Mainland master stirs up Hong Kong market

Charles Li Xiaojia cites three important triumphs from his eight years running Hong Kong Exchanges and Clearing Ltd (HKEx), the city’s stock and futures exchanges.

The first, the $2.2 billion acquisition in 2012 of the 140-year-old London Metals Exchange, was a leap for HKEx into markets beyond China and beyond stocks – and an investment that Li says has doubled in value.

The second was the Connect initiative with the Shanghai stock exchange, China’s biggest, allowing seamless cross-border trading between the two markets. And the third came in April this year when Hong Kong’s listing rules were eased to open up a possible $100 billion-plus listings bonanza, allowing ‘innovative’ technology companies to go public despite less-than-stellar financials and, more controversially, to allow dual-class shareholders.

Each move had its critics, particularly the dual-class share debate, which remains fresh and potentially problematic for Li and for regulation in Hong Kong. But for Li at least, none were as divisive or as memorable as ‘Lunch-hour-gate’. This dragged on from soon after Li’s arrival at the exchange in 2010 to 2012 and was the result of what seemed a very logical – to Li at least – and even trivial reform that was intended to align Hong Kong’s share-trading hours with those of its mainland compatriot exchanges and that turned surprisingly toxic.

Li’s charter at HKEx was – and remains – to make Hong Kong the go-to international outlet for China’s business, and to integrate China’s capital markets with its most outward-looking centre, Hong Kong. Bringing Hong Kong into line with Shanghai and Shenzhen starting, at the very least with their trading hours, was a no-brainer for investors on both sides of the frontier, or so Li thought. 

But in a town where money and food merge as territorial obsessions – after all, it was Hong Kong that gave rise to the dim sum bond – the city’s feisty tight-knit community of brokers, bankers and investors saw it very differently. Alignment meant their lunch break would be cut from two hours to one, which they groused wasn’t enough time to wine and dine clients over dumplings and duck. Li says he simply wanted to get China’s exchange ducks in a row.

At one point, Li, the first person from communist China to occupy one of capitalism’s highest offices in Asia, was even portrayed as the Italian fascist dictator, Benito Mussolini and an effigy of Li as Il Duce was marched through Central by grumpy stockbrokers, their clients and even restaurateurs.

Years on, and the hours now aligned, the fuss still bewilders Li, so much so that he spends a good part of his interview with Asiamoney talking about it.

“It was just the beginning steps of getting the markets ready, getting them together,” he says, shaking his head. “The markets needed to connect, needed to be integrated. The rest of the world trades virtually 24 hours and there’s no lunch break (there). It turned out to be a major controversy and disaster.”

Ultimately, Li won or, as he puts it, “the market prevailed.” It was one of Li’s first moves as exchange boss and “it took two years to get done,” he says. “One year to get it to an hour and a half, another to get it to one”. But it came to define his often-difficult engagement with Hong Kong’s feisty investment and regulatory community. 

Coming 13 years after the UK’s handover of its former colony to China, Lunch-hour-gate even became wound up in the delicate Hong Kong identity debate over how separate Hong Kong, with its very different economic experience, should be from China. Two years later, that sentiment articulated itself more dramatically in the umbrella protests that paralyzed Hong Kong for two months in 2014.

Li arrives for his meeting with Asiamoney exuding an animated, almost master-of-the-universe strut. His decidedly American accent is part Wall St corporate lawyer and banker, part deep south twang that he collected at college in Alabama in the mid 1980s.

He is the latest in an unrelated line of Li and Lees to helm the Hong Kong bourse. The first was the notorious Ronald Li, the 1980s-era billionaire who unified the colony’s four disparate exchanges into the Stock Exchange of Hong Kong and who was jailed for 30 months for a listing scam. 

The next was the establishment lawyer Charles Lee, who was the exchange’s chairman through much of the 1990s and 2000s and who stewarded the merger of the stock and futures exchanges. And now Charles Li, the first mainlander to run the exchange; he took over in 2010 and his contract has just been renewed for another three years. 

