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Development of Mainland China’s capital markets Hong Kong should consider its sustainability as an IPO centre for Mainland enterprises as the Mainland’s capital markets continue to develop. On 17 November 2005, I raised in this column the question of the sustainability of Hong Kong as an IPO centre for Mainland enterprises. Given the high volume of activity in the IPO market then, the question did not generate a lot of interest. Since this is an important matter, highly relevant to the maintenance of the status of Hong Kong as an international financial centre, perhaps I should address it again. The efficient mobilisation of domestic savings is the prime concern of those with responsibility for the economy, in particular the financial system. This is particularly so for a developing economy with a high savings rate (45% of GDP) and a strong need for funding to support general economic activity, including crucially investment in improving the productivity of the economy. Unlike the situation in other economies, there are two (complementary rather than mutually exclusive) alternatives open to China for mobilising domestic savings on the Mainland. There is first the solution, common to all economies, of developing the domestic financial system to provide stable, reliable, diversified and efficient channels for financial intermediation, which is a process that takes considerable time and effort. The alternative, available only to China because there are two different financial systems in the country, is to make fuller use of Hong Kong’s better developed financial system. Because of the considerable structural differences between the two financial systems, market forces have not been allowed to work freely to mobilise domestic savings on the Mainland. Examples of these differences are the use of different currencies, exchange controls on the Mainland and the restrictions on the Mainland against access by foreign (including Hong Kong) financial institutions. As a result, the mechanism for mobilising domestic savings on the Mainland is less than, perhaps even far from, optimal. There is over-dependence on the banking system, which is still in the process of being modernised. There is a strong need for diversification through the use of the capital markets, but problems there have prevented this from happening on any significant scale – there have not been many IPOs on the Mainland recently. Many IPOs were launched in Hong Kong, but these have only served to attract foreign savings into the Mainland, which is arguably quite unnecessary and has not contributed to mobilising domestic savings on the Mainland. While this has admittedly been beneficial to the status of Hong Kong as an international financial centre, it has intensified the frustration of Mainland investors, who would be quite willing to invest their savings in the high-quality shares of Mainland enterprises. It is this sentiment, along with the fundamental desire of the authorities to mobilise domestic savings more efficiently, which has led me to raise the question of the sustainability of Hong Kong as an IPO centre for Mainland enterprises. One can readily see that the logical solution to the problem is to hasten the development of the Mainland’s capital markets. An imaginative solution would be to allow Mainland investors to invest in the shares issued by Mainland enterprises in Hong Kong. This would complete (through Hong Kong’s financial system) the process of domestic financial intermediation, by which domestic savings on the Mainland are mobilised into the hands of Mainland enterprises, thereby achieving an important policy objective and satisfying the demand of the increasingly frustrated Mainland investors. Some might argue that this represents capital outflow and is not allowed under capital-account controls. Whatever outflow there is (and this can be closely monitored through well-defined channels such as the Qualified Domestic Institutional Investors mechanism), if it is for the specific purpose of investing only in H-shares, would be merely a partial reversal of the inflow which came from the IPOs of these H-shares in the first place (and which China does not really need). The H-shares, new or existing ones, could be re-packaged in the form of China depository receipts, for example, and marketed on the Mainland to satisfy investor demand there. Dual listing is also a possibility (“H+A” or “A after H”), although in the interest of healthy market development the two categories of shares should be interchangeable and traded at more or less the same prices. Before the relevant controls are dismantled and the invisible hand can be relied upon, an arbitrage mechanism might be needed to permit buying and selling in the two markets to achieve price equalisation. Since foreign-exchange transactions would be involved, the People’s Bank of China and State Administration of Foreign Exchange might have to play a role in this arbitrage mechanism.
Joseph Yam 23 March 2006
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