TVB Interview

Question 1: As a leading Hong Kong financial industry player, can you share with us the challenges that HK experts are facing, especially in exporting their services to overseas or mainland?

Answer: HKG is an international financial centre with many participants from all over the world. The international participants have overseas offices or were originally from overseas. The challenge that HK based financial services firms have to face is how to offer our services overseas. We can tie-up with an overseas firm or set up our own offices. In order to consider the most appropriate option, we need to spend substantial time and resources studying the overseas market, identifying potential partners, and negotiating the appropriate set-up. Many HK based firms do not have the resources to do this on our own.

Question 2: Would you share with us your experiences of joining HK Trade Development Council’s delegation to Moscow and St. Petersburg which led by the Financial Secretary in 2009 and Asian Financial Forum?

Answer: I have participated in many TDC delegations in China, Asia and Europe. Many HK based financial services firms have explored the markets in China and Asia but Europe has always been a little too far away both in terms of distances and time zones. The TDC’s delegation to Moscow and St. Petersburg was very useful to me personally as I was able to gauge the level of interest in the HK financial market from similar sized organisations in the Russian Federation, and from potential clients.

Many companies in Russia are looking at various financial centres for fund raising but have been disappointed in the European markets’ recent performance. They have come to realise that HKG is an important financial centre for China, and that many M&A deals can be done with Chinese entities through HKG. Russian financial advisors are also looking at tying up with partners in HKG in order to compete with the international banks.

I have attended every AFF since its inauguration. In addition to the high quality of the speakers, I have found it an excellent venue to meet potential partners. By coming to HKG to attend the AFF they already have interest in either investing in HKG or developing HKG tie ups. You might even say that they are more or less pre-qualified so we are talking to people with genuine intent.

Question 3: What is the contribution of HKTDC in promoting HK financial services to the world?

Answer: The problems faced by HK based financial services institutions are the same ones faced by HKG manufacturers and traders in the early years. How do we reach international markets with our services? How do we identify potential partners in international markets?

In the same way that TDC has helped the manufacturers and traders, it is now helping financial services firms. In addition to manufacturing and trading, HKG is now an international financial centre. The TDC has recognised this shift and has re focused itself to assist HKG financial services firms to tackle overseas markets.

The job is different and much harder. We do not have physical products to sell or show in exhibitions. What we have is our network, knowledge, expertise, and perhaps some physical infrastructure e.g.. internet trading etc. Without the leadership of TDC, I would not have been able to even consider overseas markets. The investment in time and efforts (not to mention costs) would have been too big.
In the same way that the TDC helped HKG become the premier trading centre of the world (with China as our work shop), it is now helping promote HKG as an international financial centre.

International financial institutions were successful in bringing foreign capital to China. Now that China has accumulated USD2.4 trillion of foreign currency reserves, HKG will become the fund raising centre for many international companies.

How much of "Made in China" is made in China?

The Federal Reserve Bank of San Francisco published a study which tries to answer this question. The short answer is US consumers spent 2.7% of total personal expenditure on goods which are "Made in China". The study goes further is point out that out of every dollar spent on these goods, $0.55 goes to US businesses and workers for marketing, rents, transportation, electricity, etc. Thus, only $0.45 goes towards the costs of "Made in China" goods.

However, the study did not go far enough in analysing the $0.45 that supposedly goes to China. Many US businesses (read WalMart etc) have buying offices in China which places the orders with Chinese manufacturers. The goods are shipped off to the US after a hefty markup by the buying office to drop off the profits in a lower tax regime.

For example, an iPhone which retails for $500 "costs" $179 to make in China. Of the $179, $172.50 actually goes to parts that are not made in China. So $6.50 is the assembly costs that is earned by the Chinese or 1.3% of the retail price.

So why do we think that "everythjing we buy is made in China"? The answer is simply mis-perception. Blame this on the media.

