Volatile Times
Impact of the Handover
Market Trends

Volatile Times

The years 1997 to 1999 have been volatile times for the Hong Kong economy, taking in the transfer of sovereignty to the People's Republic of China (PRC) and the downturn of the economy due to the impact of the Asian financial crisis. As the initial impact of the crisis subsided, mergers and acquisitions (M&A) specialists predicted a shift in the focus of Asian deals from equity, project finance, debt and other capital markets transactions to restructurings, insolvencies and, above all, M&A. This overview examines the M&A market in Hong Kong and considers whether such predictions are holding true.

Impact of the Handover

At midnight on June 30 1997 the exercise of sovereignty over Hong Kong was transferred under the Joint Declaration from the UK government to the PRC government and the Hong Kong Special Administrative Region of the PRC came into being. Despite much commentary and hype in the international press about how businesses and investment would be affected by the transfer, in reality, business carried on as usual in Hong Kong. Indeed, after the handover, the Hang Seng soared and red-chip issues prompted a market frenzy - an indication of investors' confidence in Hong Kong.

The Joint Declaration is now embodied in the Basic Law of Hong Kong. The Basic Law is Hong Kong's 'mini-constitution'. The Basic Law provides that the laws in force in Hong Kong before the handover will remain basically unchanged, provided they do not contravene the Basic Law and subject to amendment by future legislation. Therefore, rights to private property, ownership of corporations and foreign investment continue to be protected by law. Some changes were implemented in order to replace UK statutory provisions with local legislation, but the main body of commercial law was left largely unchanged.

Therefore, despite the transfer of sovereignty, Hong Kong has remained an attractive market for foreign investment and mergers and acquisitions. There are many reasons why this is the case. Some of these are the following:

  • a capitalist system. The Joint Declaration provides that the PRC government will maintain Hong Kong's capitalist system for 50 years following 1997;

  • a general policy of laissez faire. Subject to certain exceptions, there are few obstacles in the way of companies wishing to set up, acquire or dispose of businesses in Hong Kong. In general (although there are some exceptions for certain regulated businesses) no prior approvals, licences or consents are necessary to set up and conduct a business in Hong Kong (except for registration and filing requirements). In particular, there is no merger, restrictive practices or antitrust control; there are no exchange controls or restrictions on the remittance of capital, dividends or profits overseas; and there are no restrictions on the foreign ownership of land;

  • an established and respected legal system;

  • a well-regulated stock market. Companies listed on the Stock Exchange of Hong Kong Limited are regulated by the exchange's Rules Governing the Listing of Securities on the Exchange. The conduct of M&A activities in Hong Kong relating to listed companies are subject to the Code on Takeovers and Mergers which is enforced by the executive director of the Corporate Finance Division of the Securities and Futures Commission. The stock market as a whole is regulated by the Securities and Futures Commission Corporate Finance Division;

  • geographical and economic factors. Hong Kong is ideally placed to conduct north Asian business (ie, with Korea, Taiwan and China) and also Asian-Pacific business. It is the natural entry point to the Pearl River Delta and thus the majority of goods manufactured in south China are exported through Hong Kong.

Market Trends

Pre-crisis years
The years immediately preceding the Asian financial crisis were boom times for Asia and in particular, Hong Kong. Corporate deals in Hong Kong were traditionally in the areas of equity, debt, project finance and other capital markets transactions.

The majority of regional M&A deals were driven by the need for Asian companies to expand in order to enhance their ability to compete globally. M&A deals were conducted extremely quickly with the minimal level of due diligence necessary. The priority was very much to 'get the deal done' and investors were not overly concerned with investment risks.

The Asian financial crisis
The Asian financial crisis shook foreign confidence in the Asian markets as a whole. As a result, there was an overall decline in foreign investment in the region. Hong Kong did not escape this. Foreign investment in Hong Kong had been steadily increasing during the first half of 1997 but in October 1997, investor panic escalated. As a result, foreign investment declined sharply in the second half of 1997. The value of residential property plummeted and at the start of 1998 there was almost no capital markets activity. The economic turmoil led to the cancellation, or at best, the indefinite postponement of a number of major projects.

