China Investors Evade Capital Controls to Buy Hong Kong IPOs

It’s not hard to find reasons why cash is pouring into Hong Kong initial public offerings at a record pace: rock-bottom interest rates, frothy markets, pandemic boredom.

But one of the biggest factors behind the frenzy often goes overlooked: the growing willingness of Chinese investors to evade capital controls as regulators turn a blind eye.

Hong Kong IPOs are technically off limits to investors from mainland China, where annual foreign-exchange purchases by individuals are capped at $50,000 and residents must pledge they won’t put the money in offshore securities. While workarounds have existed for years, anecdotal evidence suggests their use has spiked in recent months as investors pile into hot new offerings from the likes of Kuaishou Technology.

Chinese social-media platforms like WeChat are now buzzing with tips on how to move money across the border. At one Hong Kong brokerage, mainland customers have driven a 10-fold surge in new account openings this year. Chinese investors likely comprised the majority of retail orders for Hong Kong IPOs in the second half of 2020, before taking leverage into account, according to three brokers in the city who asked not to be named. Their estimates were based on client data from their own firms as well as industry observations.

For now, Chinese authorities don’t seem overly concerned. Outflows haven’t grown large enough to undermine confidence in the yuan and may actually help the Communist Party’s efforts to repair Hong Kong’s image as a financial hub. The risk for anyone counting on the IPO frenzy to last, however, is that Beijing will eventually decide to turn off the taps.

“Clearly at some point, if the flows remain high, and don’t come back, then there will be a clampdown,” said Fraser Howie, author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.”

China’s State Administration of Foreign Exchange didn’t reply to a request for comment.

Of course, Chinese investors who want to trade Hong Kong stocks in the secondary market have a perfectly legal way to do so via the city’s exchange links with Shanghai and Shenzhen.

These operate as a closed-loop system, meaning any money flowing through them into Hong Kong must eventually return to China after investors sell their shares. The one big catch: IPOs aren’t included in the links. Thus the hunt for workarounds.

China Investors Evade Capital Controls to Buy Hong Kong IPOs

The easy part for Chinese investors is opening a Hong Kong trading account, which can be done in as little as half an hour at some brokerages via mobile apps.

The tricky part is funding it. While many mainland investors have offshore bank accounts at Chinese lenders in Hong Kong, these banks tend to block customers from transferring their foreign-exchange quotas into a brokerage account to buy stocks. The alternative is to open an account at an international bank that’s less stringent about enforcing Chinese capital controls, though that can be a cumbersome and time-consuming process.

Another quota workaround is called two-way exchange. Chinese investors first transfer yuan into the mainland bank account of a friend, social-media contact or professional money changer who already has cash sitting offshore. The money changer then sends the Hong Kong dollar equivalent into the investor’s offshore bank account. From there, it’s transferred into a brokerage account.

The process is far from risk free. Violators of China’s foreign-exchange rules could be added to the currency regulator’s watch list, denied the $50,000 annual quota for three years and face anti-money-laundering probes.

Heidi, a 26-year-old financial media worker from Hangzhou, is among Chinese investors willing to take that risk as she looks for opportunities to earn higher returns than those on offer in mainland equity and real estate markets. She opened a Hong Kong stock account in December to buy shares in Kuaishou, which surged in its debut on Friday after raising $5.4 billion in the world’s biggest internet IPO in two years.

“A lot of good companies are coming to list in Hong Kong,” said Heidi, who secured a small allocation to the Kuaishou offering. The risk is “acceptable given the low probability of being regulated and the immeasurable possible returns,” she said.

While Shanghai’s Star board is home to some of China’s most innovative technology firms, eligible investors must have at least 500,000 yuan ($77,262) in their stock accounts. In Hong Kong, anyone can subscribe to new shares and take on leverage with margin loans, which aren’t allowed onshore.

Odds of getting an IPO allocation in Hong Kong are also much higher at about 61%, versus 0.05% in China, according to TF International Securities Group Ltd. Annual returns from investing in Hong Kong IPOs ranged from 168% to 326% in the four years through 2020, assuming buyers won an allocation to all the listings and sold at the first day’s closing price, TF’s data show.

“Hong Kong has a better offering system,” said Bao, 35, who works at an internet firm in Beijing. “I wouldn’t mind using as much as 100 times leverage if that’s an option.”

Hong Kong IPO subscriptions by retail investors in 2021 will likely surpass last year’s record HK$6.8 trillion ($877 billion), said Jasper Chan, manager of the corporate finance department at Phillip Securities Group. That figure included Ant Group Co.’s aborted IPO and dwarfed the $51 billion ultimately raised by companies.

“It’s difficult to come up with an estimate on the mainland funds, but it’s fair to say they probably make up most of the incremental inflows,” said Frankie Hu, regional general manager of Guosen Securities (HK), where new account openings are running at 10 times the pace of a year ago.

That doesn’t mean Hong Kong IPOs are a sure thing. One third of the 144 listings in Hong Kong last year dropped on their first trading day, data compiled by Bloomberg show. If Beijing were to clamp down on capital outflows as they did when the yuan was weakening in 2016, investor demand would surely take a hit.

For Howie, one solution would be to let Chinese investors buy Hong Kong IPOs through the exchange links. That would broaden residents’ legal investment options while also keeping the money within a closed-loop system. Officials have floated the possibility in recent years, though it’s unclear whether they have plans to make a change any time soon.

“That is what I would propose, if they listened to me,” Howie said.

©2021 Bloomberg L.P.

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