We keep reading about the US trade deficit with China and how this is growing. However, as a percentage of total US production this is only a smal percentage (2.9% of a $10 trillion economy).

According to the study, 88.5% of consumer spending is on goods and services made in the US. The key word here is services, think mortagage repayment, car repayment, insurance payment, school fees, etc.

Forcing China to revalue the RMB upwards by 30% would only increase the Chinese component of the costs by $1.95, hardly enough to discourage imports from China but increasing costs to consumers. 

Would US workers be willing to work for $500 per month assembling iPhones? Probably not, so the work and money will go to some other low costs countries. US businesses do their sum everyday. If they can make it cheaper and more efficiently somewhere else, they would have already done so. The benefit is passed on to US consumers in terms of lower prices, and to US businesses as higher profits which enable them to hire US employees.

The GTM/EGX 5th Annual Award Ceremony and Gala Dinner

The following is the text of my Keynote Speech at the Global Trade Matters/Egyptian Exchange 5th Annual Awards to Outstanding Companies in Egypt

Opening Remarks

First of all I would like to thank Ashraf Naguib, Managing Director of GTM, for inviting me to participate at this event.

Address the Key Guests

Mr. Karim Helal, Chairman of the GTM/EGX Strategic Advisory Board

Members of the GTM/EGX Strategic Advisory Board

Distinguished Guests

I bring you greetings from China, the faraway land with a civilization that matches your own in antiquity

It is a great honor to be invited to participate in this very prestigious event to celebrate the achievements of Egypt’s top companies, and the men and women who have made them successful

First of all, I would like to offer my congratulations to the awardees. Not only have you survived the The Great Recession of 2007 ( I will not use the “D” word) but you have thrived and prospered in the most difficult financial and economic conditions since the 1930’s. You have every right to be proud of yourselves. Give each other a pat on the back. You are the Best of the Best!

But precisely because you are The Best, you must be asking yourselves “What’s Next? What am I going to do next year? Has the world economy recovered? Or, will we be like Japan and lose a decade, or two?”

The HKG Story: China’s Proxy

Ashraf asked me to share with you my thoughts, concerns and optimism for 2010.

Before I go on, I have a confession to make. I am not an economist nor am I a banker. I am a bean counter (an accountant) turned stockbroker. I don’t have any grand theories of economic boom and busts, nor do I have a prescription for “saving the world’s economy”.

All of you present today, run huge corporations with thousands of employees and revenues in the billions.. The fact that you are sitting here tonight is proof enough of your success. So I am not going to try to tell you how to run your business

However, in the 40 years since I started working in 1969, I have observed at first hand a few economic cycles and I have been fortunate enough to have participated in the miracle that turned China from a backward agricultural economy on the verge of starvation into the economic powerhouse that it is today.

I am sure you are all familiar with China’s economic statistics and I will not bore you with the details. However, I would like to talk a little bit about China’s proxy economy, HKG.

When I first returned to HKG in 1971, the Hang Seng Index had just closed the previous year at 211. The average daily turnover was USD2.6 million and the turnover for the whole of 1970 was USD778.4 million.

By the end of 2009, the HSI closed at 21,872. The average daily turnover was USD7.9 billion and the turnover for the year was USD1,979.4 billion. Per capita GDP was USD30,088.

During the past 4 decades, HKG benefitted by being the proxy for China. Foreign companies trading with China did so through HKG, and Chinese companies used HKG as a window on the world.

When China opened it’s doors, Chinese companies used HKG as the platform of choice in raising capital and much needed foreign exchange. Since the first Chinese company (Tsingtao Brewery) was listed in HKG in 1993, over 300 Chinese companies have have followed raising some USD280 billion in IPO and subsequent fund raising. Chinese companies now account for over 30% of the listed companies, over 60% of the market capitalisation, and over 70% of our daily turnover.

