Why most funds raised by mainland firms not repatriated
'Seventy-seven per cent of the money raised by mainland corporates in the Hong Kong equity market in the first 11 months of 2009 has stayed in the Hong Kong dollar account. That tally will swell to HK$300 billion by the end of last year.'
Norman Chan Tak-lam, chief executive,
Hong Kong Monetary Authority
That is strange, many of you will say. Keeping the proceeds in Hong Kong dollars doesn't make much business sense for these mainland firms. They do business and present their accounts in yuan. Given the appreciation pressure on the yuan and the size of their proceeds, they should have converted the money into yuan to avoid exchange losses that can run into hundreds of millions.
Besides, why sell shares if they are not going to use the money? Any investment on the mainland nowadays will be better than a Hong Kong dollar deposit.
Well, as with anything in China, there is a lot more beneath the surface.
Let's talk about the state-owned enterprises first. Ever since the listing of the first H-share companies in 1993, Beijing has been adamant that all the proceeds should be repatriated after the share sale.
It does not matter whether the firm has any immediate funding needs. Any delay would result in a penalty. After all, it is a sale of state assets by the government not the firm.
But managers tried all sorts of tricks to keep the money here. That is because getting money out from the country via legal channels has always been a pain. And having access to foreign money was a privilege in those days.
A good example was the then Guangdong Kelon Electrical Holdings, a refrigerator maker that was listed in Hong Kong in 1996. Not a single cent of the money has been sent home, according to a former executive.
Beijing imposed some tough measures. Management was not allowed to go overseas until the proceeds came home. To the mainlanders, that really hurt.
Yet, that's history. As the country's foreign exchange reserves balloon, Beijing's job is about keeping the proceeds out, not in.
In 2007 when massive capital inflows brought increasing appreciation and inflationary pressure, Beijing began to discourage firms from listing in Hong Kong or remitting the money home.
Its largest rail builder, China Railway, secured Hong Kong listing approval that year on the condition that no money would be sent home. As a result, it suffered a 4.1 billion yuan (HK$4.66 billion) exchange loss in 2008.
The ban was not relaxed until the spring of 2009 when the global financial crisis reduced capital inflows into the country. That summer China Railway finally got the approval to send US$866 million home and convert it into yuan. But that was only 15.7 per cent of its IPO proceeds.
Now that the country's economy has picked up, the foreign reserves have rocketed to US$2.4 trillion and inflationary pressure is on the rise; it will not be too difficult to imagine how Beijing will treat these share-sale proceeds.
'Stay out' is the message. After all, the exchange losses of individual firms are of no concern to the central bank.
For private enterprises, there is little incentive to send the money home other than for necessities. With rare exceptions, these entrepreneurs structure their businesses in the form of offshore companies to escape the mainland's strait-jacket regulatory regime.
The result is a corporate structure that sees the listed firm as the holding company of its mainland business.
Under China law, money can only be sent home as the equity investment of a subsidiary. It will be very difficult to get it out without dissolving the subsidiary.
What if they need the money for overseas acquisitions or to support the share price?
Keeping the money in Hong Kong provides the greatest flexibility.
Fear is another reason.
Over the head of almost every private entrepreneur on the mainland hangs the knife called yuan zui (cardinal sin).
The issue is about how they got their first bucket of gold. Was it a loan secured by bribing a bank official? Did he or she buy a state-owned business at dirt-cheap prices plus bribes?
It may be something that happened years or decades ago. But no one can be sure.
It is politics, not law, that determine when the police will arrive at his or her door step.
To these people, Hong Kong is a safe haven for their wealth.
Even if their conscience is clear, they are well aware of the 'red eye' syndrome, meaning the jealousy of others. Neither do they want the tax man to come after them.
'Yes, a share placement is public knowledge. But seeing your wealth is a lot more tempting than knowing your wealth,' said one aide to an entrepreneur.
His boss had an industrial operation listed in Hong Kong. Fund managers loved it. As the share price rocketed, the owner did several stake sales and secured a total of $6 billion. Every penny was put into an Asian bank as cash and bonds, no stock and no real estate. (Sorry, I can't name names.)
It's okay for the controlling shareholders to keep the money here but how about the corporates?
If the money does not go home, what about the corporate finance projects or investment promised in the prospectus?
One answer is the back-to-back loan. The corporate puts the IPO proceeds in a bank in Hong Kong, which will then order its mainland branch to obtain a yuan loan. The Hong Kong dollar deposit stays as loan security, according to various bankers.
The risks for both the corporate and banks are limited. For the regulators, the incentive to bar this operation is limited.
So once again, you see how deficiencies up north have brought us business. Chances are that will still be the case for some time to come.