Hong Kong observers like a bit of navel gazing. There is rarely a shortage of articles bemoaning Chinese government encroachment on the territory’s laws, the apparent obsequiousness of its government to Beijing and a gradual diminishment of its uniqueness, or its lack of dynamism when it comes to embracing change.
The events of last week should put some of these concerns to rest.
On Thursday, China’s newly introduced stock market circuit breaker was triggered for a second time in the week, when share prices plunged by over 7% within the first 30 minutes of trading.
The circuit breaker consists of a 15-minute market closure to supposedly allow cooler heads to prevail. Yet it has had a limited impact so far, and indeed has only delayed, rather than prevented, market drops.
Hong Kong’s China-company-dominated stock exchange did not do very well either. The Hang Seng index dropped over 3% in the morning of Thursday to reach 2,792.52, its lowest point in three years.
Yet there was a crucial difference between the two in approach. After the circuit breaker was imposed, the China Securities Regulatory Commission announced new share sales restrictions, to prevent large shareholders or company executives with stakes of more than 5% in a company from selling more than 1% of the company’s floatation every three months. Then, later in the day, the CSRC abruptly killed the circuit breaker, declaring, “the negative effect [of the circuit breaker] is bigger than the positive one”.
What did Hong Kong’s regulators do? Nothing at all.
This difference in approach underlines the key, Hong Kong’s enduring financial advantage: its stability.
Uncertainty issues
If there’s one thing investors and issuers don’t like, it’s uncertainty. A lack of assuredness about market conditions inevitably leads most institutional investors, chief executives and financial directors to prevaricate when it comes to major financial decisions. Better to wait until calmer, more predictable times prevail.
And uncertainties have flourished of late in China. A slowing economy, mounting debts and falling manufacturing output have combined to leave many investors inclined to sell shares.
Beijing doesn’t want to see major drops in share valuations. So it imposed restrictions on the stock market. Last summer, when shares were in freefall, it banned large shareholders holding at least 5% of a company’s equity from selling any shares. The ban was set to end on Friday, and led to fears of sudden share sales, which helped precipitate the latest rounds of sales – despite the circuit breaker. The CSRC has now extended the ban another three months.
China’s authorities had mostly good interests in mind for introducing such draconian market controls. They want to prevent huge pitches and yaws in local stock markets and to sustain local valuations, so the retail investors that account for about 90% of trading volumes feel less pain – especially in short periods.
It’s also likely the government wanted to sustain good company valuations, or at least prevent them falling far. Falling valuations make it tougher for companies to raise capital and keep debt ratios manageable.
But the arbitrary rules changes have merely added to the uncertainty for sophisticated investors, most particularly raising fears that they could be prevented getting their money out the market at the whim of the government.
This controlling attitude is evident beyond stock markets. For all the claims of the World Bank that China has a currency that is freely tradable, the People’s Bank of China is currently managing a gradual depreciation. If left to depreciate according to markets, it would likely drop far faster.
Indeed, the offshore rate of the renminbi weakened to Rmb6.72 to the US dollar on January 6, versus the Rmb6.55 rate onshore.
Hands-off approach
Hong Kong has taken the opposite approach. The former British colony inherited an impartial legal system, an independent de facto central bank and financial markets that are well-monitored by scrupulous regulators, and not subject to political whims.
It has also fully embraced the idea of capital markets, with all the rises and falls that they represent. Investors into stocks listed on Hong Kong Exchanges and Clearing know they will be able to buy and sell them according to current rules.
Hong Kong chief executive CY Leung is maligned by several parts of the city’s populace, yet it is hard to imagine his administration imposing mass stock sales restrictions or declaring short closures of the exchange after drops in valuations. For a start it lacks the legal authority to do so; plus the city’s regulators would fiercely resist any political trespassing on their authority.
The stark contrast in approaches underlines why Hong Kong will remain vital to the financial interests of international investors and companies operating in eastern Asia and beyond.
It also means the territory’s share market stands in good stead, particularly for Chinese companies seeking to list.
“Predictions of the demise of H-shares look unfounded,” said Aaron Arth, head of equity capital markets for Asia ex-Japan at Goldman Sachs. “This volatility has added strength to [the appeal of] H-Shares.”
Being boring can be an asset, after all.
