The failed attempt by Hong Kong Exchanges and Clearing to buy the London Stock Exchange Group highlights the tensions between Asia and the West and the challenges facing any attempt to harmonise economic and political interests between the two.
I believe we may have reached the inflection point in global geopolitics mooted by Samuel Huntington in his seminal 1993 article “The Clash of Civilizations”. This is now a reality that will affect trade, commodities and financial markets in dramatic and unpredictable ways.
The environment is way more complex than in the 1990s. Technology has moved on, and in 2019 we must add the additional factors contributing to the VUCA (volatile, uncertain, complex, ambiguous) environment we now live in: artificial intelligence and big data, cyber warfare, climate change, populism and so on. Set against these new threats, the existing structures and models of risk and investment strategy are clearly insufficient to meet the challenges implicit in an increasingly opaque, digitalised playing field.
Writing from Hong Kong the IPO flow looks rosy once again after the successful conclusion of Budweiser and Top Sports. Bankers are merrily collecting their fees while out on the streets mayhem has broken out between the police and a disenfranchised youth and working class that see only diminishing job prospects and reduced social mobility.
Hong Kong has emerged as one of the ideological battlegrounds in this tectonic geopolitical shift: an increasingly dysfunctional capitalist model with no unifying focus or strategy facing the Chinese model of socialism with Chinese characteristics, which has a clear strategic vision of alternative governance.
It is no surprise to find western business leaders caught in the crosshairs of these conflicting ideologies. Beijing is well aware that western multinationals are desperate to benefit from the largest growing consumer market in the world, which, unlike India and Indonesia, already boasts a world-class infrastructure. Western financial services institutions are desperate to tap the huge potential of China’s capital markets.
So why would they resist pressure exerted discreetly or, as we have seen recently, quite openly, to comply with Chinese requirements? The message is clear: if you want to be a player in our market, then you follow our rules and criteria, even when they appear directly opposed to long-cherished western standards of governance and individual rights.
In the midst of the current protests, therefore, it seemed remarkable to many that HKEX chief executive Charles Li suddenly launched a bid for the LSE. Was the timing coincidental, or was the bid a deliberate attempt to highlight that Hong Kong remains open for business and especially the financial sector on which it thrives?
There are three widely offered explanations for his bid:
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- It was an audacious attempt to take HKEX on to the international stage and gain the scale and technology it needs to compete with the big players such as ICE and CME.
- It was a cynical ruse to acquire LSE at a substantial discount when the UK economy is in the midst of a political and potential economic crisis.
- It was a strategic move to obtain an influential foothold in the European market to counterbalance the decoupling currently pursued by the US.
The first explanation is the simplest and, in my view, the most likely. Across the world, exchanges are under pressure and margins are being squeezed, so scale and technology really matter. LSE would provide not only access to one of the world’s oldest and most respected exchanges but also Borsa Italiana, FTSE Russell (which recently declined to include Chinese bonds in its index) and clearing house LCH, globally the largest processor of dollar-denominated swaps.
Such a merger would also provide an unparalleled 18 hours of trading time between Asian and European markets. For Mr Li, the acquisition would realise his long-cherished ambition for HKEX to be the pre-eminent “Chinese exchange for the world” — a fully functional channel for bonds and equities between mainland exchanges and global capital markets. In the light of LSE’s move to acquire Refinitiv, he could not hold back any longer.
Of course, LSE has taken a very different view of its future — not surprising, given that it managed only four IPOs in the past quarter. While voicing enthusiasm for the direct stock connect link with the mainland exchanges starting with Shanghai, LSE envisages a transition from the shrinking margins and competition of financial trading to data analytics as the new driver of value, hence its bid for Refinitiv.
