Wednesday, March 7, 2007

A Big Event For Chinese Stock Market in 2007

The Chinese market correction is not due to the unwinding of carry trades by international hedge funds. Chinese currency is not free floated, apart from that, only foreign investors with QFII quotas are allowed to trade Chinese A-share subject to stringent lock up conditions. So the sudden change in direction must have been solely caused by local Chinese investors and local Chinese funds.

Two very significant meetings, the so called "two sessions" -- the annual meetings of China's top legislature and political advisory body are concurrently held in Beijing over these two weeks:

i) the Fifth Session of the Tenth National People's Congress (NPC), the meeting in which new policy and legislation in China will be discussed and enacted and

ii) The Chinese People's Political Consultative Conference (CPPCC), a meeting participated by appointed representatives from all walks of life in which major policy decisions are consulted.

Before the meetings were started this Monday there have been rumours related to new government policy to cool down the stock market. Though nobody can show the exact reasons for the sudden and abrupt market correction, the fear created by the rumours is the most likely cause. Now three days has passed and no such agenda is tabled to discuss the heat of the market, investors' anxiety is relieved and the market starts to pick up again.

There is one very important message I picked up from the news this week, it’s about China’s plan to list those Hong Kong listed ‘Red Chips’ back to Shanghai market as A-share.

Before I go on, we must understand clearly what those jargons are:

Red Chips

Hong Kong registered company listed in the Hong Kong Stock Exchange with at least 30 per cent of its shares in aggregate held directly by Mainland China entities with the Mainland China entities being the single largest shareholders in aggregate terms. In plain English it is basically a shell listing in Hong Kong with assets injection from a Chinese company. Shares are denominated in Hong Kong dollar which is pegged to US dollar and is freely traded. Both Hong Kong citizen and overseas investors are allowed to trade.

A Shares

China registered companies listed in either the Shanghai Stock Exchange or the Shenzhen Stock exchange, shares are denominated in Yuan which is not a freely traded currency. Only Chinese citizens or foreign investors with QFII quota are allowed to trade.

According to a speech last week by the Chairman of Shanghai Stock Exchange Mr. Geng Liang, the Red Chips will return home as early as June this year. What’s the significance of this news?

By the end of November, there are 85 red chip companies listed in Hong Kong with a total market cap of HK$2000B, while the market cap of all Shanghai Stock Exchange listed companies is around RMB7160M (or HK$7300B). That is, over 20% of Chinese assets are listed in Hong Kong as Red Chips.

Under the current mainland China regulations, overseas incorporated companies are not allowed to be listed as A-share in mainland (companies must be registered in mainland for over 3 years and with at least 3 year’s profit records). However, as Red Chips are in fact mainland companies back door listed in Hong Kong, amending the rules will not be a too difficult task for the China Securities Regulatory Commission, the SEC equivalent in China.

Such return is seen as another step taken by the mainland to strengthen the Chinese stock market. As most of the Red Chips are large caps with long operating history under Hong Kong's listing regulation which is more stringent than the mainland rules in terms of disclosure requirements, their returns mean an increased supply of high quality stocks to the Chinese investment community. Lack of high quality stock is a reason why China Life A-share is trading at 62% premium over its H-share while the shareholder rights are exactly the same. Following table will give you some more illustrations of the A-share premium.

So who are those Red Chips in the queue to return home? Out of the 85 companies it is widely speculated that the followings will be among the pioneers:

  • China Mobile (CHL, 0941.HK)
  • China Telecom (CHA, 0728.HK)
  • China Netcom (CN, 0906.HK)
  • CNOOC (CEO, 0833.HK)

For those telecom stocks, the priority is obvious. They have immediate funding needs to prepare for the 3G capex when such license is granted, it makes sense to raise new fund in local currency which will be spent locally.

From investor perspective this will also be good news, we expect to see a healthier mainland stock market with less volatility while still giving us a very promising expected return. This is a very important first step to manage the heat of the market, another step expected to happen this year is the creation of a channel to allow arbitrage between H-share and A-share (eg, via CDR Chinese Depository Receipt) to tighten the spread between the markets. I will write more about this second step when it is closer to reality.


64 said...

What happens to foreign investors who hold shares in HK? Will the shares continue trading in HK but be available to mainland investors through the Shanghai exchagne?

Zhong Siwei 鍾思維 said...

You are touching on the 2nd step I mentioned at the end of my article.

The answer is NO for now, there is not any channel to trade HK stocks on Shanghai exchange. The hot subject in mainland is the creation of a CDR to package HK stocks to trade in China, but it doesn't exist yet.