Hong Kong Exchange Gets a Boost From China—for Now

OCTOBER 10, 2011   THE WALL STREET JOURNAL

By KATE O'KEEFFE

With its high trading costs, aging technology and history of bucking a decade-long consolidation trend, Hong Kong's stock-exchange operator stands out among its global peers.

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Yet it is the envy of many because it has something exchanges in the world's other leading financial markets lack: a tight link to China.

As stock exchanges around the world struggle to innovate or rush to merge because of increasing competition, Hong Kong Exchanges & Clearing Ltd.'s connection to China has allowed it to stay above the fray. "Hong Kong Exchanges' future is strongly linked to the continued development of capital markets in mainland China," says UBS AG analyst Stephen Andrews.

The bet on China has paid off so far. Chinese companies account for two-thirds of the equity-trading volume in Hong Kong. Global companies eager to associate themselves with the China growth story, and Chinese companies looking to raise their international profile, are all listing on the city-state's monopoly exchange. The result: Hong Kong is leading the world in total value of new listings this year, as it did for both 2009 and 2010.

That has helped the exchange's operator, also known as HKEx, become one of the most profitable in the world, with pretax operating margins this year expected to reach 77%, compared with the global average of 63% and NYSE Euronext's 48%, according to research from Credit Suisse Group AG.

Brewing Problems

The Hong Kong exchange's achievements come despite its relative lack of technological prowess and high trading costs—two issues at the forefront of competitors' minds.

Hong Kong is as much as two years behind its rival Singapore Exchange Ltd. in terms of improving and updating its trading platforms and data centers, says Credit Suisse analyst Arjan van Veen, who covers both exchanges. "HKEx is currently undertaking a decade of IT investment over the next few years" in an effort to catch up, he says.

A hefty government-imposed tax, meanwhile, makes it so expensive to buy and sell shares on Hong Kong's bourse that the high-speed traders who feature prominently in other markets can't operate there. The average cost of trading large-cap stocks was more than 40% higher in Hong Kong than it was in the U.S. in the second quarter of 2011, according to Investment Technology Group, a global broker and provider of independent trade-cost analytics.

Meanwhile, critics say the very thing that has buoyed the Hong Kong exchange so far—its link to China—could become a big negative in the years ahead.

Last year, HKEx announced plans to allow locally listed Chinese companies to prepare their financial statements using Chinese accounting standards and to have mainland auditors vet them. Some market participants have criticized the decision. They say bringing mainland audit firms to Hong Kong could erode investors' confidence in the quality of Hong Kong's capital markets, particularly amid allegations of fraud at some Chinese companies listed overseas, and reduce the regulatory power of Hong Kong's watchdogs.

Hong Kong Exchanges Chief Executive Charles Li says investors shouldn't look at such initiatives in isolation but rather as part of a broader strategy to prepare Hong Kong to reap the benefits of the eventual opening of China's capital account, which he believes will spur massive investment in Hong Kong. "Our goal is to be the international exchange of choice for Chinese investors, and the China exchange of choice for international investors," he says.

Two-Way Street?

Not everyone believes Hong Kong will benefit once China opens it capital markets, however. Some say Hong Kong could be eclipsed by exchanges on the mainland once China loosens its capital controls. Their argument is that Hong Kong is helping China develop its capital markets, but once China is up to speed and its currency is fully convertible, who will care about the tiny territory?

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Bloomberg News

The Hong Kong Exchanges & Clearing flag, left, the People's Republic of China flag, center, and the Hong Kong flag are displayed outside the stock market in Hong Kong.

It's a double-edged sword, says UBS's Mr. Andrews. "If the capital account opens, there is just as much chance of liquidity migrating to Shanghai for dual-listed stocks as remaining in Hong Kong," he says. "There is no reason to believe the relationship between Shanghai and Hong Kong will remain 'friendly' when the two exchanges start competing directly for liquidity."

Mr. Li prefers to describe the capital-account opening as a two-way street. "When people talk about China eclipsing Hong Kong they just talk about people investing in China, but they forget that Chinese investors will also come to Hong Kong," Mr. Li says. Ultimately the exchange will come out ahead, he says. "We will lose some of our market, but we will gain a lot more."

Ms. O'Keeffe is a reporter for Dow Jones Newswires in Hong Kong. She can be reached at kathryn.okeeffe@dowjones.com.

