Shanghai and Hong Kong look set for a collision course as they seek to attract yuan listings by foreign firms, in a battle where the mainland market may have the upper hand initially.
The two exchanges, which portray themselves as partners, do not face an immediate threat of slowing business that has hit their counterparts in developed economies, forcing them into a scramble of cross-border mergers.
But the success in courting overseas firms could be vital over the long term, especially since the huge wall of Chinese money that came their way in the past few years is shrinking.
For both the Shanghai Stock Exchange and Hong Kong Exchange, there will be fewer and fewer major IPOs from Chinese companies, said Joy Lin, Hong Kong-based analyst at Yuanta Financial Holdings Co. International expansion is an inevitable trend.
As part of China's plans to liberalize its capital market and make its financial hub an international financial center, the Shanghai Stock Exchange (SSE) is planning to launch its so-called international board, which would allow foreign firms to list in the mainland for the first time.
Hong Kong Exchanges and Clearing Ltd (HKEx), with a market value of $23 billion, the world's biggest among exchanges, has said it was also mulling a platform to allow firms to sell yuan-denominated shares.
Both exchanges are similar sized, based on the $2.8 trillion total market capitalization of companies listed on them.
VALUATION, LIQUIDITY FACTORS
The bourses have yet to unveil details of their plans, but Shanghai seems better placed to cash in, at least initially.
Foreign companies can fetch higher valuations in Shanghai than in Hong Kong and so can raise more money at lower cost, said Yu Wei, analyst at Guoyuan Securities Co.
Shanghai-listed companies trade at 22.4 times historical earnings compared with 16.9 for their Hong Kong-traded shares.
The Shanghai market also does not have the liquidity issue that Hong Kong currently faces. Unlike hard currencies, the yuan is not freely traded in overseas markets. Hong Kong, due to its unique position as an offshore yuan center, does have some liquidity in the currency, but not enough to handle major IPOs.
Further, a mainland listing is more desirable for international firms as it would give them more exposure to the Chinese public.
Indeed, many international companies, including HSBC (HSBA.L), Bank of East Asia and even NYSE Euronext (NYX.N) have expressed interest in a Shanghai listing. HSBC Chief Executive Stuart Gulliver said on Monday the bank is still keen for a Shanghai listing, but the timing of that is in the hands of Chinese authorities.
Globally, merger of exchanges has reached fever pitch. In less than three weeks, Deutsche Boerse (DB1Gn.DE) announced a bid for NYSE, London Stock Exchange (LSE.L) bid for Toronto Stock Exchange parent TMX Group Inc (X.TO) and BATS Global Markets said it would buy fellow privately-owned venue operator Chi-X Europe.
But the SSE is a government body that lacks motivation for reforms, he said, adding that layers of bureaucracy were slowing decision-making processes as well as of implementation of changes, including the international board.
These follow Singapore Exchange's (SGXL.SI) $7.7 billion takeover bid for Australian bourse operator ASX (ASX.AX), unveiled late last year.
The biggest risk facing the SSE is a further delay in launching the board, which was originally set for 2010.
If the HKEx gets a head start, companies itching to raise yuan funds could turn to Hong Kong, where IPO procedures are generally seen to be more transparent and efficient than on the mainland.
Hong Kong is attractive to foreign companies as an IPO destination because it is more international and has better rules, said Dominic Chan, analyst at BNP Paribas.
So yuan IPOs there would also be popular, and would surely compete with Shanghai's international board.
Chinese officials have said they hoped to launch the international board this year but details on how it would work in practice has not been revealed.
Furthermore, the liquidity issue facing Hong Kong is likely to improve.
The amount of yuan in the Hong Kong market could triple to 1 trillion yuan by the end of 2011 as part of Beijing's efforts, introduced last year, to increase yuan-denominated trade settlement, HSBC analysts said in a recent report.
The HKEx also is working with banks on a yuan liquidity pool to lay the groundwork for yuan share listings as part of its new strategy set last year to lure more international companies to maintain its status as the world's biggest IPO market.
HKEx said last month the territory's first yuan-denominated equity product was likely to be a real estate investment trust (REIT). Billionaire Li Ka-shing's Cheung Kong (Holdings) Ltd is expected to launch Hong Kong's first offshore yuan product in the form of a REIT this year.
BIG CHINESE IPOs SLOWING
Last year, 45 percent of Hong Kong's $57 billion IPO proceeds came from foreign firms such as global insurer AIA, casino operator Sands China and Russian aluminum firm RUSAL, against only 5 percent in 2007.
For Shanghai, the competition over international firms is one it cannot afford to lose if it wants to become an international financial center by 2020.
Fostering a stock market with international listings and investors is an important part of this goal, said an SSE official who declined to be identified due to the sensitivity of the issue.
Unlike other major bourses, the SSE is an extension of the government, governed directly by the securities regulator.
An SSE spokesman declined to comment for the story.
Competition between the two exchanges is growing, mainly due a rapidly shrinking pipeline of IPOs from major Chinese state-owned enterprises, which has benefited both bourses.
During the past two decades, Beijing has successfully restructured and floated many of its biggest, and most profitable, state companies, such as oil giant PetroChina and the world's biggest life insurer China Life, in both Shanghai and Hong Kong.
In the banking sector, Agricultural Bank of China's $22 billion IPO last year capped years of industry restructuring that brought all of the Big Four lenders listed on the stock market.
The slowdown in mega-sized IPOs have already started to bite for the blue-chip focused Shanghai exchange.
Its smaller rival, the Shenzhen Stock Exchange, overtook the SSE as the top mainland IPO market last year, driven by surging demand for capital from fast-growing small- and medium-sized enterprises.
Shenzhen saw a total of $45.4 billion worth of IPOs last year, while Shanghai only booked in $28.7 billion.