When the management of Hongkong & Shanghai Bank headed into work on the morning of August 28 last year, the last thing they expected to see was the Hong Kong government entrenched as their largest shareholder. Nonetheless, with an investment of $4 bn, the Hong Kong Special Administrative Region (SAR) had purchased 8.8 percent of HSBC Holdings. The fact that the bank’s principal regulator had accumulated substantial voting rights along the way must have had the IR team wondering what lay in store. And they were not the only ones. With $15 bn injected into Hang Seng Index (HSI) stocks, the impact on the corporate landscape has been far-reaching.
High stakes
Mike Wong, managing director of Edelman Financial Worldwide Asia, notes just some of the repercussions. ‘If I had the government as a major shareholder of my company I would want to speak to it as often as possible,’ he says. ‘Who is to say how the government will vote if a company is doing something it feels is not in the best interests of Hong Kong? For instance, would the government have stopped Jardines from delisting from the HKSE had it been a shareholder at the time of the move?’ Hong Kong’s corporate elite should be all the more nervous considering that the government has made it clear its investment decision had little to do with fundamentals, and more to do with battling the hedge funds. Companies were simply caught in the crossfire. The hedge funds were well-positioned to make a killing. In addition to amassing HK$30 bn in funds ready for attack, they had purchased over 80,000 future contracts to short the HSI. The objective was to pull the rug out from under Hong Kong and force the government to de-peg the Hong Kong dollar from its US counterpart. However, what at first looked like sweet pickings turned into a hedge fund bloodbath as the SAR intervened by betting HK$118 bn.
The initiative bolstered the index and caught speculators on the wrong side of the futures market. Indeed, it has since been revealed that the Hong Kong government made a profit of around HK$350 mn from its closure of futures and options positions acquired at the time. ‘Given the state of the index it was a valid decision to move from global equities into Hong Kong stocks,’ says Dr Miron Mushkat, vice chairman of Indocam Asia, a fund management company owned by France’s Credit Agricole Indosuez. ‘But instead of using one of its long-term funds, as might be expected, the government used a short-term money market fund to stop the speculators.’ ‘An unannounced policy change never goes down well, but this move shocked the market,’ adds Simon Maughan, head of research at Indosuez WI Carr. ‘The message could have been that stocks are cheap and investors don’t know where the bottom is. Instead, Hong Kong said that when things are bad and you short the market we can change the rules overnight. Investors thought stocks were overvalued in August, but the government then moved the index up 1,000 points overnight. At that point investors who may have held Hong Kong stocks decided to sell. They may not return until they are convinced another intervention is not in the offing.’
Challenge accepted
August 28, 1998 will go down in history as the day Hong Kong defeated the hedge funds. Other Asian governments had tried and failed, and many accused hedge funds of destroying the region’s financial markets. Yet, no government had the depth of reserves to match the hedge fund renegades until Hong Kong took the challenge. In the largest equity market intervention ever made by an Asian government, Hong Kong reversed the decline of its index and protected the peg. At least, that is what financial secretary Donald Tsang and Hong Kong Monetary Authority (HKMA) chief executive Joseph Yam told investors on their worldwide investor relations campaign. Having repelled previous attacks on the peg, the government was carefully following hedge fund activity. From January to August last year, over HK$30 bn of short-term money was raised through the issue of debt by multilateral organizations such as the World Bank and Asian Development Bank.
The government knew that the true borrowers behind these issues were hedge funds. In an effort to collect Hong Kong dollars, hedge funds used intermediaries in the swap market to provide attractive US dollar funding. The HKMA believes the cost of running the HK$30 bn position was HK$4 mn a day. The Hong Kong authorities also had reason to believe that hedge funds were building short positions in stock index futures. With an estimated 80,000 short contracts held among the hedge funds, every 1,000 point fall in the Hang Seng stood to bring in a profit of over HK$4 bn. The hedge funds were waiting for the right opportunity to sell their Hong Kong dollar holdings in the hope of creating a severe shortage in the money market and pushing inter-bank interest rates higher. According to Yam, this was compounded with ‘malicious rumors about the Hong Kong dollar devaluation’. Despite this, much of the financial world attacked the intervention. Long-time supporter and Nobel Laureate Milton Friedman felt the government had simply gone mad. US Federal Reserve chairman Alan Greenspan came out so strongly against the ‘jacking up of the stock market’ that he prompted an open letter from Yam. John Greenwood, architect of the peg, has pleaded for Hong Kong to ‘extricate itself from holding these positions as expeditiously as possible.’ The advice of the world financial community has had little effect. Indeed, the defense of the intervention has been made a lot easier by the fact it was a notable success. Besides a trading profit of over $4 bn registered by the government, the index has followed a steady course upward from a low of 6,660 in August. As a result, speculation on the Hong Kong dollar has eased and the interest rate environment improved.