Chief executive David Schwimmer’s abrupt dismissal of the HKEX bid leaves little room for doubt that he and his board view HKEX as a subset of the mainland exchanges and have no intention of surrendering control to an entity indirectly responsible to the Chinese government. They look at the management structure of HKEX: the government is the largest shareholder and the board consists of six normal directors, six directors appointed by government plus one senior director and Mr Li. They look at the largest customer: effectively the Chinese state. They look at the company’s lifespan in its current jurisdiction and the likelihood of its coming directly under central government control in just 28 years.
What is remarkable about the bid is, first, its apparent lack of political and regulatory awareness. I stress “apparent” as, surely, HKEX’s advisers must have warned that the UK government and US regulators would try to block such a transaction? Or was the bid launched deliberately to test the UK’s resolve at a time of weakness, given that there is no clear legal basis for government intervention? After all, an exchange is not obviously a strategic asset like, say, a defence company.
Second, what level of support, if any, did Mr Li have from Beijing? We all know that the move was criticised the day after its announcement by the party’s organ, the People’s Daily, which made the point very clearly: “Shanghai is designated as China’s future financial centre, so whose future has more potential: Shanghai or Hong Kong?” And more to the point: “The China opportunity is not divisible and cannot be divorced from the big picture of China’s overall rejuvenation, and must show conformity and consistency with the overall development interests of the country. Shanghai is right at the centre and 100% aligned with this development”.
So, had Mr Li failed to consult Beijing and simply gone ahead in the expectation of its support? Surely, it would be highly presumptuous to assume that Beijing would publicly give preference to Hong Kong over Shanghai and Shenzhen, especially at a time of such political and social chaos in Hong Kong? Or knowing this, did he choose to ignore it?
I cannot be sure of the answer to these questions, but my assumption is that he simply factored in Beijing’s likely public disavowal and, having delayed the bid for more than a year, saw this as the last chance for HKEX to strike a truly transformative deal that would place it among the top three global exchanges. There may have been tacit encouragement from some quarters in Beijing, who recognise the challenges facing the financial services industry in China, given the capital controls that remain in place.
As for the merits of the bid, Mr Li’s argument that Hong Kong is an essential gateway connecting Chinese and international markets and will remain so as long as China maintains its strict capital controls, may be a convincing one given the continuing issuance of Chinese debt and IPOs.
But Hong Kong has less to offer in terms of enhanced market access for international investors. Inclusion of the Shanghai bourse in the MSCI Emerging Market index and the opening of the securities brokerage sector to foreign participation was hailed as a game-changer. Moreover, the failures of regulation exemplified by the 2015 Chinese stock market crisis and the ever-present threat of government intervention will ensure a high risk attribution to Chinese equity investment.
Despite grand statements about market opening, no change has so far been made to the limits on foreign ownership of domestic listed companies. China still restricts foreign ownership in its Chinese-listed A stocks to a maximum 10 per cent in individual companies, while foreign markets have no similar limits on Chinese investment, much of which is effectively sanctioned and directed by Beijing. This hardly constitutes “mutual benefit” nor a level playing field, and over the past year we have seen a tightening rather than a relaxation in cross-border capital flows.
Will the bid be resuscitated after six months? I doubt it. HKEX would have to raise its offer appreciably, there are huge regulatory hurdles to overcome, and no transaction will be possible without political blessings from both sides.
The attempted HKEX-LSE merger exposes a whole new realm of risk in the conduct of global financial markets. Such risks are consistently underpriced. Markets are selectively responsive to the vulnerabilities in the global economy and often ignore high political risk factors such as Brexit: in common with other major markets, the FTSE is up 10 per cent this year despite its political quagmire and potential economic repercussions.
The advent of big data and AI-enabled trading will greatly add to the potential for market manipulation and instability. It is surely time for governments and their regulators to be proactive. If they cannot bring opposing sides back from the progressive political and economic decoupling under way, then at least they should start to create a new framework for governance and dispute resolution in global financial markets, to avert a major disaster that threatens to make previous financial crises look like mere storms in a teacup.
Originally published in the Financial Times.