Energy & Resources

Market failure

Shock as a Hong Kong exchange closes

Cheung, chairman of RUSAL, speaks to reporters in Hong Kong

In the spotlight: Barry Cheung

Exchanges are like casinos, places where the house rarely loses. So it is odd that the headlines in Hong Kong this week were about an exchange that’s just gone bust.

In a dramatic announcement last weekend the Hong Kong Mercantile Exchange (HKMEx) said it didn’t have enough cash to cover the nine months of operations required by regulators and so surrendered its licence. The shutdown was a shock. HKMEx had just celebrated its second trading anniversary and came less than six months after Hong Kong’s much older stock exchange had completed a high profile $2.2 billion takeover of the London Mercantile Exchange (LME).

On the day that HKMEx was shuttered only 200 dollar-denominated gold and silver futures contracts were outstanding. That these were the sole products offered tells the story about why the exchange has failed: it simply hadn’t been able to build critical mass. By comparison the London Mercantile Exchange reported a record 14.5 million lots traded in April. The recent collapse in gold prices may have triggered HKMEx’s demise, wrote the South China Morning Post, but it also looks to have put “a bad idea out of its misery”.

The HKMEx wasn’t considered such a bad idea when it was first mooted in 2006, setting out with a view to extending China’s influence in the global commodity markets. China might be the world’s biggest consumer of natural resources but prices for commodities continue to be set in London and Chicago. HKMEx’s founder and chairman Barry Cheung argued repeatedly that the new exchange could provide an important counterbalance.

The exchange’s backers were a roll call of big names, including the likes of China’s largest bank and shipping firm – ICBC and Cosco – and Russian commodity giant En+ Group (formerly chaired by Nathaniel Rothschild, a scion of the world’s most storied banking family). Cheung himself has a pretty impressive CV, running Hong Kong’s Urban Renewal Authority which controls the largest urban land reserve in the city. He was also Hong Kong Chief Executive CY Leung’s campaign manager during last year’s rancorous election (see WiC144). On the commercial side, the former McKinsey executive previously chaired Russian energy heavyweight UC Rural and sits on the board of Gateway Energy, the Asian unit of EIG Global Energy, which manages $10 billion worth of natural resources assets.

Cheung’s fall from grace has been equally spectacular. On Tuesday, Hong Kong police raided HKMEx’s offices and arrested four people on allegations of falsifying accounts. Cheung’s position in Hong Kong’s cabinet – known locally as ExCo – has also been suspended pending the investigation. The implosion now has the territory buzzing with conspiracy theories, with Sing Tao Daily describing HKMEx’s collapse as a “magnitude-7 earthquake” that further weakens the territory’s leader Leung, given his close relations with Cheung.

While commodities markets have barely blinked at the HKMEx’s closure, its impact in Hong Kong has been huge. Political fallout aside, the failure of an exchange is a major embarrassment for Asia’s top financial centre.

Some media preferred to dwell on the exchange’s flawed business plan. For example, the Hong Kong Economic Times noted that HKMEx’s hopes of breaking into oil futures weren’t supported by Beijing. Chinese oil importers were already using commodity exchanges in Shanghai, Dalian and Zhengzhou, while international players preferred the more established LME. HKMEx had no competitive advantage in futures contracts in this key commodity.

Worse, competition from exchanges in China itself has been increasing. The Xinhua Mercantile Exchange (XME) opened this month in China’s oil capital, Daqing. The new venture – part of the Xinhua News Agency – aims to provide spot trading on fuel oil and methanol, with the XME forecasting that trading value will reach Rmb30 billion ($4.8 billion) this year before rising to more than Rmb80 billion by 2015. The Beijing Petroleum Exchange may also offer fresh products later this month, according to the China Business Journal.


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