200 Lex ET Scientia. Economics Series?LESIJ NR. XVIII, VOL. 2/2011?AN OVERVIEW OF REGULATIONS THAT PROTECT REAL ESTATE STOCKS, REITS AND DERIVATIVE INVESTORS IN HONG KONG Rita Yi Man LI* Yi Lut LI* Abstract All investors seek to make money. The repeated financial crises in recent years not only caused many people to lose their money; it also reminds us of the importance of financial regulations to reduce investors losses due to improper business activities in a company or stock market. Together with London and New York, Hong Kong is one of the best known financial markets in the world. Real estate investment does not rest on direct investments in hotels, residential units, or the stock market. In this decade, Real Estate Investment Trusts (REITs) and derivatives provide a new source of investment. Yet, the huge volume of transactions coupled with increasingly complicated investment tools also implies that the rules of the legal system affect many people. While many European countries and China follow civil law systems, Hong Kong follows a common law system. Judge-made law forms one of the major sources of law and lays down the important rules on indirect real estate investment. The code of practice and legislation also provide a framework for investors and entrepreneurs. Keywords: Real Estate Derivatives, Real Estate Stock, REITs, Hong Kong 1. Introduction An increasing number of new financial tools are being developed to enable investors to make money. Gone are the days when the stock market was the only source of indirect real estate investment. Options, swaps, accumulators and Real Estate Investment Trusts (REITs) provide alternative ways to hedge losses in the stock market or act as alternative investment tools. Due to the smaller transaction costs, the existence of a public market place in the securitized market, higher liquidity, greater number of market participants, the indirect real estate market is generally more efficient than the direct one (Oikarinen et al. 2011). The quality of financial infrastructure relies on an effective legal framework (Herring and Chatusripitak 2000), Hong Kongs success as one of the highest rank financial centers also relies on this (MacNeil and Lau 2001). History also shows that appropriate legal regulations plays an important role in financial market, for example, overregulation and unfavourable tax treatment once resulted in a sluggish start of REITs in the U.S (Ulrich Schacht and Jens Wimschulte 2008). While previous pool of literature sheds light on causes of subprime financial crisis, few or no research paper has studied the regulations which protect indirect real estate investors. This study reviews Hong Kongs indirect real estate market statistics during financial crisis. It was found that Hong Kong REITs markets drop in prices was lowest among Australia, Japan, United Kingdom, United States, Singapore and ? *Department of Economics and Finance, Hong Kong Shue Yan University, Hong Kong, ritarec1yahoo.com.hk (corresponding contact) * School of Law, City University of Hong Kong, Hong Kong Rita Yi Man LI Yi Lut LI?201?LESIJ NR. XVIII, VOL. 2/2011 France. The stock market ranked number two in the World during financial crisis. The paper then proposes the reasons behind her success through the lens of well-established rules and regulations. The research results provide useful insights to legal drafters when they attempt to draft relevant rules and regulations. 2. Indirect real estate investment tools The merits of including real estate in a mixed-asset portfolio have been well documented. These include liability matching characteristics and risk diversification. Nevertheless, investment in the direct real estate market, which includes retail, residential, hotel and office properties suffers from obsolescence, lumpiness information asymmetries and co-ownership problems (i.e., unclear property rights) (Hoesli and Lekander 2008). In view of these drawbacks, many investors choose to invest in the indirect real estate market, such as property stocks, derivatives and REITs. 2.1 Real Estate Stocks Stock owners can be viewed as owners of the company. Although stock ownership is often raised as one of the typical examples of the principal agent problem (when the owners and managerial staff are not the same person, managers may primarily pursue selfish interests, such as power, instead of running a profitable business), it brings many benefit to both firm owners and individual investors. From entrepreneurs perspectives, a listing in the stock market is a good source of financing. Whereas borrowing money from a bank may involve huge expenses in the form of interest, money captured in the stock market does not require an expenditure on interest. On the other hand, the investors also view that it is a golden opportunity to invest in the real estate market with a sm