HKG benefitted by being on the doorstep of China but that is not the secret to our success. Many cities have had similar opportunities but by not evolving as the times changed, fell by the wayside. A prime example is Kashgar on the Old Silk Road. For many years, it was the point of entry in China and prospered for many years by being the conduit of goods between China and the rest of the world. Look at it now.

By the way, I am sure you have heard about China’s USD2.3 trillion foreign exchange reserves. Over 10% of that came through the HKG capital markets.

Yes, HKG benefited by being on the doorstep of China but the key is that we changed from being a trade entreport to a financial intermediary and we contributed to the country’s development.

Egypt and North Africa

When I talk to Western bankers and economists, they see the world as 3 regions: The Americas, Europe Middle East and Africa (EMEA), and Asia Pacific. My view of the world is a little more complicated based on population, proximity and store of resources:

North America and Canada

Latin America

Europe

Middle East and Africa

Russia

Central Asia

China and Asia Pacific

I believe that Egypt and Egyptian companies can and do play a similar role in Africa and the Middle East i.e. be the conduit between the Middle East and Africa, and the consumer nations. In terms of population and resources, Africa has the potential of being a stand alone economic entity. Forty years ago, who would have thought that China would be the economic power it is today?

Africa and China

There is a final ingredient in the mix. Don’t look to your tradional markets for growth!

In the 1800’s, British trading hongs in HKG made their fortunes by being the intermediary between China and Europe. In the 1960’s this role was surplanted by Chinese trading firms.

However, China would not have prospered without that great engine of consumption, the USA. Many companies and individuals in HKG started their fortunes by facilitating trade between China and the USA.

Most forecasters have called for anemic growth in Europe and the USA. So, where should your companies be looking for opportunities if not in their traditional marklets?

The answer, of course, is China. The annual trade between China and Africa amounted to some USD100 billion. Most of this in exports of energy and mining products from Africa to China and imports of Chinese manufactured goods.

However, the Chinese government is encouraging domestic consumption as a replacement for weak exports to the USA and Europe. It is pumping USD586 billion into the economy in 2009 and 2010 as a stimulus package. And remember, a dollar in China goes much further than a dollar in the US. When you combine this with a population of over 1.4 billion, and household and corporate savings amounting to 150% of GDP, this makes for a very scary growth story.

Just imagine selling one of your products to every Chinese! And that by the way is not so far fetched. China Mobile, the largest of 2 mobile phone operators, has 527 million users.

Conclusion

The Chinese economy grew at a comparatively anemic 8.7% last year (because of the Financial Tsunami) after a decade of double digit growth. As the world economy recovers, I expect China’s growth to resume the previous trajectory and wil one day take over as the engine of growth for the world.

To the companies represented in this room tonight, The Best of The Best in Egypt, I encourage you to take advantage of this once in a lifetime opportunity to participate in the growth of the Chinese economy.

1.4 billion Chinese customers are waiting for you. Go get them.

Thank you.

The Prime Minister of Kazakhstan led a delegation to HK and paid a visit to the HK Exchange.

In the photo, I was explaining how we used to place orders on the old trading system.

The Prime Minister was accompanied by the Governor of the National Bank of Kazakhstan (the central bank) Mr. Marchanko, as well as the Head of the Kazakhstan Stock Exchange and the CEO of Samruk-Kazyna the sovereign wealth fund.

Yuan Settlement – What is it, Who will benefit, and What is the End Objective?

Background

On 29 June 2009, Zhou Xiao Chun, Governor of the People’s Bank of China (the Chinese central bank) and Joseph Yam, Chief executive of the Hong Kong Monetary Authority (the de facto central bank and bank regulator in Hong Kong) signed a Memorandum of Understanding (“MOU”) putting into place a pilot scheme to allow the settlement of trade between HK and Mainland Chinese enterprises in Yuan (the Chinese currency also known as Renminbi or “RMB” i.e. “people’s currency”). The international currency symbol of the Yuan is “CNY”.

