As an international financial center, Hong Kong has long played a significant role in global capital markets. However, in recent years, its stock market has faced a series of challenges, including declining market liquidity, a slowdown in the IPO market, and an outflow of foreign capital. Drawing on the latest data and academic research, we examine the current state of Hong Kong’s stock market, identify key challenges, and explore potential solutions for policymakers and investors.

1. Current state of the Hong Kong stock market

The Hong Kong stock market, dating back to 1891, has long been one of the world’s premier destinations for capital-raising. Its robust legal system, deep pool of financial and professional talent, transparent and efficient regulatory framework, and business-friendly environment have laid a solid foundation for its status as a leading international financial center. More importantly, Hong Kong’s political and geographical proximity to mainland China has positioned it as a unique bridge for capital flows and investments between China and global markets, reinforcing its strategic importance.

However, in recent years, the Hong Kong stock market has faced mounting challenges. Market performance has remained sluggish, eroding investor confidence. The IPO market has experienced a concerning downturn, significantly reducing market activity. Liquidity issues have become increasingly pronounced, driven by an outflow of foreign capital and a decline in local trading activity that together undermine market stability.

1.1 Sluggish market performance

As shown in Figure 1, the Hang Seng Index (HSI) has been on a downward trend since 2018. By September 2024, it had declined by over 40% from its recent peak in 2021. Although the index saw a recovery in October 2024 following stock market stimulus measures introduced in mainland China, it remained at historically low levels. This brief rally did not fundamentally alter the overall market trajectory, reflecting persistent market challenges and the cautious sentiment prevailing among investors.

A key driver of this sluggish market trend has been the underperformance of technology firms. As shown in Figure 2, the Hang Seng Tech Index began its decline after peaking in 2021, losing nearly two-thirds of its value by September 2024. In an era where technological innovation is a core driver of global economic growth, the ability of tech companies to raise capital and thrive becomes particularly crucial. This trend highlights the deeper challenges facing the economic development of Hong Kong and China as a whole.

Meanwhile, other major Asian markets, such as Japan and India, demonstrated strong growth. A comparison of Hong Kong’s stock market with those of Japan and India since 2019, as shown in Figure 3, highlights a stark divergence in performance. While the Hang Seng Index has faced significant struggles, with returns well below the baseline, both the Nikkei 225 and the Nifty 50 have shown steady growth. The Nifty 50, a benchmark for the Indian market, showed the most pronounced increase, achieving returns exceeding 100% by late 2024. The Nikkei 225 also recorded consistent gains, showcasing Japan’s economic resilience. This sharp contrast underscores Hong Kong’s ongoing difficulties in maintaining its competitiveness and appeal in the global financial landscape.

Figure 1. Hang Seng Index

Data source: Compustat

Figure 2. Hang Seng Tech Index

Source: Hang Seng Indexes Company Limited

Figure 3. Cumulative return of Hang Seng Index, Nifty 50, and Nikkei 225

Data source: Compustat

1.2 Frozen IPO market

The underperformance of the Hang Seng Index, coupled with the comparative strength of other Asian markets like Japan and India, reflects deeper structural issues within Hong Kong’s financial ecosystem. One of the most significant challenges is the sharp decline in IPO activity, signaling a troubling shift from Hong Kong’s historic role as a top fundraising hub.

For much of the past decade, the Hong Kong Stock Exchange (HKEX) has been a dominant force in the global IPO landscape. Ranked among the world’s most active venues for initial public offerings, HKEX frequently outpaced competitors like the New York Stock Exchange (NYSE) and Nasdaq. For example, in 2019, HKEX led global IPO fundraising with approximately USD 40 billion in proceeds, bolstered by high-profile listings such as Alibaba’s secondary listing, which alone raised USD 13 billion. This marked the seventh time in 11 years that Hong Kong secured the top spot globally for IPO activity.