Many of China's Rich Look for an Exit

NOVEMBER 1, 2011   THE WALL STREET JOURNAL

By JEREMY PAGE

BEIJING—More than half of China's millionaires are either considering emigrating or have already taken steps to do so, according to a survey that builds on similar findings earlier this year, highlighting worries among the business elite about their quality of life and financial prospects, despite the country's fast-paced growth.

The U.S. is the most popular emigration destination, according to the survey of 980 Chinese people with assets of more than 10 million yuan ($1.6 million) published on Saturday by Bank of China and wealth researcher Hurun Report.

While growth has slowed, China's economic performance is still the envy of the Western world: It registered annual gross domestic product growth of 9.1% in the third quarter, and the International Monetary Fund has forecast growth of 9.5% for all of 2011.

Concerns are mounting, however, that China's growth could be derailed by a raft of problems, including high inflation, a bubbly real-estate sector and a sharp slowdown in external demand.

Many Chinese who have profited most from the country's growth also express increasing concerns in private about social issues such as China's one-child policy, food safety, pollution, corruption, poor schooling, and a weak legal system.

Rupert Hoogewerf, the founder and publisher of Hurun Report, said the most common reason cited by respondents who were emigrating was their children's education, followed by a desire for better medical treatment, and the fear of pollution in China.

"There's also an element of insurance being taken out here," he said, citing concerns about the economic and political environment.

He cautioned, though, that it was unclear if the survey results signaled capital flight as many high-net-worth individuals who were emigrating also said they were keeping much of their money invested in China.

China maintains capital controls that make it hard for rich Chinese to move their money out of the country, but there are substantial loopholes in the system.

Some economists say they have detected signs of large capital outflows in recent months, likely driven by a decline in global risk appetite and expectations of slower yuan appreciation.

A research report from Bank of America Merrill Lynch's strategy team in Hong Kong last month cited "hot-money outflows" as one of four systemic risks that could lead to a hard landing for China's economy. It said that a sign of such outflows were record gambling revenue in the gambling enclave of Macau, a former Portuguese colony near Hong Kong, where many mainland Chinese go to gamble.

In another indication of the jittery mood among China's rich, several Western embassies have also noted a marked increase this year in the number of applications for investment visas, a category that allows people to immigrate if they invest a certain amount of money, according to diplomats.

There is evidence, too, of an uptick in the number of Chinese people buying high-end properties in major Western cities, especially London, Sydney and New York, according to property analysts.

Another survey published in April by China Merchants Bank and Bain & Co. showed that almost 60% of high-net-worth individuals in China had either arranged for, or were considering emigration. Of those, more than 20% had already completed their immigration applications, or made the decision to apply, according to that survey, which covered 2,600 high-net-worth individuals.

China Merchants Bank and Bain estimated that in 2010 there were 500,000 people in China with "individual investable" assets valued at 10 million yuan and 20,000 people with 100 million yuan or more.

Bank of China and Hurun estimated there were 960,000 people with "personal assets" of at least 10 million yuan, and 60,000 people with 100 million yuan or more.

Their survey, conducted in May to September, covered 18 major cities including Beijing, Shanghai, Wuhan, Nanjing, Dalian and Suzhou, and interviewed respondents with an average age of 42 and average personal assets of 60 million yuan.

The survey showed that 46% of respondents were considering emigrating, while an additional 14% had either already emigrated or filed immigration applications.

Mr. Hoogewerf said respondents with assets of 100 million or more were even more inclined to emigrate, with 55% considering leaving China, and 21% already living overseas or having filed applications.

The top destination among those emigrating was the U.S., accounting for 40%, followed by Canada with 37%, Singapore with 14% and Europe with 11%, the survey showed.

One-third of respondents said they had assets overseas, and an additional 28% said they planned to invest abroad in the next three years. Half of those with overseas assets listed their children's education as the reason, while 32% cited emigration.

The U.S. was the most popular destination for their investments, accounting for 42%, and property was the most popular type of investment, accounting for 51%, according to the survey.

—Tom Orlik
contributed to this article.

Write to Jeremy Page at jeremy.page@wsj.com

What's behind the stellar growth of the dim sum bond market?