Time worth buying
‘There is an old Chinese saying that says: when you lose the war everything you did right is wrong; when you win everything you did wrong is right,’ says Lennon Chan, executive director of Tai Fook Securities Group, one of the largest local brokers in Hong Kong. ‘I’m not saying the government did everything wrong, but had Tsang been more secretive, like the Fed, he could have accomplished the same thing with less money. Yet, the use of substantial reserves was in the government’s favor as it registered a massive trading profit. They bought time that was worth buying.’ ‘The government had little choice but to move into the market. In New York the speculators would have been thrown in jail for manipulating the market in a criminal way,’ says Toby Heale, chairman of Investor Information Group, a Hong Kong-based stockwatch operation. ‘In IR terms, the government is a pussy-cat of a shareholder, the best there ever was. They have driven the speculators out of the temple and locked up a lot of weak stock.’ Heale adds the warning: ‘It’s easy for observers to criticize the Hong Kong government, but the effects of inactivity should also be assessed. Had the government done nothing, Hong Kong would have joined those economies that lay in ruins, whose currencies had collapsed, and civil strife lay just around any street corner.’
Regardless of the merits of the move, the Hong Kong government is now in the rather awkward position of being the largest shareholder in many HSI stocks. The biggest positions are in Swire Pacific (12.28 percent), New World Development (11.91 percent), and Cheung Kong Holdings (10.34 percent). While companies remain tightlipped about their new shareholder, some are rumored to be approaching the government to arrange share buy-backs. Other companies, such as Swire Pacific, have openly said they do not feel it is appropriate for the government to sit on the board. Heale believes the key problem with the current situation is that the government has not come out and said what it plans to do. With legislation pending on the long awaited Mandatory Provident Fund, he believes the current portfolio may eventually be earmarked for a government pension fund. The government has tried to distance itself from its holdings, and stated that the long-term objective is to disinvest. That disinvestment could come through the new pension fund, but no announcement can be made until the fund exists. ‘Hong Kong is in the extraordinary position of having a portfolio for a pension fund without the pension fund,’ adds Heale. ‘As for conflicts of interest, they are entirely manufactured by the market. The person who regulates Hongkong Bank will not be the one who handles the shareholding. I cannot see the bank regulator rushing next door to say he has checked the figures and it is time to sell the stake.’
Not so sure
Still, not everyone agrees. ‘What happens if there is a rights issue? Does the government pour in even more money?’ asks Maughan. ‘And what happens with the government stake during a takeover? These and other issues were not taken into consideration because investment was not the government’s primary concern.’ ‘I didn’t support the government intervention at the beginning as it violates free market principles,’ says Edelman’s Wong. ‘But, in hindsight, had the government not stepped in, Hong Kong would have been in worse shape. Now, however, the impact on liquidity is noticeable and IR teams must deal with the implications. Before speculators could drag down the market, now they can easily push it up to unsupported levels.’ One point is clear: foreign investors who have watched Hong Kong for some time are concerned by the government’s actions. They note that many of the ‘horrible’ speculators accused of trying to bring down the economy were backed by Hong Kong’s millionaires. They want to know why speculators were ‘burned’ when the market dropped, but not punished for pushing up Red Chips to unheard-of levels.
The consequences of the intervention may be more far-reaching than anyone suspects. As one leading fund manager notes, ‘When the financial secretary awoke on August 14, the day of the first intervention, did he decide to punish speculators by buying into the market? Or did he – as I suspect – discuss the matter before the intervention with SAR boss Tung Che Hwa? Did Tung not call his trusted advisors, many of whom come from the property sector, to discuss the idea? And, what about Beijing? Surely, Tsang could not deploy Hong Kong’s reserves in support of the stock market without clearance. In my estimation, at least twelve officials and businessmen had prior knowledge of the government’s intervention.’ This fund manager goes on to point out that the biggest share buy-backs in Hong Kong this year took place on August 11, 12 and 13, just prior to the first intervention. These share buy-backs were allegedly engineered by some of Hong Kong’s largest property tycoons. For that reason, in the streets of Central many are quietly accusing the government of punishing international investors while allowing local cartels to take the inside track.
Foggy horizon
The future remains just as unclear. In a response to claims of conflicts of interest, the government has appointed its internally-controlled Exchange Fund Investment Ltd (Efil) to manage the portfolio. Meanwhile, the government has merged its HK$211.4 bn Land Fund with the HK$735 bn Exchange Fund in order to strengthen the defense of the market and the currency peg against any renewed speculation. Efil, which will handle the equity portfolio of the Land Fund and Exchange Fund, should be expected to act in line with government policy. After the merger the government has stated that it may decide to re-weight its portfolio, but no information was given as to how. In the end, the success of the Hong Kong intervention has done more than just bolster confidence in the local market. Other governments around the region are taking heart from the defeat of the hedge funds. Malaysia, for example, is using some of its pension funds to buy securities. Taiwan announced the creation of its own $7 bn stock market stabilization fund to restore confidence. And Japan is under continuing pressure from some quarters to step into its own market in a similar vein. However, no-one should count out the hedge funds and speculators just yet. Asia still isn’t clear of the choppy waters of financial turmoil.
