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Hong Kong as a capital formation centre

Date 11/07/2005

Paul Chow, Chief Executive, Hong Kong Exchanges and Clearing Limited

This article explores Hong Kong’s emergence as a major global centre of capital formation. It traces the development of the Hong Kong stock market, and looks at the factors which underpin Hong Kong’s current capital-raising strength.

Hong Kong, with its population of close to seven million people, is the twenty-fifth largest economy in the world. In 2004, as a result of a number of large-scale listings by Mainland China enterprises, Hong Kong overtook major centres like Tokyo and London to become the world’s third largest market by total equity funds raised (see Figure ). Such performance is mainly due to global interest in the emergence of the Mainland China economy, for which Hong Kong now serves as the premier international fund-raising platform.

Figure 1: Ranking of world markets by total equity funds raised (2004)

Historical development

The Hong Kong stock market, formally established in 1891, is more than a century old, but it began to play a major role in the economy from the 1960s onwards. In its early days, the stock market was dominated by British firms, but with the opening of the Far East Stock Exchange in 1969, stock trading was brought to the local Chinese population. Development in those years was particularly vigorous, with no fewer than four stock exchanges in operation by the early 1970s. These four exchanges subsequently merged in 1986 to form the unified Stock Exchange of Hong Kong. In March 2000, the Stock Exchange of Hong Kong and the Hong Kong Futures Exchange demutualised and merged with the Hong Kong Securities Clearing Company to form the Hong Kong Exchanges and Clearing Limited, or HKEx. HKEx was listed on its own exchange in June 2000.

Banks, transport and utility companies dominated the market in the early days, with consumer companies like Lane Crawford following as the territory grew wealthier. There were also conglomerates, like Hutchison, Swire or Jardines. However, Hong Kong is only a city and the domestic economy could not facilitate the development of heavy industries or natural resource companies. That changed in the past decade with the listing of large Mainland China enterprises in petrochemicals and other sectors.

Figure 2. Changing profile of Hong Kong listed issuers

  1962 1973 1983 1993 2004
1 Hongkong Bank Hongkong Bank Hongkong Bank HSBC HSBC
2 Whampoa Dock HKLand Hang Seng Bank HK Telecom China Mobile*
3 HKLand Jardine Matheson China Light SHK Properties Hutchison Whampoa
4 China Light Hutchison Intern?l Hutchison Hang Seng Bank Hang Seng Bank
5 KM Bus (1933) EANavigation HK Electric Hutchison SHK Properties
6 HK Electric New World Dev HK Land China Light Cheung Kong
7 HKTelephone Wharf Wharf & Godown Cheung Kong CNOOC*
8 Yaumati Ferry China Light Swire Pacific Swire Pacific Standard Chartered
9 HKTram Wheelock Marden Jardine Matheson Henderson Land Bank of China*
10 Wheelock Taikoo Swire General Oriental Wharf CLPHoldings
11 Jardine HKTelephone HKTelephone HKLand Swire Pacific
12 Swire HK Electric Swire Properties HKElectric HK &China Glass
13 Lane Crawford Hang Seng Bank Cheung Kong New World Dev China Unicom*
14 Kwong Sang Hong Whampoa Dock SHK Properties Jardine Matheson HKElectric
15 GICement HK&Shanghai Hotels New World Dev CITIC* Henderson Land

* Mainland China Enterprises

Mainland China dimension

Today, Mainland China enterprises account for a quarter of Hong Kong’s listed issuers, almost half of market turnover, around 30 per cent of market capitalisation, and almost 80 per cent of IPO capital raised. Mainland enterprises are the Hong Kong market’s major stream of new business.

The listing of Mainland China enterprises in Hong Kong is perhaps the latest manifestation of Hong Kong’s historical role as a bridge or entrepot between Mainland China and the world. In the early 1980s, following the commencement of Mainland China’s open door policy in 1978, Hong Kong companies began moving their manufacturing operations into the nearby Pearl River Delta. Many of them listed in Hong Kong to raise capital for expansion. In this way, the business community, including professionals such as accountants and lawyers, gained experience of auditing assets and verifying legal rights in Mainland China. At the same time, Mainland China enterprises began setting up in Hong Kong and some of the largest ones listed on the Exchange. These were the first ‘Red Chips’ – Hong Kong- or foreign-incorporated Mainland China enterprises. In the early 1990s as Mainland China opened further, wholly Mainland-based Red Chips began listing in Hong Kong.