However, Hong Kong’s leading position in IPO markets has diminished in recent years. As shown in Figure 4, IPO activity has fluctuated over the years but recently plummeted to historic lows. The figure shows the total volume of IPOs from 1999 to 2023. In 2023, only USD 5.9 billion was raised through IPOs, marking the weakest performance since 1999. This contrasts sharply with past peaks, such as in 2010 when the market raised an impressive USD 57.9 billion. The decline reflects a confluence of factors, including global economic uncertainties, geopolitical tensions, and weakened investor confidence, all of which have contributed to a notable reduction in IPO activity and liquidity in the Hong Kong market.

The weakening IPO market is further evidenced by a decline in “Star IPOs.” In 2020 and 2021, several high-profile listings—including JD, NetEase, Kuaishou, Baidu, Bilibli, and XPeng—drew significant investor interest and global attention. These deals not only raised substantial capital but also spurred regional interest in tech investments, boosting market activity and economic development in a broader sense. In 2022 and 2023, the frequency of such marquee listings dropped sharply as market dynamics changed. Few new IPOs garnered comparable attention, while deal sizes shrank considerably. While past major IPOs routinely exceeded billions of dollars, more recent offerings often struggled to reach even a fraction of that amount.

Figure 4. IPO volume in Hong Kong

Data source: Bloomberg

1.3 Liquidity crisis and geopolitical uncertainties

Another pressing challenge for the Hong Kong stock market is the liquidity crisis. While the total market trading volume at HKEX had shown a steady increase since the 2000s, this momentum reversed after 2021, with trading volumes contracting significantly (see Figure 5). This trend not only reflects reduced overall market activity but also signals waning investor interest and confidence.

A closer analysis of stocks with zero daily trading further underscores the severity of the liquidity issue. Figure 6 compares the percentages of daily zero-volume stocks across the Hong Kong, Shanghai, Shenzhen, and Singapore stock markets. That ratio has steadily risen in Hong Kong, reaching nearly 30% by 2023. That means nearly one-third of listed stocks experienced no trading at all each day. Although this figure is lower than that of Singapore, it remains significantly higher than those in mainland Chinese stock markets and other major international financial centers. The high proportion of inactive stocks highlights a critical liquidity problem that hampers market vibrancy and investor engagement. Addressing this issue is crucial for enhancing the overall attractiveness and efficiency of the Hong Kong stock market.

Figure 5. Trading value of Hong Kong stock market

Data source: HKEX

Figure 6. Zero volume stock ratio

Data source: Compustat

While metrics such as trading volume or the value and proportion of zero-trade stocks provide some insight into market liquidity, they do not capture an essential aspect of liquidity analysis: price impact. To address this gap, we employ the Amihud Illiquidity Ratio (Amihud, 2002), which quantifies the price impact of trading volume. The Amihud Illiquidity of a single stock and the whole market is calculated using the following formula:

Where  is the Amihud ratio of stock i during period t, n is the number of trading days during period t.  stands for the daily stock return (in percentage) of stock i on day j.  is the daily trading volume (in million HKD) of stock i on day j. MarketAmihud is the Amihud ratio of the whole market, which is the weighted average of individual stocks’ Amihud ratio with market capitalization being the weighting factor. 

The Amihud Illiquidity Ratio measures the percentage change in stock prices for every million Hong Kong dollars traded. The higher the ratio, the worse the liquidity condition, indicating that even small trading volumes can trigger significant price movements.

Figure 7 presents the monthly Amihud ratio for the Hong Kong, Shanghai, and Shenzhen stock markets since 2015. The data shows that Hong Kong consistently has a higher Amihud ratio compared to its mainland counterparts, with a clear upward trend and significant volatility in recent years.

Notably, there is a strong correlation between changes in Hong Kong’s Amihud ratio and major events in China-U.S. tensions (see Figure 7). Market liquidity noticeably worsened following the start of the China-U.S. trade war in 2018. Specifically, after then-U.S. President Donald Trump announced a 25% tariff on $50 billion of Chinese goods in June 2018, Hong Kong’s Amihud ratio surged by 105% within five months. Another sharp increase in the ratio occurred during tense U.S.-China talks in Alaska in March 2021, after which President Joe Biden warned businesses about operating in Hong Kong. These events triggered substantial rises in the Amihud ratio, peaking when then-U.S. House Speaker Nancy Pelosi visited Taiwan on August 2, 2022. In 2023, rumors of a potential U.S. ban on investments in China’s tech sector—later formalized in August—set off another substantial deterioration in market liquidity.