The MOU was quickly supplemented by detailed directives issued 2nd and 3rd July 2009 which laid out the conditions for the Yuan settlement.

What is it?

Under the Yuan settlement scheme, enterprises in China and Hong Kong trading with each other will be allowed to settle those trades in Yuan. The scheme will now allow enterprises whose costs are mainly in Yuan to reduce their foreign exchange exposure by using Yuan as the currency of trade. Previously, trades have been settled in foreign currencies, mainly US dollars which had weakened against the Yuan over the past 3 years.

Under the pilot scheme just announced, qualified enterprises in certain cities in the Yangtze (Shanghai) and Pearl River (Guangzhou, Zhuhai, Shenzhen and Dongguan) deltas will be allowed to participate. The list of eligible enterprises has yet to be announced but it is expected that no more than 500 enterprises will be eligible in the initial phase.

It is expected that all companies in Hong Kong and Macau trading with mainland enterprises will be allowed to participate.

In addition to companies Hong Kong and Macau, companies in the 10 Association of South East Asian Nations (“ASEAN”) will also be allowed to participate in using Yuan as the currency of trade and settlement with the to be designated Chinese enterprises.

In order to encourage the Chinese enterprises to use Yuan for trade and settlement, the Chinese Government will provide certain tax incentives.

What is the impact?

Since 2004, Hong Kong banks have been allowed to conducted limited Yuan business. This has been limited primarily to accepting deposits of Yuan from companies and individuals in Hong Kong. Most of these deposits are generated by retailers in Hong Kong from the spending of Mainland Chinese tourists travelling under the “independent travellers” scheme.

As of the end of March 2009, the Yuan deposits held by Hong Kong banks amounted to CNY 53 billion (USD 7.7 billion). While this may appear to be fairly substantial, it pales in significance when viewed against the USD 200 billion bi-lateral trade between Hong Kong and China.

Mainland banks will also allowed to lend Yuan to Hong Kong banks as part of trade finance settlement. However, under the detailed rules issued on 3 July 2009, the trade finance lending can only be for up to 1 month and is capped at 1% of the Mainland banks Yuan deposits as of the end of 2008. Foreign banks borrowing Yuan on the Chinese Mainland interbank market is capped at 8% of the its Yuan deposits at the end of 2008. Chinese banks will be required to provide the PBOC with detailed breakdowns of Yuan lending to foreign banks.

The limited amount of Yuan deposits in Hong Kong can be supplemented by a CNY 200 billion currency swap facility between the HKMA and the PBOC. Hong Kong banks requiring Yuan funds may borrow from the HKMA which will drawdown on the swap.

Under a separate arrangement, Hong Kong banks will also be allowed to issue Yuan denominated bonds on the Mainland and in Hong Kong to fund their Yuan business.

The stringent controls are put in place to discourage the flow of “hot” money into the Chinese economy if foreign banks were to be allowed to borrow unlimited amounts of Yuan.

What is the End Game?

China has been running massive trade surpluses with the US and has nearly USD 2 trillion in reserves. In march 2009, Premier Wen Jiao Bao of The People’s Republic of China indicated concerns about the huge amount of the country’s reserves held in US dollars and Zhou Xiao Chun the PBOC Governor has been talking about the need for a new world reserve currency.

The introduction of a limited pilot scheme to settle trade in Yuan is the first step towards the ultimate goal of internationalising the Yuan as an international currency of trade and settlement.
The inclusion of the ASEAN countries is an attempt at creating a Yuan currency block in South East Asia with smaller trading partner nations. For example, China is trying to create an ASEAN free trade zone based in Nanning, Guangxi.

In the meantime, as more Yuan circulate in the Hong Kong economy, it is conceivable that the Yuan will one day replace the US dollar as the base currency in the Hong Kong dollar peg.

Corporate Governance CITIC Pacific

On 20 October 2008, Citic Pacific disclosed that it had incurred losses of HK$15.5 billion from using currency accumulators to hedge against a rise in the Australian dollar. Citic Pacific directors and management are being heavily criticized for not disclosing the losses earlier when they had known of the problem at least 6 weeks before the public announcement.

