Source: Securities Times.

Recently, 41 Hong Kong-listed companies jointly sent a letter to relevant institutions, urging to lower the threshold for the Hong Kong Stock Connect, temporarily postpone adjustments in "outward investment", and retrospectively adjust companies that have already "gone out"; at the same time, they also request support for Hong Kong-listed 18A companies to directly enter the Hong Kong Stock Connect.

The call from the above companies to lower the threshold of the Hong Kong Stock Connect is not surprising. Currently, mainland funds flowing southward through the Hong Kong Stock Connect have become an indispensable force in the Hong Kong stock market. Lowering the threshold or expanding the Hong Kong Stock Connect will inevitably bring more incremental capital to the above companies.

However, industry insiders interviewed by Securities Times generally believe that the overall lowering of the threshold for the Hong Kong Stock Connect or direct inclusion of 18A companies involves multiple aspects such as supporting technological innovation, investor protection, etc., and requires comprehensive consideration and balancing of various interests in the market. It is necessary to gradually and timely adjust the thresholds.

Small and medium-sized market value companies face liquidity challenges.

In fact, the fundamental reason why 41 Hong Kong-listed companies issued a joint letter is to attract more attention under the current liquidity crisis, hoping to attract more funds.

It is understood that in several major global markets, apart from large-cap companies, almost all small and medium-sized companies face liquidity challenges. Taking the Hong Kong stock market as an example, on October 23, the highest turnover was Meituan, reaching 8.764 billion Hong Kong dollars, followed by Tencent Holdings at 6.257 billion Hong Kong dollars, and then Semiconductor Manufacturing International Corporation at 6.117 billion Hong Kong dollars. In addition to these star companies, on the same day, there were over 500 stocks in the Hong Kong stock market with no transactions, and these stocks were not all penny stocks, including some companies with market caps ranging from tens of billions to hundreds of billions of Hong Kong dollars.

Looking at the 18A companies, 7 companies have turnover exceeding 0.1 billion Hong Kong dollars, but at the same time, 4 companies had no transactions, 10 companies had turnover below 0.1 million Hong Kong dollars, 14 companies had turnover ranging from 0.1 million Hong Kong dollars to 1 million Hong Kong dollars, and the turnover of other companies ranged from several million Hong Kong dollars to tens of millions of Hong Kong dollars.

"This is a global market phenomenon, where 20% of the shares receive 80% of the market liquidity. In recent years, the strong have become stronger, and the Matthew effect is more prominent. The increase in US dollar interest rates raises the company's financing costs, but leading enterprises, with stronger balance sheets, stable and growing businesses, attract a large number of institutions to participate, increasing liquidity, thereby enhancing valuation. In addition, factors such as information transparency, stock liquidity, and a company's competitive advantages all have an impact," said Yanzhaojun, an analyst at Zhongtai International.

Therefore, it is not surprising that 41 Hong Kong-listed companies have issued a joint letter, and the benefits of inclusion in the Hong Kong Stock Connect are obvious. Judging from this year's trading volume, the Hong Kong Stock Connect has brought a significant amount of incremental funds to the Hong Kong stock market, making its influence increasingly apparent.

Yanzhaojun's analysis shows that the average daily trading volume of Hong Kong stocks in 2018 was 106.8 billion Hong Kong dollars, with the Hong Kong Stock Connect accounting for 10.4%. Since the beginning of 2024 to date, the average daily trading volume of Hong Kong stocks has reached 126.4 billion Hong Kong dollars, with the Hong Kong Stock Connect's share increasing significantly to 31.0%, making the Hong Kong Stock Connect funds one of the main participants in the current Hong Kong stock market.

A review by reporters discovered that after being included in the Hong Kong Stock Connect, the trading volumes of most companies have experienced varying degrees of growth. On September 10th this year, the list of symbols included in the Hong Kong Stock Connect underwent a new round of adjustments, with 33 stocks including Alibaba, Imotionautotech, Shunfeng Community, and Cloud Music, being included. Market data shows that the stocks included in the Hong Kong Stock Connect rose by an average of around 1.2% on the same day, with trading volume increasing by about 177% year-on-year.

Undoubtedly, lowering the threshold for the Hong Kong Stock Connect helps address certain liquidity issues for small and medium-sized companies. According to Huang Lichong, President of Huisheng International Capital, reducing the threshold for the Hong Kong Stock Connect is theoretically to increase market participation and improve stock liquidity. Improved liquidity helps reduce trading costs, increase market efficiency, thus attracting more investors to participate. Since 2022, the threshold for the Hong Kong Stock Connect has decreased by about 20%, and this measure may have already had a positive impact on market liquidity.

Different 'voices' exist in the market.

It is worth noting that among the Hong Kong-listed companies that issued the joint letter this time, about half are Hong Kong 18A companies. The so-called 18A companies refer to unprofitable biomedical technology companies listed in Hong Kong after Chapter 18A of the listing rules was introduced by the Hong Kong Exchanges and Clearing.

According to Yanzhaojun's data, since the introduction of the 18A listing system by the Hong Kong Exchange, a total of 66 companies have completed Hong Kong IPOs through this special listing system, raising over 120 billion Hong Kong dollars. As of October 20, 2024, only 7 out of the 66 listed 18A companies are trading above their IPO prices, meaning 89% of the companies have seen their stock prices drop, with many experiencing significant declines. At the same time, 39 of the companies that have entered the Hong Kong Stock Connect or hold Hong Kong Stock Connect shares accounted for a high percentage of 59%. This implies that many mainland investors who invested in 18A companies have suffered significant losses.

