Wednesday, June 15, 2011

Shanghai vs Hong Kong as Leading Chinese Financial Centre

There are more and more direct competitions ahead for Shanghai and Hong Kong to position themselves as the leading financial centre in China. In our earlier article, we already discussed about Shanghai's strategic plan over the next decade. While Shanghai has planned to be an international financial centre by 2020, Hong Kong has not been, however, just waiting for competition from the north of the border.

In early 2010, the Hong Kong Exchanges and Clearing Ltd (HKEx stock code: set up its own strategic plan for 2010-2012 to start introducing Renminbi (RMB, CNY, or Yuan) products and to build Hong Kong as an international financial marketplace to encourage RMB internationalization. On 10 December 2010, in order to attract more mainland China enterprises listing, HKEx then announced to accept mainland China Accounting and Auditing Standards and also accredited mainland audit firms for mainland incorporated companies listed in Hong Kong.

By end-2010, the Shanghai Stock Exchange (SSE) and Hong Kong Stock Exchange (HKEx) are respectively the 6th and the 7th largest exchange in the world.

Table 1: Top 10 Exchanges by Domestic Equity Market Capitalizations in 2010

RankingExchangeCountry/RegionDomestic Equity Market Capitalizations (USD billion)
1NYSE Euronext (US)U.S.A.13394
3Tokyo Stock Exchange GroupJapan3828
4London Stock Exchange GroupU.K.3613
5NYSE Euronext (Europe)Europe2930
6Shanghai Stock ExchangeChina2716
7Hong Kong Stock ExchangeHong Kong SAR2711
8TMX GroupCanada2170
9Bombay Stock ExchangeIndia1632
9National Stock ExchangeIndia1597
10BM&F BOVESPA Brazil1546

By the end of 2010, HKEx's securities market did lead the world for the second consecutive year in fund-raising size through Initial Public Offerings (IPOs). Shanghai Stock Exchange, however, ranked only number 5 in the world during the same period.

Table 2: Top 10 Exchanges by IPOs Equity Funds Raised in 2010

RankingExchangeCountry/RegionIPOs Equity Funds Raised (USD million)
1Hong Kong Stock ExchangeHong Kong SAR57915
2SIX Swiss ExchangeSwiss44868
3Shenzhen Stock ExchangeChina44279
4NYSE Euronext (US)U.S.A.33813
5Shanghai Stock ExchangeChina29234
6Australian Securities ExchangeAustralia24294
7London Stock Exchange GroupU.K.19388
8BME Spanish ExchangeSpain18091
9Tokyo Stock Exchange GroupJapan10059
10National Stock ExchangeIndia9445

By total turnover of securitized derivatives, HKEx managed to lead the world again in 2010. SSE, as expected, ranked very low due to the lacking of securitized derivatives products (see Notes #2 and #3 below) there.

Table 3: Top 5 Exchanges by Total Turnover of Securitized Derivatives in 2010

RankingExchangeCountry/RegionTotal Turnover of Securitized Derivatives, including Warrants and CBBCs (USD billion)
1Hong Kong Stock ExchangeHong Kong SAR534.0
2Korea ExchangeSouth Korea354.3
3Deutsche BorseGermany79.6
4SIX Swiss ExchangeSwiss38.1
5NYSE Euronext (Europe)Europe34.8

Source: World Federation of Exchanges (WFE) Statistics.

As you may also know, Shanghai today acts as a major financial gateway and has unprecedented access to its strong industrial base at central and northern China, with absolute dominance over the Yangtze River Delta (YRD) region. Financiers from Asia normally access the China market through Shanghai, whereas financiers with network between Chinese and non-Asia normally position Hong Kong as the premier intermediary hub.

While Shanghai is still a domestic financial centre with limited international finance by now, Hong Kong is already an international financial centre and also has a solid financial connection with southern China in the Pearl River Delta (PRD) region. However, from the above ranking of exchanges, you may agree that Shanghai's ranking is already comparable to that of Hong Kong. In fact, both Shanghai and Hong Kong have actually ranked very well by WFE. They are very close in ranking in most areas, except for the securitized derivatives market which Shanghai should pay more attention to in the coming years.

Shanghai's potential is huge, although there are shortcomings for Shanghai as stated in our earlier article Shanghai Strategic Plan in the Next 10 Years. In fact, nowadays Shanghai is no longer that isolated, and the financial news from the Shanghai market are apparently influencing other markets (especially Asian markets), or vice versa. On top of that, Shanghai's commodity markets (especially copper, and also steel) are gaining increasingly importance on the world's stage. If you could somehow trade the Shanghai stock or commodity markets, you would probably understand what we mean.

Although Shanghai is growing fast, yet when comparison is expanded to legal system, talented financial professionals, capital flow freedom, currency and languages, Hong Kong still retains its leading superiority.