“It’s been a bit long,” he says. “Time just flies over.” He’s a permanent resident of the territory that has been his home for 17 years. He is also a big football fan. Asiamoney poses the crucial sports test and asks him which team he would support if the Hong Kong squad were to play China in a World Cup. 

“I refuse to get into that,” he laughs. “I’d want both of them to win, but beating others.” Li, now 56, gets mixed reviews as HKEx boss. Some see him as a pliant Beijing instrument and think he has been lax on regulation. Others say that as a US-educated banker from the mainland, he has the right professional and personal polish for the job, particularly at this stage in Hong Kong’s evolution as China Inc’s efficient shop front, and that he has modernized and internationalized the exchanges.

As poacher turned gamekeeper, he knows the vagaries of the market and of Hong Kong. In 2016, when HKEx trading volumes fell to a three-year low, his bonus took a 25% hit. That it came a few months after his $15 million home was turned over by burglars seemed only to add insult to injury.

Much of Li’s mantra at HKEx has been about reinvention. And he has done quite a bit of that himself during a career shaped in large part by China’s market reforms and opening up, the so-called kaifeng policy of China’s late leader, Deng Xiaoping.

Li was born in Beijing but grew up in far-flung Gansu province, in China’s west. He toiled on a state oil rig in the Bohai Sea before completing a BA at Xiamen University in 1984. He then became a journalist with China Daily, the communist party’s English language mouthpiece (a detail curiously absent from the HKEx’s official biography for Li), a paper that had only been established in 1981 as part of Deng’s policy of opening up to the outside world.

Li was among the first waves of Chinese students to pursue foreign education in the middle of the 1980s. In 1978, Deng declared: “We are going to send thousands or tens of thousands to receive overseas education,” a remark that would have been heresy just two years earlier under Mao Zedong. With memories of the Cultural Revolution still very fresh, Chinese families took years to be convinced there would not be any backlash from embracing anything vaguely Western.

Li remembers writing to many US universities requesting financial aid to study stateside. At the time there was much enthusiasm about China’s coming in from the cold and Li says, “there was a lot of curiosity among universities” about students from a country that had isolated itself for decades.

Working from an alphabetical list, he got a place studying journalism at the University of Alabama, arriving in Tuscaloosa with barely $50 in his pocket, the maximum that China’s foreign exchange controls of the day allowed. Li got a waiver for tuition, a scholarship and found 20 hours of work a week with a university professor. There were just 18 fellow mainlanders on campus, he recalls.

“I was probably at the later end of the first wave of Chinese students,” remembers Li. “The big torrent was much later than that.” He denies his family was advantaged and, as is often suggested in Hong Kong, that he was a so-called princeling, or scion of Beijing’s communist party elite. 

“No, no, no! I don’t have any relatives or anything like that,” he insists. “My father thinks I’m a prince,” he jokes. “He’s about the only one. “My parents couldn’t really afford anything. We had no money. We needed to get scholarships. My family incurred a lot of debt just to buy the ticket to send me off.”

He retains warm memories of Tuscaloosa. It was “the first time I gained freedom, so to speak. I was able to drive. I was able to live in a place that had hot water. I had a kitchen. I had a TV. Wow! I never had a hot shower in my home (in China) at all, it was the public bathroom.” 

A college essay about defamation law helped him secure a scholarship at Columbia University’s law school in New York after Alabama, which in turn opened up jobs at the white-shoe New York law firms Davis Polk & Wardwell and at Brown & Wood. The US left an indelible mark on him, in his accented English and his regard for markets.  “I’m reading a lot of Trump,” he says. “He’s driving everybody nuts.”

In 1994, Li joined Merrill Lynch’s China team in Hong Kong as an investment banker, where he worked on China’s first sovereign bond offering in the US and a brace of big China Inc IPOs. He was with Merrill Lynch for nine years, during which he became its China boss, before leaving to join JPMorgan as the Beijing-based chairman of its Chinese franchise. 

In 2005, Li and JPMorgan advised state oil company CNOOC in its $18.5 billion bid to buy US oil firm Unocal; that would have been China’s biggest offshore acquisition but pressure from Washington scotched the deal.