In 1993, a further stream of Mainland China business opened for the Hong Kong stock market in the shape of ‘H shares’. These are Mainland China-incorporated enterprises listed in Hong Kong. H shares became the preferred vehicle, and in recent years there have been numerous large listings, such as PetroChina in 2000 and China Life in 2003. Some of the H shares and Red Chips have also been listed on overseas markets, mainly New York. However, most of the trading in these dual listings gravitates to Hong Kong.

Mainland China private enterprises are another stream of business. Prior to 2000, all the Mainland China enterprises listed in Hong Kong were state-owned. However, with the growth of Mainland China’s private sector, the need of private enterprises to raise capital became overwhelming. Many Mainland private enterprises are attracted by Hong Kong’s Growth Enterprise Market (GEM), as this has lighter listing requirements than the Main Board.

The various stages of Hong Kong’s Mainland China development are summarised in Figure 3.

Figure 3. HKEx’s Mainland China dimension

In fact, the ten largest IPOs in Hong Kong since 1993 are all by Mainland China enterprises.

Table 1. The 10 largest IPOs in Hong Kong since 1993


Hong Kong is by far the leading overseas venue for the listing and trading of the securities of Mainland China enterprises. Although quite a number of stock markets list Mainland China enterprises, the greatest number – over 300 – are to be found in Hong Kong. Statistics on the Mainland China dimension of the Hong Kong stock market are given in Table 2.

Table 2. Mainland China dimension of the Hong Kong market

Not only are there more Mainland China enterprises listed in Hong Kong than overseas, but where cross-listing does take place, Hong Kong usually gets the lion’s share of the trading. In 2004, 81% of the trading in Mainland China securities listed in Hong Kong and New York took place in the Hong Kong market (see Figure 4).

Figure 4. Market share of Hong Kong and US in the turnover of dual-listed

Source: HKEx data, Reuters

Hong Kong has been successful as an international capital raising centre for Mainland China companies as it is able to position itself as the home market for these companies. From the viewpoint of international investors, Hong Kong has obvious political, geographical and cultural proximity to Mainland China. Hong Kong provides global investors with exposure to the fast-developing Mainland economy within an international-standard regulatory environment. Crucially underpinning this advantage is Hong Kong’s strong retail investor base. Local retail investors identify with and invest in Mainland China securities, thereby providing liquidity, which in turn attracts more listings and trading.

Although many Mainland enterprises do list on the Mainland China exchanges, listing in Hong Kong has major attractions for the larger and high quality enterprises that are likely to interest international investors. The Hong Kong stock market provides enterprises that can meet its standards with access to international capital, while on the Mainland exchanges, apart from the small B share sector, capital-raising is only in RMB. Hong Kong, which can attract investors from around the globe, supports large-scale capital raisings in the primary and secondary markets. Perhaps most importantly, the Hong Kong market provides issuers with the cachet of an international listing. By listing in Hong Kong, Mainland enterprises achieve compliance with international standards, acquire high-quality investors, and enhance their international recognition.

In addition to providing the capital-raising facility through listing, HKEx also provides derivatives for investors to manage their exposures. In December 2003 the exchange launched the H-share Index Futures; perhaps because of the then boom in the underlying H shares, this product caught on and is now trading some thousands of contracts a day. H-share Index Options successfully launched in June 2004 to complement the H-share Index Futures. HKEx also lists stock options and derivative warrants on Mainland China enterprises, which trade actively.

Maintaining confidence

The very high figures for capital raised quoted at the start of this article indicate the confidence of global investors in Hong Kong-listed Mainland China enterprises. To maintain confidence over the long term, numerous measures have been taken.

