Shenzhen second board may outshine GEM

Hong Kong's fledgling Growth Enterprise Market (GEM) is haunted by a phantom that does not exist - yet. Reports yesterday that former Hong Kong stock exchange chief executive Alec Tsui is to join the Shenzhen Stock Exchange as a consultant underline the looming threat to the GEM from its mainland counterpart. Late last year, China announced plans to launch its own growth enterprise market based in Shenzhen for high-growth and technology companies. The launch - delayed since the end of last year - forms part of a wider plan to consolidate the mainland's main-board stock exchange in Shanghai. If the Shenzhen board competes directly with Hong Kong, all the signs are that it will be a formidable adversary. While technology valuations have crumbled in Hong Kong - with the GEM Index down nearly three-quarters from its starting level in March last year - mainland stocks have been a haven from the global turmoil, rising to all-time highs this year. Higher valuations mean cheaper capital for companies, and listing fees for Shenzhen are also expected to be cheaper than Hong Kong's. The Hong Kong GEM offers an international profile and the chance to raise hard currency, but for mainland enterprises that need neither, Shenzhen is likely to be a compelling alternative. That could drain away many of the listing candidates that were the GEM's original target market. With the mainland's domestic stock markets roaring, the GEM has lost many of its relative attractions as a place to list. The beleaguered Hong Kong second board has been derided by investment commentators for relaxing its listing rules, admitting companies of dubious merit, and for the collapse in share prices. Its defenders point out that the GEM has enabled 69 companies to raise about HK$18 billion since it was set up in November 1999 - a strong performance for a new market, particularly in comparison with more established regional second boards. Moreover, the collapse in Internet share prices was a global phenomenon that GEM could not have escaped, they argue. Yet the GEM now faces an uncomfortable reality: many of its companies are thinly traded with a high concentration of shares among a small number of investors. Despite a steady rise in the number of new listings, in the first three months of this year the average daily trading volume was HK$121.58 million, down 76 per cent year on year, according to stock exchange data. For the whole of last year, the average daily volume was HK$341.24 million. By contrast, the mainland's markets have been awash with cash. Witness the trading frenzy that followed China's recent decision to open the B-share markets to domestic investors (B shares were previously restricted to foreigners). The GEM somehow needs to attract more mainland companies if it is to survive and thrive. GEM listing committee chairman Lo Ka-shui predicted earlier this year that about 70 per cent of new listings on GEM would be mainland-controlled companies in 10 to 20 years. About 15 of the 69 GEM-listed companies are either private mainland enterprises or state-controlled H shares. Ill-equipped to compete, the GEM's salvation may lie in closer co-operation with its mainland counterpart - perhaps to the extent, in the longer term, of a full-scale merger. Taiwan-based brokerage and GEM sponsor Core Pacific-Yamaichi Capital has urged mainland regulator the China Securities Regulatory Commission (CSRC) to conduct a feasibility study on co-operation with the Hong Kong stock exchange. Managing director D.C. Lee has suggested a dual-listing system similar in concept to Hong Kong-listed H-share firms issuing and listing A shares in the mainland. 'We already have one country, two [economic and political] systems. I do not see why we cannot work on similar lines for the GEM market,' Mr Lee said. This 'if you cannot beat them, join them' strategy would see Hong Kong acting as China's window on the international investment community for young but fast-growing companies, while Shenzhen would tap the vast pool of domestic mainland savings. The hurdles to such a partnership are significant. Listing rules and regulatory structures would need to be harmonised - a challenging task given the differing stages of development of the mainland and SAR markets. Yet there are signs that such preparations are under way. The launch of the Shenzhen second board has been delayed, and doubts remain over when it will make its debut. CSRC chairman Zhou Xiaochuan said in March the launch date was still uncertain, despite having indicated earlier technical preparations could be completed last year. Analysts believe the delay is due to concerns that the regulatory regime might be unable to prevent market manipulation on the second board, which would have easier entry requirements than the main board. 'Spelling out the rules can be fast and easy, but building up the necessary resources to implement the day-to-day market monitoring is another matter,' said Tai Fook Securities group managing director Peter Wong, who is also a member of the Hong Kong GEM's listing committee. The delay has given the GEM more time to work with Shenzhen on harmonisation of rules. However, market watchers said a merger or fully fledged reciprocal dual-listing arrangement was not feasible within the next few years. CSRC chief adviser Anthony Neoh said a merger 'in the true sense' would be difficult, with the key barrier being the fact that the two markets operated in different currencies. With the yuan unlikely to become fully convertible for the foreseeable future, cross-border stock investment - even if allowed - will be limited. For a merger to happen, company law and regulations would also need to be harmonised. The regulatory regime of the planned Shenzhen second board, although modelled on the Hong Kong GEM's, has slightly different requirements. There are also significant gaps between the two markets in corporate governance and accounting standards. While Beijing has stepped up efforts to improve the corporate governance of listed companies, this is a long-term process. 'The proposed merger between the Shanghai and Shenzhen stock exchanges already involves so much politics. The complications can only be greater for a Hong Kong-Shenzhen GEM merger,' said Mr Chan. In the near term, a loosely defined dual-listing format would be the most feasible, according to market watchers. This would be similar in concept to Hong Kong-listed H shares issuing A shares on the mainland, with the trading of the shares governed by the rules and regulations of the market where they were issued. This would require some form of understanding or agreement between Hong Kong and mainland regulatory bodies, Mr Wong said. Mr Neoh said this was the more feasible scenario, but given that mainland companies tended to command higher valuations in the domestic stock market, he believed not many would go through the convoluted dual-listing route. Such decisions will hinge on how soon the Shenzhen second board can be launched and how much the listing candidates need foreign currency proceeds, international exposure and strategic investors. About 2,000 private mainland enterprises are said to be queuing up to list on the planned Shenzhen GEM. According to investment bankers, many are debating whether to seek a listing on the Hong Kong GEM or wait for the Shenzhen board to launch with the prospect of achieving a higher valuation. 'From the mainland listing candidate's point of view, it is easier to raise a larger sum of money from the domestic market, which also gives them better liquidity than Hong Kong's GEM,' said Joseph Chan, director at GEM companies sponsor Oriental Patron. Shenzhen-based Kingdee International Software Group was one company that teetered between the two listing options. Last November, it was preparing for a Shenzhen GEM listing in anticipation of the board's launch early this year, despite having earlier indicated interest in listing on the Hong Kong GEM. In February, it decided to go for the Hong Kong board as it appeared increasingly unlikely the Shenzhen board would go ahead soon. 'If these young mainland firms wait until the Shenzhen board is launched, they would have already missed the opportunity [to sell shares],' said Mr Lee of Core Pacific-Yamaichi Capital. Such cases show that the Hong Kong GEM does retain appeal for mainland companies - if only because it is already in operation. Some market watchers and officials of Hong Kong Exchanges and Clearing - which operates the GEM - believe fears that mainland companies will flock to the Shenzhen high-technology board are overstated. They believe the market is large enough to accommodate both boards, saying they cater to different companies and investors. A stock exchange spokesman said in the short term the exchange did not see the possibility of a merged market, but added it had been in 'frequent contact and co-operation with Shenzhen, including exchanging market development experience'. Graphic: anal08gbz