Further analysis of the Amihud ratio across different sectors (see Figure 8) and different firm sizes (see Figure 9) suggests that 1) the manufacturing and real estate industries have been most affected by the liquidity drain, and 2) the decline in market liquidity since 2018 was largely driven by the liquidity issue of small firms.

This correlation suggests that geopolitical risk is a major factor influencing the Hong Kong stock market, with China-U.S. tension emerging as one of the key drivers of the market’s downturn in recent years.

Another critical observation supports this argument: the “Trump effect” on the Hong Kong stock market. As shown in Figure 10, Hong Kong’s stock market reacted negatively to developments in Donald Trump’s 2024 presidential campaign. In January 2024, when Trump won the Iowa caucus, signaling his strong position in the Republican primary race, the market dipped. A similar reaction followed when Ron DeSantis suspended his campaign and endorsed Trump during the New Hampshire primary. The market experienced further declines mid-2024 (the bottom three sub-figures of Figure 10), coinciding with Trump and President Biden’s first debate—where Biden’s performance was widely perceived as weak—and an incident in which Trump sustained a minor injury to his ear in a shooting. Each of these events pointed to an increased likelihood of Trump’s electoral victory, eliciting negative responses from the Hong Kong stock market. These market responses suggest that Hong Kong’ stock market, along with the broader Chinese market, have negative expectations of Trump’s potential return to office. The underlying reason lies in the harsh policies toward China that Trump and the Republican Party have indicated they would adopt.

The 2024 Republican Party Platform, released in July, underscores the aggressive stance that Trump and his party intend to pursue. The platform advocates for strict measures against China, emphasizing “America First” policies and trade protectionism. Plans include significantly raising tariffs, such as imposing a 60% base tariff on Chinese imports, and revoking China’s Most Favored Nation status. It also aims to curb Chinese imports of electric vehicles and restrict investments in the United States, promoting a “de-Chinaization” of global supply chains. Moreover, the platform prioritizes bolstering the U.S. economy by focusing on key technological sectors like cryptocurrency, artificial intelligence, and space technology.

These proposed policies are expected to escalate China-U.S. tensions, amplify uncertainties and further spread concern across the Hong Kong stock market and the broader Chinese economy. The “Trump effect” highlights how geopolitical uncertainties, particularly those from strained China-U.S. relations, are a key driver of Hong Kong’s liquidity crisis and overall market underperformance.

Figure 7. Amihud Illiquidity ratio of Hong Kong and mainland China stock markets

Data source: Compustat

Figure 8. Amihud ratio of Hong Kong stock market by sector

Data source: Compustat

Figure 9. Amihud ratio of Hong Kong stock market by firm size

Data source: Compustat

Figure 10. Trump effect

Data source: Compustat

2. Foreign capital drain

Another significant factor compounding the challenges faced by the Hong Kong stock market is the foreign capital drain, which reflects deeper concerns over geopolitical instability, economic policies, and market confidence.

A detailed analysis of individual stock ownership data of all stocks on the HKEX main board, sourced from Refinitiv, reveals a consistent decline in foreign investor shareholdings since 2019. As shown in Figure 11, foreign ownership decreased by 4 percentage points by the end of the third quarter of 2024, representing a 14% reduction from its 2019 peak. The largest drop occurred in early 2024, coinciding with an escalation in U.S.-China tensions in 2023. Key incidents contributing to these frictions included the spy balloon crisis, battles over semiconductor supply chain control, intensified military competition, and U.S. restrictions on investments in China’s tech sector. At the same time, China’s economic challenges deepened, fueled by the ongoing real estate crisis that began in 2021. These developments collectively heightened the perceived risks among overseas investors regarding Hong Kong and broader Chinese markets, prompting capital outflows.