Hong Kong vs Shanghai as financial centre

Hong Kong vs Shanghai: Attractiveness as Regional Headquarter.
Source: Michael Enright and Edmund Thompson

Basically an international financial centre is, by definition, all about cross-border and cross-currency financial transactions. Before it can really surpass Hong Kong, Shanghai still needs some fundamental changes, which include but are not limited to:

(i) Full RMB convertibility.
(ii) Freeing controls of capital flow.
(iii) Sound legal system.
(iv) Securitized derivatives market development.
(v) Foreign exchange market development.

As majority of Chinese banks are state-owned with headquarters in Beijing, the political capital of China still holds the true financial power tightly. Remember capital is always the lifeblood of any economy. To qualify as a leading Chinese financial centre, Shanghai has no choice but to rely entirely on its ability to develop capital markets. We therefore believe full RMB convertibility and removal of capital flow controls are currently the two most crucial changes necessary for Shanghai to upgrade to the next level.

Regarding Shanghai's regulation standard, we trust that a financial market is first developed when demand is there. The financial market itself will then force regulation standard to improve, just like what Hong Kong happened in the past.

In this year 2011, however, there are more and more direct competitions between Hong Kong and Shanghai. On 5 March 2011, China 12th 5-year plan officially promote Hong Kong as a RMB offshore centre. Read also: China's 12th 5-Year Plan and Government Work Report. Starting 7 March 2011, the HKEx has further extended its trading hours of the securities and derivatives markets to 5 hours in total per trading day so as to increase the overlap of trading hours with the mainland exchanges in Shanghai and Shenzhen. On 18 May 2011, The Hong Kong Mercantile Exchange (HKMEx), a new competitor of COMEX, began trading by launching an USD-denominated Gold futures contract for 1kg (i.e.: 32-troy-ounce) of Gold with physical delivery in Hong Kong.

Being one of the "Four Asian Tigers" that included economic miracles of South Korea, Singapore, Hong Kong and Taiwan, Hong Kong has positioned itself as a global trading centre with unrivalled access to the mainland China. It also operates as a leading "proxy to invest in China" for foreigners. In fact, Hong Kong has historically served as the bridge between the mainland China and the West. In this city you can always find conservative Chinese views mixing together with the Western liberal capitalistic values.

To most foreigners, Hong Kong might have already been part of China since 1997, but to the eyes of Chinese central government, Hong Kong still remains foreign. For Chinese policymakers, China's main financial centre has to be located onshore, otherwise how can they possibly regulate and control it? As long as Hong Kong remains offshore, the best role Hong Kong can play is an offshore financial centre and, by definition, a complementary centre. Being a leading onshore financial centre, Shanghai possess all the advantages that Hong Kong does not have. Shanghai has better support from Chinese central government, simply because Shanghai is more obedient to the central government than autonomous Hong Kong. While Hong Kong people demand for more democracy, the Chinese central government may have to hedge its bet. If Chinese policymakers did 100% trust Hong Kong, they would not have to build Shanghai as another international financial centre by 2020.

Although language and business culture still favor Hong Kong, national politics unavoidably favor Shanghai. Therefore we would say the main risk for Hong Kong's financial centre development has to be the political risk, which may also lead Hong Kong to be further marginalized. Similarly, we also believe that Chinese policymakers would not bet 100% on Shanghai either. There is no reason that they need to put all their eggs into a single basket, especially as both Shanghai and Hong Kong are still performing.

Who will win? or you better ask why Chinese policymakers have to kill either one? We trend to feel that it should not be a zero sum game. Shanghai and Hong Kong are not necessarily just competitors. In the long run, Shanghai should take an important lead in mobilizing domestic funds to fuel the mainland China's economic reforms. Hong Kong's premier role should be as a financial centre serving the region. Its secondary role should be a gateway for foreign capital inflows to the mainland China. To further take advantage of its free flow of capitals, Hong Kong should also focus on developing itself as a leading wealth management centre.

At the end of the day, the key function of Hong Kong is to let people do business with China as they cannot do the same freely in the mainland China.


(1) NASDAQ OMX Nordic Exchange: includes Helsinki, Copenhagen, Iceland, Riga, Stockholm, Vilnius and Tallinn Stock Exchanges.

(2) Warrants: they can be either equity / subscription warrants (issued by a listed company) or derivative warrants (issued by third parties). Equity warrants give holders the rights to exercise and buy the underlying stocks of a company, while derivative warrants can be either Calls or Puts. The time value and hence the total value of a warrant normally decreases over time as it gets closer to its expiry date.

(3) CBBCs (Callable Bull / Bear Contracts) are a kind of structured product that tracks the performance of an underlying asset in a way that investors do not have to pay the full price for the actual asset. They are normally issued as either Bull or Bear contracts with a fixed expiry date. However, CBBCs can expire early whenever the price of the underlying asset hits the call price (i.e.: trigger a mandatory call event). The issue price of any CBBC consists of funding costs which are gradually reduced over time towards expiry. In general, the longer the time duration of the CBBC, the higher its total funding costs. Upon the occurrence of a mandatory call event, investors will have to lose the funding costs for the whole lifespan of the CBBC.


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