With many Mainland enterprises already raising funds in Hong Kong, the idea of allowing Mainland investors to trade Mainland stocks floated here one day may not be far-fetched.
When a Mainland enterprise contemplates raising capital through an initial public offering (IPO), it has the choice of doing so either on or outside the Mainland. If it opts to raise funds outside the Mainland, it has a choice between doing so in Hong Kong or in one of the other developed equity markets. Hong Kong is fortunate to have been the prime location for such activities. There are, I am sure, many considerations specific to the enterprise that will be taken into account before it decides where to organise the IPO. Among these are, of course, the marketing efforts made by the Hong Kong Stock Exchange and, most importantly, the policy of the Mainland in supporting Hong Kong’s role as an international financial centre. While these favourable factors will continue to underpin Hong Kong’s position as the preferred platform for Mainland financial intermediation, we need to ask ourselves whether they are adequate for that position to be sustained.
We all know that the savings rate on the Mainland, over 40% of GDP, is very high by international standards. The question that the Mainland authorities face is how to mobilise the large amount of domestic savings effectively in order to sustain the rapid economic growth and development on the Mainland. Objectively speaking, with such a high domestic savings rate and rather strict capital controls, particularly in respect of outflows, the case for tapping foreign savings, which is what a listing outside the Mainland aims to achieve, may not be very strong. Of higher priority, if there is a need to assign priorities, is the development of the domestic financial system to enhance the stability, integrity, diversity and efficiency of financial intermediation on the Mainland.
The development of the domestic financial system of course takes time. There has been much progress in recent years in modernising the banking system, through commercialising it, cleaning up the stock of bad debts and stemming the flow of new ones, injecting capital into the banks, upgrading corporate governance and strengthening banking supervision. But the development of the capital market has proven to be more challenging. As a result the debt and equity markets have been playing a less prominent role in mobilising domestic savings, and domestic financial intermediation continues to be effected predominantly through the banking sector. Meanwhile, there remains a need for diversity to satisfy the wide spectrum of risk appetite of investors that comes with economic progress. And there is, of course, the increasing desire on the part of Mainland enterprises in need of funds to raise them not only by borrowing from banks but also by issuing debt and equity. When there is no effective mechanism for them to do so in the domestic market, these enterprises have little choice but to obtain equity and debt finance outside the Mainland, notwithstanding the foreign exchange exposure that they will incur in the process.
We in Hong Kong are of course happy to get the business in the meantime, but we have to understand that this is due to the underdevelopment of the capital market on the Mainland, which may not be permanent. We have to understand that this underdevelopment is frustrating investor demand on the Mainland and possibly resulting in higher funding costs for the Mainland issuers. We have to ask ourselves what is likely to happen to us if this turns out to be only a temporary phenomenon and is addressed in the future by market reform. I cannot provide an authoritative answer, but I can see a risk for the sustainability of our role as the platform for Mainland financial intermediation if a channel is not found quickly to allow Mainland investors access to the shares and bonds issued by Mainland enterprises in Hong Kong.
The design of such a channel is a complex matter, involving currency exchange and capital control issues, but it is not impossible. Currency exchange should not be an insurmountable issue given that the IPOs in Hong Kong have generated an inflow to the Mainland enterprises in the first place and this will only be partly offset by capital outflow if Mainland investors are somehow given access to the shares. In any case, the channel can always be designed in a manner which allows the flow to be monitored and if necessary controlled to address any concerns.
Joseph Yam
8 September 2005
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