A breakdown by investor type (see Figure 12) shows that corporate investors accounted for the largest withdrawals with a net reduction of 3.0%, while mutual funds contributed a 1.4% decline. Sector-specific analysis (see Figure 13) shows that the consumer sector experienced a notable outflow following the outbreak of the pandemic, with an additional drop in Q3 2024. The healthcare and technology sectors have seen the largest foreign capital withdrawals since 2021, reflecting their status as primary targets of U.S. restrictions on China. The real estate sector suffered capital outflows post-2021, coinciding with China’s property crisis triggered by Evergrande’s default. The financial sector has also faced sustained outflows since 2019, underscoring long-term concerns about the industry’s stability and resilience.

Figure 11. Shareholding of foreign investors in Hong Kong stock market

Data source: Refinitiv

Figure 12. Shareholding of foreign investors in Hong Kong stock market by investor type

Data source: Refinitiv

Figure 13. Shareholding of foreign investors in Hong Kong stock market by sector

Data source: Refinitiv

3. Potential solutions

The trend of foreign capital outflows not only indicates external investors’ negative expectations of the market but also reflects the challenges posed by geopolitical and economic conditions to Hong Kong’s status as a global financial hub. Addressing these challenges requires proactive solutions to revitalize Hong Kong’s stock market and restore investor confidence. We propose potential solutions in various aspects below.

3.1 Attract more investors and leading companies from the Middle East and Southeast Asia

In light of the geopolitical tensions mainly driven by U.S.-China relations, Hong Kong can emphasize its strategic advantages, particularly its role as a bridge between mainland China and global markets, to attract more investors from the Middle East and Southeast Asia. Currently, Middle Eastern investors hold only about 0.3% of total shareholdings in the Hong Kong stock market (see Figure 14), significantly lower than their American and European counterparts. However, this low level also indicates significant growth potential.

Before 2023, there were clear signs of growing interest from Middle Eastern investors in Hong Kong stocks. Although this momentum was disrupted by rising geopolitical risks, it highlights the potential to attract more Middle Eastern investment as a means to offset capital outflows from other regions, primarily the U.S. and Europe. To capitalize on this potential, Hong Kong could consider measures such as: introducing tax incentives and investment benefits targeted at Middle Eastern investors, such as reducing capital gains tax and offering a wider range of financial instruments; strengthening bilateral investment and trade agreements with Middle Eastern countries to facilitate cross-border capital flows; and promoting cultural awareness and exchanges to foster mutual trust. These strategies could enhance Hong Kong’s attractiveness to Middle Eastern investors, expand its position in the global capital market, mitigate the issue of capital outflows, and increase the market’s diversity and stability.

A promising step in this direction is the recent listing of the first Saudi Arabia-based exchange-traded fund (ETF) focused on the Hong Kong stock market, enabling Saudi investors to access Hong Kong’s market directly from their home country. Hong Kong should expedite similar initiatives, such as creating region-specific ETFs for Middle Eastern and Southeast Asian investors, offering them convenient and diversified access to both Hong Kong and global markets. Even indirect participation through ETF products can enhance market connectivity.

Hong Kong should also focus on attracting prominent companies and growing tech firms from these regions. With Southeast Asia’s rapid economic growth and many innovative companies seeking international expansion, Hong Kong can position itself as an attractive listing destination for the region’s top firms by proactively adjust listing policies and investment thresholds. For example, simplifying compliance requirements and streamlining the IPO approval process can reduce the listing costs for these companies.

The Hong Kong government can also organize promotional roadshows targeting local companies across key capital markets in Southeast Asia, the Middle East, and other regions. These events would showcase Hong Kong’s strengths and investment opportunities, thereby attracting more capital inflow and encouraging emerging enterprises to list in the city.

Figure 14. Shareholding of Middle Eastern investors in Hong Kong stock market

Data source: Refinitiv

3.2 Lower the threshold for the Shanghai-Hong Kong Stock Connect to enhance liquidity

Mainland capital is a crucial source of liquidity for the Hong Kong stock market, particularly amid ongoing foreign capital outflows. Increasing the flow of mainland investments could revitalize Hong Kong’s market activity. The Shanghai-Hong Kong Stock Connect is the main channel for mainland funds to invest in Hong Kong, but it still faces many restrictions. Lowering the entry barriers for this program could enable more individual and institutional investors from mainland China to participate in the Hong Kong market.  

