HKEx/China JV largely symbolic … for now

The proposed joint venture between the Hong Kong Exchanges and Clearing and China's Shanghai and Shenzhen stock exchanges makes strategic sense, according to analysts, but it is only the start of a long haul.
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The proposed joint venture between the Hong Kong Exchanges and Clearing (HKEx) and China's Shanghai and Shenzhen stock exchanges makes strategic sense, according to analysts, but it is only the start of a long haul.

“It makes sense for HKEx to have integration with the Chinese exchanges to be able to harness whatever symbiotic benefits are there and to ensure that, as compared to other non-mainland exchanges, HKEx should be able to be a more entrenched player in China through agreements like this,” said Anshuman Jaswal, analyst at financial markets research firm Celent.

On 18 August, HKEx issued an announcement saying that it has entered into talks with China's Shanghai and Shenzhen stock exchanges about a potential joint venture to develop index and equity derivative products.

With Hong Kong looking to further cement its position as the capital markets gateway to China, the value of any JV to the Chinese exchanges will be access to the products, expertise and infrastructure of a global exchange.

“Hong Kong has much experience in engaging the global community but Chinese exchanges don't because of the restrictions on foreign exchange and capital flows. The benefit of a tie-up with Hong Kong is access to international capital markets. If China wants to attract capital from offshore, it would make a lot of sense to use Hong Kong as a platform,” said Alex Frino, CEO of Australia-based research consultancy Capital Markets Cooperative Research Centre.

However, the significance of the proposal may be only symbolic until more discussions are held and the details of any deal thrashed out. In its statement, HKEx emphasised that there was “no binding agreement” between the exchanges.

Analysts said it was only a matter of time before HKEx sought closer cooperation with the Chinese exchanges given that the less ideal alternative would be direct competition when the flow of capital becomes less restricted in the longer term.

During a recent visit to Hong Kong, China's vice-premier Li Keqiang announced a measure to allow qualified entities to invest their renminbi holdings into Chinese stock market through a Qualified Foreign Institutional Investor scheme at an initial size of RMB20 billion (US$3.13 billion). “We note that any such move to allow greater direct investment into the Chinese exchanges represents a potential threat to HKEx,” said Arjan van Veen, research analyst at Credit Suisse. “While this potential JV enhances the longer-term growth profile of the HKEx, we highlight that the nearer-term fortunes of the stock are more market volume related.”

Analysts said the immediate impact of the JV is unlikely to be significant since derivative trading makes up only around 15% of HKEx's revenues and ETF volumes have yet to take off in Asia. “Turnover velocity is materially higher for the Chinese exchanges than for HKEx,” van Veen observed.

The Hong Kong-listed iShares FTSE A50 China Index ETF, Asia Pacific ex-Japan's top-ranked ETF in terms of assets under management and trading volume, recorded average daily volume (ADV) of US$111.4 million as at end-May, according to BlackRock. The US-listed SPDR S&P 500, the world's largest ETF, recorded ADV of US$19.9 billion at end-May.

Although they are increasingly listings competitors, HKEx, the Shanghai Stock Exchange and the Shenzhen Stock Exchange have already collaborated on a number of fronts. In June 1993, Hong Kong and Chinese regulators and exchanges drew up a memorandum of regulatory co-operation and in 2001 the three bourses created the China Stock Markets website.

HKEx targeted future growth opportunities from mainland China in part facilitated by the internationalisation of the Chinese renminbi in its three-year strategic plan initiated in March 2010.

Exchange's globally have pursued both strategic alliances and M&A opportunities in pursuit of volume growth and revenue diversification in recent years.

A proposed merger between the Singapore Exchange and the Australian Securities Exchange was thwarted by considerations of national interest while a London Stock Exchange/TMX Group combination was derailed by a rival offer from Canadian financial institutions. A strategic alliance between BM&F Bovespa of Brazil and the US's CME Group has resulted in distribution agreements and pooling of technology resources. The progress of a Hong Kong/China exchange JV may depend on the rate at which existing restrictions on capital flow across China's borders are dismantled.

Author: Jill Wong