Hong Kong Stock Exchange’s banner year is tarnished by a tax hike on trades

February 24, 2021, 11:10 AM UTC

Our mission to make business better is fueled by readers like you. To enjoy unlimited access to our journalism, subscribe today.

Hong Kong Exchanges and Clearing (HKEX), the operator of the Asian financial hub’s only bourse, announced its full-year profits for 2020 surged 23% on Wednesday, hitting a record $1.48 billion.

Despite the stellar results, HKEX’s share price closed 9% down after the Hong Kong government announced the same day that it would increase the stamp duty, or tax, it collects on stock trades for the first time since 1993. The company’s stock had recently hit record highs.

“We were not consulted, so we received the news together with the public,” HKEX interim CEO Calvin Tai said during an earnings call Wednesday, after local markets had closed. “We are disappointed, but we understand why the government wants and needs to increase the stamp duty.”

Subscribe to Eastworld for weekly insight on what’s dominating business in Asia, delivered free to your inbox.

Hong Kong Finance Secretary Paul Chan revealed the stamp duty increase during his presentation of the local budget on Wednesday. The small tax hike, from 0.1% to 0.13%, could add an extra $1 billion to the Hong Kong government’s coffers but will slightly raise the cost of buying Hong Kong stocks.

The Hong Kong government is trying to recoup its losses from propping up an economy hit by the pandemic in 2020 and by protests in 2019. The government ran its largest ever fiscal deficit last year, overspending its budget by $33 billion.

News of the tax hike dampened what should have been a celebratory occasion for HKEX, which has grown into the world’s largest exchange operator based on its own market value.

Morgan Stanley analysts said in a note that the increased stamp duty could dull investor sentiment in Hong Kong and hurt earnings for HKEX in the near term, but Tai urged investors not to “overreact” to the tax increase and HKEX’s sudden stock drop.

“I think we need time to let the market digest and pan out,” Tai said.

Bruce Pang, head of macro and strategy research at investment bank China Renaissance Securities, says the increased stamp duty will make the Hong Kong market “less competitive” but may not dent trade volumes.

“The stamp duty increase won’t necessarily disrupt market sentiment—especially with the expectation of strong and continuous support from southbound inflows,” Pang says.

The “southbound inflows” are investment funds coming from mainland China traders, who can invest in Hong Kong–listed stocks through the stock exchange programs HKEX has developed with mainland China bourses.

According to HKEX’s annual report, trade flows along the stock connect schemes—which connect the Hong Kong exchange with bourses in Shanghai and Shenzhen—reached a record high in 2020, with $3 trillion traded along the southbound channel.

Tai says HKEX is “confident” the heavy trade flows along those routes will continue through 2021 as mainland China investors “need more channels” through which to access international stocks.

Hong Kong’s role as a gateway for investment between mainland China and the rest of the world got a boost last year, as political tensions between China and the U.S. encouraged more Chinese firms to list closer to home.

According to Tai, Hong Kong served as the world’s second largest market for IPOs in 2020, with 154 companies raising a cumulative $51.5 billion from Hong Kong debuts—a 27% increase from 2019. KPMG predicted Nasdaq would emerge as the world’s leading destination for IPOs in 2020.

Last year’s Hong Kong debuts include secondary listings from the likes of Nasdaq-listed JD.com—China’s second largest online marketplace—which raised $4.5 billion through its placement in Hong Kong last June.

A push from U.S. lawmakers to pile greater regulatory scrutiny on U.S.-listed Chinese firms, prompted such “homecomings.” Chinese firms hedged their bets against a possible U.S. crackdown by seeking secondary listings in Hong Kong.

HKEX expects homecoming listings to continue to be a growth driver in the year ahead.

“The IPO pipeline remains very strong going into 2021,” Tai said.

More politics coverage from Fortune:

Subscribe to Well Adjusted, our newsletter full of simple strategies to work smarter and live better, from the Fortune Well team. Sign up today.