Company shares fell 42 percent between Sept 7, when the board learned of the company's exposure to risk, and Oct 20. Hong Kong's benchmark Hang Seng Index dropped 23 percent over the same period.

The red-chip group purchased equipment and supplies in Australian dollars and euros. To help fund the mining endeavor, group finance director Leslie Chang signed derivative contracts that stood to profit the company, as long as the US dollar grew weaker against the Australian currency.

When the financial crisis exerted a downward pressure on commodities prices last summer the Australian dollar fell sharply against the US dollar. The resulting loss may be the biggest derivatives loss ever reported by a Chinese company.
As a result of the losses, Citic Group had to step in to save the company from going under. Shareholders of Citic Pacific have now approved the issue to the parent Citic Group of US$1.5 billion in convertible bonds which on conversion will give the parent company majority control with 57.6% (up from 29.4%) diluting management shareholder Larry Yung.

According to a statement to the Stock Exchange, Citic Pacific revealed that its entire board of directors was being investigated by the SFC over the incident. Those under the investigation included Citic Pacific Chairman Larry Yung, Citic
Pacific Managing Director Henry Fan and 15 other directors of the
company, while Yung’s daughter, Frances Yung, former group finance
director Leslie Chang and former financial controller Chau Chi-yin were
not on the investigation list, papers reported.

Citic Pacific’s disclosure that all its directors were subject to the SFC’s investigation was made to comply with amendments to the Listing Rules that went into effect on 1 January. The amendments require continuous and timely disclosure by listed companies of information concerning directors who are subject to any investigation, hearing or proceeding by any securities regulatory
authority, or any judicial proceeding in which a violation of any securities
law or regulation is alleged. Many listed companies made similar announcements on Friday to comply with the amended rules since some of their board members were also Citic Pacific directors.

Investor Sentiment and Forecast for 2009

The J.P. Morgan announced that the J.P. Morgan Investor Confidence Index in HK moved up slightly from the previous quarter when sentiment was at its weakest.

The Index is designed to measure the outlook of retail investors in the local market over the next six months. The index rose to 98 in December from 95 in September, when it fell below its neutral level of 100 for the first time since July 2006. The December index shows that overall investor confidence in Hong Kong has stabilized although investors are still wary of the risk of a deeper economic recession in the next six months.

Hong Kong investors anticipate that the employment market may deteriorate further over the next six months, according to the survey. 44% of those surveyed expect an increase in the Hang Seng Index over the next 6 months from the current level. 39% expect the Hang Seng Index to exceed 16,000 at the end of June 2009.

The index covers six areas: Hong Kong stock market performance, the local economic environment, the local investment environment, the global economic environment, personal asset valuations, and amount of investments. Each of those index components registered an increase in the latest survey, with the exception of plans to increase investments.

Both aggressive and conservative investors continue to shift their attention from overseas to the Hong Kong market. Portfolio strategists will tell you that the high concentration of equity investments in the local market may limit the potential scope for returns when the global economy begins to recover, and also increases the risk of portfolio volatility from over-dependence on a single market. However, all portfolio management theories have been thrown out the window this time around. So much for diversification (geographic, industry, asset class, currency). Everything got clobbered.

Of course, retail investors are always the worst predictors of the market.

I don't see any real improvements until after the April final results reporting season. HK has the longest reporting period of any of the developed markets. Final results have to be reported with 3 months.

Institutional investors are sitting on their hands right now and waiting for results announcements. No one wants to buy now and finish with egg on their faces when the results come out and the company announces huge "hedging losses".

So things will be very volatile between now and then. Morgan Stanley just downgraded Hsbc with a target of 52 (was 75 now 66). The market went up 1,200 points on the first 2 days of trading to 15,500 and now has given up more than 2,000 points!

