Page 1 of 3

IN THE FAST-CHANGING WORLD of securities exchanges, Hong Kong Exchanges and Clearing sits in an enviable position. The Hong Kong Stock Exchange, which it operates, is the world’s fifth largest by the market capitalization of its listed companies, $2.83 trillion, and one of the most profitable. Over the past five years, it has had a greater volume of initial public offerings, $141.7 billion, than any other exchange in the world thanks to its status as the premier gateway to corporate China. At home it enjoys a statutory monopoly that protects it from upstart electronic exchanges, which have bedeviled established bourses elsewhere. Not surprisingly, investors have rewarded HKEx with a market cap of $21.5 billion, making it the most valuable exchange in the world, ahead of No. 2 Chicago-based CME Group.

Yet for all of the company’s strengths, CEO Charles Li Xiaojia knows he can’t afford to be complacent.

HKEx has a much narrower business than most of its global rivals, relying mainly on equity trading for its revenue and profits. The lucrative IPO business is vulnerable to erosion if the powers that be in China decide to promote their domestic exchanges in Shanghai and Shenzhen. Li needs to make the company bigger and broader if he wants to assure its continued success.

The former investment banker is moving quickly to do just that. Last June, HKEx outbid half a dozen rivals, including CME, Intercontinental­Exchange and NYSE Euronext, to acquire the London Metal Exchange for £1.4 billion ($2.2 billion). The deal gives HKEx control of the world’s largest metals-trading venue and will, Li believes, enhance the LME’s position in China, the world’s biggest consumer of metals. He intends to use the LME’s platform to expand into other commodity sectors, such as energy.

In addition, Li and his team are creating a slew of investment products based on the renminbi, ranging from futures contracts in the Chinese currency to renminbi-denominated stocks and derivatives. This initiative is still in its early stages, but the potential for growth is enormous as China gradually liberalizes its currency and allows freer movement of capital in and out of the country.

“We are building HKEx into an integrated, multiple-asset-class exchange,” Li, 51, tells Institutional Investor. “Our mission and aim is to be the global exchange of choice for China-based clients and international clients seeking China exposure. The key thing is, we need to be in every single important place. We will leverage London Metal Exchange as a catalyst to help facilitate an accelerated opening of China’s capital account.”

Li’s ambition is bold, but he faces a number of challenges in trying to achieve those goals. Hong Kong does enjoy a natural advantage as China’s preferred offshore center — many of Beijing’s recent financial liberalization moves have specifically targeted the Hong Kong market — but HKEx remains well behind Singapore Exchange, and even further behind global players such as CME and Deutsche Börse, in developing derivatives and nonequity products. And to secure the LME, Li had to offer a full price and commit to maintaining the exchange’s physical trading floor, known as “the ring,” for the next three years. That commitment may prevent HKEx from realizing efficiency gains in the short term and eventually lead to lower returns on the deal.

In his three years at the helm, the CEO has already injected a lot of dynamism into the exchange. Those who know him well say Li, a mainland-born Chinese who studied in the U.S. and worked as a  Wall Street investment banker, has the perfect blend of experience and knowledge to secure HKEx’s future in China’s wider financial sector.

“Charles is a banker who was a lawyer by training, and he has a deep understanding of China’s stock market,” says Yin Ke, vice chairman of Citic Securities Co., China’s largest investment bank, and chief executive of its Hong Kong–based subsidiary, Citic Securities International Co. “When he became CEO of HKEx, some people were worried: Can an investment banker lead an exchange? But Charles is someone with strategic vision. Since becoming CEO he’s helped move HKEx from being a passive player of China’s interests to being an active player and caterer to China’s interests.”

Born in Beijing and known for his strong ties to senior officials, Li has taken steps to transform HKEx’s relationships with mainland exchanges to be more collaborative than competitive. Last year the company formed a joint venture with the Shanghai and Shenzhen stock exchanges to develop index-linked products that can trade on all three markets; it has rolled out three indexes so far. HKEx intends to use the LME to forge similar ties with other mainland exchanges, including the China Financial Futures Exchange in Shanghai, the Shanghai Metal Exchange Market, the Shanghai Futures Exchange and commodities exchanges in Dalian and Zhengzhou, says Romnesh Lamba, co-head of HKEx’s global markets division.