In the early stage, it was recognised that, given the country’s development level, investor protection in Mainland China would not be on a par with that in Hong Kong. To address such concern, Mainland enterprises came as Red Chips, i.e. the listed vehicle was a Hong Kong-incorporated company. This pragmatic use of a ‘foreign’ holding vehicle meant that investors of these Mainland enterprises enjoyed the same rights as investors of Hong Kong companies generally. Subsequently, the Mainland authorities indicated that they wanted their enterprises to list as Mainland-incorporated holding companies. These listings became known as H-share enterprises.

Since at the time of the first H share listing in 1993 Mainland China did not have a set of comprehensive company laws, there was a need for another solution. The solution was to require the H-share enterprises to adopt some key shareholder protection provisions of Hong Kong law into their constitutive documents. This is the same approach as the Exchange takes for other overseas-incorporated companies. Now that Mainland China laws have developed, for example with the enactment of a Company Law in 1994, this is less of an issue than it was. The Exchange also requires these H-share enterprises to provide for disputes between shareholders and the company to be taken to arbitration, in Hong Kong or the Mainland at the election of the claimant.

Another essential area is accounting and auditing. In the early 1990s, there was a wide gap between Mainland China practice and international standards. This gap was addressed by requiring the enterprises to prepare accounts in accordance with international accounting standards (IAS) or Hong Kong standards. Since the enterprises also had to prepare accounts in accordance with Mainland China regulations, they were required to publish a statement reconciling their respective profit figures under IAS and Mainland China accounting, and the audits are required to be conducted by international accountancy firms. Since then, again, this area has become more straightforward as Mainland China’s accounting standards have developed. There are now fewer differences between Mainland China accounting standards and IAS.

As a further safeguard, H-share enterprises are required to retain the services of their sponsor for one year after listing to assist them in compliance with the Listing Rules.

Exchange procedures

It is not only listing candidates that have to conform with high standards. The Exchange recognises the importance of public confidence in its own processes. So, for example, within the Exchange, the listing process has been designed to minimise the possibility of undue influence. No single official can approve a listing. Instead, approval is by a Listing Committee comprises only external market practitioners with the exception of the Chief Executive of HKEx. There is also an appeal apparatus: any person dissatisfied with the Exchange’s decision can apply to the court for judicial review.

Within the executive departments of the Exchange there are also Chinese walls. Exchange marketing staff members are not permitted to contact the issuer once its application is in progress; listing staff members are not engaged in marketing. The Listing function is subject to audit by the Securities and Futures Commission (SFC) whereas both the Exchange and the SFC are subject to review by the Hong Kong’s Independent Commission on Corruption.

In February 2005, as a means to further enhance its process for listing decision-making, the Exchange launched a consultation exercise on proposals to put in place a clearer and more efficient structure for approving listing applications and addressing suspected breaches of the Rules. The consultation conclusions will be published in due course.

Enhancing confidence

Global standards of corporate governance continue to rise, and this is recognised by the Hong Kong authorities. In January 2003, the Financial Services and Treasury Bureau (FSTB) of the Hong Kong Government launched a Corporate Governance Action Plan. This is currently in the process of implementation. These reforms are not targeted specifically at Mainland China enterprises, but apply to all Hong Kong-listed companies.

Amendments to listing rules relating to corporate governance

In March 2004, the Exchange released a major set of amendments to the Listing Rules. The requirements for listing on the Main Board were tightened; for example, issuers have to have initial market capitalisation of USD25m-equivalent and 300 shareholders – respectively a doubling and a tripling of the previous requirements. Key corporate governance rules were clarified.

Revised Code of Corporate Governance Practices

In November 2004, the Exchange’s revised Code of Corporate Governance Practices came into effect. The existing code was greatly expanded to follow the UK Combined Code. The Code sets out the principles of good governance in areas such as directors’ responsibilities, directors’ remuneration, accountability and audit, delegation by the board, and communication with shareholders. There are two tiers of compliance based on these principles: the ‘Code Provisions’ for which a listed issuer is required to comply or explain its non-compliance in its Report on Corporate Governance Practices, and the ‘Recommended Best Practices’ for which compliance is encouraged but disclosure of non-compliance is voluntary. This ‘comply or explain’ approach strikes a balance between providing a structured regulatory approach towards corporate governance while maintaining flexibility to allow listed companies a free hand to explain their reasons for adopting, or not adopting, particular corporate governance practices.

