Is Hong KongÆs role as a fund-raising hub threatened?

PricewaterhouseCoopers says no, but Credit SuisseÆs head of China research sees increasing competition between China and Hong Kong.
The surge of initial public offerings in Shanghai and Shenzhen last year has caused concern among Hong Kong-based financial services companies that their IPO-related businesses are about to be snapped up by their Chinese counterparts. Adding further to these worries, PricewaterhouseCoopers (PWC) last week projected that a continued lack of mega IPOs will result in less funds raised in Hong Kong in 2008 than in 2007.

However, PWC believes Hong Kong will maintain its competitiveness as a fund-raising platform for global capital in the next five years. It argues that the equity capital markets in Hong Kong and China are different and that there is little competition between them.

ôDifferent companies have different aims when they go public,ö says Edmond Chan, a partner in PWCÆs capital market services group. ôSome companies want to polish their brands and images, to get access to international capital and to enjoy higher flexibility of money flow. They will choose to list in Hong Kong. Companies that list in the A-share market, which is (largely) restricted to domestic investors and is being operated under an exchange control regime, are primarily focused on raising renminbi funds to finance their expansion in China.ö

According to reports issued by the accounting firm, ample liquidity and the return of Hong Kong-listed H-share companies to the A-share market resulted in a tripling of the total IPO funds raised on the Shanghai and Shenzhen exchanges last year to Rmb477.1 billion ($65.7 billion). The Rmb438 billion raised on the Shanghai Stock Exchange saw the Chinese bourse top the world in terms of IPO funds raised in 2007, surpassing both the London Stock Exchange and the New York Stock Exchange. Companies going public on the Hong Kong stock exchange raised a combined HK$295 billion ($37.8 billion).

Part of the reason for the sharp increase of IPOs in China is that Beijing has been directing large profitable Chinese companies to list in Shanghai or Shenzhen as a way of raising the profile of the local equity markets. While the regulators have issued no formal guidelines in this respect, it is no secret that several companies that originally sought to go public in Hong Kong changed their plans and went for a domestic listing instead.

Indeed, Vincent Chan, who is head of China research at Credit Suisse, argues that there is now real competition between Hong Kong and China, compared with the situation before 2006 when Hong Kong was the dominant market for Chinese companies wishing to raise equity capital.

ôCompanies can raise funds either domestically in Shanghai or overseas in Hong Kong and the domestic (China) market will be playing a bigger and bigger role,ö says Chan. ôRight now the A-share market is commanding extremely rich valuations, which I donÆt think is sustainable, and in the near term, when the market starts to correct, there might be a cooling-down period of A-share listings. But in the longer term, domestic listings will be a trend, and to a certain extent, the Hong Kong market is threatened by that trend.ö

That said, he notes that Hong Kong maintains its edge as an international fund-raising hub û for now.

ôCurrently the A-share market is mainly attracting domestic funds and H-shares are mainly attracting overseas funds. Gradually the line will be increasingly blurred, but it will take some time,ö he says.

One reason for this is that the main way for international investors to buy A-shares today is through the qualified financial institutional investor (QFII) scheme and that is still relatively small in scale. Also, until the renminbi is fully convertible, companies will continue to raise funds in both markets, he adds.

PWC notes that Hong Kong achieved the highest ever number of new listings in 2002 with 117 companies going public, including 57 on the Growth Enterprise Market (GEM). Despite a significant drop in the number of new listings on the GEM board, the number of new listings remains at 70 or over each year. In 2007, Hong Kong saw 86 new listings even though there were 125 new listings in Shanghai and Shenzhen combined.

ôBased on these statistics and the different roles of Hong Kong and mainland China stock exchanges, we can conclude that the A-share market has not affected the Hong Kong market much so far,ö says PWCÆs Chan.

The firm expects the number of new Hong Kong listings to increase to 90 in 2008 from 86 last year, but the total capital raised will shrink by about 5% to HK$280 billion. The IPO activity will be driven by new listings of mid-cap Chinese enterprises with fund-raising targets between HK$1 billion and HK$5 billion. These will typically be privately-owned entrepreneurial firms, rather than the state-owned giants that have dominated the Chinese IPO issuance in the past.

At the same time though, PWC predicts that the Chinese government may allow Hong Kong-listed red-chips to sell shares in the A-share market this year, following the mass return of H-share companies last year. Companies that already have H-shares listed in Hong Kong accounted for 70% of the total IPO funds raised in the A-share market last year, even though funds raised by other mainland companies increased by 68% to Rmb154.9 billion.

ôWe see this momentum continuing in 2008 although most of the H-share companies have already listed in the A-share market. The market is looking forward to the next cycle led by A-share listings of the red-chips,ö Frank Lyn, China markets leader of PWC, says in a written statement.

Today, red-chip companies are prevented from listing in the A-share market because they are incorporated outside Mainland China, but the regulators have indicated that they are considering changing the rules to make a domestic listing possible. If they get a green light to sell A-shares in 2008, the total IPO funds raised in the Shanghai and Shenzhen capital markets are expected to reach Rmb480 billion, Lyn says.

Perhaps it is too early to draw the conclusion that Hong Kong is losing its competitive advantage as an international fund raising hub, but it is quite true that its ôGolden Ageö with mega state-owned Chinese IPOs has already gone. According to the PWC reports, there were only six new H-share listings on Hong KongÆs main board in 2007, compared with 17 in 2006.

ôOn the international fund-raising side, Hong Kong will definitely maintain the edge for some time, because the domestic A-share market is still quite distant to attract foreign financing. But the overall pie for foreign financing is declining. The period after Sars, between 2003 and 2006, was probably the best period for Hong Kong market development. Competition is definitely risingö, says Vincent Chan at Credit Suisse.
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