27 October 2011   By Standard & Poor's


The market for offshore Chinese renminbi-denominated bonds is relatively small, but its growth has been spectacular.
The so-called “dim sum” market has raised Rmb150 billion (or close to $25 billion) since its inception in mid-2007. The market has even bucked the global trend by continuing to function in the past few months despite struggling at times. During the past 10 years, roughly Rmb40 billion worth of dim sum bonds were issued, a period during which G3 cross-border markets had essentially shut down.
What’s fuelling the development of the dim sum market? 
The rapid accumulation of offshore renminbi deposits is likely to continue to propel the development of the dim sum market for the foreseeable future. The increasing amount of trade that is settled in renminbi is feeding the growth of these deposits. The usage of the Chinese currency will keep on rising as long as Chinese authorities support its internationalisation. In the second quarter of this year, for example, China settled about 10% of its trade in renminbi compared with only about 1% a year earlier. Offshore renminbi deposits in Hong Kong now amount to over Rmb600 billion from roughly Rmb100 billion a year earlier.
What other factors support the market? 
The monetary and credit tightening that has prevailed over the past year in China has certainly led a good number of borrowers to the dim sum market. In that sense, the dim sum market has operated as a substitute for the domestic Chinese loan market. This is most likely a temporary phenomenon, and not necessarily a positive one, as it brought with it some of the opaqueness that is characteristic of the mainland bank loan market. More important are the series of measures that China’s vice-premier Li Keqiang announced last August to boost the role of Hong Kong in developing an offshore renminbi market. In effect, Chinese companies will now be allowed to directly issue bonds in the dim sum market, rather than through offshore subsidiaries. Mr. Li also indicated that China, through the Ministry of Finance, would be a regular issuer, which should prove critical in helping establish a reference curve in the dim sum market.
Are there any impediments to future growth?
The thorny issue of repatriating proceeds to the mainland remains a significant impediment to the offshore renminbi market developing into a truly major global offshore market — one that would be commensurate with the relative size of China in the global economy. While procedures can be put in place to facilitate that process, such as — those to be introduced for the repatriation of proceeds for foreign direct investment purposes — the challenges won’t be completely resolved until China fully liberalises its capital account and makes the renminbi freely convertible. Some mainland policymakers have recently hinted that this could occur within five years.
What is the typical credit risk profile of dim sum issuers?
Issuers in the dim sum market have covered the whole gamut from sovereign (AA-/Stable/A-1+, cnAAA) to some property developers that we rate in the ‘cnBB’ category of the Greater China credit scale. An early characteristic of the market was that it was largely unrated and credit risk appeared to be a secondary consideration to currency appreciation. Global events, however, have very much promoted the importance of credit risk, and there is now clear evidence of pricing differentiation based on creditworthiness. Notwithstanding the market’s still relatively limited liquidity and lop-sided demand imbalance, spreads have significantly widened for speculative-grade-rated and non-rated issuers in the past few months. The prevalence of rated issuers is also likely to increase as the focus on currency appreciation diminishes and a stronger credit culture takes root.
How diversified is the market?
The dim sum market is increasingly attracting state-owned enterprises of various industries and international issuers, and both of these groups tend to be rated. The market is also well represented in terms of industry players, including property developers, high-tech companies, policy banks, commercial banks, and state-owned corporations that cover the natural resources, energy, telecom, transportation, public utilities and capital goods industries.
Mainland China issuers represent the bulk of issuance to date, but an increasingly broad range of global issuers have tapped the dim sum market with sometimes significantly more sizable issues. (A/Stable/A-1, cnAA+) became the first non-Chinese issuer to enter the market last August with a Rmb200 million issue. Others that followed include (A/Stable/A-1, cnAA+), (A-/Stable/--, cnA+), (not rated), (A+/Stable/A-1), and (BBB/Watch Neg/A-3, cnA). Notably, (A/Stable/A-1, cnAA+) became the first French issuer in the offshore renminbi market last month, with two issues aggregating Rmb2.6 billion.
Standard & Poor’s recently launched a Greater China credit rating scale. What is it for?
The rapid development of the offshore renminbi market was, of course, the impetus behind the development of the scale. The underlying rating criteria, methodology and processes that we use to assign Greater China credit ratings are identical to those associated with Standard & Poor’s global scale ratings. The mapping between Standard & Poor’s Greater China and global scales is publicly available.
In essence, the Greater China rating scale responds to the needs of investors and other credit risk management professionals who focus on Greater China as an asset class in and of itself. The scale provides a credible benchmark against which users can form their own independent opinion of relative credit strength within their investable universe of Greater China. For these users, the Greater China scale can provide more granularity of credit risks than is possible with Standard & Poor’s global scale. The rating distribution is also better aligned to their expectations of relative creditworthiness within a Greater China context, with China itself anchoring the scale at ‘cnAAA’.
We are assigning Greater China credit scale “issuer” ratings to all Greater China-domiciled obligors and “issue” credit ratings to their debt instruments. We are also assigning Greater China “issue” ratings to all Hong Kong dollar-denominated and offshore renminbi-denominated debt instruments regardless of the domicile of the obligor. Click here for more information.
What is the profile of investors in the offshore renminbi market?
That’s also very much a developing story. In terms of geography, investors are overwhelmingly Hong Kong-based, with most of the remainder based in Singapore. When UK-based retailer (A-/Stable/A-2, cnAA) launched a Rmb725 million issue earlier this month, Hong Kong-based investors accounted for less than 50% of the total allocation, Singapore about 30%, and European investors close to 20%. It was very much a global story.
Among investors, Chinese banks are particularly well represented. This partly explains the presence of a relatively large number of unrated issues (as the dim sum market essentially functions for them as an alternative to China’s bank loan market). An important development in the past year has been the emergence of an ever-increasing number of specialised funds investing in offshore renminbi paper. These funds have brought considerable professionalism to the market and acted as a vehicle for greater retail investor participation.
So is the dim sum market impervious to difficulties in other cross-border markets? 
No, far from it. It’s certainly quite remarkable that the dim sum market remained open during the dry spell that prevailed since early August in the G3 markets. But it should be noted that investors in the offshore renminbi market have also been very selective during that period: While China’s ‘cnAAA’-rated bonds were oversubscribed, a number of speculative-grade-rated issuers, non-rated issuers, and at least one highly rated issuer had to delay their planned issues. These issuers operated in industries ranging from airlines and property development to aluminium extrusion and pharmaceuticals.
It is also important to realise that supply-demand conditions could shift — conceivably rapidly and dramatically so. Fast-growing offshore renminbi deposits and the ever-increasing number of specialised offshore renminbi funds (more than 17 to date) make the dim sum market very much a seller’s market for now, but this could change. For instance, mainland banks and insurance companies are reportedly planning to issue subordinated debt instruments in the dim sum market. Given these institutions’ immense capital needs, and depending upon whether these institutions seek to come to market at the same time or not, this could easily bring supply-demand conditions into balance or trigger overwhelming demand.
Another fundamental change is now taking place. The widely held assumption that the renminbi will always appreciate is being challenged. While this might be a hiccup in the development of the dim sum market by forcing a painful repricing of risk, it should prove healthy over time. It should eventually help the market shed its strong remaining speculative element around currency play to that of a more mature market where decisions are taken based on careful risk-reward considerations.

