Spate of Hong Kong stock plunges signals challenges for regulator amid flood of Chinese money

Wild gyrations in Hong Kong share prices are raising concerns that a new trading link with mainland China is a conduit for questionable trading practices that could undermine the city's reputation as a center of global finance.

At least four companies that climbed to dizzying values in only a few months have come abruptly crashing down in the past several weeks for reasons that remain unclear.

The strange trading patterns have gripped Hong Kong's financial community with a narrative of paper fortunes built quickly and then wiped out in an even shorter time.

The most high profile case is Chinese solar panel maker Hanergy Thin Film Power Group Ltd., now under investigation by the market watchdog. Also affected are two Hong Kong-listed units of Chinese billionaire Pan Sutong's Goldin conglomerate involved in horse breeding and wine trading.

The most recent is Digital Domain Holdings Ltd., whose main business is a California special effects firm founded two decades ago by Titanic and Avatar director James Cameron, who no longer has a stake after it went bankrupt in 2012. It's perhaps best known more recently for creating a hologram of deceased rapper Tupac Shakur to perform alongside Snoop Dogg at a California music festival. In a little over two months, the shares soared nine-fold and then abruptly plunged last week to a third of their peak.

Market watchers say a tide of money sweeping in from mainland China following the launch of the Shanghai-Hong Kong Stock Connect trading link last year has amplified speculation and increased risks for investors. The link allows investors in each city to trade on the other city's exchange. Hanergy and the two Goldin companies are among 286 stocks mainland investors can buy via the link.

"The recent developments have sparked concerns about new dynamics that our regulators need to deal with," said Michael Cheng, Hong Kong research director at the Asian Corporate Governance Association. "We hope that it will be the two markets upping the game for each other but with the recent developments, we have a genuine concern that there's a real risk of a race to the bottom."

Recent price swings are "unprecedented" in Hong Kong, he said.

The city along with London, New York and Tokyo is a key global financial center, a status underpinned by the reputation of its legal and financial systems which are based on the laws of its former colonial ruler Britain. Hong Kong, which is a semiautonomous Chinese territory, also has its own currency that is pegged to the U.S. dollar and a vigilant anti-corruption police.

Local traders say the market turbulence is a sign of the larger stock trading frenzy spilling over from China, where the Shanghai benchmark has more than doubled in the past year in a boom powered by borrowed money and a stampede of rookie traders.

Nine of the Hong Kong exchange's 10 busiest days on record were in April or May as trading on the link surged to a high.

Experts believe the companies most susceptible to manipulation are those with a relatively small amount of freely traded stock, known as the free float, making them more volatile.

Hong Kong's market regulator, the Securities and Futures Commission, warned on June 8 that Goldin Properties Holdings Ltd. stock could "fluctuate substantially" and investors "should exercise extreme caution" because its Chinese billionaire owner and 13 other shareholders own more than 95 percent of outstanding shares.

Even companies not on the official list of stocks eligible for trading on the link, such as Digital Domain, are affected, said David Webb, a former investment banker turned shareholder and corporate governance advocate who believes many mainland Chinese are coming to Hong Kong to open stock trading accounts.

"There are dozens of stocks that are trading far away from fair value," he said. "It's a fairly widespread phenomenon at the moment."

In Hanergy's case, shares of the solar panel maker backed by Chinese billionaire Li Hejun rose more than sixfold since last summer until May 20, when they suddenly halved in the first hour of trading for no apparent reason, wiping out about half his fortune. The shares are now suspended.

In an interview with Chinese state media released a week later, Li dismissed reports that the company was under scrutiny. The next day, the Securities and Futures Commission took the unusual step of confirming it had launched a formal investigation "into the affairs" of the company.

Separately, Goldin Financial Holdings Ltd. and Goldin Properties Holdings Ltd. tumbled more than 40 percent, wiping out a combined $15 billion of market value. Before the crash, the shares had quadrupled, inflating Pan's personal fortune. Forbes now estimates it at $11.2 billion.

It's unclear why Hanergy or the Goldin companies plummeted.

Digital Domain's sell-off appears to have been sparked by rumors that a mainland Chinese businessman linked to the company was arrested.

The businessman, Che Fung, and a partner were the previous owners of the special effects firm but, in an intricate deal, sold their stake two years ago to Digital Domain in exchange for convertible bonds. Under certain conditions the bonds can be exchanged for stock worth nearly half of the company's enlarged share capital, giving him the potential to become one of the company's biggest shareholders.

Digital Domain denied "suggestions in certain media reports" that any executive directors or senior management had been arrested recently. It confirmed Che was a bondholder but declined to comment on his status.

"For Digital Domain, this is just a very short term bubble" that popped after the arrest rumors triggered the liquidations by speculators, said Alex Wong, director of asset management at Ample Capital. "The company is selling a concept in virtual reality, so that is a very long term story" not matching the company's brief spike in valuation.