China is in the midst of a transformation from being a net importer of capital to build up its manufacturing industries to becoming a net exporter of capital that seeks global investments across a wide range of asset classes. Li wants to make sure HKEx becomes one of the primary conduits of this process. The potential is staggering: If China accelerates its financial liberalization, Chinese companies could issue as much as 31 trillion yuan ($5 trillion) worth of equities in the coming decade, as well as 258 trillion yuan worth of fixed income and currency products, and they could buy 95 trillion yuan of commodities, including futures contracts and other hedging tools, according to HKEx’s strategic plan for 2013–’15, which Li and Lamba presented to local analysts and media in January.

Those heady numbers may seem well out of reach today, but Li believes the LME deal could be a catalyst for faster liberalization.

“China is facing a growing need for market access,” he says. “They are shortchanged with the status quo. They are worse off with markets closed than markets open. If we are able to provide a solution in a place like Hong Kong, where they feel comfortable, and offer a value proposition to solve that problem, that will go a long way to eliminate the paranoia and concerns of opening up.”

HKEX HAS ENJOYED ROBUST GROWTH SINCE THE turn of the century. The rush by Chinese companies to raise capital offshore, including major privatizations by big banks and other state-owned enterprises, helped the exchange expand its listings to 1,533 companies between 2000 and 2009 and triple the total market cap of its companies. As exciting as that growth was, however, the HKEx board feared that the exchange was becoming a one-trick pony: It gets most of its revenue from equities and equity derivatives. By contrast, CME and Frankfurt-based Deutsche Börse get the bulk of their revenues from a wider variety of higher-margin derivatives and ancillary services such as clearing and settlement and data provision.

With average daily turnover in equities tumbling 23 percent last year, to HK$53.9 billion ($6.96 billion), HKEx’s revenue declined by 8 percent, to HK$7.2 billion, and net profit fell 20 percent, to HK$4.1 billion. Equities and equity derivatives generated 58 percent of revenue and 57 percent of profits.

“HKEx’s long-term prospects are still mainly about equity market volumes,” says Arjan van Veen, a Hong Kong–based analyst with Credit Suisse. Trading volume has recovered strongly so far in 2013, and van Veen predicts that the group’s earnings will rebound by 20 percent this year. “Long term we see the outlook for HKEx as very strong as China’s capital markets continue to develop,” he says.

The Hong Kong exchange faces much stiffer headwinds than it did a decade ago, however. China has built the Shanghai and Shenzhen stock exchanges into powerful rivals; they boasted market caps of $2.55 trillion and $1.15 trillion, respectively, at the end of 2012. Other regional bourses have developed more-diverse suites of products. In 2005, Singapore Exchange expanded into commodities through a joint venture with the Chicago Board of   Trade called the Joint Asian Derivatives Exchange, or JADE. Singapore also offers one of Asia’s broadest ranges of equity index derivatives, including products based on the Chinese, Indian and Japanese markets, and it has developed one of Asia’s leading central clearinghouses.

In January 2010 the HKEx board hired Li as CEO, replacing Paul Chow, and gave him a mandate to broaden the exchange’s offering. For a company that had always been run by British expatriates or Hong Kong citizens, the decision to appoint a mainland-born chief spoke volumes about the direction in which HKEx sought to go.

Though he was born in Beijing, Li was raised in Gansu, a rural province in northwestern China where his parents were petrochemical engineers. In 1977, when Li was 16, his parents arranged for him to work on an oil rig in the Bohai Sea, off the northeast coast of China. The Cultural Revolution had just ended, but the country’s schools were not yet operating normally, and Li never attended senior high school. In 1980 he enrolled at Xiamen University, in the southeastern province of Fujian, and obtained a BA in English literature.

Single Page    1 | 2 | 3