EUR 850.00 For Business Accounts Only

Morningstar | Hong Kong Exchanges' 20/20 Strategic Vision; Building on Success With Evolutionary Strategic Plan. See Updated Analyst Note from 28 Feb 2019

With the announcement of a largely in line fourth quarter and fiscal 2018 result, the focus was on Hong Kong Exchanges and Clearing’s strategic plan for 2019 to 2021. In our view, the plan is an evolution of the last strategic plan, and it does not alter our long-term view of the wide-moat rated exchange. We continue to believe the exchange is well positioned for the liberalisation of the capital markets in China. Our fair value estimate increases to HKD 225 from HKD 210, and the exchange remains overvalued. Our forecast assumes a steady increase in average daily turnover value, or ADT, for the exchange, which in our view, takes away the task of pinpointing ADT for a single year. As we have previously noted, ADT is still a key driver for the exchange’s share price, despite a diversification of the exchange’s earnings into commodities. We reiterate our view that investors should focus on the underlying fundamentals of the exchange.

In the last strategic plan for 2016 to 2018, the key theme was mutual market access in linking the Chinese capital market and international participants, and vice-versa. Some of those initiatives were reiterated in the current plan. These include broadening the scope of the two stock connects with the inclusion of more stocks and additional financial products in exchange traded funds for the cash market, the development of new financial products within each of its asset classes in derivatives, fixed income, and commodities, and changes to micro-market structure. Progress of the above were made with the launch of the bond connect, the introduction of dual-class structure for equities, and a push for biotech listings.

While the overall vision for the exchange is unchanged, new initiatives include further changes in micro-market structure, risk management, and technology. Our wide-moat rating, in which we believe the exchange can maintain its competitive advantage over a 20-year time frame under our methodology, is reaffirmed. Some of the new initiatives will strengthen the exchange’s competitive advantage in our view. Part of this is the vertically integrated business model, where trading of financial instrument is also cleared through the exchange’s clearing house. Plans to increase cross-asset optimisation on margin account, and an upgrade in collateral services will increase switching cost. The netting-off of positions across different asset classes, along with the acceptance of collateral, will lower capital commitments for market participants. The latter has become more costly given the tightening of capital rules under Basel III. The exchange’s over-the-counter clearing, or OTC Clear, also lowers capital commitments by taking the assets off a financial institution’s balance sheet. Broadening of its range of financial products will strengthen switching cost as the margin account can be utilised on even more positions.

Management is not concerned about market participants bypassing Hong Kong in accessing the respective markets directly, citing a different level of investor sophistication. While complete liberalisation of the capital markets in China could be the ultimate end game, this will take some time to occur. It would also result in the complete opening of the country’s capital account and the Chinese authorities ceding control over its currency. We do not see this occurring in the medium term. Looking back over the last 20 years, the Qualified Foreign Institutional Investor program was launched in 2000, Qualified Domestic Institutional Investor program in 2006, and the two stock connects in 2014 and late 2016, respectively. The Chinese regulator and government is conservative, in our opinion, and any significant volatility in capital markets will see approval times for new initiatives delayed, as it did for the stock connects. Meanwhile, an acceleration in launching new financial products and gaining liquidity will strengthen the product’s network effect, as more liquidity lowers spreads and costs for buyers and sellers, and for the exchange as well.