"Blackout Period"

Recently front-page advertisements have been taken out in the local papers protesting against a change in HK’s Stock Exchange rules which came into effect on 1 January 2009. Over 200 listed companies have signed a letter protesting this rule change that in their opinion will undermine the viability of Hong Kong’s market making it easier for unwarranted hostile takeovers, corporate exits, reduction in stock market liquidity and exodus of management talent.

Under the old rules directors and managers of listed companies were allowed to trade shares in their companies until a month before results are announced. The problem is that listed companies are allowed three months after the end of the period to report half-year results, and four months for the year-end. This meant that they were able to trade on information that was not publicly available between the end of the reporting period and the start of the “black out period” i.e. for two months before the interim results were reported, and three months for the final results.

In theory, the Listing Rules also require companies to announce meaningful events as soon as practicable, and the SFC does have the power to investigate insider dealing. But such disclosure is still problematic and after the fact. For example, recently Citic Pacific only disclosed news of a $2 billion currency loss six weeks after the fact was known to the directors.

Under the new rules which were originally promulgated in January 2008, directors and managers are not allowed to trade shares in their companies until after the results are announced. Therefore, if the companies continue to make full use of the 3 month interim reporting period and the four months final reporting period, directors and managers are barred from trading for a total of seven months.

In the US, financial results are reported quarterly and must be disclosed within 40 days of a quarter-end and 60 days of a year-end. Thus, if a listed company in HK can announce interim results within 40 days and final results within 60 days (using the US as rule as an example), the total “black out” period is only 100 days and not 7 months.

The problem, of course, is that auditors have to co-operate and the auditors would like to have as much time as possible after the year end before giving the company a clean bill of health because of their own scheduling. Also, companies may sometimes need more time after the year end to work with the auditors on the results.

On December 30th, the Stock Exchange announced that it would delay introduction of the new regime until April 1st. Opponents to the proposals hope the delay will become permanent.

Corporate governance advocates would like to introduce more frequent reporting to increase transparency, and to ban insider trading until important information has been publicly announced to level the playing field.

2009 Emerging Markets

The MSCI Emerging Markets Index fell from 54% during 2008. Many have laughed at those who suggested that the emerging markets will perform better than the established markets. Sure, "de-coupling" did not occur. The problems in the US and Europe split over into all other markets. But by the same token, none of the popular investment concepts worked either. Diversification did not work, all markets and all industries got clobbered. The destruction of wealth occured in every market be it equities, commodities, currencies, you name it. If there was a theme for 2008, it was disintegration.

The housing slump in the US will take a couple of years (optimistic) to work itself out. This is not helped by the US governement pumping money into the system to prop up ailing banks. The urgency and market discipline will be lacking and the market will take a while to find the bottom and make the proper adjustments.

Unlike developed developed economies which have multiple drivers, most emerging markets have a central theme. They are energy based, commodities based or like China, simply a huge market that has only started moving. As the world starts to recover, the demand for these products will rise again leading the emerging markets out of the current difficulties.

These markets have fallen more than the developed markets simply because of the lack of liquidity. By the same token, there is more upside.

The MSCI China Index fell 60% in 2008 having risen some 370% from 1 November 2004 through 31 October 2007. Much of this was due to indiscriminate selling by hedge fund (to meet margin calls) and traditional funds (in anticipation of redemptions). Slowing demand for Chinese goods from the US and Europe will slow growth but the Chinese government will be spending over US$586 billion over the next 2 years to stimulate the economy with most going into infrastructure projects which will major consumers of energy and commodity products. Chinese stocks now trade at 12 times earnings compared to 53 times in October 2007.

Yes, China's growth will slow from over 11% in 2007 to an estimated 7.5% in 2009. The Chinese government is targetting growth of 8% which looks achievable given the stimulus package. We like Chinese stocks in the following sectors - energy, construction materials, banks, and retail products with strong franchiese.