Several threshold adjustments could support this goal. First, the criteria for Hong Kong stocks included in the Stock Connect could be further relaxed—potentially allowing investment in stock index futures and easing ETF inclusion requirements to expand the range of investable assets. Second, lowering investment eligibility requirements would help; currently, individual mainland investors must have combined securities and cash account assets of at least RMB 500,000 to trade via the Stock Connect, which excludes most retail investors. Reducing this threshold could significantly boost liquidity in the Hong Kong stock market.

Encouraging more mainland capital inflows would not only address Hong Kong’s liquidity shortages caused by foreign capital outflows but also provide the market with greater stability. Mainland investments, characterized by long-term perspectives, can serve as a reliable source of support for the market.

3.3 Launch government-guided funds and optimize the Mutual Recognition of Funds between mainland China and Hong Kong

Hong Kong could consider establishing government-guided investment funds focused on strategic sectors, such as green energy, innovative technology, and biomedicine. These funds would not only support local companies in raising capital through listings but also provide liquidity support after listing. The involvement of government-guided funds would help alleviate liquidity pressures caused by foreign capital outflows, stabilize market expectations, and restore investor confidence. This, in turn, would attract more private and external capital to participate in the market, further alleviating the liquidity issue.

Meanwhile, Hong Kong should expedite efforts to optimize the Mutual Recognition of Funds (MRF) between mainland China and Hong Kong. This could include further loosening restrictions on cross-border fund sales quotas and inclusion criteria, granting investors in both markets easier access to one another’s fund products. This would attract more mainland capital to the Hong Kong market, creating a stable, long-term funding source.

3.4 Promote High-Frequency Trading

High-Frequency Trading (HFT) offers significant potential to enhance market liquidity and efficiency. According to Goldman Sachs Global Investment Research, Algorithmic Trading (AT) accounted for about 65% of global equity market turnover in 2017, with regional variations. In the U.S., AT represented nearly 60% of equity market trading in 2017, while AT/HFT accounted for only around 10% of trading activity in Hong Kong from 2018 to 2020 (HKIMR report 2021). This low level of HFT is somewhat at odds with Hong Kong’s status as a major international financial center, highlighting an opportunity to leverage HFT to revitalize the market. HFT can not only significantly boost trading volume but also enhance the price discovery process and improve overall market efficiency.

A key obstacle to the expansion of HFT in Hong Kong is the high transaction costs and complex fee structures. Transaction costs in the Hong Kong stock market include broker fees, transaction fees, clearing fees, government fees, stamp duty tax, and platform fees, resulting in a more complex and expensive structure compared to markets like the U.S. or mainland China. While the U.S. generally employs fixed fees for many services, most fees in Hong Kong are proportional. This fee structure is particularly unfavorable to high-frequency traders, especially when dealing with high-priced stocks (e.g. most technology stocks). This discourages HFT participants from entering the market.

To address this issue and attract more HFT participation, Hong Kong could consider the following measures:

1. Reducing Transaction Costs: Lower or exempt certain transaction fees, such as stamp duty or clearing fees, especially for bulk trades and high-frequency traders. This would lower operating costs, making HFT more viable and appealing.
2. Setting Fee Caps: Introduce fee caps, such as setting maximum transaction fees within specific timeframes (e.g., monthly or annually). Such policies could incentivize more HFT firms and participants to trade in the market, thereby boosting overall trading volume.
3. Optimizing Market Infrastructure: Upgrade the stock exchange’s technology and communication infrastructure to enhance trading speed and data processing, creating a more favorable environment for HFT participants.
4. Introducing Market Incentives: Offer fee discounts or rewards for HFT firms that contribute significantly to market liquidity. These incentives could encourage HFT companies to become more active in Hong Kong.
5. Adaptive Regulation: Maintain flexible and transparent regulatory policies that accommodate new trading technologies and strategies while ensuring market stability and fairness.

By adopting these measures, Hong Kong can increase market activity, promote HFT development, and enhance market liquidity and efficiency in a sustainable way.

