Hong Kong Bourse Looks to Russia, Mongolia as China IPOs Falter

By Chia-Peck Wong

July 1 (Bloomberg) -- Hong Kong's stock exchange, facing the worst market for first-time share sales in five years, began accepting applications from companies in countries such as Russia and Mongolia to sell depositary receipts.

Hong Kong Exchanges & Clearing Ltd. is betting the lure of $2.7 trillion in Chinese savings will attract companies and investors to the products, succeeding where Tokyo and Singapore have so far failed. The world's depositary receipt market, dominated by New York, London and Frankfurt, doubled in size last year, according to JPMorgan Chase & Co.

Initial public offerings by Chinese companies that made Hong Kong the world's sixth-biggest stock market have dried up as investors, roiled by a U.S. financial crisis that threatens global growth, fled emerging markets. Expectations that depositary receipts will cut dependence on Chinese listings may be misplaced, said SG Asset Management's Winson Fong.

There is ``zero chance'' they will provide the exchange with meaningful business, said Fong, who helps manage $3 billion at SG in Hong Kong. Thin trading of Asian depositary receipts and a lack of research would discourage fund managers, he said.

IPOs by mainland companies in Hong Kong have dropped to HK$45.6 billion this year from HK$110 billion in the year-earlier period, the lowest since 2004.

Depositary receipts, or DRs, are securities that represent the stock of an overseas company. Because they are traded like domestic shares, they eliminate currency exchange, and legal and administrative obstacles, such as transfer of ownership.

Russia, Mongolia

Mining and resources companies from countries such as Russia and Mongolia would be the most likely candidates to sell DRs in Hong Kong, taking advantage of the city's more developed capital market, said Jason Cox, co-head of Asia equity capital markets at Merrill Lynch & Co.

Oleg Deripaska, Russia's richest man, plans to sell shares in copper and molybdenum producer SMR in Hong Kong this year, Geoffrey Cowley, the company's chief executive officer, said in February. Deripaska's United Co. Rusal, the world's biggest aluminum producer, may pick Hong Kong over London, the Financial Times reported earlier.

Elena Shuliveystrova, a Moscow-based spokeswoman at Rusal, didn't reply to e-mailed questions on the plans.

Skeptics over DRs should bear in mind the city's success with mainland Chinese shares, said Kenneth Tse, head of JPMorgan's Asian depositary receipts group.

Chinese Individuals

``Few would have expected the market to develop to today's scale,'' he said. China restricts foreign investment in its domestic markets, and mainland companies have used Hong Kong to tap overseas demand for shares.

Daily trade on the Hang Seng Mainland Composite Index, comprising 125 companies, averaged HK$40.6 billion this year, or about half of the Hong Kong total, according to data compiled by Bloomberg.

When China relaxes controls on outbound investment, mainland individuals will flock to Hong Kong DRs, said Lawrence Fok, the bourse's head of issuer marketing.

``It's a matter of time before mainland China will allow individual investors to buy stocks overseas,'' he said. ``Which is the major category of investors there? Retail.''

Individuals already account for more than a third of turnover in Hong Kong, said Fok.

Still, the regulation and oversight needed to protect non- professional investors may discourage some companies, said Jeffrey Maddox, a partner at law firm Jones Day.

`Nitty-Gritty Review'

DRs are subject to the same ``nitty-gritty review process'' as ordinary share sales, which may lead executives to conclude ``they're better off listing in their own market,'' he said. ``The Hong Kong stock exchange is pretty much the toughest place to list in the world.''

There's also no guarantee that the anticipated surge in Chinese funds will materialize, said SG's Fong.

Chinese banks are currently allowed to invest in Hong Kong, Japan, Singapore, the U.K. and the U.S. under the Qualified Domestic Institutional Investor program approved in 2006. Of the more than $15 billion approved for investment abroad, about half has gone to Hong Kong. The government is pushing for more of the funds to go to other markets.

The strengthening yuan may also deter Chinese investors from buying overseas, said Wang Lei, who helps manage $52 billion, including Hong Kong Exchanges shares, at Thornburg Investment Management in Santa Fe, New Mexico.

The yuan has advanced 6.5 percent this year against the dollar, the second-best performing Asian currency. Hong Kong's currency is pegged to the dollar.

No Market Share

Asian exchanges have struggled to attract a bigger share of trading in depositary receipts, which reached $1.2 trillion in the first quarter from a year earlier, JPMorgan data show.

Tokyo trading of receipts sold by Posco, South Korea's biggest steelmaker, averaged 1,314 shares a day in the past year, data compiled by Bloomberg show. That compares with 799,000 for the company's New York ADRs and 334,000 common shares in Seoul.

``It's a bit early for the introduction of Hong Kong-listed DRs, simply because the demand does not exist yet,'' said Howard Wang, who oversees $10 billion at JF Asset Management, including shares of Hong Kong Exchanges.

To contact the reporter on this story: Chia-Peck Wong in Hong Kong at cpwong@bloomberg.net
Last Updated: June 30, 2008 22:13 EDT