IBM: Intriguingly Boring Mergers

OCTOBER 7, 2011    THE WALL STREET JOURNAL

By ROLFE WINKLER

Boring deals tend to be better deals. That's the tip Hewlett-Packard should take fromInternational Business Machines' latest acquisition.

On Tuesday, IBM bought little-known Q1 Labs, a small, privately-held security software specialist, for an undisclosed price.

Agence France-Presse/Getty Images

Not surprisingly, the deal failed to excite. Acquisitions like H-P's $10 billion blowout buy of Autonomy get far more attention. They also tend to be worse for shareholders.

Contrast that with IBM's stated strategy to spend $20 billion total on acquisitions from this year thru 2015. What sets IBM's dealmakers apart is their discipline. They target small companies that will benefit from being plugged into IBM's massive, worldwide distribution network. They also look for compelling technology that fits with their existing products.

The strategy seems to have worked well. IBM's return on capital, which measures total operating profit after taxes relative to total debt and equity invested in its business, has averaged a healthy 16% since 2000, according to CapitalIQ data. Over the same period, H-P's return on capital has averaged 9%. It makes sense that IBM would have higher returns given its greater emphasis on high-margin software. Yet the fact that its returns continue to grow suggests the company's acquisition strategy is creating value for shareholders.

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H-P has at times followed the acquisition script successfully. At 3Par, which H-P acquired in 2010, revenue grew in the triple digits in the second quarter compared with the prior year, according to an H-P spokesman. But the Autonomy deal doesn't offer the same potential benefits. Autonomy is already sizable, with revenues estimated at $1.1 billion in 2011. And while its technology is interesting, H-P doesn't have a strong distribution platform for software like it has for hardware. That could limit H-P's returns from the deal.

H-P has destroyed value in the past. It acquired Compaq for $17.3 billion, net of debt and cash. Yet today analyst Toni Sacconaghi of Sanford C. Bernstein estimates its whole PC business is worth less than $12 billion.

