Inside Business

December 11, 2012 4:52 pm

Cultural clean-up needed in HK and Shanghai

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Liquidity is suffering because markets have been dysfunctional

The 11,000 job cuts unveiled by Citigroup last week are not expected to have a huge impact on Asia – but there is an argument that they should, at least in its equities business. Asia may promise the best economic growth in coming years but for Citi and its peers that is unlikely to mean a big pick-up in their equities operations.

Globally, the sales and trading side of investment banking is suffering the structural change of rapid automation and the demand for cheaper dealing costs. Both equity trading and the capital-raising businesses have been hurt this year by the collapse in risk appetite. New listings and trading volumes on the world’s leading exchanges are at multiyear lows.

Risk appetite is cyclical – but for Hong Kong and mainland China there are deeper issues to be solved. They stem from the hangover left by frantic new listing activity in Hong Kong and Shanghai in recent years.

The first is capacity. From 2008, banks bet big on Asian equities to service a flood of Chinese listings and the consequent trading. Local recruitment experts – and more realistic bankers – reckon the industry is 20-25 per cent overstaffed.

Second, there is too much capacity in the equity capital markets business, which raises capital for companies, because the era of blockbuster deals out of China is over. The biggest groups most in need of cash have all come to market. Other sectors will bring large deals at some point, for example utilities. But China’s State Grid and its peers are, for now, flush with cash. Luxury car dealer chains and other high-end consumer businesses should bring some fun and fees next year, but not enough to save the industry.

However, the third and most important reason that equities businesses will stay subdued is because stock markets in Hong Kong and Shanghai have squandered a crucial quality: trust. Liquidity is suffering because markets have been beset by disappointment and dysfunction. It is a problem that will not be solved quickly.

There are different issues in each market, but there is a similarity in their cultures of investing – especially in initial public offerings. It is a central tenet of both market cultures that retail investors should be handed a quick win on day one of an IPO. The joke in Hong Kong is that this is given in lieu of democratic rights.

This trend has become exaggerated. Credit Suisse studied IPOs in both markets over the past two years and discovered that the only way to make money was to buy in the marketing phase and then sell on day one. The situation was more extreme in Shanghai than Hong Kong – you win more with a day-one sale (on average a gain of 23 per cent for Shanghai versus 6 per cent for Hong Kong), but lose more if you hold the stock for any length of time (minus 42 per cent versus minus 15 per cent over the first year). This has created a string of zombie listings – companies whose share prices only drift lower, generating no interest beyond their first day’s pop.

Both markets have plans to clean house. In Shanghai, the talk is that the securities regulator will make big changes in coming months. This could involve making it easier to delist the worst performers, but it will certainly mean fighting insider trading and other market malpractice. Guo Shuqing, head of the securities regulator, led a global roadshow this summer to drum up more foreign interest in China’s stocks. The country needs more foreign institutional money to provide liquidity and to create a different investing culture. Its own institutions have a long way to grow before they can play a bigger role.

Hong Kong is overhauling its IPO process after a wave of disappointing listings from China. This month it will unveil new rules for IPO sponsor banks, making them criminally liable for auditing or reporting falsehoods at companies they bring to market. It is ironic that the securities regulator is itself pursuing one of those auditors, Ernst & Young, through the Hong Kong courts to force the release of Chinese audit documents. How should sponsor banks react to being made liable for audit work they may not be able to remove from China?

If China wants its companies to have access to international money at home, in Hong Kong, the US or anywhere, the odd use of state secrecy laws in financial matters must be addressed.

For both markets the acid test will be enforcement. Mark Steward, the Hong Kong regulator’s head cop, is winning plaudits for his dogged pursuit of several cases that should each improve an element of market integrity. But for both markets these are not easy steps. A new reputation cannot be gained with a simple change of clothes – companies and investors must see good behaviour over a period of time.

paul.j.davies@ft.com

www.ft.com/insidebusiness

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