Li’s time in Beijing was useful in building close relationships with mainland policymakers, but such intimate ties backfired in 2015 when it emerged Li had recommended that JPMorgan hire relatives of senior Chinese officials, the real so-called princelings. 

The officials included Huang Hongyuan, who was then a ranking official at the China Securities Regulatory Commission and now chairs the Shanghai Stock Exchange, an HKEx trading partner. According to a leaked email, Li wrote: “I am getting quite tired with all these requests but guess that most of my clients are getting to the age that their children are reaching intern age. This is something nice to leverage on but excessive demand is a big problem.”

In 2016, JPMorgan agreed to pay US authorities $246 million to settle a probe into the bank’s so-called ‘Sons and daughters program’, considered a breach of the US Foreign Corrupt Practices Act. The SEC said JPMorgan had “engaged in a systematic bribery scheme by hiring children of government officials and other favoured referrals who were typically unqualified for the positions.” Then came the HKEx. Li remembers getting a call from a headhunter for the HKEx job in 2009, while he was at JPMorgan. 

“I said I don’t know anything about them, but it was interesting,” he tells Asiamoney. “I was in banking for a long time and, you know, there is this hidden urge to do something different, to do something with a little bit of public good rather than just in banking with clients, with a little bit of policy orientation. I didn’t know the exchange well at that time.” 

There is much angst in Hong Kong about Li’s dual-class share initiative. 

“One share, one vote” had been a near-sacred principle of share ownership in Hong Kong since the 1980s. As recently as 2015, the Securities and Futures Commission had opposed it. However, soon after Hong Kong’s new chief executive, Carrie Lam, took office, the SFC had a sudden about-face on the policy. Neither Lam nor the SFC responded to requests for interview.

Hong Kong chief executive Carrie Lam

The Li-led amendment has been described by some observers as destroying shareholder democracy. Jamie Allen, secretary-general of the Asian Corporate Governance Association, says the introduction of the dual-class share is part of “a race to the bottom that Hong Kong and China seem desperate to win”. Li reckons the fuss is much ado about nothing, and that very little has changed for the average shareholder.

“There is a misconception about dual shares, and some people automatically associate that with lesser protection to the investor,” he says. “People think that their rights are being changed.” Not so, he says. “All we did, in the new era, is to say that the people who should call the shots may not necessarily be the one who have the most money in there. We have all the bells and whistles (protecting) the smaller shareholder, not being abused by the big ones. Nothing has changed there.”

Li says that Hong Kong has always had family-controlled companies and state-controlled companies: “So our public shareholders by and large here other than HSBC and (his own employer) Hong Kong Exchange are living in a controlled shareholder environment, meaning public shareholders are always a minority. Here, invariably, it’s a big shareholder-controlled market. Whoever has put more money into the company calls the shots.”

Now with dual-class shares, he says: “It’s just that we have allowed (the likes of Alibaba’s) Jack Ma and Pony Ma (or Ma Huateng, founder of Hong Kong-listed tech firm Tencent) to use a special voting power. We’ve simply allowed a different way to gain controlling voting power.” It took four years of talks – not only with the SFC but also with the government, the stakeholders, investors and media – to push the changes through, Li says.

“Look at the competitive landscape, the massive market in the US which is supposed to have a much higher level of governance standards and they all allow it, so, systematically China and Hong Kong are losing. There’s a competitive angle, there’s no question about that. Everybody will go there. Tencent (HKEx’s biggest listing) was the exception.” 

We speak with Li in April as he prepares to welcome the listing of mainland telco hardware firm Xiaomi, which announced its IPO in Hong Kong soon after the city agreed to allow super-voting stock. 

Xiaomi’s IPO is expected to raise upward of $10 billion, the biggest IPO raising since Alibaba, and would vault Xiaomi into HKEx’s top 10 companies by capitalization. Li says the share class changes could unlock a bonanza for the HKEx. “Xiaomi would definitely go to the US if we don’t have this,” Li says. “And we have a whole range of companies after Xiaomi. I can count at least 10 mainland companies that would be worth $20 billion now.”  