3.5 Facilitate tech firm listings

Attracting innovative technology firms to list on the Hong Kong Stock Exchange is crucial for the market’s growth and resilience. Hong Kong has already taken steps in this direction with regulatory reforms. For example, in March 2024, the HKEX introduced Chapter 18C of the Listing Rules, designed to attract and encourage listings of specialist technology companies. This rule was implemented in response to the global demand among tech companies for more flexible listing rules and a favorable funding environment.

Chapter 18C creates a fast track for innovative technology companies, easing profitability requirements at the time of listing and thus allowing more high-growth companies that have yet to achieve stable profitability to access the capital market. This rule is particularly significant for R&D-intensive enterprises, such as biotech, AI, and chip design companies, which may not generate steady profits in their early stages but possess tremendous growth potential in technology and innovation. By targeting firms with disruptive technologies, these measures aim to enhance market vitality and diversity while offering investors a wider range of opportunities, enabling the stock exchange to better compete in global capital markets.

In 2021, the Hong Kong Stock Exchange launched the special purpose acquisition company (SPAC) listing mechanism to attract more startups and growth-oriented companies. A SPAC is a shell company formed solely to raise funds and merge with a private company in two years, facilitating the latter’s entry into public markets. The advantage of SPACs lies in their accelerated timelines for going public and circumvention of some traditional IPO requirements.

These initiatives have already begun to yield results, particularly among technology firms in the Asia-Pacific region. This year, AI-powered medical company QuantumPharm Inc. and autonomous driving chip firm Black Sesame Technologies both listed under Chapter 18C. Synagistics, a leading e-commerce agency in Southeast Asia went public via SPAC in Hong Kong with a valuation of HKD 3.5 billion. While these reforms have shown initial success in attracting high-tech companies, significant efforts are still needed to achieve broader goals, particularly in invigorating Hong Kong’s capital market as a whole and meaningfully supporting the real economy.

3.6 Lower investment thresholds to broaden the investor base

To address the issue of low liquidity in the Hong Kong stock market, moderate easing of account opening restrictions could be a viable strategy to expand its investor base. In addition to Hong Kong permanent residents and locally based investors, allowing qualified mainland residents to open accounts and invest in Hong Kong stocks could help inject much-needed liquidity into the market.

High investment thresholds for certain Hong Kong stock products also present a barrier to broader participation. For example, Hong Kong’s Bitcoin ETF products are not on the whitelist of many institutional investors and remain inaccessible to mainland investors. Similarly, SPAC investments are currently confined to professional investors. These limitations directly affect the liquidity and fundraising potential of these products. Lowering these investment thresholds would allow a wider range of investors to participate.

Concerns about investor protection associated with broader participation can be addressed through enhanced disclosure requirements. For instance, the Securities and Futures Commission (SFC) could impose stricter disclosure standards for SPACs rather than limiting access for retail investors. Such measures could invigorate the market while upholding investor protections.

3.7 Strengthen regulatory oversight and corporate governance for better investor protection

To enhance the transparency, stability, and international appeal of the Hong Kong stock market, it is crucial to improve regulatory frameworks and corporate governance oversight. Hong Kong can draw on best practices from mature markets such as the U.S. to raise governance standards for listed companies, strengthen information disclosure requirements, and improve post-listing supervision. Between 2022 and 2023, the U.S. stock market saw 335 new listings and 838 delistings, resulting in a delisting rate of 250%. This “high turnover” model keeps the market vibrant and healthy, and protects investor interests from the ground up. Hong Kong should also improve its delisting system, ensuring that non-compliant companies exit promptly to foster a healthier market environment. By optimizing regulatory oversight and corporate governance standards, Hong Kong can better safeguard investor interests, elevate market quality, and enhance its attractiveness and competitiveness as a global financial center.

References

Amihud, Y., 2002. Illiquidity and stock returns: cross-section and time-series effects. Journal of Financial Markets, 5(1), pp.31-56.

Report on “Algorithmic and High-frequency Trading in Hong Kong’s Equity Market: Adoption, Market Impact and Risk Management”, Hong Kong Institute for Monetary and Financial Research (HKIMR), 28 June 2021