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You could practically hear the champagne corks popping in Lan Kwai Fong’s chic bars and restaurants near Central’s business district on the evening of Jan. 17. Earlier in the day, the Hang Seng Index had just hit a record high at 31,983.4, topping the previous intraday high of 31,958.4 in October 2007.

Just 24 hours earlier, the city’s main market index had surged to its highest close, gaining 1.8% to end at 31,904 points. The good times were back with a bang, not a whimper, after weathering the fallout from the global financial crisis more than a decade ago.

Back then, in the dark days, the Hang Seng was bouncing around the mid-teens, slumping to 12,618.38 on Oct. 24, 2008.

“Look at the overall scheme of things: we have had … how many years of downtrend? Almost eight or nine years,” said Raymond Cheng, the head of Asia equity strategy at JPMorgan’s private bank unit in Hong Kong. “Yes, last year we had a big rally, but it’s well-justified in my mind by the earnings pick-up.”

Apart from the markets, the overall economy is projected to expand by between 3 to 4% this year after stronger-than-expected growth in 2017 came in at 3.8%, the fastest pace since 2011.

“The city’s budget surplus will likely hit HK$138 billion [US$17.64 billion] for the fiscal year ending March, exceeding the government’s original forecast of HK$16.3 billion. Fiscal reserves are expected to hit HK$1.09 trillion [at the same time],” Paul Chan, the financial secretary, told Hong Kong’s Legislative Council.

At first glance, the overall financial and economic picture appears to have a deep sunset glow. But business professionals, analysts and economists, who talked to Asia Times, are concerned that dark clouds are just hovering behind the horizon.

Innovation and scale of growth in the Hong Stock Exchange are cited as problem areas, according to Brett McGonegal, the chief executive officer of Capital Link International, an investment advisory firm, in the city, and the former CEO of Reorient Group, which is listed on the Hang Seng.

Increase liquidity

Over the years, he has called for market reforms and even submitted detailed proposals to shake up the “status quo” and increase liquidity. Change, he pointed out, is always good “and the speed of change is even better.”

“As we see the next wave of innovation in the growth of young tech companies, it is vital to understand the relationship that a country’s stock market plays in relation to providing both a funding source for growth in companies and an identity to a country or economy,” said McGonegal, who is also a principal investor in Asia Times.

“Its often been said your stock market represents the identity and pulse of an economy. Following that thought, Hong Kong is the poster child of the stock market, providing a glimpse into the soul of the city, but unfortunately it is not a tale of innovation,” he continued. “It is the exact opposite.

“Hong Kong’s stock exchange has taken a course of action ruled and detailed by bureaucrats with what seems to be a strategy of defense and status quo. How can you attract cutting-edge technology companies when your business plan is ruled by stale themes and inflexible thoughts,” McGonegal added.

Others are just as scathing while pointing out that Hong Kong is still a major international financial center. Expanding trading hours and making the derivatives market more competitive have been suggested.

Creating futures contracts, which would track hundreds of Asian companies, would also broaden the scope and scale of the city’s bourse, a move that the Hong Stock Exchange is considering.

“Hong Kong is an international financial center,” Shih Wing-ching, the founder of one the city’s biggest real estate agents, Centaline Property Agency, told Asia Times. But it has weaknesses such as the gap between its trading hours and those of its rivals, and the scale of its futures operation.

“Free capital outflow from the mainland would also open up the Hang Seng further for Chinese investors [and stimulate volume],” he said.

At least Hong Kong is reported to be working with MSCI, a leading provider of stock market indexes, to bring in futures contracts, which would enlarge the market to take in an array of Asian companies.

“HKEX [Hong Kong Stock Exchange] is constantly exploring ways to expand our suite of derivative products, including futures contracts, to meet market demand,” Jeffrey Ng, a spokesman for the HKEX, told Bloomberg News. “HKEX will update the market when there are further developments.”

There are, of course, other fundamental issues at play. Transaction costs, when buying and selling stocks, are high in Hong Kong.

Back in the late 1990s, the Nasdaq changed its minimum spread from .25 to ultimately .01, pushing trading volumes up and trading costs down. A similar overhaul in the Hong Kong Stock Exchange would have the same effect.

“At 10.8 basis points per execution, HKEX stands as the most expensive developed market to trade and has completely shut itself out from computer-driven automated trading volume that supports global markets,” McGonegal said.

“The exchange needs to facilitate trade and should do so in the most efficient client-friendly way. As far as HKEX goes, the stamp tax is the main course and nothing else seems to matter. Innovation has got to be the focus for the future – the question is who can make that decision?” he added.

His view is shared by David Webb, a shareholder activist and the editor of Webb-site.com, after retiring as an investment banker. Transaction costs, he agreed, are prohibitive and weigh on market trading.

Shareholder rights

But he has also called for greater shareholder rights and a unified regulatory system. This, he stressed, would make the Hong Kong Stock Exchange more competitive and transparent.

“We have a monopoly stock exchange, so there is no competition for exchange services,” he told Asia Times. “Consequently, transaction costs are higher than they would be in a competitive market. Because of the monopoly and regulatory status, the government controls the HKEX via statutory provisions, and only six of its 13 directors are elected by its shareholders.

“We also have a multiplicity of financial services regulators, namely the SFC [Securities and Futures Commission], HKMA [the Hong Kong Monetary Authority], the Insurance Authority and MPFSA [the Mandatory Provident Fund Schemes Authority], rather than a unified financial services regulator, leading to regulatory arbitrage,” he added.

Indeed, warning signs are also flashing in the broader economy with an over-reliance in the service sectors. The government has been accused of failing to act quick enough to cultivate technology companies and the creative industries.

This, in turn, has left an “innovation culture” black hole, and curbed research and development programs essential to high-tech, value-added manufacturing.

“Hong Kong only has slogans to develop new industries,” Andy Kwan Cheuk-chiu, who runs the ACE Center for Business and Economic Research in Hong Kong and was a former associate economics professor at the Chinese University, told Asia Times.

“To develop innovation and technology, there has to be manufacturing. But Hong Kong does not have a manufacturing sector or an innovation culture. It does not have the basic ingredients to do innovation and technology. Manufacturing accounts for less than 1% of GDP, while the service sectors account for 98%,” he added.

In the end, Hong Kong will need to realign its economy, rekindle its innovative spirit and embrace change in the markets if it is to move forward. The city has done it before, and it can do it again.

Read Part 1: Behind the glitz and glamour of ‘Monopoly City’

Read Part 2: Life in a ‘shoebox’ for the lucky rich in Hong Kong

Read Part 3: Little guys struggle in the land of the giants

Read Part 4: Road transport runs into a dead end in Hong Kong

Next: Dreaming of a vibrant past and fearful of an uncertain future