Hong Kong Exchanges and Clearing needs to upgrade its systems and introduce commodities trading in order to compete with rival exchanges in Shanghai and elsewhere in the world, local brokers and international investors said.
They said the city's stock exchange faced a growing challenge to its status as a key regional player because its former flagship products, so-called H shares, had lost their lustre after their poor performance.
H shares, which are shares of mainland companies traded on the market, mark their 20th year of listing in Hong Kong today. The first to list, on July 15, 1993, was Tsingtao Brewery, and since then a further 175 mainland-incorporated companies have listed on the market.
Brett McGonegal, the chief executive of Reorient Financial Markets, said international investors invested in H shares as a way to invest in China.
"But the future will be more challenging for Hong Kong, because China has started to open up its market to the West. If international investors have more direct access to mainland markets, there will be less need for them to invest through Hong Kong," McGonegal said.
In addition, the local market was suffering from reduced liquidity, or turnover of shares, and as one of the few markets that levied a stamp duty on share transactions, the government had discouraged international investors from using computer programs to trade.
"The liquidity pool is proving to lack depth, and this means large fund houses and investors have to weigh liquidity constraints when considering investing in the Hong Kong market," McGonegal said.
To tackle these challenges, the government should lower stamp duties and the HKEx should upgrade its trading system to match international standards, he said.
The mainland still has capital controls governing the free flow of capital across its borders, but since the early 2000s it has allowed limited access to local assets by international investors through the qualified foreign institutional investor scheme. Shanghai's stock market, meanwhile, has become a growing threat to Hong Kong as it plans to introduce an international board and invite international big names such as HSBC and Coca-Cola to list.
HKEx has responded by trying to turn competitors into partners, setting up a joint venture with the bourses of Shanghai and Shenzhen. China Exchanges Services, a HK$300 million operation in which the three bourses hold equal stakes, compiles index services.
However, a Shanghai government source described the joint venture as "somewhat like a married couple who share the same bed but have different dreams".
Once market sentiment recovered, he said, the Shanghai Stock Exchange will present direct competition with Hong Kong on major-sized initial public offerings. "Many big state-owned enterprises have not yet listed, and the Hong Kong market will quickly see a rising challenge from Shanghai in terms of IPO rank and trading volume."
Over the past two decades, many mainland firms opted for dual listing of H shares in Hong Kong and A shares in Shanghai, but the Shanghai official said dual listing involved more regulatory approval procedures and many would prefer listing in Shanghai alone.
However, Huang Shumin, an investment manager for greater China at JP Morgan Asset Management, said Hong Kong would continue to play a role in H-share listings. "There are different investors in Hong Kong and Shanghai, and it makes sense for companies to have dual listings. Hong Kong has more international investors to trade while Shanghai has more domestic mainland investors," she said.
HKEx's chief executive, Charles Li Xiaojia, has so far responded to the challenges by spending £1.39 billion (HK$16.3 billion) on the London Metal Exchange to step into commodities trading.
Christopher Cheung Wah-fung, a legislator for the broking community, said: "Expanding into commodities trading will provide long-term benefits for Hong Kong, but in the shorter term we should lobby more mainland firms to list here to increase business for local players.
"The HKEx should also make it easier for Hong Kong brokers to become members of the LME so that they can trade the commodities' products for Hong Kong investors."