Buyer Beware: Hong Kong's $4.8 Billion Stock Wipeout Shows Risk

(Bloomberg) -- Hong Kong’s second unexplained wave of stock plunges in three months shows the risks investors face in the world’s fourth-largest equities market.

Ten mid- and small-cap shares plummeted as much as 81 percent for no apparent reason Thursday, wiping out $4.8 billion of investors’ money. The firms hadn’t published news that would move markets and said they knew no reason for the drop, fueling speculation that ranged from debt repayments to missing executives. The next day, as several of these stocks rebounded, another inexplicably tumbled.

The swings should concern investors sitting in London or New York because some of these shares are included in global benchmarks. Local observers speak about “dark corners” of Hong Kong’s market where a web of cross-holdings and low liquidity fuel corruption and keep valuations at one of the lowest levels in the world.

Hong Kong’s small and mid-cap space is a corporate governance “minefield,” said Manuel Schlabbers, chief executive officer of small-cap focused investment firm Accudo Capital Ltd. “For something to blow up 80 percent, it is unlikely to be driven by fundamentals.”

Buyer Beware: Hong Kong's $4.8 Billion Stock Wipeout Shows Risk

Much of the losses on Thursday came from Chinese developer Jiayuan International Group Ltd., which plunged 81 percent. After some traders pointed to Jiayuan’s $350 million of maturing debt, the company said it has fully repaid the notes, its financial condition is healthy and operations are normal. It rose 75 percent on Friday.

However another small-cap, Chong Sing Holdings FinTech Group Ltd., fell 33 percent on Friday. As recently as November, the company was part of the MSCI China index. Calls to Chong Sing’s office went unanswered.

The swings bring back memories of Hong Kong’s small-cap tumble in November and the so-called Enigma Network crash in 2017. While the wild moves haven’t roiled confidence in the broader market -- the Hang Seng index on Friday completed its first three-week gain in almost a year -- the gauge is valued at less than 10 times its companies’ reported earnings as price volatility and the U.S.-China trade war restrict potential.

A representative for the Securities and Futures Commission declined to comment. Hong Kong Exchanges & Clearing Ltd. conducts robust monitoring of the market to support orderly trading, makes inquiries as needed and will continue to do so, a representative said by email.

“Hong Kong gives the impression of a developed market because of huge listings like Xiaomi but there is an underbelly of small companies with cross-holdings and opaque transactions that is shocking in scale,” said Fraser Howie, who has two decades of experience in China’s financial markets and co-authored the 2010 book ‘Red Capitalism.’ “There is such uncertainty about what is going on and no one in authority seems to care.”

Market insiders say there are some measures that could be adopted to mitigate some of the issues. These include:

Problem

Potential Solution

Frequent bouts of volatilityMore disclosures when a stock is used as collateral may go some way to resolve the problem. Currently, a controlling shareholder need not disclose a share pledge if the transaction is for personal finance reasons
Huge small-cap swingsExtend to small caps a mechanism imposed on large companies that briefly limits how much a stock can move
Low liquidityDecreasing the minimum trading increment for small-company shares would encourage more professional traders
Prevent bubblesExpanding short selling could help in price discovery. Currently shares of only some of the largest firms are eligible for short sales

©2019 Bloomberg L.P.