HKEx facing many challenges in wake of London Metal Exchange purchase

Charles Li Xiaojia is promising big things after his success with the London Metal Exchange but he must not lose sight of the core business

PUBLISHED : Saturday, 08 December, 2012, 12:00am
UPDATED : Saturday, 08 December, 2012, 3:46am

It's the London Metal Exchange! It's a once-in-a-lifetime opportunity [to buy this crown jewel]. We got to grab it," a director of the Hong Kong Exchange and Clearing told your columnist in June.

Whether that's the case for the exchange is debatable. But it could well be true for its chief executive Charles Li Xiaojia.

His position - in pursuit of a world-renowned asset with an expensive price tag - is one that any CEO would dream of. He is sitting on a monopoly with a massive endowment. That makes a HK$16.6 billion cash offer possible. That turns the offer into peanuts that requires no shareholder approval.

He is heading a company desperate for a new growth engine. All the hype about renminbi-denominated stocks and listing of international corporates has died down.

He has a non-executive chairman who has no exchange experience and was only two months into the job when the deal was endorsed.

Most importantly, he has a de-facto controlling shareholder - the Hong Kong government - eager to build a commodity centre in Hong Kong in order to prove the city's value to Beijing.

Former chief executive Donald Tsang Yam-kuen made that a focus of his policy speech in 2007 and an exchange priority.

When Li's predecessor Paul Chow Man-yiu told Tsang that Hong Kong had no advantage in metal trading, the government spent a fortune to raise its stake in HKEx to 5.8 per cent.

Despite this show of clout, Chow did not yield. Now, Li is telling them that, not only it can be done but it can be done in one go by acquiring LME. The excitement in Lower Albert Road is not hard to imagine.

It is therefore not surprising to see the board approving the deal unanimously. Six members, including the chairman, were appointed by Tsang. It is therefore also not surprising to see the board endorsing a share placement, which is speedy and hassle-free for the management, instead of a rights issue to raise the cash for the acquisition.

All but one shareholder has any chance of preventing their stake from being diluted. The Hong Kong government is the exception. It received HK$450 million worth of shares from the placement.

It is therefore not surprising to see the board agreeing with a bridging loan provided by China Development Bank and the hiring of its securities arm, China Development Bank Securities (CDBS), as its financial adviser in the placement.

This is despite the fact that CDBS is so new to Hong Kong and it is not licensed by the Securities and Futures Commission.

For those in London, regulators are more concerned with the recapitalisation of debt-ridden banks and brokers (who will be paid well for their LME stakes) and keeping LME in London than its ownership. The players are happy with the guaranteed status quo for three years.

Li is a master at playing with these dynamics, completing the historic deal in less than five months. Yet, delivering the real gold is no easy task.

First, his pitch of getting more business from the mainland has been happily accepted by some, given his own background and the loan from the China Development Bank.

But didn't we make the same assumption when mainland-related banks joined the Hong Kong Mercantile Exchange as founding members and when HKEx launched the yuan-denominated share programme? How have they been doing?

Beijing may have made no objection to the LME acquisition but relaxing its control, risking more trading losses and antagonising markets at home is a different game.

Second, the plan of setting up LME's own clearing house and warehouse as well as future fee rises will be a major test for Li.

The ventures into a new terrain among major market players will test the HKEx.

Charting this strange water without over-reliance on the LME and losing control will be another test for Li. Anyway, a rise in the pay and cost of LME is almost a safe bet.

That leads to the third challenge - staying focused on the core business while busy working out the new one.

Under Li's leadership, the exchange has lost two-thirds of its department heads. Among them is the marketing chief, now pitching IPOs for the Singapore bourse.

Staff have been cut to make way for the newcomers specialising in the new market. When you are bringing home most of the income yet getting cut, it's hard to be good.

Li knows the challenges. He has made it clear that LME will not bring in any profit until 2015 - interestingly enough, that will be the end of his second three-year contract.