Therefore, there are quite a few different 'voices' in the market regarding the automatic inclusion of 18A companies in the Hong Kong Stock Connect. Wind data shows that out of the current 66 18A companies, 21 have already been included in the Hong Kong Stock Connect, accounting for 31.82%.

"The industry's proposals tend to stand more from the perspective of listed companies, because biotechnology companies have high capital needs in the early stages of research and development, belonging to a cash-burning industry. The low stock prices and valuations in the secondary market will seriously damage the company's financing capacity, thus affecting the progress of innovative drug research and development. However, from the actual inclusion situation, since the two exchanges announced at the end of 2020 that unprofitable biotechnology stocks (18A) would be included in the Hong Kong Stock Connect, the current proportion of unprofitable biotechnology companies included in the Hong Kong Stock Connect has far exceeded the proportion of other Hong Kong stocks included in the Hong Kong Stock Connect." said Yan Zhaojun.

In Huang Lichong's view, the proposal for the automatic inclusion of 18A companies in the Hong Kong Stock Connect needs to comprehensively consider various factors such as market impact, investor protection, liquidity demand, and regulatory standards. Regulatory authorities and market participants should engage in full discussions and evaluations to ensure that any decisions are in line with the overall interests of the market.

Yan Zhaojun believes that more importantly, the automatic inclusion of 18A companies in the Hong Kong Stock Connect will to some extent increase liquidity, but it does not necessarily relate to improving valuations or stock performance. "As of October 18th, the average trading amount since the beginning of the year for biopharmaceutical companies included in the Hong Kong Stock Connect is 15.56 million Hong Kong dollars, far higher than the 1.25 million Hong Kong dollars for biopharmaceutical companies not included. However, the stock price performance of biopharmaceutical companies included in the Hong Kong Stock Connect since the beginning of the year is -29.1%, worse than the -26.1% of those not included in the Hong Kong Stock Connect. Therefore, based on the data, whether the company's stock price or valuation has room for improvement mainly depends on the company's fundamentals, research and development capabilities, and pipeline."

Some interviewees also agree to further reduce the threshold for the Hong Kong Stock Connect. Yang Feng, Chairman of Blue Ocean Capital, told reporters that the actual threshold for the Hong Kong Stock Connect is 4 billion Hong Kong dollars, close to 0.6 billion US dollars. Looking at this market cap from the perspective of the Nasdaq in the United States, it already represents a good company. Therefore, this threshold is not considered very low. "Whether it's the Shanghai-Hong Kong Stock Connect or the Shenzhen-Hong Kong Stock Connect, they both need to maintain around 20% of the trading volume. If based on the 4 billion Hong Kong dollar market value standard, companies are excluded, in the current market's relatively sluggish conditions, it would be an additional blow to enterprises, making it very difficult to attract more funds to support Hong Kong's new economy."

Yuan Huaming, General Manager of Huahui Chuangfu Investment, also believes that after several years of adjustment, the current valuation level of Hong Kong stocks is relatively low, and the risk of further market decline is relatively small. It may currently be a good time window to further promote the interconnection between the financial markets of Hong Kong and the mainland.

Gradual Reduction of Thresholds

Setting aside the issue of direct inclusion of 18A companies in the Hong Kong Stock Connect, interviewees do not deny that lowering the overall threshold of the Hong Kong Stock Connect will have a certain positive impact on market liquidity. However, a comprehensive evaluation is still needed from the perspective of market development and investor rights.

Regarding the market cap threshold for the Hong Kong Stock Connect, Securities Times reporters found that since June 2022, this threshold has been lowered 5 times, from 7.218 billion Hong Kong dollars to the current 5.74 billion Hong Kong dollars, a decrease of approximately 20%. In reality, based on LiveReport's big data calculations, as of October 16, 2024, the average market cap of listed companies needs to be around 5.9 billion Hong Kong dollars to potentially be newly included in the Hang Seng Composite Index in the next review. Therefore, the actual inclusion threshold for the Hong Kong Stock Connect is around 5.9 billion Hong Kong dollars, while the actual removal threshold is 4 billion Hong Kong dollars.

In response to the issues regarding the Hong Kong Stock Connect threshold raised in the joint letter, reporters learned that the Hong Kong Stock Exchange previously replied that it is committed to further expanding the scope of mutual access and optimizing related mechanisms. The current criteria for the inclusion of securities are implemented based on agreements between the relevant regulatory authorities and exchanges of the two places, hence any changes require consensus. Mainland regulatory authorities and the Hong Kong Stock Exchange periodically review the operation of mutual access and actively discuss how to optimize related mechanisms to make mutual access a more attractive and robust channel.

Yan Zhaojun believes that the current threshold for the Hong Kong Stock Connect is reasonable, and regulatory authorities need to strike a balance between safeguarding investors' rights and market development. At the same time, Hong Kong stocks are mainly driven by institutional investors in a mature stock market, where changes in the market cap or valuation of listed companies already reflect investors' judgments on the company's fundamentals and prospects. Lowering the threshold significantly could potentially lead to more poorly-performing listed companies being included in the Hong Kong Stock Connect. In his view, the process of adjusting the threshold for the Hong Kong Stock Connect needs to be gradual.

Editor / jayden