At the tail end of September, a confluence of global and domestic factors reawakened investor interest in Chinese equities. The US Federal Reserve’s decision to cut rates, coupled with a string of capital market policies at home, sparked renewed momentum across China’s markets. In lockstep, A-shares, Hong Kong stocks, and US-listed Chinese companies rallied. The Shanghai Composite Index and Hang Seng Index have both surged over 20% since the rally began, with trading volumes on the A-share market rocketing past RMB 3 trillion (USD 420 billion).
Bull markets often see brokerage stocks leading the charge. Their bread and butter—commission revenue—is tethered to market activity, and their stock prices tend to mirror the booms and busts of the financial cycle. But brokerages aren’t the only ones benefiting. Securities exchanges themselves also stand to gain from heightened market activity.
Among mainland China’s three major exchanges, the Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE) operate under a membership-based model, while the Beijing Stock Exchange (BSE), although company-structured, isn’t publicly listed. That leaves the Hong Kong Stock Exchange (HKEX) as the only listed entity in this space -making it a rare and valuable target for investors.
In the final days of September, as both A-shares and Hong Kong stocks caught fire, HKEX shares soared from HKD 220 (USD 28.6) to nearly HKD 400 (USD 52). But after China’s National Day holiday, when momentum eased, the stock price retreated to around HKD 320 (USD 41.6). Year to date, HKEX has climbed about 23%. The question now is, after this pullback, is there an entry point worth considering?
Riding the wave of trading volume
HKEX’s stock price has been a standout since its listing in 2000, rising more than 100-fold—leaving the Hang Seng Index in the dust. What’s driving this? The exchange’s financial performance isn’t heavily linked to the ebb and flow of the broader index. Instead, it’s deeply tied to the market capitalization and turnover rates of Hong Kong stocks.
That’s where HKEX makes its money.
Breaking down its revenue sources, HKEX relies on service income—primarily trading fees, clearing fees, and listing fees—and investment income, which comprises mostly interest spreads on margins for its derivatives business and interest from its own funds. In 2023, trading fees and clearing fees accounted for 30% and 20% of total revenue, respectively, while investment income made up another 24%.
Operationally, HKEX is split into three segments: cash trading (stocks and ETFs through Stock Connect), derivatives (including options and futures), and commodities. In the first half of 2024, the exchange pulled in HKD 106.21 billion (USD 13.8 billion). Cash market services and investment income delivered HKD 41.29 billion (USD 5.4 billion), while the derivatives segment added HKD 30.99 billion, and commodities contributed HKD 14.05 billion (USD 1.8 billion).
Although the cash and derivatives markets bring in roughly similar amounts of revenue, their structures are worlds apart. The cash market thrives on trading and clearing fees, while derivatives feed on margin interest.
In the first half of 2024, HKEX earned HKD 30.14 billion (USD 3.9 billion) in trading and clearing fees from cash markets, along with HKD 1.19 billion (USD 154.7 million) in investment income. Meanwhile, derivatives trading fees brought in HKD 11 billion (USD 1.4 billion), with margin interest income topping HKD 14 billion (USD 1.8 billion).
Despite these differences, both segments move in sync: when cash market activity picks up, derivatives tend to follow suit. This is because HKEX’s financial model is closely tied to market turnover, which feeds directly into trading fees and clearing fees. Those, in turn, power net profits, driving up dividends and ultimately stock prices.
And what ties all of this together is one critical factor: the average daily turnover (ADT) of stocks and ETFs. The ADT is the best indicator of where HKEX’s stock price is headed, as the two metrics move in lockstep.
In the first half of 2024, HKEX’s trading and clearing fees in Hong Kong hit HKD 21.43 billion (USD 2.8 billion), while the Stock Connect program with Shanghai and Shenzhen delivered HKD 8.71 billion (USD 1.1 billion). ADT drives HKEX’s revenue not just from Hong Kong itself, but also from Stock Connect trades, which in turn influence derivatives markets.
Lean operations, high margins
When you look under the hood, HKEX operates with enviably high profit margins. In the first half of 2024, its total operating expenses were HKD 27.94 billion (USD 3.6 billion), with employee costs accounting for HKD 19.37 billion (USD 2.5 billion). Depreciation and amortization added another HKD 6.98 billion.
The exchange uses EBITDA margin as its primary profitability measure. In 2021, 2022, 2023, and the first half of 2024, EBITDA margins were 78%, 72%, 73%, and 73%, respectively. Net profit margins stood at 61%, 56%, 59%, and 59% over the same periods.
What this means is simple: HKEX’s revenue, particularly from trading and clearing fees, flows smoothly into profits. With its asset-light business model, HKEX doesn’t need to retain much of its earnings. Instead, it returns most of its profits to shareholders through dividends. Between 2006 and now, HKEX has generated HKD 1.344 trillion in net profit, with HKD 1.209 trillion distributed as dividends—an impressive payout ratio of nearly 90%. Recent dividend yields have hovered around 2% to 3%.
So, as turnover grows, so do profits, dividends, and ultimately stock prices. HKEX’s market transaction volume sets the ceiling for its stock price.
Short-term versus long-term: Turnover versus market capitalization
When dissecting market transaction volumes, it becomes clear that long-term growth depends on market capitalization, while turnover rates dominate in the short term.
Since 2002, Hong Kong’s stock market turnover rate has oscillated between 40–80%, while market capitalization has ballooned from HKD 3 trillion to more than HKD 30 trillion.
This means that, in the short term, HKEX’s stock price is driven by high-turnover markets, whether in a volatile environment, a bull market, or even a mild bear market.
At the end of September 2024, Founder Securities reported that ADT in Hong Kong had surged to HKD 1.6921 trillion (USD 220 billion)—an 80% year-on-year increase. This spike pushed HKEX’s stock price from a September low of HKD 220 to HKD 326 by the end of the month, with a brief flirtation near HKD 400 in early October, largely driven by turnover.
But over the long haul, HKEX’s ability to sustain growth will hinge on expanding its offerings and increasing the market capitalization of its listed stocks.
Limited downside, significant upside potential
Given HKEX’s stable 2–3% dividend yield and its strong link to the broader Hong Kong market, downside risks are relatively low. Since 2010, its price-to-earnings (P/E) ratio has mostly stayed above 30. At the moment, it’s around 35, sitting comfortably at the 50th percentile.
Assuming a P/E floor of 30, HKEX’s stock price could see a potential correction of around 15%, suggesting limited downside risk. For investors who expect trading activity in Hong Kong and A-shares to stay robust, HKEX could still be an attractive short-term investment.
Investment carries risks, and it’s essential to be cautious. This article does not provide investment advice. Investors should consult professionals and make informed decisions before committing to any investments.
This article was written by Fan Liang and was originally published by 36Kr.
