How China Built Capital Markets on Hong Kong's Shoulders

Book: Financial Cold War by James A. Fok | ISBN 9781119862765

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Chapter 5 of Financial Cold War shifts from history to finance. James A. Fok’s title says it all: two steps forward, one step back. This first part covers how China used Hong Kong to list state firms, how regulators tried to protect retail investors and ended up distorting prices, and how Zhu Rongji cleaned up banks without ever letting the market fully take over.

The growth model behind the markets

China’s miracle was not magic. It was demographics plus suppressed consumption. A baby boom met the one-child policy and created a huge working-age share. The state kept wages low, locked rural land rights with local governments, and used financial repression to channel savings into investment.

The hukou system kept migrant workers compliant. Workers at non-financial firms got about 40 percent of what they produced, versus near 70 percent in most countries. Household consumption fell to under 40 percent of GDP by 2018. Government revenues, once you count land sales and social insurance, roughly tripled as a share of GDP since 1996.

That model built roads, ports, and factories at stunning speed. It also stored up domestic tension and global friction. Wen Jiabao himself called the economy unstable, unbalanced, uncoordinated, and unsustainable.

Going public

In February 1997, Hank Paulson and Goldman bankers drove through Zhongnanhai to pitch Zhu Rongji on listing China Telecom. The company did not exist yet. Eight months later it raised $4.22 billion in Hong Kong and New York during the Asian Financial Crisis.

Early listings were awkward. SOEs ran hospitals, schools, and cemeteries for workers. Investment bankers carved out profitable subsidiaries and left social costs with parents. Shanghai Petrochemical’s listing forced the city government to absorb those bills. Ma’anshan Steel saw redundant workers pushed back into the listed entity after IPO.

China Telecom was different. An entire industry got packaged. KPMG deployed 350 accountants. Provincial officials fought to keep telecom assets. The listing started with Guangdong and Zhejiang mobile networks, with more provinces to roll in later. Cornerstone investors, Hong Kong tycoons buying 10 percent and holding a year, became a template.

Why Hong Kong and not Shanghai? Zhu wanted capital, but more than that he wanted discipline. Listing abroad forced governance upgrades and transparency. Russia’s rushed privatization was a warning. The government kept majority control, so minority floats were not true privatization. The market pressure was the reform tool.

Hong Kong offered convertibility, common law, low taxes, and the SFC. Mainland markets lacked all of that. The 810 Incident in Shenzhen in 1992, when 700,000 people queued for shares and riots broke out over rigged allocations, showed why regulators wanted an offshore escape valve.

The CSRC grew teeth through offshore listings. No CSRC approval meant no overseas IPO and no money. The 327 bond futures scandal in 1995 bankrupted Shanghai Wanguo Securities and let the CSRC finally seize control from the PBOC.

The protection racket

Zhou Xiaochuan at the CSRC raised standards. Laura Cha from Hong Kong’s SFC helped on governance. But concentrated power created three traps: corruption, political interference, and bailout culture.

Listing approvals stayed discretionary. Hot IPOs went to connected firms. When markets fell, the CSRC slowed or halted new listings. After the 2015 crash, a national team spent a reported $234 billion propping up prices.

Circuit breakers in January 2016 made things worse. A 5 percent drop halted trading for 15 minutes. A 7 percent drop shut the market for the day. Traders sold early to avoid getting trapped. The mechanism lasted one week. Chairman Xiao Gang lost his job.

IPO prices were capped at 23 times earnings. Every 2017 listing jumped 43 to 44 percent on day one. Companies left money on the table. Short selling stayed restricted. SOE shares could not be sold below book value even when book value lied.

One billionaire told Fok: if you are rich in China, you are not really rich. The money belongs to the government. That quote explains why so many firms still list offshore.

The price of money

By the 1990s China’s Big Four banks were technically bankrupt. Roughly 20 percent of loans were non-performing, about 15.6 percent of GDP. Zhu tasked Zhou Xiaochuan at CCB to fix it.

The recap was creative. The MOF issued bonds bought by the banks themselves, funded by freed reserve requirements. Then four asset management companies bought bad loans at full face value, funded again by the banks and PBOC loans. The banks and AMCs stayed tangled. Dividends circled back to pay AMC bond interest.

Strategic investors like Bank of America, RBS, and Goldman bought into the cleaned-up banks. IPOs in Hong Kong in 2005 and 2006 followed. But when Huang Ju, Zhou’s political sponsor, fell ill in 2005, Wen Jiabao shifted bank control to the MOF. Market reform lost ground.

After Lehman, state-directed lending returned with force. Lending targets doubled to 10 trillion yuan in 2009. Local government debt exploded. Hubei province alone planned stimulus spending that dwarfed anything the US had tried before COVID.

The bond market story mirrors the banks. Rates were set by fiat, not risk. Zhu kicked government bond trading off the stock exchanges onto the interbank market after a Shanghai housewife complained. Zhou later used commercial paper and medium-term notes to bypass approval bottlenecks. That helped fund the stimulus. By 2009 banks still held over 70 percent of bonds. Households held about 1 percent.

Fok’s punchline at this stage: if the state lends to itself at wrong prices, capital gets misallocated. That creates domestic risk and foreign tension. The next post follows where that misallocation leads.

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