Published On: Fri, Oct 15th, 2010

Hong Kong Tops Japan as Asia’s Biggest Market for Short Selling

Hong Kong has surpassed Japan for the first time as Asia’s most-lucrative market for stock lenders, boosted by investor demand for Chinese securities to be used in short sales.

Pensions, mutual funds and banks reaped $245 million in the past year from loaning out Hong Kong shares, compared with $241 million from Japanese equities, according to fee data tracked by Data Explorers since 2007. Short sellers borrow and sell stock hoping that prices will drop and they can buy back the securities, repay the loan and pocket the difference.

Rising demand to borrow reflects heightened interest in Chinese companies from bulls and bears alike, not just speculation equities will fall, according to Emil Wolter, the Singapore-based head of Asian regional strategy at Royal Bank of Scotland Group Plc. Hong Kong’s Hang Seng Index trades for 14.6 times the profit of its companies, down 40 percent from its 2009 high, while the Shanghai Composite Index fetches 19 times earnings compared with 51.6 in 2007.

“As the Hong Kong market grows, there’s an increasing amount of activity that is not necessarily directional, like arbitrage, program trading and more complex trading strategies that are being put to work,” Wolter said. “Japan has been a market that’s been fading away for a long time and people are frustrated with it.”

Firms lending Hong Kong stocks are able to charge bigger fees because investor demand is growing and the city has fewer listed companies than Japan, said Will Duff Gordon, senior analyst at Data Explorers. More revenue is being generated from Hong Kong even as the value of the country’s shares on loan is half the level of Japan, the world’s second-largest equity market behind the U.S.

Chinese Growth Story
China’s gross domestic product may increase 8.9 percent in 2011 and Hong Kong will grow 4.3 percent, according to the median economist estimate tracked by Bloomberg. Japan is projected to expand by 1.4 percent next year. Companies doing business in mainland China make up 58 percent of Hong Kong’s market value, according to an Oct. 5 presentation by Charles Li, head of the city’s bourse.

The annual fee to borrow stocks in the U.S. and Japan is 0.5 percent or less for more than 56 percent of the securities that can be loaned, Data Explorers said in an Oct. 7 presentation. In Hong Kong, 38 percent of shares are that cheap.

Cost to Borrow
Lenders charge at least 1.5 percent annually for 47 percent of Hong Kong’s shares on loan, according to Data Explorers, which tracks more than 20,000 securities lending programs managed by institutional investors and custody banks around the world. The proportion is 32 percent for borrowed Japanese shares and 25 percent for those in the U.S.

“In Hong Kong, you’ve got a very small supply of expensive merchandise going out the door,” said Duff Gordon in an interview from London. “There are still plenty of inefficiencies in the Hong Kong market and arbitrages between China and Hong Kong shares, which means people will continue to be active in playing these trades.”

More than $24 billion of stock was on loan in Hong Kong last month, according to figures compiled by Data Explorers. That compares with $44 billion in Japan, the data show. Boston- based State Street Corp., and JPMorgan Chase & Co. and Bank of New York Mellon Corp., both based in New York, run the world’s three largest securities lending programs, Data Explorers said.

Lending Revenue
Revenue for securities lenders has risen as companies from Agricultural Bank of China Ltd., the nation’s largest lender by customers, to phone company PCCW Ltd. sold shares in Hong Kong this year. Companies raised HK$326 billion ($42 billion) in the first nine months of 2010, the most for any January-to-September period since at least 1999, data compiled by Bloomberg show.

About 62 million shares, or HK$253.7 million, of Beijing- based Agricultural Bank were shorted on Oct. 12, according to the Hong Kong Stock Exchange. Investors borrowed and sold 367 thousand shares, or HK$1.02 million, of Hong Kong-based PCCW, the same day the data show.

Asian companies outside of Japan may raise a further $116 billion in share sales by the end of the year, boosting the total for 2010 to a record $291 billion, New York-based Citigroup Inc. said in a Sept. 20 report.

Mutual Funds
Investors have poured money into equity mutual funds that invest in Asia excluding Japan for the past five weeks, adding $5.3 billion, as economic growth in the region exceeds Europe and the U.S., based on an Oct. 7 note from EPFR Global. They’ve withdrawn cash from funds that buy Japanese shares in 14 of the past 15 weeks, data from the Cambridge, Massachusetts-based research firm show.

The Hang Seng Index reached a two-year high on Oct. 11 and has rallied 5.7 percent this year on rising Hong Kong property prices and economic reports that show China’s economy gaining momentum. Japan’s Nikkei 225 Stock Average is down 11 percent for 2010 after the yen rallied to a 15-year high, spurring speculation profits for Japanese exporters will weaken.

“The universe of names is increasing and the quality of the companies has increased” for Asian countries outside Japan, said Jesse Lentchner, the Hong Kong-based chief executive officer of BTIG LLC’s Asia Pacific operations. “I don’t think you’ll see an increase in the number of people concentrating on Japan or an increase in the assets chasing performance in Japan.”

To contact the reporter on this story: Lynn Thomasson in Hong Kong at lthomasson@bloomberg.net.

To contact the editor responsible for this story: Nick Gentle at ngentle2@bloomberg.net.

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