Shanghai isn't likely, as the two are ferocious rivals. "But in the long run, the [far smaller] Shenzhen exchange might merge," he figures.

Here is what the local press is saying about the Hong Kong government's increased ownership stake in the stock exchange and China's growing capital flows into the former British colony.

Market jitters in Hong Kong

The Hong Kong government's decision to up its stake in the company that runs the local stock exchange has sparked a political controversy, reported the Oct. 10 issue of The Standard, a local financial daily. At an Oct. 9 meeting, Hong Kong's top financial officials told legislators that the government's decision to up its stake in Hong Kong Exchange & Clearing to 5.88% was designed to ensure the stability and integrity of the monetary and financial systems. But lawmakers say the move, made in September, smacks of state intervention, which runs counter to Hong Kong's laissez-faire tradition.

The coming stampede

A flood of money from the mainland may soon wash into Hong Kong. According to an Oct. 10 article on, Beijing's decision to permit retail investors and qualified institutional investors from the mainland to buy shares traded on the Hong Kong stock exchange could free $200 billion to flow in within a year.

By Chi-Chu Tschang and Frederik Balfour, with Dexter Roberts in Beijing

— With assistance by Dexter Roberts

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