When Charles Li was asked last week about the recent wild gyrations of some stocks in Hong Kong, the head of the Hong Kong Exchange compared the market to a city that is reasonably well-run but has “a few dark alleys and little corners”.
“We all need to relax,” he added. “This is a great market. You don’t want the regulator to solve all your problems.”
Investors in China Huishan Dairy might think differently after its shares plunged 90 per cent in an hour last Friday for no apparent reason, wiping more than $4bn off its market capitalisation. On Monday, Chinese developer Kaisa Group leapt by almost as much after ending a two-year share suspension.
The two are just the latest examples of Hong Kong’s extreme stock price fluctuations, the likes of which are rarely seen elsewhere. Here are some reasons why.
Lack of daily limits
Hong Kong does in fact have circuit breakers, introduced last year. But they only apply to the city’s largest stocks, covering the 50 blue-chips of the Hang Seng index and members of the 81-strong China Enterprises index. Under the new system those stocks enter a cooling-off trading band for five minutes if they move more than 10 per cent in five minutes. The Hong Kong Exchange has no imminent plans to extend the system, but says it monitors market developments.
This is arguably a bigger issue than the absence of a circuit breaker given the preponderance of companies in Hong Kong either subject to owner-founder control or state-backed. The higher the stake held by a controlling shareholder, the less appealing the company is to many fund managers — and the fewer shares that are available. In Huishan Dairy’s case, its founder Yang Kai has taken his stake in two years from 52 per cent to 74 per cent. The average number of shares traded daily fell 40 per cent in that time. The less liquid and the less widely held a stock is, the more likely it is to leap or plummet.
Heavy use of share-backed loans
This is a second-order effect, but it can make a company’s stock particularly vulnerable to wild price swings. Disclosures in December indicated Huishan’s Mr Yang had pledged a quarter of the company’s equity as collateral for a personal loan from Ping An Bank. A company filing this week showed his total share pledges actually amounted to 71 per cent of the company’s equity. Loans of that nature tend to carry strict margin calls if share prices fall heavily, meaning Mr Yang’s control of the company might be in doubt unless he can satisfy any lender demands.
These can last days, weeks or even years, as Kaisa Group demonstrates. Designed to protect small shareholders from trading without full information, they can artificially inflate the value of a troubled company, or suppress that of a recovering one. Kaisa’s two-year market hiatus allowed it to restructure following a debt default and produced Monday’s pent-up demand.
Investors in Hanergy Thin Film are approaching their own two-year anniversary since trading in the stock was halted following a 47 per cent price drop that wiped $19bn off its market cap. Seven months after the stock was suspended, Li Hejun, its chairman and dominant shareholder, sold some of his stake for a price worth just 5 per cent of HTF’s last traded price. Smaller investors have no such recourse.
Last Friday Huishan Dairy got a trading halt an hour after its stock began falling. On Tuesday, the company said the suspension would remain until the board got a full update on its finances.
China, China, China
One factor linking stocks in companies from Huishan to Kaisa to Hanergy is that they are all mainland operated. That is no real surprise since three-quarters of Hong Kong-listed blue-chips call the mainland home. But the dominance of Chinese groups illustrates how a market whose structure evolved in the city’s colonial era might struggle to cope with the influx of companies subject to different laws and corporate practices — and how this can prompt investor suspicion and wariness.
Those wary feelings go both ways, however. Just before December’s launch of the Shenzhen Stock Connect linking Hong Kong to its sister market, a Cantonese phrase loh tsin, meaning trickster or conman, began popping up in mainland stories questioning the reliability of Hong Kong’s markets. Price falls such as Huishan’s will do little to foster better market relations on either side of the border.