Adding dual-class shares to the HKEx roster “is not the selling point,” Li says, “it’s removing the block.” The problem with Li’s argument is that just a few weeks later, in early June, Xiaomi gave Hong Kong a proverbial bloody nose when it announced it would sell at least half of its shares in Shanghai in the form of Chinese Depositary Receipts.

Still, Li defends dual-class shares vigorously. “We are not giving them anything that is beneficial, we are simply allowing our market to do what the US does. That’s all.” Li cites Alibaba as an example of why dual-class shares work.

“Jack Ma got to be where he is, Alibaba got to where it is not because Jack Ma threw a lot of money to it. (Softbank’s) Mr (Masayoshi) Son threw quite a bit of money…. Yahoo’s got a little bit, but vis-à-vis the size of the company, the money is irrelevant, it was marginal,” Li argues. “It’s really the intangibles that allowed this company to really grow into massive scale. In Apple, Steve Jobs disproportionately created value to that company and we should allow (the likes of) him to call the shots.”

Li’s unsolicited mention of [Jack] Ma and Alibaba references Li’s biggest setback during his tenure, and the admitted motivation behind his push for the share-class rule change in Hong Kong. The Chinese online product-sourcing firm first went public in 2007, in Hong Kong, in floating the alibaba.com website. That listing struggled, and by the middle of 2012, Ma and his partners had bigger ideas. Alibaba Group bought out minority investors and took the company private. The stock was delisted.

In 2013, as Alibaba was negotiating a new listing of the wider Alibaba Group between the NYSE – which allows dual-class shares – and the HKEx, which then did not, the company’s co-founder and vice-chairman Joseph Tsai said that “the question Hong Kong must address is whether it is ready to look forward as the rest of the world passes it by.” 

Hong Kong was a “natural…. first choice” for the new float, Tsai said, “but we firmly believe that Hong Kong must consider what is needed in order to adapt to future trends and changes.”

Alibaba wasn’t proposing a dual-class shareholding structure, Tsai said, but a “governance structure that would enable Alibaba’s partners – key people who manage our businesses – to set the company’s strategic course without being influenced by the fluctuating attitudes of the capital markets. We understand Hong Kong may not want to change its tradition for one company.”

Ma and Tsai chose the NYSE over Hong Kong and took Alibaba public in what was, at the time, the largest ever IPO, a $25 billion-plus float. The result was Li lost the prestigious Alibaba listing that would have boosted his trading revenues and international cachet. “Of course we would have liked them,” he says. “I would like everybody here. Alibaba is an extremely important catalyst, an important example, a case study for people to look at. This is real consequences to a market, real cost to a market.” 

He says the value of Alibaba’s daily trading volume in the US is equal to 20% of Hong Kong’s total daily volume. “This is how much the market overall suffers from missing out. The US will have an even harder time to figure out what Alibaba is doing here.”

David Webb, a prominent shareholder activist and former non-executive HKEx director, says HKEx’s dual-class share move arose because the decision by China’s home-grown companies, like Alibaba, to list in the US was a “huge loss of face” and source of “national shame” in Beijing.

“There is a feeling that US regulators have too much say over Chinese companies,” Webb says. A long-time thorn in the side of Hong Kong market officials, Webb says he thinks Li does not care a great deal about regulation and supervision. “It’s like: ‘Ooh, it makes us look bad, but oh, never mind because we are going to list Xiaomi and all the big tech companies’,” Webb says. “Quite rationally, his interest is in maximizing turnover at HKEx and milking that monopoly. That’s how he is motivated, with his remuneration and so on, shares and bonuses. That’s his job. It’s his job to make sure China is happy. The biggest customer of HKEx when you think about it is the mainland government.”

Of the top 20 HKEx-listed companies by capitalization, at least 15 are Chinese state-owned enterprises, he notes: “What they (Beijing) want is paramount.” Webb points to an inherent conflict of interest in Hong Kong’s listing and regulatory regime, which is that the businessmen-dealmaker bosses of the HKEx and the lawyers who run the SFC are ultimately appointed by the Hong Kong government.

