Traders seek source of Hong Kong’s ‘Enigma’ market crash
Tangle of cross-shareholdings and fuzzy balance sheets linked to small-cap sell-off
Amid the hundreds of Hong Kong companies screened every year by independent investor David Webb, the 50 he chose to dub the “Enigma” network could seem insignificant. But when almost half that list plunged this week without warning or known cause, the group he mapped in May suddenly took on new importance.
The crash erased $6bn in market capitalisation on Tuesday, left the stock prices of 13 companies down more than 50 per cent with the worst off 94 per cent lower. On Wednesday the bloodbath continued, pulling Hong Kong’s junior Growth Enterprise Market to a record low.
It was, however, only the latest in a series of wild market moves in the city over the past two years that are forcing regulators to act. On Tuesday, the Securities and Futures Commission did not deny that it was investigating some of the companies involved.
The network laid out by Mr Webb is a noodle soup of tangled cross-holdings that vary from less than 1 per cent to more than 50 per cent. The companies involved range from an umbrella maker and building contractors to several brokers and the would-be owner of English football club Hull City FC.
Mr Webb, a one-time investment banker and a long-time thorn in the side of Hong Kong’s market officials, drew the network after he noticed a series of fuzzy balance sheet disclosures of “financial assets” with no detail. After he pushed the Hong Kong Exchange last year to enforce its disclosure rules, the cross-holdings emerged through earnings updates and annual reports.
And his network probably does not cover all the connections: “I couldn’t fit them all in,” he admitted.
But even Mr Webb does not know what exactly caused the crash.
“Maybe we never will,” he said. “But the bigger thing here is that this situation has been allowed to build up by the Hong Kong Exchange and the SFC.”
Over the past two years, several issues have emerged through a series of dramatic price swings and events — all of which are evident to some extent in this week's crash.
One is the lack of disclosure for share-backed lending, a popular form of borrowing in Hong Kong where stock is pledged for cash loans. A popular theory to explain Tuesday’s crash is that a lender dumped a portfolio of pledged shares after a borrower could not meet a margin call.
Another is Hong Kong’s struggle to stamp out the creation of “shell” companies, which often soar on the expectation they will become vehicles for a mainland group to reverse into and avoid the scrutiny of a full listing. Some of Tuesday’s crashes would fall into this category, such as China Jicheng, the umbrella maker that ended down 94 per cent. It rose more than 20-fold in the seven months after listing.
At the heart of it all, however, is what an increasing number of investors, analysts and regulators — privately at least — are calling manipulation.
The smaller end of the Hong Kong market is characterised by companies with thin turnover and highly concentrated shareholdings. The SFC went as far on Tuesday as to admit the conditions were conducive to misconduct.
Activities under that range from share buybacks seemingly designed to ramp up a share price — an allegation levelled at Evergrande, the Chinese developer that began to buy its shares the same day it promised to cut leverage — to the sort of hard-to-find connections between separate groups as mapped by Mr Webb.
The importance of those links was exemplified on Wednesday by Amco United, a medical device maker and one of the biggest decliners, which warned it would report a “substantial” half-year loss due to its share trading activities.
Said one fund manager: “That Churchill line about a riddle wrapped up in an enigma — that’s the Hong Kong market, and David Webb has probably only scratched the surface if you look at today’s falls.”
All but 10 of the 50 Enigma stocks ended lower again on Wednesday, with the worst off, Hao Wen Holdings, losing 53 per cent.
Mr Webb, formerly an independent director of the for-profit HKEX, is however unsparing of both groups and has called repeatedly for the SFC to take over the exchange’s regulatory powers.
“The SFC has been lackadaisical in its overall supervision of listed companies in that it has failed to exercise its full powers,” he said. “The HKEX has allowed companies to say they’re in the business of investment and trading but not disclose what is in there.”
Regulators are beginning to act. The Hong Kong Exchange has put forward plans to raise the bar for its Growth Enterprise Market, the junior board equivalent to London’s AIM. The SFC and the HKEX, meanwhile, are jointly consulting on streamlining the city’s convoluted listings process.
Regardless of any long-term changes from this week’s drama, short-term opportunists were already moving in on Wednesday. Said one bargain-hunter: “Some of those companies own hard assets. Even if you think the businesses they say they run are a zero, there might still be value in there.”