Hong Kong Exchanges and Clearing Ltd may knock on the doors of the tech-heavy Nasdaq or Chicago's CBOE as the world's most valuable stock exchange operator eyes a partner amid a frenzy of merger activity engulfing the sector.

Despite their geographical proximity, political, economic and organizational challenges make any potential marriage between the HKEx and the Shanghai or Shenzhen stock exchanges difficult.

If I am the Hong Kong exchange, I would be trying to approach the bigger U.S. stock exchanges like Nasdaq right now, said Ronald Wan, managing director of the Hong Kong unit of China Merchants Securities.

Merger mania has gripped the sector in the past week, with Deutsche Boerse's planned takeover of NYSE Euronext and the London Stock Exchange's push to buy the parent of the Toronto Stock Exchange as operators seek economies of scale to lower costs and fend off pressure from new electronic rivals.

Singapore Exchange kicked off the latest round with a $7.9 billion bid for the Australia stock exchange operator ASX Ltd late last year.

PRESSURE MOUNTING

Pressure is already mounting on the HKEx to show that it can effectively compete against any new and bigger competitors, with shareholders pushing its stock to a four month intra-day low on Friday.

The stock drop and the deal speculation prompted the HKEx to put out two statements stressing that it was open to strategic alliances, but had not yet identified any opportunities.

We may seek strategic alliances with technology providers, industry participants and our regional and global counterparts to expedite our growth initiatives, the company said in a statement on Friday .

Any potential cooperation with the Nasdaq or the CBOE will fill the two areas where the HKEx has traditionally been weakest -- attracting listings from technology companies, and enhancing its capabilities in the derivatives and stock-options market.

There's no use getting a tiny little exchange and Europe doesn't have much left, so the least they should consider doing is more co-operation with other big players, Wan said.

Besides Foxconn International and UC Rusal, the Hong Kong exchange has struggled to attract a steady flow of other brand-name technology and commodities companies to list in the city.

The exchange also has certain rules that, while meant to ensure quality, have prevented listings.

HKEx lost billionaire Li Ka-shing's $6 billion spinoff of his port operation under Hutchison Whampoa to Singapore because Hong Kong only allows properties to be packaged in the form of a trust to be traded on the stock exchange.

Combining with another stock exchange would allow HKEx to address any concerns that larger, combined exchanges would now be able to use their scale to gain market share on Hong Kong.

M&A activity is a trend in the stock exchange space, and it would be reasonable for Hong Kong as well, said James Zhong, chairman and chief executive of Shenzhen Eastern Bay Investment Management, which has over $1 billion in assets under management.

The economies of scale and the bigger stage will all be beneficial for Hong Kong in the long run.

HKEX LIKELY TO BUY

While speculation is high, there is no evidence yet that the HKEx has any deal afoot. And just as there could be the case for a transaction, there is the case to wait and watch as well.

If the HKEx does pursue anything, it is most likely to do so as a buyer, thanks to its pricey $24 billion market cap, and because current laws prohibit anyone from owning more than 5 percent of the company's shares.

It also had some HK$43.3 billion ($5.6 billion) available for investments in September 2010, the HKEx said last year, higher than the Nasdaq's $5.4 billion total market capitalization.

CBOE, the largest U.S. options exchange, is valued at around $2.6 billion.

Most analysts named the Shanghai and Shenzhen stock exchanges as candidates that would gain the most from any merger with the HKEx, but said the current economic climate and the organizational structure of the companies make such a deal difficult. Politics plays a role as well.

Anyone who is thinking of making a bid for the Hong Kong exchange will need the consensus of the government, and they probably won't get it, said David Webb, a shareholder activist and a former HKEx independent director.

There is a nationalistic sentiment involved, and that sentiment will likely come from other countries as well.

A tie-up with Taiwan and its long list of tech companies such as Acer and HTC seems even further away, as investments from China and Hong Kong frequently remain mired in political controversy between the two former foes that were once on the brink of war.

The Shanghai and Shenzhen stock exchanges are seen as extensions of the government that come under China's securities regulator, so any potential merger would require a complete overhaul of the two bourses.

Capital controls on the Chinese currency and Shanghai's own aspirations to eventually displace Hong Kong as China's financial center further complicate the politics of a deal.

Shanghai has been looking at setting up an international board for global companies, something NYSE-Euronext has expressed an interest in listing on, along with companies such as HSBC.

China currently limits the amount of yuan that can flow into the country, and foreign investors who want to invest in Shanghai's domestic A-share market have to apply for a Qualified Foreign Institutional Investor (QFII) license.

If everything was perfect, Shenzhen would make sense, said Ivan Li, an analyst at Kim Eng Securities. But right now, there're so many problems with any tie-up with a China operator it makes it impossible. (Additional reporting Alison Leung; Editing by Lincoln Feast)