Hong Kong as World-Beater Cut in London Metal by Mandarin Li

Charles Li, the chief executive officer of Hong Kong Exchanges & Clearing Ltd., put on a tuxedo for the first time and stood before a crowd of 2,000 metals professionals at London’s Grosvenor House Hotel in October, capping an impromptu speech with a couple minutes of Mandarin.

That a quarter of the guests assembled for the annual dinner of the 136-year-old London Metal Exchange were Chinese bankers or traders who understood him underscored the new order at the venue Li would soon acquire.

The Gansu-raised former chairman of JPMorgan Chase & Co. in China paid $2.2 billion for the LME. At 180 times trailing income, the deal, announced June 15 and completed Dec. 6, is the most expensive bourse acquisition over $1 billion since at least 2000, according to data compiled by Bloomberg. The price was justified because the world’s second-biggest economy accounts for as much as 44 percent of global consumption of aluminum and copper, Li said.

“I didn’t go to London to do this to make history,” Li said in a February interview at his 12th floor office with a view beyond Victoria Harbor to the mainland. “More importantly for us is to really use the LME as a catalyst to achieve a breakthrough in the barrier between China and the rest of the world.”

Li is taking over the LME at a time when most metals and energy trading in Asia is done through contracts anchored in Europe and the U.S. Besides the LME’s 80 percent share of global industrial metals, the benchmarks for oil, West Texas Intermediate and Brent, are settled in New York and London. Global benchmarks for everything from corn to wheat to soybeans are set in Chicago.

Iron, Coal

The Hong Kong bourse’s all-cash offer beat Intercontinental Exchange Inc. to win control of LME. CME Group Inc., which vies with Hong Kong Exchanges for the title of world’s biggest bourse company by value, had dropped out of the bidding earlier. Hong Kong Exchanges dropped 0.1 percent to HK$132.10 today, while the Hang Seng Index ended the day 0.3 percent higher.

With the LME behind it, Hong Kong plans a venue for its own products in iron ore, coking coal and crops, and will expand the LME’s network of warehouses for storing physical commodities into China, Li said. That will give Hong Kong Exchanges a chance to capture the yuan-denominated commodities trade, valued at a combined 95.3 trillion yuan ($15.35 trillion) in 2012, which is now confined to three Chinese exchanges that restrict foreigners, according to the China Futures Exchange Association. Those venues are in Shanghai, the northern port city of Dalian and Zhengzhou, capital of Henan province.

Hong Kong can provide a “demilitarized zone” where domestic consumers and foreign suppliers establish prices using indexes, futures and physical delivery contracts, Li said.

Three Leaders

“With a strong suite of listed products consisting of equities, commodities, fixed income and currencies, I see HKEx joining CME and ICE as one of the three leading exchanges in the world in five to 10 years,” Eric Shi, global commodities head of BOC International, the investment-banking unit of Bank of China Ltd. wrote in an e-mail Feb. 26. “There are still many hurdles for HKEx/LME to be successful, particularly in the short term, given the complexities of China.”

Li said the opening of the Chinese economy echoes his own journey from growing up in a rural territory bordering Mongolia to speaking at the London LME dinner. He wants to cement Hong Kong’s position as China’s outward-facing financial center rooted in every asset class.

“What influenced my life and the life of my generation is this great wave of change of China, in the short space of 15 years that allowed my generation to experience something that other people hadn’t experienced over 20, 30, 40, 50, 60 years, because of the change in China from nobody to the second-largest economy,” he said.

Colorful Career

Li, who turned 52 last month, worked in an oil field in China’s Bohai Bay the late 1970s before earning a Bachelor of Arts in English literature from Xiamen University, a master’s in journalism from University of Alabama, and a law degree from Columbia University. He was a lawyer in New York at Brown & Wood LLP before joining Merrill Lynch & Co. and later JPMorgan.

He joined HKEx in 2009 and became CEO in January 2010. Last year, Li received a cash bonus of HK$6.6 million ($850,000) on top of his HK$7.6 million salary, according to data compiled by Bloomberg.

Beijing’s gradual reduction of restrictions on the use and trading of its currency is an opportunity for commodity venues, according to Li. Hong Kong has the largest deposits of yuan outside the mainland, rising almost 10-fold at local banks since 2009 to 651.72 billion renminbi at the end of February, according to Hong Kong Monetary Authority data.

Even as it battles inflation that rose to a 10-month high in February, China maintained its goal for economic growth at 7.5 percent for 2013, unchanged from last year and below 8 percent growth from 2008 through 2011.

Management Stretch

HKEx’S LME investment was a mistake, according to David Webb, an independent financial commentator based in Hong Kong and a former director of the exchange.

“The justification for buying it, whatever the price was, was diversification and that’s never a good reason to buy something in and of itself,” Webb said in a Feb. 28 phone interview. “It’s 6,000 miles away. It doesn’t have any synergies with HKEx and it stretches management capabilities to assimilate something so different.”

The bourse company’s net income fell 32 percent in the fourth quarter to HK$864 million, below analysts’ estimate and the worst since the first of quarter of 2009. The decline was due to falling volume and listings, the firm said. The share price, while gaining 6.3 percent in 2012, is about half of its peak at HK$265.60 in November 2007, and almost 10 percent below the closing level on Jan. 15, 2010, the day before Li took charge.

Weakening Equities

Li’s acquisition of LME may help offset declining business from equities. Turnover dropped to HK$13.3 trillion last year, a 22 percent slump from 2011, according to data from the bourse.

Hong Kong Exchanges’ pipeline of initial public offerings from China is drying up as the country goes from being an importer of capital to being an exporter, Li said. It was the biggest single venue for IPOs in 2010, hosting $53 billion including AIA Group Ltd. and Agricultural Bank of China Ltd. That fell to $8 billion in 2012.

Even with the reduction, cross-border equity listings, mainly from China, are already several times higher than in the U.K. and the U.S. By contrast, HKEx lags behind Spain’s Bolsas y Mercados Espanoles SA, operator of the biggest securities exchange on the Iberian peninsula, in bond revenue, and handled roughly a third of the value of fixed-income products than did the Korea Exchange in South Korea in January.

‘Growing Relevance’

“The point is to create a growing relevance and importance in the Asian time zone, of the Asian price-discovery system, the Asian volume,” said Li, who helped lead China’s first international bond sale in New York 19 years ago. “Unless you have fixed income and currency markets you are not a real capital market, you are not a real international financial center. Our chance lies in the renminbi.”

Shares of Hui Xian Real Estate Investment Trust started trading in yuan in April 2011, the world’s first IPO in the currency outside mainland China. It’s still the only yuan IPO to have taken place in Hong Kong and the fund’s returns have been outpaced by a 14 percent decline in the shares since listing. That compares with a 26 percent gain by the Hang Seng REIT Index in the same time.

Aside from a supplementary listing of Hopewell Highway Infrastructure Ltd. shares, no other companies trade in yuan on the bourse.

Popular ETFs

Exchange-traded funds that use quotas to invest directly in China’s A-share market, open only to domestic investors and qualified foreigners, have surged in popularity. The ChinaAMC CSI 300 Index ETF and the CSOP FTSE China A50 ETF, which trades in yuan in Hong Kong, are among the city’s most-traded ETFs on a daily basis after their introduction in December, according to data compiled by Bloomberg.

Adding new products is “like breaching when you have a battlefield,” Li said. “It’s the fastest, quickest, easiest opening because that sends the signal to the whole battlefield that the breach is possible. It’s all a confidence builder.”

Before it's here, it's on the Bloomberg Terminal.