Dual-currency IPO breaks cardinal rule of capital markets

Two-track yuan and Hong Kong dollar listing plan is one bad idea, despite surface appeal of being first off the block and tapping more pools of liquidity

PUBLISHED : Wednesday, 15 August, 2012, 12:00am
UPDATED : Wednesday, 15 August, 2012, 12:34am

According to yesterday's Business Post, mainland chemical manufacturer Meilan International Holdings is hoping to become the first company to launch a dual-currency yuan and Hong Kong dollar share offering on the city's stock market.

It's a lousy idea.

You can see why someone thought a dual-currency listing might be a clever plan. No doubt the company's bosses reasoned that selling two tranches of shares, one denominated in Hong Kong dollars and the other in yuan, would allow them simultaneously to tap into two pools of liquidity.

They would not only get demand from the ordinary investors and institutions who buy into standard Hong Kong dollar offerings. They would also be able to sell their shares to any offshore holders of the yuan eager for returns higher than the meagre 0.2 per cent interest rate they currently earn on a 12-month yuan time deposit.

And then, of course, there would be all the attendant publicity they could expect to generate by becoming the first company to launch a two-currency stock issue. That should drum up yet more demand, and in today's difficult markets, any extra demand is a highly valuable commodity, allowing companies to charge a higher price for their shares.

Company executives might even have figured that the possibility of arbitraging between the two share classes would keep investor interest alive in the secondary market.

Alas, if that was their reasoning, it was badly flawed.

Although a dual-currency offering might sound like a strong selling point, it would break a cardinal rule of the securities markets: don't split your liquidity.

Liquidity breeds liquidity, so by dividing their offering into two separate tranches, Meilan's bosses risk ending up with a listing that is less than the sum of its parts.

With the pool of yuan in Hong Kong still relatively shallow, it is likely that trading in the company's yuan-denominated shares would soon languish. And, with fewer Hong Kong dollar-denominated shares outstanding than if the company had launched a standard offering, volumes in the Hong Kong dollar shares would probably suffer too.

Meilan's executives might not care much about that initially. But illiquidity in the secondary market carries a heavy cost. It deters buyers, so your shares tend to trade at a discount. And that pushes up your cost of capital should you ever want to issue a follow-on offering.

In any case, it is far from clear that there is any significant demand for yuan-denominated shares in the Hong Kong market.

Shares in the Hui Xian Real Estate Investment Trust (Hong Kong's sole yuan-denominated stock apart from an index-tracking fund launched last month) have plunged a gut-wrenching 27 per cent since their debut last April (see the first chart). And trading in the stock is lacklustre to say the least. Turnover yesterday was just 4 million yuan (HK$4.90 million). On Monday it was 1.3 million yuan. Those are negligible amounts for a stock with a market capitalisation of 19 billion yuan.

With the mainland economy slowing, and the outlook for corporate earnings increasingly bleak, investors' interest in mainland company shares is unlikely to return soon. Beijing's stimulus efforts may help prop up profits in the construction sector, but analysts see little prospect of an earnings rebound for industrial companies like Meilan.

Worse, selling shares in yuan is unlikely to sharpen anyone's appetite. Investors may have liked the idea when the currency was strengthening. But with the yuan down 1 per cent against the Hong Kong dollar over 2012 so far, and official mainland media openly calling for currency depreciation to help exporters, enthusiasm for holding the yuan is waning.

On the mainland demand for foreign currencies has soared in recent months, with figures released yesterday hinting at heavy capital outflows last month.

Meanwhile, in Hong Kong, the pool of offshore yuan deposits has shrunk by 70 billion yuan since its high in November, a fall of 11 per cent. With the yuan now weakening, any fresh deepening of yuan liquidity in the city looks doubtful in the near term (see the second chart).

As a result, there would be little advantage to Meilan or anyone else in launching a dual-currency IPO at any point in the near future, but very likely a clear disadvantage.