Regulation of listed issuers

In the disclosure-based regulatory regime in Hong Kong, an important measure already in force is that of dual filing. Under the dual filing procedure, which came into effect with the Securities and Futures Ordinance in April 2003, all issuer documents filed with the Exchange are deemed also to be filed with the SFC. The SFC can therefore take action, with its statutory powers of enforcement, on instances of false or misleading disclosure.

In order to further strengthen the regulation of listed issuers, the Exchange is of the belief that a number of important Listing Rules should be backed by statute to allow for more effective enforcement. The statutorily backed rules should be administered by the SFC which has the investigative powers of a law enforcement agency. Based on the Government’s consultation conclusions on the regulation of listing published in March 2004, the current direction is to enshrine in statute the key Listing Rules provisions such as regular financial reporting obligations of listed companies, disclosure obligations in relation to corporate transactions, particularly connected transactions, and the obligation to disclose price-sensitive information.

Recently, the Government and the SFC have issued two separate consultation papers to propose the requisite amendments to the Securities and Futures Ordinance to effectuate the enhanced statutory backing for key Listing Rules. The Exchange has submitted its response indicating its overall support while making specific recommendations on enhancing administrative and enforcement demarcation between the Exchange and the SFC.

Regulation of sponsors and independent financial advisers

Another important area is the regulation of sponsors and independent financial advisers. Sponsors are responsible for bringing the issuers to market, in the course of which they perform due diligence. The investing public is entitled to rely on the sponsor’s work. By more closely regulating the sponsors, the Exchange hopes to encourage them to more closely scrutinise the corporate transactions they bring to the market. In October 2004, the Exchange amended its Listing Rules to tighten the supervision of sponsors.

Regulation of the accounting profession

The Government is working on plans to establish a Financial Reporting Review Committee (FRRC), along the lines of the UK Financial Reporting Review Panel. The FRRC, when established under the proposed Financial Reporting Council (FRC), will have the power to review listed company financial statements, query them, and require correction where the statements need clarification.

The Government is also planning to establish an Audit Investigation Board under the FRC to monitor the audits of listed companies. At present this function is performed by the Hong Kong Institute of Certified Public Accountants. However, following practice in some other leading jurisdictions, there is a drive to move the regulation of the auditing profession, at least in relation to listed companies, into a statutory body.

Public education

Improvements in corporate governance are not just about rules and codes and enforcement – important though these are. The soft side – the awareness and ethical standards of individual directors and market practitioners – is also important. Recognising this, the Exchange is working with the Mainland authorities on plans for educational seminars for Mainland directors and senior management.


Hong Kong’s current success in raising equity capital reflects global investor demand for exposure to the emerging Mainland China economy. With its highly-developed equity culture, Hong Kong is well-positioned to support fund raising by Mainland China enterprises. By providing local liquidity, retail investors ensure that Hong Kong remains the dominant trading venue for most of these enterprises, even where the enterprises are also listed on major markets overseas. By establishing a special framework for H-share enterprises, steps were taken to assure investor protection.

Looking ahead, the success of the Exchange lies in its ability to work with the Government, the SFC and other stakeholders to uphold its roles as an international financial centre and a premier capital formation centre for Mainland China enterprises. Improving and maintaining market quality is the most important prerequisite. This is the reason why the Exchange is committed to taking an active role in enhancing corporate governance in the market. Higher corporate governance standards translate into better internal control and risk management practices of issuers, which result in higher investor confidence, a lower cost of capital for issuers, increased order flows, and increased liquidity for the market. This creates a virtuous cycle where more quality enterprises are attracted to list in Hong Kong, and more investors around the world are attracted to invest in the Hong Kong securities market.