Post-crisis trends
The types of corporate transactions conducted in Hong Kong subsequent to the financial crisis have shifted away from equity, debt, project finance and capital markets transactions towards regional and local mergers and acquisitions and restructurings.

The rationale behind mergers and acquisitions in Hong Kong has changed since the financial crisis. Before the crisis, the majority of regional mergers and acquisitions in Hong Kong were driven by the desire to expand in order to enhance global competition. Post crisis, many mergers and acquisitions are driven by necessity - those very companies which had previously made acquisitions to expand felt they could not survive the tough economic climate without off-loading part of their assets.

This trend is set to continue as Hong Kong-based companies realize the need to focus on and consolidate those businesses that are most likely to succeed in current market conditions. Many of the companies that have recognized the need to consolidate have been able to construct pragmatic deals. A particularly good example is the sale by Amsteel of a 73% stake in Hong Kong-listed Lion Asia to Hong Kong-listed CIL Holdings. This was a complex deal that involved restructuring parcels of assets of both companies to produce much simpler and focussed structures for both companies.

Shortly after Hong Kong succumbed to the spreading regional crisis in late 1997, commentators predicted an increase in the number of M&A deals undertaken by cash-rich foreign investors seeking bargains in the form of stricken Hong Kong companies.

Although the level of M&A activity in Hong Kong has increased since the crisis, acquisitions by 'bargain hunters' have been fewer than predicted. The expectations of buyers and sellers were in most cases mismatched. Buyers were looking for bargain basement prices reflecting what they perceived to be the current reality, whereas sellers were reluctant to sell below 1997 values. However, reports indicate that this valuation gap is closing and sellers are finally appreciating the strategic reasons for M&A.

Investors have become increasingly aware that seemingly attractive investment opportunities in Hong Kong, as in the rest of Asia, may not be what they first appear. Throughout 1998 and the first half of 1999, Hong Kong was seen by investors as a financially-distressed environment which would inevitably involve a high degree of investment risk. In particular, awareness of insolvency risk increased. Therefore, extensive commercial, legal and financial due diligence investigations of investment opportunities have become very important - in marked contrast to the 'get the deal done' approach of foreign investors before the financial crisis.

The number of company insolvencies and restructurings has increased dramatically since the financial crisis. In Hong Kong, the retail and tourist industries were most severely hit, although most companies felt the impact of the increase in interest rates that was necessary to protect the HK$/US$ peg. Many companies were unable to react in time to the changing economic climate. The best example is probably the collapse in January 1998 of Peregrine Investment Holdings, the Hong-Kong based pan-Asian investment bank. Others have appreciated the need to restructure in order to survive and have constructed comprehensive financial restructurings with their lenders.


Hong Kong's economy is still a long way from recovering from the downturn caused by the Asian financial crisis. In the first quarter of 1999, gross domestic product (GDP) contracted by 3.5% as compared with the same period in 1998, indicating that Hong Kong was stuck in its fifth quarter of recession. However, the economic indicators point to early stages of recovery. The decline in GDP had slowed from a 5.7% slide in the fourth quarter of 1998 and the government has predicted a growth of 0.5% in GDP in 1999.

It is likely that as Hong Kong's economy continues to recover and stabilize, foreign investment in Hong Kong will increase as investors continue to look for bargains and/or recognize the well-established benefits of an Asian business base in Hong Kong. The trend in corporate and debt restructurings is set to continue and asset and business sales will feature prominently. Reports indicate that the level of M&A activity will increase over the next year as Hong Kong corporate assets are effectively re-priced as sellers at last accept that their assets will not realize pre-crisis values.

For further information on this topic please contact Nick Norris at Simmons & Simmons by telephone (+852 2583 8265) or by fax (+852 2810 5040) or by e-mail ([email protected]). The Simmons & Simmons website can be accessed at: www.simmons-simmons.com.
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