The SEHK main board raised a record high of HKD451.3 billion equity capital in 2000, underpinned by the exercise of warrants/purchase plan (accounting for 47.7% of total capital raised) and fresh concept of local corporations. However, without the support of solid earnings, the stock market dived dramatically amid the burst of the technology bubble. Fund raising campaigns seems to be revitalized in the recent year after several years' market correction. Total equity funds raised in the main board in 2005 climbed to HKD 298.7 billion, and it is expected to exceed HKD 400 billion this year. The new round of fund raising campaigns was mainly triggered by conglomerate mainland corporations, raising HKD 165 billion capital or 55% of the total in 2005. Sparked by gigantic IPO by Bank of China and Industrial and Commercial Bank of China, total equity funds raised in Hong Kong by newly listed companies hit HKD 260 billion in the first ten months this year, surpassing New York and also closing the gap with London. For the whole year, it is quite possible that Hong Kong would emerge as the top IPO capital raising center in the world.

There are several reasons for the great enhancement in Hong Kong's capital raising capability in recent years:

(1) New listings were temporarily Suspended in the Shanghai and Shenzhen stock markets in 2004 due to the split share structure reform.

(2) Regulation for listed companies in the U.S. has been tightened after the enactment of the Sarbanes-Oxley Act of 2002. Section 404 of the Act requires the companies to ensure the accuracy and reliability of the financial information disclosed, otherwise the chief executive officer and chief financial officer would be charged with criminal offences and subject to a maximum penalty of 20 years' imprisonment. The requirements of this Article significantly increase the operation expenditure and risks faced by senior management, as a result curbed the interests of China enterprises to list in the New York market;

(3) Regarding the market environment, acceleration in global economic growth during the last three years, low interest rates, abundant capital supply and booming stock markets are lending support to giant fund raising campaigns in Hong Kong;

(4) A cluster of listed mainland corporations has been established in Hong Kong. Meanwhile, about 350 China enterprises (including H shares, red chips and private corporations) have listed in Hong Kong's main board and growth enterprise market, which is 7.6 times the number of China enterprises listed in the New York Stock Exchange and Nasdaq (18 mainland enterprises listed in NYSE and 28 listed in Nasdaq, with total sum of 48 China corporations listed in those two markets). Hong Kong has served the listings of mainland enterprises for 13 years and has built up an internationalized professional team, forming an efficient capital raising system for the China enterprises;

(5) The regulatory system in Hong Kong suits the needs of China enterprises in their reform toward standardization, diversification and internationalization well, especially for the expansion of strong China enterprises as multinational corporations through raising capital for foreign asset acquisition. A typical example is Lenovo's acquisition of IBM PC business through Hong Kong's capital market.

2. Profound Impact from Solidifying Foundation

With the new round of capital raising dominated by new listings including reputable China enterprises, Hong Kong's sources of capital raising have been broadened. This has positive implications for the development and restructuring of Hong Kong's stock market as well as the overall financial industry.

(1) Rousing the rally of turnover in stock market. Stock transactions were uplifted by the injection of high quality assets in recent years. Average daily turnover of the Hong Kong's stock market (main board plus growth enterprise market) dropped to HKD 6.65 billion in 2002, but rebounded to HKD 18.3 billion in 2005 and reached HKD 30.88 billion in the first 10 months this year. Average daily turnover in November was further lifted to HKD 49.1 billion, marked the period with the heaviest trade ever recorded.

(2) Raising the market capitalization. Market capitalization increased to HKD 8,179.9 billion in 2005 from HKD 6,695.9 billion in 2004, aided by the new listings and their share gains. The benchmark Hang Seng index topped the 19,000-point milestone on 15 November 2006, with its market capitalization rising above HKD 12,000 billion.

The surge of the Euro's exchange rate has prevented Hong Kong from taking over Deutsche Börse as the 7th largest securities market in the world in terms of market capitalization. Nevertheless, Hong Kong's market size is expected to outstrip Frankfurt and Toronto under strong growth momentum, though overtaking the Euronext would be arduous in short term. It is noteworthy that Euronext was formed in a merger of stock exchanges from four countries (Paris, Amsterdam, Brussels and Lisbon) and London International Financial Futures and Options Exchange (LIFFE). Market capitalization of Hong Kong would exceed each of these individual markets. It is thus evident that when measured by individual economy, Hong Kong's stock market has had the potential to surpass Frankfurt and Toronto in the short to medium term, and becomes the fourth biggest stock market, following New York, London and Tokyo.

(3) Driving bank deposits upward. Since the Asian financial crisis in 1997, overall growth in Hong Kong's bank deposits has been sluggish, slowed to an average annual rate of 4.1% during 1997-2002. Recent capital raising campaigns has become a magnet for capital, accelerating the average annual growth of bank deposits to 7% during 2002-2005. The gain was further bolstered this year, marked the sharpest surge in a decade. Total deposits hit HKD 4,563.3 billion by October, increased 15.3% over the same period of the previous year.

(4) Energized the asset management service. Restructuring of conglomerate mainland lenders has provided new investment opportunities to international investors and attracted various types of funds to Hong Kong's market. According to the research of Hong Kong Investment Funds Association, the value of fund-managed assets in Hong Kong has increased by HKD 2,890 billion from HKD 1,640 billion in 2002, to reach HKD 4,530 billion in 2005. In other words, fund-managed asset value has edged up 76.2% over 2002, with average annual growth rate at 42.5%.