The chairwoman of HKEx – prominent lawyer and regulator Laura Cha – is a former vice-chair of China’s Securities Regulatory Commission (CSRC) and is also appointed by the government. A member of Hong Kong’s de facto advisory cabinet, the Executive Council, China-born Cha chairs the government’s Financial Services Development Council. Six of HKEx’s directors are appointed by the Hong Kong government and six are elected by the shareholders. The 13th is the chief executive Li. 

“It’s a government-controlled company that won’t admit it,” says Webb. He worries about the exchange’s regulatory rigour and points to the so-called ‘Enigma Network’ scandal of last year, in which he unravelled a complex network of 50 manipulated listed companies that had not been detected by the HKEx. 

After Enigma was revealed by Webb, the market took a $6 billion hit. Webb says Enigma showed “that the system does not work; that it’s not fit for purpose because HKEx allowed this to build up and didn’t apply enough resources to scrutinize it.”

Li did not directly admit to any regulatory shortcomings in the wake of Webb’s Enigma disclosures. In remarks to reporters a few months before Enigma was unearthed, Li dampened fear of slipshod regulation, saying: “We all need to relax. This is a great market. You don’t want the regulator to solve all your problems”. 

Li said the Hong Kong market was like a generally well-run city that has “a few dark alleys and little corners”. But in April this year, the HKEx moved to deploy Nasdaq-derived artificial intelligence surveillance software known as ‘regtech’ to track irregular trading activity. Webb compares Hong Kong’s regulatory regime unfavourably to the UK’s. “When the London Stock Exchange was demutualised, this conflict was recognized, and the whole regulatory function moved out to what is now the Financial Conduct Authority,” which is structured and operates independently of government.

Webb says he and other corporate governance activists lobby authorities “as often as we can” to separate the direct line to government, but it falls on deaf ears. “If the government doesn’t want to, they won’t do it. They would rather control everything,” he says. The purchase of the London Metals Exchange in 2012 followed the mixed results of Li’s push to lure foreign listings to the HKEx. The Hong Kong exchange has attracted high-profile listings from the Swiss-based mining group Glencore and Brazilian mining house Vale, as well as from US fashion retailer Coach, Italian fashion house Prada and the French cosmetic firm L’Occitane International. The Russian oligarch Oleg Deripaska has also listed his Rusal Group in Hong Kong. But trading volumes have generally underwhelmed.

However, the LME has delivered for HKEx, and owning it has been a “great experience,” Li says. HKEx had implanted a “commercial DNA” into the venerable members-only exchange. He says the LME contributes about 12% of group taxed profit. That translates, he says, to a market value of around $4 billion to 4.5 billion – based on HKEx’s notional market capitalization of around $40 billion – and is more than double what HKEx paid for LME.

As for China, Li would like it to keep doing what it’s doing.  “I want China to keep changing, keep being dynamic, there’s so many things China needs to do. Just keep on doing them and we will figure out a way to respond,” he says. “China is so big and so different and no longer willing to change itself to fit into the rest of the world, because they have their own ecosystem, its own logic, (so) the world is now going to have to change itself to fit into China.”

His Connect model with Chinese stock exchanges plays into that and is a pragmatic way of joining two different corporate systems, he says. He points out that the total value of Hong Kong’s listed stocks is around HK$35 trillion ($4.5 trillion), which is disproportionately large compared to Hong Kong’s domestic economy.

“It’s a little body with a big fat head,” he says. “Our whole market is China, and we are the one that is doing the connecting. Anybody who does that needs to constantly be agile, always trying to find the right position…the right place to align needs, the right timing.”

As for future reforms, Li says, “we are largely still equity, but fixed income, currency and commodities are big things to deal with.” He hints at possible tie-ups beyond China, to help China Inc connect to the world.  “We want to be the world’s exchange for China, we want to be the Chinese exchange for the world.”