Hong Kong v Shanghai: the battle over China’s capital markets
The battle over the future of the London Stock Exchange Group is also a fight for the future of the world’s financial markets.
A takeover of the LSE has implications not just for London’s future as a hub of activity, but also for how China will connect its rapidly expanding capital markets to the rest of the world.
Hong Kong’s stock exchange said on Tuesday that it would not proceed with a formal takeover offer for the LSE, after its £32bn indicative bid was rebuffed last month. In considering the proposal, the target’s shareholders had a call to make: will China’s capital markets open up via the special administrative region of Hong Kong, as the deal’s logic suggests, or through the rival market on the mainland in Shanghai?
The LSE favours its own £27bn deal to buy data and trading provider Refinitiv, over a combination with Hong Kong Exchanges and Clearing. In management’s view, the future is information and Hong Kong’s status is on the decline.
“We view Shanghai as the financial centre for China,” David Schwimmer, the LSE’s chief executive, told delegates at a London conference last month.
His opposite number at HKEX, Charles Li, sees things differently. For Mr Li, Hong Kong is the financial equivalent of an electrical transformer connecting China with the world, which will be hard to replicate.
“We are 110V, they are 220V — it doesn’t fit. Somebody needs to find a way to connect them. Practically speaking, it’s very difficult to do,” he said at the same conference.
Why does China have barriers to foreign capital?
China’s dilemma rests on an economic concept known as the “impossible trinity”. This says that no state can exert full control over its foreign exchange rate, enjoy free flows of capital and have independent monetary policy — the ability to determine interest rates — all at the same time. They have to pick two of the three.
China has an independent monetary policy and foreign exchange controls, which rules out the free flow of capital. Hong Kong has taken a different path: free flow of capital, foreign exchange controls (in the form of a US dollar peg) and no independent monetary policy. Its interest rates track those set by the US Federal Reserve.
Mr Schwimmer sees the slow relaxation of capital controls on the mainland as an “inevitable path”. That would erode Hong Kong’s competitive edge.
But Mr Li, born in Beijing but head of HKEX for nearly a decade, says Chinese policymakers are cautious about allowing the uncontrolled movement of funds.
“The idea that China will actually one day relax its capital controls, we’ve been talking about for 20 years. We’re going to continue to talk about it for 20 more years,” he said.
How does Shanghai connect to the world?
The Shanghai stock exchange hosts some of China’s biggest and most liquid onshore equities. Its market capitalisation of $4.5tn puts it behind only the New York Stock Exchange and Nasdaq in the US, and the Japan Exchange Group, according to data from the World Federation of Exchanges.
The Shanghai bourse is state-run and regulators cap the pricing and decide the timing of each flotation, in addition to limiting the size of daily moves in share prices. Only approved overseas investors can trade in China.
A quota on total purchases of stocks and bonds by foreign investors was scrapped in September, as part of an effort to bring in more overseas capital. However, those quotas were rarely fully subscribed.
Shanghai also has a new link with the LSE, via a stock connect programme. UK-listed companies can issue Chinese depositary receipts in Shanghai. Shanghai-listed companies can issue global depositary receipts in London as long as they have a market capitalisation of more than Rmb20bn ($2.8bn).
So far, just one Chinese company, Huatai Securities, has listed in London, although Mr Schwimmer says there is another in the pipeline.
What is Hong Kong’s pitch?
With a domestic market capitalisation of $3.8tn, Hong Kong’s stock market is smaller than Shanghai’s but simpler to access for international investors, given that the Hong Kong dollar is freely convertible. Chinese companies, too, have an easy option for offshore fundraising.
Internet group Tencent, which is headquartered in Shenzhen, is listed in Hong Kong. The territory also has stock connect programmes with Shanghai and Shenzhen, which allow Hong Kong-based investors to invest in more than 4,000 mainland-listed stocks.
The programmes sidestep capital controls by requiring investors on either side to cash out from stocks they buy in their own currencies. The linkages help ensure Chinese stocks’ inclusion in global equity benchmarks. Cumulative net foreign purchases of Chinese stocks through the two programmes now total more than $116bn. Hong Kong also has a bond connect programme that allows foreign fund managers to trade in government, agency and corporate debt on China’s interbank bond market.
The latest meeting of China’s State Council’s financial stability development committee reiterated that the country would “further expand” its “two-way opening of the financial industry”.
That promise, however, came at the end of a long list of domestic policy priorities. Few expect Beijing to loosen its restraints on foreign capital in the short term.
“You need Hong Kong in as far as you keep capital controls,” said Alicia García Herrero, chief Asia economist at Natixis. “It doesn’t mean you don’t need Shanghai. It’s that Shanghai alone can’t do it.”