(5) In the long-term, enhanced capital raising capability in the stock market would boost Hong Kong's stock market and asset management business to become the main drivers of Hong Kong's financial sector, taking over the banking industry. As Hong Kong has long been recognized as one of three international banking centers, the banking industry has mainly contributed to Hong Kong's development as a financial center. In 1997, total loans of authorized financial institutions once reached HKD 4,121.7 billion, with its share in GDP at 302%, far greater than the share of stock market capitalization to GDP at 235%. Value-added by the banking industry has contributed 8.4% to GDP in 2002, exceeding contributions of 2.5% from the securities industry (including funds, leasing)etc and 1.3% from the insurance industry, by a substantial margin.

Nonetheless, Hong Kong has experienced vast changes in the past two years. The value-added by the banking industry plunged to HKD 100.5 billion in 2004, with its share of GDP fell to 8.0%. In contrast, the value-added by the securities and insurance industries raced up 2.8% and 1.4% to HKD 35.1 billion and HKD 17.3 billion respectively. The resilient stock market in 2005 should further increase the value added by the securities industry. At the same time, the share of bank loans to GDP tumbled considerably to 167%, far behind the ratio of stock market capitalization to GDP, which peaked at 592%. In view of the significantly higher growth in stock market capitalization in comparison with bank loans in 2006, the gap between the two ratios to GDP is expected to further widen.

The prospect of traditional deposit/loan business of the banking industry is rather uncertain. According to Regulation of the People's Republic of China on the Administration of Foreign-funded Banks, foreign-funded banks must be first registered as locally incorporated banks before they can engage in local and foreign currency business for the China citizens. Incentives are thus provided for Hong Kong based local and foreign-funded banks to transform their branches to locally incorporated banks in China, thereby bringing great challenge to the development of HK's offshore deposit/loan business , as well as Hong Kong's status as an international banking center. Nevertheless, Hong Kong banks have embraced great opportunities to diversify their businesses such as the asset management in the future, their prosperity can not be judged just by the growth of the deposits and loans. However, the development of the asset management needs the services from the capital market, and conversely also highlights the importance of the stock market.

Currently, absolute value-added by the securities and fund management industries are still lower than the value-added by the banking industry. A prosperous stock market would spread strong wealth effect, and its relevance would be greater than traditional deposit and loan business of the banking industry. In the long term, the stock market may replace the banking industry as the main driver of Hong Kong's development as a financial center. This structural change is worthy of close attention.

3. Stock Market: Bright prospect amidst a Challenging Environment

To look forward, there is still much room for Hong Kong's stock market to enhance its capital raising capability, stemming from solid growth in China. The listing resources are sufficient in both private and state-owned sectors, and the opportunities are spread across a wide range of businesses. Take the banking sector as an example, Some of banks (13 banks included) and city commercial banks, which have undertaken reform and the introduction of foreign strategic investment, are preparing for overseas listings, following the conglomerate mainland lenders. There are 117 city commercial banks in China at end of 2005, with total asset value shot up to RMB 2,040 billion under the current phrase of high growth. Separately, a vast number of corporations among the value chains of auto production, real estate, pharmaceutical, food, agriculture, hunting, forestry and fishing industries are growing on solid footing and planning for further integration. Listing resources are not expected to be drained out in the foreseeable future.

Nevertheless, Hong Kong has to envisage challenges in the future, including:

(1) Several China enterprises have already undertaken dual listing in both the Hong Kong and Shanghai markets, issuing A shares and H shares simultaneously. Though more dual listings would take place in future, loopholes in supervision still exist as a mature cross border supervision mechanism for listed mainland corporations is yet to be developed under separate legal systems.

(2) Although there are eye-catching results in exploiting overseas listing services of mainland corporations, Hong Kong has made scant progress in exploiting other emerging markets like ASEAN, India, Pakistan, Middle East and Eastern Europe. Hence, development of the stock market will greatly rely on resources from the mainland. Should demand from mainland corporations to list aboard fade or be absorbed by other markets, growth momentum of capital raising in Hong Kong could be curtailed.

(3) Progress toward internationalization of the Shanghai and Shenzhen stock markets has been bolstered amid bureongoing foreign exhange reserves and strengthened yuan, and China would gradually opens the A share market for foreign investment. Meanwhile, stock exchanges of Shenzhen and Shanghai are putting much effort to attract overseas investment( for example, installing terminals in Hong Kong, New York and London to facilitate the direct transactions of stocks in the A share market), which would magnify its substitution effect on the H share market in Hong Kong.

In addition, New York has noticed its weakened fund raising business. In order to maintain competitiveness, the U.S. Treasury Secretary Henry Paulson has urged the federal regulators to review the Sarbanes-Oxley Act. On the other hand, John Thain, CEO of New York Stcok Exchange, has promoted the dual listing of "A+N" share during his recent trip to China. Part of the overseas listings of mainland corporations would probably be absorbed, if the New York market regains its attractiveness.

To sum up, enhanced capital raising capability in the stock market could bolster the development of the entire financial industry. Even more important, this helps to attract talents and financial institutions to Hong Kong, fostering the transformation of Hong Kong from a financial product distribution center to an innovation center, eventually elevating Hong Kong's status as a financial center. In future, growth impetus for the stock market is expected to be solid in the midst of ballooning demand from mainland corporations (including fund raising, overseas merger and acquisition, asset management and corporate governance). But still, we have to envisage the challenges and consolidate Hong Kong's status as a capital raising center for global emerging economies through enhancing our supervision system, exploiting new markets and diversifying our stock market services.

Tse Kwok Leung
Senior Economist