HKEX’s China based Strategy: Fruitful Past, Uncertain Future

A key reason behind Hong Kong’s high rank in terms of capital market development, in spite of being the 37th largest economy in the world, is its vicinity to China. Hong Kong acts as a conduit between Chinese companies and international investors, helping Chinese companies access capital from the outside world as well as providing Chinese investors access to investment opportunities in the Asian region; around half of companies listed on the HKEx are from China. Consequently, since the mid-1990s, Hong Kong’s capital market growth has largely been driven by growth of the mainland economy. Hong Kong’s exchange operator, the HKEx group, has built its core business around the China growth story and came out relatively unscathed from the crisis of 2008. A dominant theme in the group’s recent strategy has been to move even closer to the mainland market by connecting to the mainland’s stock exchanges and providing members of two exchanges mutual access. In November, 2014, HKEx launched the Shanghai-Hong Kong Stock Connect program, enabling Chinese investors to trade shares listed and traded in Hong Kong and vice versa; Shenzhen HK connect is planned in the near future. In the last three years China has been opening up the Renminbi (RMB), and Hong Kong is positioning itself as China’s offshore RMB center by building RMB capability and developing diversified RMB products. HKEx is looking to capitalize on this opportunity as well. The mainland’s high demand for raw materials and international trades in commodities is another driver for the HKEx group. It recently acquired the London Metal Exchange (LME) Group to signal its intent to grow a commodity business. Leveraging on this acquisition it plans to build an “East Wing” of commodities clearing for the whole Asian region and during Asian time zone. HKEx’s future prospects, like its historic growth, are contingent on the mainland dynamics. While it has many upsides, too much reliance on China can have downside risks in case of slowing down of the Chinese economy or emergence of policy hurdles. Recent slowdown of Chinese economy has raised concerns about the prospects for its future growth and its potential adverse impact on the China-Hong Kong trading link. On the commodities front China seems uninterested at this point in taking help from other markets. Furthermore, commodities trading practices differ between China and Hong Kong as investors in China, unlike those in Hong Kong, want physical delivery. This requires significant warehouses that the HKEx is still in the process of developing. Lastly, neighboring Singapore will present competition in the OTC space as it also plans to be a major player in the region focusing on South East Asia and China.