When it comes to Q1 Labs, it may be hard for IBM shareholders to get excited. And that's why they should be.

Write to Rolfe Winkler at rolfe.winkler@wsj.com

Investors Spooked by China

OCTOBER 1, 2011   THE WALL STREET JOURNAL

By OWEN FLETCHER And DINNY MCMAHON

BEIJING—Investors dumped the stocks of some of China's biggest Internet companies, as scandals with some smaller Chinese firms has shaken Wall Street's confidence in the country's businesses.

U.S.-listed shares of China's leading search engine, Baidu.com Inc., and Sina Corp., the operator of the country's Twitter-like messaging service, plunged 16% and 18%, respectively, in the last two days of trading on the Nasdaq Stock Market even though these companies haven't been accused of wrongdoing.

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A series of alleged accounting frauds this year at little-known Chinese companies listed in the U.S. has triggered a sharp shift in sentiment among investors, who are now worried about hidden business risks or financial problems.

"If the whole sector's sentiment is negative, then investors tend to be panicking, and then they sell the most liquid names, regardless of whether there are really any problems," said Jeffries analyst Cynthia Meng. "We don't think that the flagship [Chinese] Internet names have accounting issues."

For years investors, swept up in the broader China growth story, gave Chinese companies that listed their stocks on U.S. exchanges the benefit of the doubt on governance and regulatory issues.

A series of frauds at little-known Chinese companies listed in the U.S. has triggered a shift in sentiment among investors. John Bussey joins digits to discuss. Photo: AP.

That was particularly true of the Internet sector. Investors were prepared to overlook unreliable Internet traffic data, pervasive censorship, and a reliance on an inherently risky corporate structure in their enthusiasm to profit from the explosive spread of social media, online shopping and search.

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The latest news to send investors running was a Thursday Reuters report quoting Robert Khuzami, the director of enforcement at the U.S. Securities and Exchange Commission, saying the Department of Justice is investigating accounting irregularities at Chinese firms.

A person close to the matter confirmed the Justice Department is investigating Chinese firms, but declined to identify the companies.

Along with Baidu and Sina, other major Chinese Internet companies plunged this week. Social-networking website Renren Inc. Friday fell 13% to $5.10 on the Nasdaq. Online video company Youku.com Inc., after losing 18% Thursday, gained 12 cents to $16.36 Friday. None of those companies have been accused of wrongdoing.

A Youku spokesman said the company hasn't received any inquiries from U.S. regulators. A spokeswoman for Renren said the company hasn't been contacted by the SEC.

Baidu, Sina and online-video company Tudou Holdings Ltd., whose U.S.-listed shares fell about 24% on Thursday and Friday, each declined to comment.

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"The market seems to be factoring in the worst-case scenario" J.P. Morgan analyst Dick Wei told clients in a research note.

He noted concerns about accounting issues at some Chinese companies, and risks attached to a corporate structure used by many Chinese Internet companies to get around restrictions on foreign investment in the sector.

Chinese Internet stocks were buffeted last week following reports that Beijing was looking into ways to overhaul how it regulates the "variable interest entities" structure.

The structure uses a series of contractual agreements to allow an offshore holding company owned by foreign investors to effectively run a business inside China. It is used by most U.S.-listed Chinese companies.

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Reuters

The Chinese national flag is seen in the financial district of Pudong in Shanghai, Sept. 22.

Dozens of small Chinese companies listed in the U.S. have been accused by their auditors and short sellers of having lied to investors and misrepresented the true extent of their businesses over the last 12 months.

The SEC weighed in toward the end of last year and started investigating both the financial-services firms that helped bring the companies to market and the Chinese companies themselves.

Chinese tech companies aren't without their challenges. Data describing China's Internet sector can often be murky, whether it be from third-party researchers or Internet companies themselves.

That was highlighted earlier this year when Renren revised a key user number in its prospectus ahead of a U.S. initial public offering. Renren later said the change was due to typographical errors in the original data.

Market volatility and general investor concern in recent months have slowed to a trickle the flow of U.S. IPOs by Chinese Internet companies.

Xunlei Ltd., a Chinese online video-and-game service in which Google Inc. holds a small stake, in June filed for a U.S. IPO but the next month postponed it "due to stock market conditions."

Write to Owen Fletcher at owen.fletcher@dowjones.com and Dinny McMahon at dinny.mcmahon@wsj.com

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