World Markets

New Chinese plans are raising questions about Hong Kong's IPO prominence

Key Points
  • China is laying the groundwork for China Depository Receipts, allowing major firms to issue a type of secondary listing in the mainland.
  • Some are worried that could negatively affect the Hong Kong IPO market, but experts said it's unlikely to have a major impact in the short term.
The Hong Kong exchange building.
Vincent Isore | IP3 | Getty Images

A slate of hot Chinese technology companies are expected to debut in Hong Kong this year, potentially making the city the top market for IPOs in the world.

Advisory firm PwC has estimated total fundraising could reach as much as 250 billion Hong Kong dollars ($31.2 billion) in 2018. But some of the excitement over the potential blockbuster year has been overshadowed by ascendant competition: markets in mainland China.

Potentially undercutting Hong Kong

The government in Beijing wants more Chinese tech companies to list domestically, rather than choosing to make their market debut in New York.

In March, China introduced draft rules for China Depository Receipts, which are designed to let its biggest tech firms make a form of secondary listing that can be held by Chinese investors.

It's been suggested that that move from the mainland could undercut Hong Kong's own ability to compete with the New York IPO market: Chinese tech companies listed stateside may in the future issue mainland CDRs on the mainland instead of choosing Hong Kong for a secondary listing.

Shares of Hong Kong Exchanges and Clearing initially came under pressure following the announcement of the CDR plan, although concern later diminished when more details about of the initiative were released, said Kenny Wen, a Hong Kong-based strategist at Everbright Sun Hung Kai.

People walk along an elevated walkway as an electronic ticker displays the figures of the Shanghai Composite Index, top, and the SZSE Component Index in the Lujiazui Financial District in Shanghai, China, on Monday, Feb. 26, 2018.
Qilai Shen | Bloomberg | Getty Images

That's partially because meeting the requirements to be a CDR issuer doesn't look easy. According to draft rules issues by the China Securities Regulatory Commission, Chinese companies listed abroad will need a market capitalization of at least 200 billion yuan ($31.3 billion) to join.

Just five listed companies — Tencent, Alibaba, Baidu, and Netease — currently qualify, according to a note from DBS Group Research last month. A number of currently unlisted companies, including Ant Financial and Lufax, "should be able to meet" the requirements if they decided to participate, analysts from the bank said.

Hong Kong, meanwhile, has tried to grow its own pool of potential listings. The city's exchange introduced new rules allowing listings that would never have been permitted before: companies with dual-class shareholding and biotechnology firms without revenues.

Distinct markets

Despite potential competition from the mainland, some are less worried about Hong Kong's prospects due to the different characteristics of markets there and on the mainland. Hong Kong is recognized as a place to raise money from international sources, whereas domestic retail investors feature more heavily in mainland markets.

Given that stark difference, it's unlikely that Hong Kong will lose out on business to the mainland markets, said Eddie Wong, capital markets services partner at PwC Hong Kong. Instead, he said, the new rules are expected to make capital markets in Hong Kong and on the mainland more complementary.

Wong said "many, many more" companies were expected to apply under Hong Kong's new listing rules in the months ahead. He added that the second half of the year has typically seen more activity when it came to companies listing in the territory.

Specifically, there are now at least five large companies in the process of preparing IPOs in Hong Kong, Wong told CNBC. At least two of those companies were estimated to raise funds of around 100 billion Hong Kong dollars ($12.7 billion) between them, he said.

Pedestrians walk past the Stock Exchange of Hong Kong on May 24, 2018 in Hong Kong.
S3studio | Getty Images

But the advantage of international exposure that Hong Kong currently enjoys could diminish down the road, said Kevin Leung, executive director of investment strategy at Haitong International Securities.

That's especially the case given how MSCI's inclusion of China A shares, which begins in phases starting on June 1, is set to increase inflows into Chinese securities.

Still, analysts are predicting it would take some time before Hong Kong feels any negative impact from the CDR program. Everbright's Wen, for one, said it could be five to 10 years before the situation changes.

"Chinese tech giants will surely support the CDR, at least on the surface. But to them, listing in Hong Kong (or the U.S.) will be their key interest," DBS Group Research analysts Ivan Li and Chris Gao said in a note, citing the depth of those markets and fundraising freedom as differentiation.

"This advantage may not last forever for sure," the analysts said.